We have downgraded our long-term recommendation on
Southwest Airlines Co
) to Neutral from Outperform as the positive impact of falling fuel
prices has largely been priced in the stock. In addition, a
weakening economy is restricting the demand for business travel
that would hurt the carrier's profitability going forward.
The company reported impressive earnings in the second quarter,
outpacing the Zacks Consensus Estimate and the year-ago earnings.
But volatility in fuel prices, high maintenance costs associated
with the fleet modernization program, increased salaries, wages and
airport fees, and the ongoing market turmoil are keeping the prices
of Southwest at check.
Further, new advertising rules and stiff competition from
United Continental Holdings Inc
Delta Air Lines Inc.
) keep us cautious on the stock. Besides, Southwest is dependent on
) as its sole supplier for aircraft. If Southwest is unable to
acquire additional aircraft from Boeing or if the latter is unable
to provide adequate support, the company's profitability will
inevitably be hampered.
Nevertheless, we are encouraged by the company's cost-cutting
measures, fleet rightsizing, network optimization, Evolve retrofit
program, steady capacity growth, All-New Rapid Rewards program and
several ancillary revenues. The overall fleet modernization plan
will likely boost pre-tax income by about $70 million in 2012, $300
million in 2013, $500 million in 2014 and $700 million in 2015.
Further, the Evolve retrofit program and fleet rightsizing have
revenue potential of roughly $200 million and $100 million,
respectively, for this year.
The AirTran merger is also providing additional synergies. The
transaction is expected to generate net synergies of more than $400
million by 2013 on full integration. The company expects to produce
half of the net synergies ($200 million) this year, with two-thirds
realized from revenue and one-third from cost savings. Till the
first half of the year, Southwest generated $180 million in annual
Consequently, the stock also holds a short-term Hold rating with
the Zacks # 3 Rank.
BOEING CO (BA): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis
SOUTHWEST AIR (LUV): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis
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