There are two ways to look at Southwest Airlines (NYSE:LUV) stock at the moment. On one hand, Southwest shares have rallied 77% since May. That’s a gain that would seem to incorporate a good amount of optimism. It might suggest that the easy money has been made.
But from another perspective, LUV stock still look cheap. After all, the stock remains nearly one-third below February highs.
Obviously, the novel coronavirus pandemic explains the huge volatility in trading so far this year. Demand for air travel has been crushed, and Southwest has not been immune.
Of late, however, investors are starting to price in a return to normalcy for travel, as I’ve argued they should. That’s the key reason why LUV stock has rallied along with other airline names.
I believe there’s still more upside ahead. Normalcy is returning, however slowly. Southwest remains on solid financial footing. Management is solid. Patient long-term investors still can’t go wrong with LUV stock.
Last week, Southwest updated investors on its business. The airline still is facing near-term issues, but the situation unquestionably is improving.
Cash burn for the third quarter now should come in around $17 million a day — better than Southwest’s earlier projection of $20 million. Fuel prices are better than expected, but the biggest factor is that demand is slowly but steadily recovering.
To be sure, the news isn’t great. In fact, it isn’t even good yet. Southwest still expects revenue for September to decline 65% to 70% year-over-year, and another 65-75% in October. Capacity reductions in the range of 35% obviously aren’t enough to match that lower demand, which is why the company still is burning cash.
But at the least the trends are headed in the right direction. And Southwest is strong enough to make it through until real improvement arrives.
A Strong Balance Sheet and Solid Management
Roughly $500 million a month in cash losses is nothing to sneeze at. But it’s also not nearly enough to put Southwest in any real danger of bankruptcy.
As of Sept. 15, Southwest had nearly $15 billion in cash. That’s more than enough to get the company through this rough patch. In a worst-case scenario, the company can tap $10 billion worth of aircraft to raise cash.
In fact, unlike other airlines, Southwest has no plans to raise debt against its loyalty program. That leaves that asset unencumbered once demand returns — and limits the amount of interest expense the company will face going forward.
Southwest is in that position now because of how it managed its business in the past. Before the pandemic hit, Southwest always had the most conservative balance sheet in the industry. It’s why Southwest is the only major airline to never have filed for bankruptcy.
That past prudence allows Southwest to weather the current crisis. And the company will weather it. Consumers won’t stay at home forever. Southwest has more limited exposure to business travel, which may take a bigger, longer hit amid videoconferencing adoption.
Yes, LUV stock has rallied. But again, it’s down almost one-third from early-year highs — and even then, it wasn’t expensive.
It’s not hard to imagine Southwest stock reclaiming those highs at some point in the next couple of years. That would be a rally of roughly 50% from current levels. Even if it takes LUV three or even four years to get back to that point, investors still are earning double-digit annualized returns. That’s nothing to sneeze at.
Is LUV Stock the Best Choice?
To be sure, LUV is one of several airline stocks that look attractive at the moment. The broad case for the stock — a return to normalcy — holds for the entire sector.
And it’s worth noting that other airline stocks — particularly those with much more debt than Southwest — probably make more sense for more aggressive investors. Higher leverage means higher returns if the bull case plays out.
Of course, it also means higher risk, as we’ve already seen this year. LUV stock is 32% off its highs, but the other major airline stocks have dropped by 47% or more.
This isn’t the “go big or go home” play. But that’s not a bad thing. What Southwest is is a well-managed airline in solid financial shape that is going to see steadily improving demand.
That’s more than enough. It’s why LUV stock has rallied since May — and why it still has further to fly.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now.