Southwest Airlines (NYSE: LUV) has lost 10% in value since early January 2023 – falling from levels of around $32 then to under $29 now – underperforming the S&P 500 by more than 50% over this period. This can primarily be attributed to a 21% decline in the stock’s P/S ratio from 0.8x revenues in 2022 to 0.6x revenues now. However, the company’s sales grew 14% from $24 billion to $27 billion over the same period. LUV stock has been weighed down due to a drop in profitability, amid rising costs and fewer aircraft deliveries expected this year, weighing on its overall operations. Our dashboard on Why Southwest Airlines Stock Moved has more details.
Notably, LUV stock has performed worse than the broader market in each of the last three years. Returns for the stock were -8% in 2021, -21% in 2022, and -12% in 2023. In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, is less volatile. And it has outperformed the S&P 500 each year over the same period.
Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride, as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, could LUV face a similar situation as it did in 2021, 2022, and 2023 and underperform the S&P over the next 12 months — or will it see a recovery? We estimate Southwest Airlines’ valuation to be around $29 per share, aligning with its current market price. Our forecast is based on 0.7x sales for Southwest, aligning with the stock’s average over the last two years.
Southwest Airlines’ revenue grew from $15.8 billion in 2021 to just $26.1 billion in 2023, driven by a recovery in travel demand post pandemic. Southwest Airlines’ revenue passenger miles grew 32% between 2021 and 2023, while passenger revenue per available seat mile also grew 30% over this period.
Although the company saw a rise in sales, its operating margin plunged from 10.9% in 2021 to 0.9% in 2023, and further to -1% for the last twelve months period. With a decline in margin, the reported earnings decreased from $1.64 in 2021 to $0.78 in 2023, primarily due to higher fuel and other operating costs. The company’s fuel costs surged 87% over the same period.
Even if we look at the latest quarter, Southwest Airlines reported operating sales of $7.4 billion in Q2’24, up 4.5% y-o-y. However, higher maintenance expenses and a rise in wages resulted in earnings of $370 million in Q2’24 vs. a $758 million in the prior year quarter. The adjusted profit per share plunged 51% to $0.58 per share, compared to $1.19 in the prior-year quarter.
Southwest stock has also been in focus lately after Elliott Management built a $2 billion position in the airline. Elliott Management is known for forcing management changes in the companies in which it builds positions. The board of Southwest Airlines will see major changes now, with its executive Chairman retiring next year and six other directors expected to retire later this year. With the board being refreshed, it is likely that some of the new members are per Elliott’s recommendation. [1]
Overall, Southwest Airlines will likely deliver a mid-single-digit average annual top-line growth over the next three years. Investors haven’t been happy with the stock, evident from a decline in valuation multiple, but is it worth picking now? We don’t think so. While the board restructuring may help the company in the long run, we think the near-term headwinds from fewer airplane deliveries and rising costs will weigh on the company’s performance in the near term. As such, investors willing to pick LUV will likely be better off waiting for even lower levels.
While LUV stock looks appropriately priced, it is helpful to see how Southwest Airline’s Peers fare on metrics that matter. You will find other valuable comparisons for companies across industries at Peer Comparisons.
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