Summary
- An efficient business model improves operating margins and profitability.
- Big growth opportunities exist with international expansion, US economic growth, and AirTran acquisition synergies.
- A strong Q3 earnings report demonstrates the financial strength and growth strategies of LUV.
Southwest Airlines' Efficient Business Model
In terms of business strategy, Southwest Airlines (NYSE:LUV) is centered around efficiency and cost minimization. There is an emphasis on low-cost, short-haul, and point-to-point service. This idea encourages the flying to regional airports, reduces landing fees, and improves on-time performance. Southwest also consolidates and reduces aircraft buying and maintenance costs by only flying Boeing 737 jets. Southwest reduces the time cost of boarding flights by utilizing a unique boarding method that eliminates random seating, and this boarding method is the fastest among all major airliners. Southwest also seeks efficiencies through means, such as having an internal oil hedging team that is among the best in the airline industry. Over the past year, the oil hedging team has saved the company over $20 million. Switching customer satisfaction, in terms of airline ticket prices, Southwest prices are the cheapest 40% of the time, which benefits customers. Since customers seek to minimize their travel costs, customers are inclined to travel with Southwest Airlines, which will increase company revenue. In addition, customers enjoy carrying bags free of charge, which enhances customer service and does not significantly increase oil fuel expenses since most flights are of short duration. Despite low costs, customer satisfaction ratings are quite high. Overall, the combination of all of these factors have helped Southwest Airlines achieve an industry leading gross margin of 59.17%.
Growth Opportunities & International Expansion
Southwest Airlines will realize massive upside potential with the identification of these six growth opportunities. First, Southwest Airlines entered into new airports, such as LaGuardia Airport in New York, after American Airlines merged with US Airways and divested out of some regional markets. Expansion with less competition will benefit Southwest Airlines in terms of revenue. Second, Southwest Airlines is now cleared to provide nonstop flights from Dallas to New York, Los Angeles, Chicago, and Washington DC, among other cities. Expansion into new big cities and increasing the frequency of nonstop flights between cities are keys to airline growth, customer retention, and customer satisfaction. Third, unlike other airline companies that have floated in and out of bankruptcy, Southwest Airlines maintains a strong balance sheet and can afford to invest in big expansion opportunities. Fourth, Southwest's acquisition of AirTran adds 50 destinations and big potential for international expansion to Canada, Mexico, and the Caribbean. Since Southwest Airlines previously operating as a regional domestic airline, international expansion is huge and, and I expect this to improve revenue growth by at least 2%. The acquisition is also expected to save $400 million in synergies. Fifth, rapidly falling oil prices will increase profitability, since jet fuel is a large expense of aircraft operations. Finally, with America experiencing strong economic growth (3.9% GDP growth and 5.9% unemployment rate in Q3 2014), I expect discretionary income for Americans to increase as well, causing an increase in the consumption of travel and vacation. Keeping in mind that the travel and vacation industry is very seasonal, the upcoming Thanksgiving and December holiday season should be an extremely lucrative period for Southwest Airlines.
A Review of Q3 Earnings Report
Southwest Airlines recently reported its Q3 earnings results, and they were very strong. Southwest beat analyst EPS estimates by $0.02 in EPS and by $10 million revenue. EPS grew 62% year over year. Revenue per passenger increased by 5.6%, and the utilization rate increased by 1.1%, meaning that more planes are flying with less empty seats. Furthermore, operating margin increased year over year from 3.8% to 13.5%, which is a substantial improvement. On the expenses side, Southwest expects to pay close to $3 per gallon in fuel costs, and low fuel prices decreases expenses and improves company profitability. Alongside falling oil prices, Southwest has benefited from clever oil traders, who have saved the company over $20 million by using oil-hedging strategies.
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Financial Ratios
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Investment Risk
Despite all of the positive traits of Southwest Airlines described in this article, a few investment risks remain. First, growth of future cash flows are expected, not guaranteed. Second, while the US economy is growing at a steady rate, Europe, Russia, and Japan have stagnant economies, and this could negatively impact investor confidence. Third, LUV stock has already risen 108% YTD, so investors may be buying near the top.
Conclusion
Overall, Southwest Airlines is a strong company laid on the foundations of an efficient business model, industry leading financial metrics, and big growth opportunities. The triggers for this stock to trend higher include high consumption of travel and vacation in the holiday season, strong US economic growth, and the realized synergies from the closing of the acquisition of AirTran.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. (More...)
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Source: southwest - Google News http://ift.tt/11ImiuY
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