Pick Southwest Stock For Long-Term Gains

We believe that there is a hidden opportunity in Southwest Airlines’ stock (NYSE: LUV), which has lost 30% of its value since the beginning of the year and currently trades near $40. Until June, Southwest generated $520 million of operating cash, supported by $784 million of PSP grant proceeds (payroll support program). Considering the $16 million/day cash burn rate, the company is likely to observe operating cash outflow of $2 billion for the full year, net of PSP proceeds for the third quarter. Therefore, the staggering $8 billion drop in the stock’s market capitalization looks unwarranted. On comparing Southwest Airlines’ stock performance during the current crisis with that during the 2008 recession and the ongoing consideration of another handout for the sector, the stock has the potential to recover to pre-crisis levels despite a slow recovery in travel demand.

2020 Coronavirus Crisis

Timeline of 2020 Crisis So Far:

  • 12/12/2019: Coronavirus cases first reported in China
  • 1/31/2020: WHO declares a global health emergency.
  • 2/19/2020: Signs of effective containment in China and hopes of monetary easing by major central banks helps S&P 500 reach a record high
  • 3/23/2020: S&P 500 drops 34% from the peak level seen on Feb 19, as Covid-19 cases accelerate outside China. Doesn’t help that oil prices crash in mid-March amid Saudi-led price war
  • From 3/24/2020: S&P 500 recovers 52% from the lows seen on Mar 23, as the Fed’s multi-billion dollar stimulus package suppresses near-term survival anxiety and infuses liquidity into the system.

In contrast, here’s how LUV and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

  • 10/1/2007: Approximate pre-crisis peak in S&P 500 index
  • 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
  • 3/1/2009: Approximate bottoming out of S&P 500 index
  • 1/1/2010: Initial recovery to levels before accelerated decline (around 9/1/2008)

Southwest Airlines vs S&P 500 Performance Over 2007-08 Financial Crisis

LUV stock declined from levels of around $14 in October 2007 (pre-crisis peak) to levels of around $5.50 in March 2009 (as the markets bottomed out), implying LUV stock lost 60% from its approximate pre-crisis peak. It recovered post the 2008 crisis to levels of about $10 in early 2010 – rising by 94% between March 2009 and January 2010. In comparison, the S&P 500 Index first fell 51% in the wake of the recession before recovering 48% by January 2010.

Southwest Airlines’ Fundamentals in Recent Years Look Stable

Southwest Airlines’ Revenues grew by 13% from $19.8 billion in 2015 to $22.4 billion in 2019, driven by a slow growth in air travel demand. Also, the company’s margins remained relatively flat within the 10-12% range largely due to rising fuel costs. However, the EPS increased by 30% from $3.30 in 2015 to $4.28 in 2019, due to lower shares outstanding. In Q2 2020, the company’s revenues fell by 83% (y-o-y) as the capacity (ASMs) dropped by 55% and the passenger load factor plummeted to 31%.

Does Southwest Airlines Have A Sufficient Cash Cushion To Meet Its Obligations Through The Coronavirus Crisis?

Southwest Airlines’ total debt increased from $1.8 billion in 2019 to $8.9 at the end of Q2 2020, while its total cash increased from $4 billion to $14.4 billion over the same period. The company has been raising capital through multiple debt and equity offerings in the past six months. Per Q2 filings, Southwest had $15.5 billion of available liquidity, which can support $23 million/day of cash burn for more than a year.


Phases of Covid-19 crisis:

  • Early- to mid-March 2020: Fear of the coronavirus outbreak spreading rapidly translates into reality, with the number of cases accelerating globally
  • Late-March 2020 onward: Social distancing measures + lockdowns
  • April 2020: Fed stimulus suppresses near-term survival anxiety
  • May-June 2020: Recovery of demand, with gradual lifting of lockdowns – no panic anymore despite a steady increase in the number of cases
  • July-October 2020: Poor Q2 results and lukewarm Q3 expectations, but continued improvement in demand, a decline in the number of new cases, and progress with vaccine development buoy market sentiment

Another round of payroll support for the airline industry and sizable reduction in cash burn rate are the key triggers for an upside in Southwest Airlines’ stock.

What if you’re looking for a more balanced portfolio instead? Here’s a high quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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