In this article, let's take a look at Southwest Airlines Co. (LUV, Financial), a $23.38 billion market cap company, which is a major passenger airline that provides scheduled air transportation in the U.S. Some of the largest publically traded companies include Ryanair Holdings (RYAAY, Financial), Delta Air Lines (DAL, Financial), United Continental Holdings (UAL, Financial), US Airways Group (LCC, Financial), JetBlue Airways (JBLU, Financial), and SkyWest (SKYW, Financial).
Industry characteristics
The airline industry is cyclical and is characterized for becoming more comprised in the last decade. Further, due to the financial crises it has limited capacity growth. Also, new entrants (including international ones) can enter the business reducing profits. We think they are going to grow in an improving economy.
The largest
The company is the largest domestic airline in the U.S. One important thing is that it has obtained a low-cost advantage by flying one aircraft type on direct point-to-point routes to secondary airports. This meant that the firm can take the maximum profit from aircraft and employee productivity. Talking about profits, it has an impressive record of 41 consecutive years of operating profits.
Acquisitions
In an industry where international growth through acquisitions is very common, Southwest acquired AirTran and with the deal it opened up 37 new markets. Apart from that, it reached a better access to the Hartsfield-Jackson Atlanta International Airport.
It is expected that at the end of this year, it will retire the AirTran brand and transition the fleet because it will improve some inefficiencies.
International flights
In July 2014, the firm started international flights and plans to expand routes and frequency in the future.
Revenues, margins and profitability
Looking at profitability, revenues decreased by 7.94% and led earnings per share mo0re than doubled in the most recent quarter compared to the same quarter a year ago ($0.67 vs $0.31).
During the past fiscal year, the company increased its bottom line by earning $1.06 versus $0.56 in the prior year. This year, Wall Street expects an improvement in earnings ($1.80 versus $1.06).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| LUV | Southwest Airlines | 15.18 |
| HA | Hawaiian Holdings Inc | 22.32 |
| LFL | LATAM Airlines Group SA | -1.84 |
| ALK | Alaska Air Group Inc | 32.37 |
| CPA | Copa Holdings SA | 26.68 |
| Â | Industry Median | 6.46 |
The company has a current ROE of 15.18% which is higher than the industry median. Also, it is higher than the one exhibit by LATAM (LFL, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So, for investors looking at those levels, Hawaiian Holdings (HA, Financial), Alaska Air Group (ALK, Financial) and Copa Holdings (CPA, Financial) could be the options. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
We must mention that current ROE exceeded the one from the same quarter one year prior, and this is a sign of strength.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 21.7x, trading at a premium compared to an average of 18.60x for the industry. To use another metric, its price-to-book ratio of 3.10x indicates a premium versus the industry average of 1.74x while the price-to-sales ratio of 1.3x is above the industry average of 0.55x.
As we can see in the next chart, the stock price has an upward trend in the five-year period.
Final comment
The firm is the largest carrier in the U.S., and it has introduced the Boeing 737-800 which is more fuel efficient, and this is crucial in times when travelers look at economical transportation alternatives.
Further, the PE relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this stock.
Hedge fund gurus like Ray Dalio (Trades, Portfolio) and James Barrow (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
