- Southwest Airlines (LUV) has a fuel hedging strategy that could provide a major boost vis-a-vis competitors.
- April started on the wrong foot, but it’s a minor hiccup in the firm’s return.
- Southwest is well-funded and the bleeding has stopped.
Southwest Airlines (NYSE:LUV) is usually a safe bet among airline stocks. The firm seems to consistently manage itself better than other airlines which often makes it a go-to investment within the sector.
That looks to be the case right now. Several pieces of information imply that LUV shares are a buy-the-dip opportunity right now. Let’s jump into the reasons that make that the case. Southwest Cost Structure is Favorable
One of the most important costs to consider for any airline is fuel. Investopedia notes that fuel costs account for between 10% to 12% of airline operating expenses. Airlines buy futures contracts for fuel to lock in prices which turns fuel into a fixed expense to a degree. However, when oil prices spike upward unpredictably that has historically been a very bad sign for airlines.
With Russia invading Ukraine, that is precisely what has happened. Oil prices are very volatile currently. And history suggests that such a period is very detrimental to the airline industry. Airlines went through a restructuring back in 2008 when oil shot up above $145 per barrel. Brent crude is hovering around $100 now but those prices peaked above $130 in early March.
The company already raised guidance for fuel costs per gallon by 20 cents when it released earnings in late January. That was prior to the invasion of Ukraine. But there’s good news among all of the negative: Southwest has long practiced a strategy that should help it now.
The firm is a big proponent of fuel hedging. It agrees to purchase fuel at pre-set prices months and years in advance. So when they spike unexpectedly the firm will be able to buy fuel at much lower prices.
Indications are that Southwest is 64% hedged for the remainder of 2022. In other words, it likely has a significant advantage over unhedged airlines including United (NASDAQ:UAL) and Delta (NYSE:DAL). That said, Southwest was hit particularly hard by recent issues affecting airlines at large.
Tough Start to April
Thunderstorms over a large portion of Florida bungled flights across Florida over the first weekend in April. Those thunderstorms caused 1,900 flights to be canceled on Saturday with an additional 1,500 canceled on Sunday. Unfortunately, Southwest suffered a disproportionate portion of the trouble.
Southwest had to cancel 600 flights on Saturday and delay 1,500 more. That equated to 14% of flights becoming cancellations and 44% of flights being delayed. It canceled an additional 400 flights on Sunday.
On the one hand, the snarled traffic is merely two days out of the year. However, Southwest was hit the worst because it is the largest domestic carrier. Further, spring break is in full swing. Other airlines were affected so revenues will drop wholesale but LUV stock got dinged particularly hard.
Southwest is still among the best airline stocks. It posted a modest net income of $977 million throughout 2021. That was a massive improvement over 2020 in which it lost $3.074 billion. The same was true of the fourth quarter for the firm.
Basically, Southwest isn’t in any danger now. The airline ended 2021 with $16.5 billion in liquidity. At that time its current and non-current obligations totaled $10.7 billion.
However, Southwest already provided first-quarter revenue guidance with an expectation of 45-55% lower revenue compared to Q1 ‘19. That was based on 5,600 canceled flights through January. April’s bad start won’t be added to that tally. So one question will become how effective was Southwest’s fuel hedging strategy?
The answer could be ‘very effective’. That’s a bet worth taking because if it’s correct, LUV stock jumps. Otherwise, investors are left with a well-respected stock that has 28% upside based on analysts’ consensus prices.
Other analysts have downgraded LUV stock recently. But even so, the overall thrust is positive. The airline has been given a lot of leeway throughout the pandemic because it is strong operationally. Some suggest that it should now be punished because valuations are stretched. I don’t see it. Strong operations are a positive, not a negative.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.