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Analysis of Southwest Airlines: one of the few airlines to offer a dividend

Charles Sainsbury
10. 4. 2023
6 min read

The airline has had a difficult 5 years. First the global lockdown and then high inflation which prevented many people from travelling. Despite this, some airlines seem to be doing well. Will they continue to do so?

Southwest Airlines $LUV-0.4% is an American low-cost airline based in Dallas. Founded in 1967, it is the largest low-cost airline in the world as measured by the number of passengers carried.

Southwest has one of the lowest costs per seat in the industry. Thanks to its efficient operations and simple operating model, it is able to offer low fares. Southwest has a very loyal customer base that values low fares, a great customer experience and free baggage.

Southwest also has a strong balance sheet and generates strong operating cash flow that allows it to invest in growth and remain financially stable during difficult times. Southwest operates only within the U.S. and its routes are focused on smaller cities and regional airports. It lacks a network of international and long-haul routes.

Sector

Southwest Airlines operates in the air transportation sector, specifically in the short- and medium-haul segment. This sector is characterised by the following features:

It is traditionally a highly competitive industry with low margins. Southwest Airlines is one of the competitive low-cost carriers that seeks to price itself well below its competitors.

Significant seasonal fluctuations and factors such as the price of oil, economic conditions or events such as terrorist attacks affect demand. These instabilities have a significant impact on the performance of companies in the sector.

The growth of the low-cost airline segment in recent decades has led to improved accessibility of air travel to the general masses and the expansion of short-haul air travel. This trend has been fueled by the rapid growth of Southwest Airlines. It has high fixed costs, especially for a modern fleet, which leads to the need to maintain high occupancy rates to ensure profitability.

Competition

American Airlines $AAL-0.4%: One of the largest companies in the sector, it operates a large fleet of aircraft and serves a large number of routes. Prices are slightly above Southwest Airlines.

Delta Air Lines $DAL+0.4%: Another large traditional airline with a modern fleet. Offers a wide route network including long-haul routes. Prices are in line with the market average.

United Airlines $UAL+0.4%: Large airline offering, like its competitors, a wide route network including intercontinental services. Prices and service are in line with the market average.

JetBlue $JBLU-1.1%: A low-cost airline with a modern fleet operating mainly on routes on the US East Coast. Prices are comparable to Southwest Airlines. Poses the biggest threat to Southwest Airlines.

Spirit Airlines $SAVE-1.3%: Operates the cheapest flights in the U.S. with extremely low fares but also relatively limited service. Not a direct competitor to Southwest Airlines, but can influence pricing in the market.

Southwest Airlines has the advantage of long experience in the segment, a stable financial position and a low-cost strategy with excellent value for money. The company's ability to respond flexibly to competition and customer demand contributes to its success.

Current situation

Given that the company is not expected to improve net profit more than other airlines, it is difficult to understand why their multiples are so high.

If the company grows its revenues faster than its competitors and eventually manages to reach a point where it has similar margins to those competitors, it is likely to outperform those companies in terms of earnings per share - and thus justify a higher P/E.

EPS hasn't exactly been high lately. Source

Southwest has not yet gotten its gross margins to similar levels as before the pandemic. Currently, the company's gross margin is around 25%, while it was just over 31% in 2019, a full year before the global pandemic.

The margin is around 25%. Source.

Airfares are the biggest contributor and it's unclear whether airfares will continue to head upwards after this long period of inflation we're seeing. Operating costs have also been hit by high inflation and wage increases will also have some longer term impact on operating costs.

Revenues in 2022 are up 50.8% from 2021 and operating expenses are up 46.4% over the same period. However, it's notable that the company reported roughly the same amount of revenue last year, but operating expenses were 20% lower due to things like wage inflation, general inflation, higher maintenance costs and other factors.

The P/E is really high

When compared to peers, while revenue growth is projected to be slightly faster than competitors, cost of revenue and operating expenses remain higher than peers - resulting in lower net income growth.

Despite this, analysts are positive. Source

Southwest's balance sheet is uniquely strong because the company's balance sheet is stronger than other major airlines including Delta, United and American Airlines.
When comparing the total net long-term debt of American, United, Delta and Southwest Airlines, Southwest is the only company with a negative number, meaning the company has no net debt. Unlike United, Delta and American Airlines, Southwest's cash position is $4.2 billion higher than its total debt, showing the strength of Southwest's balance sheet.

Thanks to its strong balance sheet and operating margins, Southwest is one of the few airlines that offers a dividend - specifically , 1.14%.

Though its history is a bit wilder. Source

Not only are more airlines predicting a strong demand environment for 2023, but the price of oil is also trending downward. Further, Southwest Airlines has the strongest balance sheet compared to United, American and Delta Air Lines, giving the company more freedom to continue to focus on upgrading its fleet to a new and efficient model instead of paying down high-interest rate debt.

Personally, I'm not looking for a candidate in the sector - but LUV strikes me as an interesting candidate for several reasons.

What about you? Do you have a representative among the airlines? Which one and why?

Disclaimer: This is by no means an investment recommendation. This is purely my summary and analysis based on data from the internet and other sources. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.

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