After peaking at over $40, fears of the rapidly spreading coronavirus across the United States sent Southwest Airlines (NYSE:LUV) sharply lower. Increasing selling pressure may send LUV stock back to its 52-week low of $22.47.
But that isn’t necessarily too much for the carrier to overcome. After all, Southwest has a favorable debt/equity profile compared to its peers. That is because it always has run with comparatively thin margins, Southwest has a good chance of surviving the current turmoil.
So, at what stock price should investors consider when buying shares?
Relative Growth Should Lift LUV Stock
Southwest’s expected growth exceeds that of the industry. Though its expected sales growth is under 2% above the industry average, the company earns a growth score of 78/100, above that of the S&P 500’s 75/100 score.
In the next year, sales will fall. The -2.9% may prove too optimistic if travel restrictions imposed by the European Union on the U.S. are not lifted soon. Still, in the next three years, sales may grow by almost 2%. This is a realistic expectation that Southwest’s management may plan for.
|Sales Growth Next Year||69.20%||67.60%||11.40%|
|Sales 1‑Year Chg (%)||-2.90%||-10.30%||18.20%|
|Sales 3‑Year Avg (%)||1.90%||0.90%||13.80%|
Southwest has a higher gross margin than its peers. And if it aggressively cuts costs further to improve cash flow, it will have no problem sustaining a decent net margin. Plus, with a better debt/equity profile than the bigger airlines, Southwest may survive long periods of low passenger traffic.
As shown above, Southwest runs at the highest operating and gross margin combination. This also suggests that if flight demand remains weak for the rest of the year, less efficient airlines will file for bankruptcy first. This will cut flight supply and give Southwest Airlines an edge.
LUV stock also benefits from the tact that the company is also more nimble than the bigger airline companies. With higher profit margin potential, the company does not need to cut as much operating costs. This would help it sustain its service levels and customer satisfaction.
In its June 11 report, Southwest estimated an average daily core cash burn will be in the range of $20 million to $25 million. Previously, the company forecast a cash burn of around $25 million in Q2.
Southwest also raised $16.7 billion. It did so by getting $12.2 billion from financing and sale-leaseback transactions. It also sold $2.2 billion worth of common shares. The Payroll Support Program (PSP) added $2.3 billion to its balance sheet.
Markets hardly reacted to Southwest’s massive stock sale: the stock traded at around $35 and ended at around $32 at the end of last week. The lack of major selling pressure suggests that investors want to bet that the company is strongly suited to weather the storm ahead.
Wall Street Analysts have lofty price targets on Southwest Airlines. More recently, analysts issued price targets in the $40 – $5 range:
Analysts are likely too bullish in assessing Southwest’s 1-year valuation. Though the company has around 24 months of liquidity, it is not making a profit in the near-term. The industry needs to consolidate. More importantly, it needs travel demand increasing at an accelerating and sustained rate.
The continued spikes in coronavirus infections are a deep concern that investors cannot ignore. This may change investor sentiment and pressure Southwest’s stock price.
When it comes to the ability to recover, Southwest is one of the best-positioned airlines in the U.S. Even though its prospects are uncertain in the next few weeks, investors looking for airline stocks should watch this one first.
Any data pointing to a sustained increase in passenger traffic will justify another rally for Southwest shares.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.