LUV Stock: Those Bearish on Southwest Stock Now Will Kick Themselves Later

Bearish on Southwest StockHere’s Why I Love LUV Stock

Southwest Airlines Co. (NYSE:LUV) was founded in 1971 in Texas and the company started to thrive in the post-deregulation years after 1978. LUV stock is currently trading around $48.00 per share, which is a full $11.00 higher than its price target set a year ago, when earnings were under pressure from weaker-than-expected growth. However, cheap oil prices have favored airline stocks in general. The value of Southwest stock had the advantage of being anchored to the airline’s ideal and trendsetting business model, which means that it will continue to grow at a fast pace, with LUV stock easily hitting $50.00 in 2016.

After U.S. Pacific Southwest Airlines (PSA), founded in May 1949 and bankrupt in 1988, Southwest Airlines is the second low-cost airline in the world and it has the distinction of having turned a profit every year since 1973. Until 1978, Southwest only flew in Texas; since 1979, the airline has carefully expanded to address travel demand in Louisiana, New Mexico, Oklahoma, Arizona, Nevada, and California. Southwest Airlines stock has benefited from the integration of AirTran in December 2014.

Southwest is the third-largest airline in the U.S. after Delta Airlines and American Airlines, but it is the world’s largest domestic flights airline in the world. If the current pace of growth persists in the coming years, Southwest could reach a market of 150 million passengers, which is the number served by Delta Airlines so far in 2015. In 2014, Southwest had flown 135 million passengers to their destinations.

Southwest Airlines has not just been about profitability. It has also operated aggressively, stealing market share from larger airlines: that is the secret of Southwest stock’s strength. Such has been the Texan airline’s success that its strategy has provided the subject matter for countless business strategy classes in business schools all over the world.

Not only is Southwest stock strong in comparison to the rest of the airline industry, but it is also quite simply a strong stock.

Southwest was the first airline to overturn the traditional airline service model, offering little by way of passenger amenities or special class categories. Southwest Airlines offers coach class only, with fewer amenities than the slew of low-cost airline competitors that it inspired. There isn’t even assigned seating on Southwest flights. Yet the original low-cost airline has maintained a consistent stronghold over the low-cost flight market to the delight of those owning LUV stock.

Recently, Southwest announced third-quarter 2015 net earnings of $584 million, translating to $0.88 in earnings per share (EPS), compared to $329 million a year earlier. On an adjusted basis, the low-cost air travel pioneer posted $623 million in profits and EPS of $0.94, compared to the $0.92 consensus. Operating revenues totaled $5.32 billion, versus $4.8 billion the previous year, reflecting growth of 11%. The consensus estimate was $5.11 billion.

For most airlines, such results would spur a celebratory frenzy: not at Southwest, however, where profits are the norm.

Despite a fuel-hedging strategy in 2014, falling prices of oil allowed Southwest to save 8.2% compared to 2013. The drop in oil prices started to have an impact on profitability during the first quarter of 2015 through to the present, according to Southwest’s CEO, Gary Kelly.

Profit Is the Key Word at Southwest Airlines

Employees of Southwest Airlines enjoy a profit-sharing program, which may partly account for the airline’s success. They shared some $335 million in 2014, compared to $228 million in 2013, according to Mr. Kelly. Southwest’s expansion strategy and the integration of its former, if smaller, rival AirTran, which cost $1.5 billion in 2011, have also been completed.

Southwest, from its Texas-only service base at Dallas Love Field (hence the “LUV” ticker), has managed to grow without betraying its profitability focus, rapidly developing new markets, including New York LaGuardia and Washington Reagan National Airport. As of the end of 2014, Southwest had some 46,000 employees and a fleet of nearly 665 aircraft, comprising only single-aisle “Boeing 737s” and operating some 3,400 flights per day.

Southwest is the launch customer for the new “Boeing 737-MAX,” featuring a new and more efficient engine, which will help to save more fuel. The new airliner’s redesigned winglet alone is expected to bring a 1.8% reduction in fuel consumption compared to current fins. Southwest Airlines will receive the first 170 units of the 200 it has ordered in the third quarter 2017.

If more evidence were needed that Southwest “gets it” and LUV stock will deliver returns for the long run, consider that Europe’s most successful and fastest-growing airlines are built on Southwest’s model.

Easy-Jet and Ryanair are among the most profitable airlines in the world. In fact, Ryanair is the most profitable airline anywhere. The company achieved this title by methodically copying the method of Southwest Airlines in the United States. Its credo, like Southwest’s, is to keep costs down, mostly doing so by limiting its airliner type. Now, British Airways, KLM, and American Airlines are trying to get into the Southwest game as well.

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