Southwest Airlines (
) is the largest airline in the United States, based on
domestic passengers carried. Southwest Airlines operates more than
3,100 flights a day, as of December 31, 2010, utilizing a fleet of
548 Boeing 737 aircraft. Southwest Airlines currently serves 71
cities in 36 states. It also provides freight services with in the
United States, and the company competes with American Airlines (
), Delta Airlines (
), and U.S. Airways (
). In September 2010, Southwest announced plans to acquire AirTrain
Airways, which is expected to close in Q2 2011.
Launch of Coverage on Southwest Airlines; $14.10 Price
We've broken down our analysis of Southwest Airlines into two
main business segments:
Southwest Passenger Flights
Freight, Service Fees and Other Revenue
U.S. Airline Industry at a Glance
Commercial aviation helps generate more than $730 billion in
economic activity and supports almost 11 million U.S. jobs. As the
U.S. and world economies begin to recover from the recent economic
downturn, the aviation sector will make a strong contribution in
revitalizing the job market. The U.S. airlines industry suffered a
major setback in 2008 due to the recession that reduced both
business and leisure air travel. Most major airlines showed a
negative EBITDA margin in 2008 and 2009 except for Southwest
Airlines, which managed to remain profitable for 38 consecutive
years, a feat unmatched in the commercial aviation industry.
Since then, the U.S. economy has been slowly recovering which
has led to an increase in demand for air travel in 2010 and
consequently higher average fares. Traffic demand is highly
correlated with economic growth and consumer spending accounts for
nearly 70% of economic activity in the U.S. Goldman Sachs predicts
that U.S. GDP will grow at about 2.7% in 2011 and 3.6% in 2012.
This should lead to strong demand in airline travel.
Increasing fuel prices pose a challenge for all the airlines.
Fuel costs represents roughly one-third of operating expenses of
airlines. Growing demand of fuel oil in emerging economies and
increasing tension in the Middle East poses a great risk
to profitability of airlines.
Southwest's Niche … A Low Cost Structure
The major strength of Southwest lies in its low cost structure.
Adjusted for state length, Southwest has lower units costs on
average than most major carriers. Its low cost structure is
facilitated by its reliance on a single aircraft type, Boeing 737,
that helps reduce the maintenance capital expenditure, its
operationally efficient point-to-point route structure, and its
highly productive employees.
Southwest provides point-to-point, rather than hub-and-spoke
services. The hub-and-spoke system concentrates most of an
airline's operations at a limited number of central hub cities and
serves most other destinations in the system by providing one stop
or connecting service through the hub. Any issue at a hub such as
bad weather or security problems can create delays throughout the
system. By not concentrating operations through one or more central
transfer points, its point-to-point route structure allows for
direct non-stop routing than the hub-and-spoke model and therefore
better enables it to control delays and total trip time.
Another key to its financial success is its fuel hedging
programs where the company agrees to secure future fuel contracts
at a particular price. Southwest Airlines hedges more oil than any
other airline, which has ensured the lowest prices on jet fuel
following the spike in oil prices in 2007 and 2008. Continued cost
management will help Southwest remain a profitable airline and
industry leader supporting our $14.10 valuation, which is around
16% ahead of the market price.
Last September Southwest announced plans to acquire AirTran
Airways, which is set to close in the second quarter of year. In
late February, the Federal Aviation Administration (
) approved the deal, which will allow the acquisition to close.
We will write more on this acquisition in subsequent
See our full analysis for Southwest Airlines.