The quarantine hit travel companies extremely hard. Even solidly managed Southwest Airlines (NYSE:LUV) suffered tremendous losses thanks to global shutdowns. It has stemmed daily cash burn and denied a federal bailout, but it is not out of the woods. Travel has yet to fully recover and LUV stock is down from its February levels. The worst just may not be over for the sector.
For the last few months, investors are stuck trading these companies with a ton of emotions. Even Warren Buffet closed out of his airline positions — and at the worst possible spot. Emotions cause mistakes, but with a little bit of homework, investors can avoid committing the obvious ones.
Airline stocks did not bottom in March like most of the stock market. Instead, they kept falling until the middle of May. Then with a flick of the switch the Robinhood trader mentality kicked in.
LUV stock — along with the rest of the cohort — quickly rallied almost 100% from the bottom. There were hiccups along the way and a bunch of opportunities to trade around the rally. For example, at the end of May when the stock fell for a few days, I wrote about buying that dip.
My advice was timely because that 10% correction delivered another leg higher into June.
LUV Stock Is Predictable
Since then, Southwest has traded inside a well-defined range. This is good because it give investors actionable levels. For example, LUV stock is currently threatening the upper ends of said range. This is an opportunity to watch because if the bulls are able to get above $38 per share they could extend the rally for another $7.
While this is not a guarantee, it is an excellent upside opportunity just waiting to trigger.
Alternatively, the stock could fade toward the lower side of the range. Then the right thing to do is to buy the dip as it nears $32 per share. This zone has been a proven support level for the last three months. Furthermore, the volume profile tells us that this is also the where the bulls and bears have been most active. This also provides support on the way down, so it will take extraordinary news to break through that area.
Knowing this makes the upside opportunity much more likely than the downside risk. Conversely, there is tremendous resistance between $40 and $43 per share. These have been big failure levels this year, so the onus is on the buyers to take them out.
The Bottom Line on Southwest Airlines
LUV stock is not out of the woods, so there is still a chance for long-term investors to accumulate shares. From an investment perspective, the stock is not cheap, but the metrics that we now see are out of whack. Income statements are bludgeoned because traffic is down 70% from last year. Airline companies have staved off the extinction scenario, but in the process they buried themselves into even deeper debt.
Normally excessive debt is not a death sentence, especially when interest rates are so low. But in this case their income is almost nonexistent, so it could become a massive problem. In other words, what they are doing now, which is borrowing a lot and not making any money, cannot continue too long. Eventually airlines will have to face the music.
But there is one important thing to consider in this reality. Unlike some of its competitors, Southwest was built on a no-frills model, so it can run “lean” better than its peers. While travel demand remains depressed, LUV stock should do better than its peers.
How then do you approach LUV stock? I have been sticking to the charts and trading around obvious pivot levels. So far they have been dead-on. For Southwest Airlines, this means buying shares when they near $32 and selling when they near $37.
Nicolas Chahine is the managing director of SellSpreads.com. Join his live chat room for free here. As of this writing, he did not hold a position in any of the aforementioned securities.
