One of the things that I find fascinating about the stock market is the way that economic and industry dynamics impact stock prices.
Part of the challenge – and therefore, the intrigue – comes from the fact that stocks don’t always react the way you would expect. What you may perceive as good news or positive indicators can often be interpreted in an entirely opposite fashion; in the same way, it isn’t a given that what is generally considered as negative information will have a commensurate, negative reaction.
In the Airlines industry, the narrative for most of the past three and a half years has been centered on the impact of the pandemic and its restrictions on travel demand. In the last year or so, airlines have reported healthy increases in demand that have lifted their own forecasts and begun to boost bullish sentiment for the industry. For some companies, such as Southwest Airlines (LUV) that rise in demand has allowed management to reinstate dividend payouts that had been suspended early in the pandemic. LUV reinstated their dividends at the start of this year, and was the first in the industry to do so.
After following a multiyear downward trend, LUV bottomed in May at around $28 per share. Picking up significant bullish momentum from that point, the stock has rallied to its latest level around $37 as indications that summer travel demand is nearing pre-pandemic levels. LUV’s fundamental strengths include one of the strongest balance sheet in the entire industry along with manageable debt levels.
The real question, of course is whether the latest rally is simply being fueled by market optimism, or is there enough fundamental strength behind it to suggest that the rally could continue. For bargain hunters, there is also the natural additional question of whether the stock offers a useful value at its current price. Let’s run through the numbers so you can decide for yourself.
Fundamental and Value Profile
Southwest Airlines Co. (Southwest) operates Southwest Airlines, a passenger airline that provides scheduled air transportation in the United States and near-international markets. The Company provides point-to-point service. The Company offers ancillary services, such as Southwest’s EarlyBird Check-In, upgraded boarding, and transportation of pets and unaccompanied minors, in accordance with Southwest’s respective policies. EarlyBird Check-In provides customers with automatic check-in and an assigned boarding position before general boarding positions become available. It offers its fare products directly to customers through its Internet Website, Southwest.com. It has approximately 728 Boeing 737 aircraft in its fleet and 121 destinations in 42 states, the District of Columbia, the Commonwealth of Puerto Rico, and ten near-international countries, such as Mexico, Jamaica, The Bahamas, Aruba, Dominican Republic, Costa Rica, Belize, Cuba, the Cayman Islands, and Turks and Caicos. LUV’s current market cap is $22 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 15.62%, while revenues increased by 21.56%. In the last quarter, earnings increased by 28.95%, while sales decreased by -7.55%. The company’s operating profile shows that that despite the improvements in earnings, pressure remains on the company’s bottom line, with Net Income running at 2.65% of Revenues for the last twelve months, and -2.73 in the last quarter.
Free Cash Flow: LUV’s free cash flow was -$1 billion over the last twelve months, a number that declined from $837 million a year ago and -$134 million in the quarter prior. This is a clear confirmation of the negative Net Income pattern described above.
Debt to Equity: LUV’s debt/equity ratio is .78, implying a conservative approach by management to the use of leverage. More to the point, in the last quarter cash and liquid assets were a little over $11.6 billion, while long-term debt was around $8 billion. These are useful counterpoints to the negative picture described by the company’s Net Income and Free Cash Flow numbers, implying that debt remains manageable.
Dividend: LUV pays an annual dividend of $.72 per share, which translates to a dividend yield of about 1.94% at the stock’s current price. This is also the same level the company’s dividend was at in the beginning of 2020, before management suspended the dividend to preserve cash during the pandemic.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at around $55.50 per share. That means the stock is impressively undervalued, with 50% downside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays LUV’s price action over the last year. The red diagonal line displays the stock’s downward trend throughout the period, with the low point coming in May at around $28. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. The stock’s bullish momentum has pushed it above all three retracement lines, marking current support at around $36.50 where the 61.8% retracement line sits, and immediate resistance expected at around $37, based on pivot activity in that price area in January and February of this year. A push above $37 should have upside to about $40, where the stock peaked in December of last year, while a drop below $36.50 should find next support at around $35, near the 50% retracement line.
Near-term Keys: At its current price, LUV offers an interesting value proposition, along with a useful dividend and still-healthy balance sheet providing fundamental strength; however the reality of declining Free Cash Flow and restricted, negative Net Income are concerns that I would prefer to see reverse before taking the stock’s value proposition seriously. That means that best probabilities to work with the stock lie in short-term trading strategies. A bearish trade, by shorting the stock or buying put options offer a lower-than-normal probability of success, and given the strength of the stock’s bullish momentum should be avoided. A push above $37, however should be taken as a good signal to buy the stock or work with call options, using $40 as an attractive profit target on a bullish trade.