Southwest Airlines Granddaddy of Discounters

Since bottoming out in September, 2005, the airline sector has been showing some optimism on the chart as the trend is bullish. The AMEX Airline Index (^XAL) is looking higher, but is clearly facing some resistance at the 55 level. A strong upside break at 55 could see a move towards the 60 level, last encountered in December, 2004. The index is looking bullish as the 20-day moving average broke above the 200-day moving average from below. The Relative Strength is also above neutral and rising.

 The decline in oil prices from over $70 a barrel is a major factor for the rise in the airline sector. The sector is also seeing a continued pickup in travel, albeit there are competitive pricing pressures impacting margins.

 So, what airlines do you invest in? In my view, I continue to like the discount airlines.

 At the top of my list is the granddaddy of all discounters and where every player wants to emulate, Dallas, Texas-based Southwest Airlines Co. (NYSE/LUV)

 Southwest Airlines started with three Boeing 737 aircrafts in June, 1971, serving Dallas, Houston, and San Antonio. Today, Southwest is the dominant discount or low fare airline in the U.S. with 400 Boeing 737 aircrafts. Its routes are focused on the U.S. and are generally short haul and high frequency, but there are long haul routes.

 The carrier focuses mainly on point-to-point routes (direct non- stop city to city) rather than hub-and-spoke service (including indirect flights). This is a significant difference favoring Southwest.

 The airline industry is not in a growth mode, but the discount area has excellent potential. With all of the negative news in the industry, it may be an opportune time to buy Southwest.

 In spite of the carnage in the airline industry, Southwest has been reported some decent numbers over the past few years. Its ability to turn a profit year after year is impressive. Southwest has been profitable for the last 32 consecutive years. That is truly impressive.

 Its low cost structure and experience at running a discount carrier for over 20 years gives the company an advantage over other low fare carriers and the major airlines.

 Southwest’s forward FY05 estimated P/E of 20.70x its FY07 EPS is reasonable given the situation. Earnings in the FY07 are expected to jump to $0.81 on revenues of $9.48 billion. The airline’s valuation is superior to that of its peer group. Other discounters to keep an eye on include Frontier Airlines Inc. (NASDAQ/FRNT) and JetBlue Airways Corp. (NASDAQ/JBLU).