Southwest Airlines: Flying Too Close To The Sun? - Investopedia

Investors who have only recently started looking at airline stocks can't appreciate the full magnitude of the industry's recovery in recent years, as most airlines have endured long periods of huge losses and plunging stock prices. With many airlines forced to seek bankruptcy protection at least once during their corporate lifetime, Southwest Airlines stands out as having consistently remained profitable throughout its history, even during the industry's dark days.

Now that most of its competitors have finally found their financial footing, Southwest is no longer the only successful airline on the block. And with its stock having soared fivefold since late 2012, some investors increasingly fear the heights at which Southwest's share price finds itself could ultimately mimic the Greek legend of Icarus, who flew too close to the sun and came crashing down to Earth as a result. Let's look at what has lifted Southwest to its current level and what it will take for the company to stay there.

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What held Southwest back

Southwest spent decades building its reputation as a low-cost discount carrier, offering no-frills flights with strong customer service. While most of its airline rivals struggled with high debt levels and higher operating costs, Southwest consistently eked out at least small profits even in the toughest times for industry.

More recently, the airline industry's resurgence has left Southwest in a much tougher competitive position. Bankruptcies among major legacy carriers crushed their shareholders, but they also left the surviving airline companies much leaner and able to take on new financial obligations to expand their fleets and increase efficiency. Mergers among top airlines also led to synergy-related gains for Southwest's rivals, and the spike in ancillary revenue from baggage fees and other charges -- which Southwest has thus far resisted -- bolstered their profitability and made it easier to compete on raw fare prices.

In response to the industry pressure to consolidate, Southwest acquired AirTran. Yet it took more than four years after its 2010 announcement for Southwest to fully integrate the new subsidiary into its existing operations, as challenges stemmed from different ways of doing business. For instance, unlike Southwest's Boeing 737-only fleet, AirTran planes were of different models and also had first-class seating that was incompatible with Southwest's open-seating policy. Still, AirTran helped Southwest build a foothold in Atlanta, and valuable slots at New York's LaGuardia Airport and Washington, D.C.'s Reagan National also helped the company to expand its appeal to business travelers. The time and effort involved, however, proved to be a distraction during tough times for Southwest that involved unprecedented labor disputes, rising costs, and the emergence of lower-fare airlines that ate away at the airline's reputation for value.

How Southwest got its groove back

Now, though, Southwest is moving forward more aggressively. Plans to operate larger versions of the 737 will help it put more customers on busier flights, with the 737-800 aircraft sporting 175 seats versus 143 seats in Southwest's 737-700 planes. Future moves could also include adding the 737-900 and its roughly 200-seat configuration, reducing per-passenger costs even further.

Another major milestone involves Southwest offering international travel for the first time. Thanks to the AirTran merger, Southwest inherited the rights to expand into Latin America and the Caribbean. With the airline looking to boost its global reach even further with the addition of international-terminal expansions at airports in Houston later this year and Fort Lauderdale, Florida, in 2017, Southwest will become a threat in key international markets where rivals have historically enjoyed more exclusivity.

Most important, some of the adverse trends that have hurt Southwest over the years could move back in its favor. Falling fuel costs will clearly reduce a big part of Southwest's cost structure, opening the door to a combination of more competitive fare pricing and more profits for shareholders. The airline expects lower first-quarter 2015 fuel costs could save the company about $500 million just over that three-month period. At the same time, revamping the Rapid Rewards frequent flier program should give Southwest greater success in aligning incentives for its highest-value customers.

Southwest has already seen many of its efforts pay off. In its most recent earnings release in January, the company reported record net income for 2014, posting its 42nd straight profitable year. Return on invested capital soared to 21.2%, and employees earned record profit-sharing contributions of $355 million, up 56% from the previous year. Investors have enjoyed the rewards of those stellar results in their share-price gains.

Why Southwest can keep soaring

Southwest Airlines has already delivered stellar returns to shareholders, but the company is not done. With a host of new initiatives designed to help it grow even further, Southwest looks like it can climb still higher before having to worry about suffering Icarus' fate.

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Dan Caplinger has no position in any stocks mentioned.

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