We recently upgraded our long-term recommendation on
Southwest Airlines Co.
) to Neutral from Underperform following better-than-expected first
quarter earnings results and strong growth opportunities.
The company reported lower year-over-year earnings in the first
quarter but outpaced the Zacks Consensus Estimate. Despite surging
fuel prices, the better-than-expected performance in the quarter
was credited to robust revenue growth driven by fare hikes,
cost-cutting measures, network optimization, All-New Rapid Rewards
and synergies from the AirTran acquisition. (Read our full coverage
on this earnings report:
Southwest Beats, Upped to Neutral
Southwest Airlines is working on a number of initiatives to
increase revenue and reduce costs over the next three years. The
companyis expected to improve its revenue and earnings on the back
of fleet rightsizing, the Evolve retrofit program, steady capacity
growth, All-New Rapid Rewards and several ancillary revenues. The
AirTran merger will also provide additional synergies when fully
integrated with the company's fleet.
Southwest is streamlining its cost structure including fuel and
non-fuel, which is boosting profits amidst high fuel prices and the
ongoing market turmoil. The company is successfully passing on the
increased cost to customers in the form of fare hikes.
Additionally, the company is using fuel-hedging strategies and
cutting capacities to manage the rising fuel prices.
Though fleet modernization planswill dilute profitability in the
short term, these are expected to boost pre-tax income by about $70
million in 2012, $300 million in 2013 and $500 million in 2014.
In addition, we expect AirTran merger to be accretive to
Southwest's earnings and generate net synergies of more than $400
million by 2013 on full integration. On the other hand, the
successful integration of AirTran would result in a one-time charge
of $500 million, of which $155 million has been exhausted until the
first quarter. Further, Southwest expects non-fuel costs to grow
due to higher labor, maintenance and airport costs.
Moreover, new advertising rules and stiff competition from
United Continental Holdings Inc.
Delta Air Lines
) 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.
Consequently, the stock also holds a short-term Hold rating with
the Zacks # 3 Rank.
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