We are downgrading our long-term recommendation on
Southwest Airlines Co.
(
LUV
) to Underperform owing to feeble macro data points in the entire
airline industry and the company's weak outlook for the first
quarter.
Theentire airline industry is struggling with higher fuel prices
and a slow moving U.S. economy. We expect conditions to worsen
further over the year, due to the weak outlook for Europe, stemming
from its financial problems, which is dragging down the global
airline profits to half from the 2010 peak.
In the worst-case scenario of a full-blown Euro-zone crisis,
Europe will likely drag the U.S. into a recession, pulling down
growth in China and other emerging economies. Ensuing losses in the
global airline industry would then be massive, perhaps the worst
since the 2008 financial crisis.
Coming to Southwest, it expects fuel costs of about $3.50 per
gallon for the first quarter. This is higher than its previous
expectation of $3.35 per gallon. In addition, the company saw
weaker-than-expected passenger revenue per available seat miles
growth of 4% in February compared with 7% in January. This
represents the smallest increase since last July.
As a result, Southwest is not expected to report profits in the
first quarter. The Zacks Consensus estimates a loss of 3 cents for
the first quarter, representing a substantial 215.15% decline on an
annual basis.
Although Southwest is poised to benefit from fleet rightsizing,
the Evolve retrofit program, steady capacity growth, All-New Rapid
Rewards, AirTran merger synergies and several ancillary revenues,
we are mainly concerned about high maintenance and operating costs
associated with fleet rightsizing and modernization. Additionally,
the successful integration of AirTran would result in a one-time
charge of $500 million, of which $134 million was expended last
year.
Further, coupled with surging fuel prices, Southwest also
expects non-fuel costs to grow modestly this year primarily due to
higher salaries, wages and benefits, maintenance and airport
costs.
Moreover, new advertising rules and stiff competition from
United Continental Holdings Inc.
(
UAL
) and
Delta Air Lines
Inc.
(
DAL
) keep us cautious on the stock. Besides, Southwest is dependent on
Boeing Co.
(
BA
) 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.
The largest U.S. low-cost carrier also launches fare sales from
time-to-time, with discounted ticket prices in order to boost
sales. These actions, however, hurt overall revenues.
Consequently, the stock also holds a short-term Strong Sell
rating with the Zacks # 5 Rank.
DELTA AIR LINES (
DAL
): Free Stock Analysis Report
SOUTHWEST AIR (
LUV
): Free Stock Analysis Report
UNITED CONT HLD (
UAL
): Free Stock Analysis Report
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