Southwest Airlines (NYSE:LUV) recently provided investors an update on about its operations and finances. Investors now have significant hope that LUV stock can recuperate over the next year as the company’s recovery continues.
As a result, LUV stock has been rallying. In the past 10 days it’s up nearly 8%. In fact, over the month of August, Southwest stock us up more than 21%.
I expect the stock will continue to rally as the company makes progress on recovering its prior revenue and reaching breakeven load factors. Moreover, it has one of the best cash burn and balance sheet financials in the industry.
However, the truth is that substantial recovery will not occur for this airline or any travel related stock until a vaccine(s) is not only effective but widely available. I expect that will not happen until sometime in the first quarter of 2021.
Southwest’s Update Was Positive
Southwest said that while in early July it had a decline in revenue and an increase in cash burn, the airline has now this turned this trend around. For example, it said that in August its load factor had increased to an estimate of 40% to 45% of last year. This compares to its prior estimate of 30 to 40%.
Moreover, the company believes that September will show an even higher increase in load factors and revenue. For example, it now estimates that the load factor will be higher in the range of 40% to 50%.
And revenue will be down by just 65% to 70% of last year, compared to July and August where sales are likely down 70% to 75%. In other words, sales declines in September will not be as great, on a year-over-year basis, as in prior months.
Southwest’s Balance Sheet and Financials Shine
The most important fact that Southwest updated on was cash burn. It provided two numbers. One was its estimate of an “average core” daily cash burn of $20 million for the third quarter. That is an improvement over the prior estimate it had provided last month of $23 million.
Moreover, the company also provided a new cash burn number that includes a real free cash flow element: changes in working capital. Most airlines are not providing this kind of a cash burn number. But this number completely aligns “cash burn” with how free cash flow is calculated.
Here is the good news: this new alternative cash burn number for July, which includes changes in working capital, was only $16 million per day in July.
That last number implies that actual real cash outflow on an ongoing basis will be just $$1.456 billion per quarter. Southwest now has $15.2 billion in cash as of Aug. 18, up from $14 billion on July 23 when it last updated the markets.
Therefore, this means that the company could last over 10 quarters, or two and a half years, assuming there is no improvement in revenue growth and achieving breakeven or positive cash flow. Of course, that is not very likely at this point. But it shows the tremendous margin of safety in terms of survival and liquidity at Southwest Airlines.
What To Do With LUV Stock
A Bank of America analyst recently pointed out that domestic leisure bookings are now almost at the same level as late June. After that the number of Covid-19 cases began to accelerate. However, he pointed out that corporate bookings for the fall are “non-existent and no clear signs of an inflection,” according to Seeking Alpha.
However, any time there is news about a vaccine or vaccine developments, airline and travel stocks tend to pick up. Most investors believe this sector is dependent on revenue returning when a vaccine is available for most travelers.
At this point, it is impossible to estimate LUV stock’s inherent valuation with a good deal of confidence. Probably the simplest way to do this is compare the stock to its pre-Covid-19 stock highs.
For example, in the last 52 weeks, the stock’s high was $58.83. In the last five years its high was $66.07. So at today’s price near $38, it is at 66% of its 52-week high, and 58% of its five-year high. That seems fairly reasonable given that the company is still burning cash.
It the stock hits 90% of its highs, assuming a vaccine is available to travelers, there is still upside for LUV stock. For example, on a 52-week basis, that would mean a target price near $53. On a five-year basis, the upside is $59.50, or $53%.
Over the next six months LUV stock could rise by 36% to 53%, once sentiment turns around. Those are reasonably good ROIs to expect.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
