Southwest Should Trade Around $50 as Coronavirus Cases and Cash Burn Drop

Airlines must be feeling like the ugly duckling of the stock market at this point. Although the novel coronavirus pandemic has been brutal on the broader markets, it has taken an exacting toll on airlines in particular. For instance, Southwest Airlines (NYSE:LUV) stock finds itself down almost 40% in six months, through no fault of its own.

Southwest Airlines (LUV) logo on aircraft that is taking off from McCarran in Las Vegas, NV.
Source: Eliyahu Yosef Parypa / Shutterstock.com

Although the future remains murky, I don’t expect the next six months to be as bad as what we’ve already seen. Share prices for the wider sector will recover. But I believe LUV stock will outpace that recovery because it has taken better decisions in response to this crisis than many of its peers.

However, if you are investing in Southwest stock, it has to be for the mid- to long-term time. Although Covid-19 cases are plummeting in the U.S., passenger traffic is returning at a slow rate. So, if you are looking for a stock to trade, perhaps this is not for you. But if you want a company that has solid fundamentals, then Southwest could be an excellent addition to your portfolio.

LUV Stock Is Already on the Path to Recovery

While it still has a long way to go, Southwest is already on the path to recovery. Shares are up almost 45% after falling to $22.46 in mid-May. But LUV stock is still off its 52-week high of $58.83 per share. So, shares still have some upside to them.

The resurgence is attributable to several factors, some under Southwest’s control and some not. Daily TSA traffic levels are slowly inching up, and Covid-19 cases are plummeting. Meanwhile, companies like Southwest have done an excellent job of reaching cash flow breakeven numbers ahead of schedule.

The reduction in daily cash burn is one of the big reasons why Southwest decided to turn down the government loan on offer under the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act. Not taking the loan is also a net positive since it would have come with stipulations on stock buybacks and dividends. I guess its a case of once bitten twice shy.

Payroll support under the CARES Act came with its own set of regulations. Long story short, carriers could not afford furlough or dismiss workers under its rules. That led to a lack of flexibility for several airlines in cutting costs. Although almost every airline took assistance under the program, you can understand their skepticism when it comes to taking more capital from the government. Southwest has done an excellent job of making sure it is not in a position that it has to tap the government loan for financing.

Another point to note on cash burn before we move on. Southwest has issued Q3 daily cash burn guidance of $20 million. Just to put things in perspective, July had a cash burn of $17 million. So, I believe the forecast is very conservative since trends are positive that each month will bring an increase in demand. I guess management doesn’t want to go overboard and issue a very aggressive target. But I don’t think achieving a $20 million cash burn rate during the quarter will be difficult.

Covid-19 Cases Are Plummeting

One of the biggest reasons to be bullish on airlines at the moment is the Covid-19 situation. For the first time since the crisis reared its ugly head, cases are plummeting in the U.S., leading to easing of restrictions. New York is perhaps the most prominent bright spot. The finance capital of the world is slowly reopening and its ripple effect across the northeast.

Domestic carriers like Southwest should be justifiably elated at the news. Even though significant travel restrictions remain in place, there is hope that with the number of cases dropping, we will hear some good news there as well.

Takeaway

Covid-19 has had a devastating impact on the airline sector, but things are getting better with each passing day. As cases go down, Southwest’s cash burn will reach breakeven levels ahead of schedule.

Considering so much going right for the stock, I think its time to load up on Southwest. My 12-month price target for Southwest stock is $5o. I know that seems high considering the state of the sector. But take into account this critical fact; Southwest was on an eight-year streak of raising its dividend before the pandemic, and over the last two years, the company has beat consensus EPS estimates seven times. Don’t let Covid-19 scare you off; Southwest stock is one you would want in your portfolio.

Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. Faizan Farooque does not directly own the securities mentioned above.   


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