Airline stocks remain grounded -- except 1

Why is Southwest the only carrier that's soaring?

By InvestorPlace Jan 26, 2012 12:34PM
Image: Airline (© Christie & Cole/Corbis)By Lawrence Meyers

Question: Why on earth would you want to buy an airline stock? Answer: You wouldn't. Except for one.


That's because airlines have an awful business model. If oil prices go up, the cost of flying the jets goes up even more, requiring carriers to hedge, which distracts them from what they should be doing: transportation.


Then there's the economy. When it tanks, airlines tank along with it. These companies require tons of capital spending to maintain their airplanes. And because of the tragedy of Sept. 11, a business known for crappy customer service has become even worse, thanks to the TSA's ridiculous airport security processes.


So, how is it that Southwest Airlines (LUV) is the only airline that's doing well financially and always scores near the top of customer satisfaction lists?


It's because management has understood from the start how to run an airline efficiently. It has a different strategy of flying into secondary airports. It has more flexibility in its purchase and exchange options. It has a corporate culture that makes employees feel like partners, and that culture transfers all the way down to the workers who make the flights (almost) bearable. Despite being 80% unionized, the airline has never had a labor action. Finally, Southwest's marketing wisely focuses on selling freedom, not selling what everyone else does -- flying.


It's safe to say that, after more than 30 years, Southwest's strategy is working. Even when its quarterly numbers aren't stellar, there's still plenty to like. Per-gallon fuel costs went crazy -- up 34% year-over-year. But because Southwest runs an airline most people actually like, it was able to offset most of that with its pricing power: It boosted its average fare by 7%.


Because the airline is strategically smart, and because it has the financial ability to act in support of smart moves, it's able to upgrade its fleet to more fuel-efficient aircraft in the face of these high oil prices. But Southwest is wisely not expanding that fleet until it hits internal profit targets. Instead, it will concentrate on boosting unit revenue performance.


The result? While American Airlines just filed for bankruptcy and other competitors continue to struggle, often losing money, Southwest just had its 39th consecutive year of profit. For an airline, that's amazing. You know what's even more amazing? The company has $3.1 billion in cash -- and the same in debt. In contrast, competitors are crushed under tons of debt.


It's difficult to value an airline based on things like the price-to-earnings ratio. Instead, I prefer to look at the enterprise value to EBITDA ratio. Southwest is at 5. JetBlue (JBLU) and Delta (DAL) are at 6. United Continental (UAL) is at 2.8, but it carries $5 billion in net debt and has historically had vastly inferior margins to Southwest.


Southwest is trading at $9.55, which is 60% off its all-time high. That's the kind of sale price that would make folks jump at an airline ticket and, in this case, at the stock.


Did I mention their planes are getting a makeover later in the year?


Lawrence Meyers does not hold shares in any company mentioned.


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6Comments
Jan 26, 2012 1:51PM
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I owned this stock for a long time because of just this type of thinking. The only major airline to avoid bankruptcy. The airline that ONLY flies nice, big, and safe Boeing 737s. You won't get on any tin cans when flying SWA. All that said, I finally unloaded it for minimal profit because it wasn't going anywhere. Meanwhile I was watching AA or United or US Airways post a loss and the stock would jump because the loss wasn't as bad as expected. Sure buy stock in a money losing company and ignore the one that has made a profit for 30+ years. Years later and the story is the same except now the stock is down in the $9 range (I was in during the $14-$16 range as I recall). I like the company. I like flying with them when I can. I'm not convinced the market is smart enough to invest in their stock. It is a boring stock and it doesn't get rewarded for being a constant winner.
Jan 26, 2012 7:15PM
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Airlines have been horrible stocks at least back to the1987 failed buy out of United that led to the 87 market crash.  However, there is an exception and it is not Southwest. Although SW is a very well run airline, look at Alaska Air.  That stock has soared from a low of 25 in March, 2009 to the 75 level today, a triple.  Alaska, like SW, flies newer Boeing 737's and is a primarily west coast airline with some daily flights to east coast markets.  Most flights are over 90% full.  The big plus is that they have avoided the pitfalls of the majors. 
Jan 26, 2012 5:16PM
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Billionaire Richard Branson (Virgin Air, etc) said it:  "It's easy to become a millionaire;  borrow a billion bucks and start up and run an airline for awhile..."  How many airlines have come and gone since the early 70s?  I have no idea.  Other than the restaurant industry, I can't think of a riskier endeavor, except for making a blockbuster movie that will turn a profit. 
Jan 26, 2012 7:03PM
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The comment about the crappy service due to the TSA is right on the money.
They need to be regulated,  and right away.


Jan 26, 2012 6:13PM
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Yeah, I got a comment and not about the financial aspect of airline stocks; yes, they're a crappy (to use your word) investment. But "...the TSA's ridiculous airport security processes."! Way out of line in my book. All this whining about the TSA screening gets really tiresome and is pretty sadly indicative of (1) the sissification of America, and (2) the short term memory of the citizenry.

 

I'm a retired airline pilot and a pacemaker wearer and I've had the expanded attention and pat-downs that goes with that device for several years now. I've never been treated with anything but the utmost courtesy and professionalism by the TSA screeners. More to the point, all it will take is ONE airplane getting bombed to have all you dilitantes screaming for the TSA's scalp for not "protecting you."

 

'Nuff said -

Jan 26, 2012 5:15PM
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Bad guidance, Lawrence.  They haven't changed their model and the 10 year look back doesn't lie. From a investment perspective, they are no better than any other airline.  All airline stocks should be avoided equally!  Hope you didn't spend they whole day writing that story!
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