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TSC Ratings' Updates: Southwest Airlines

Southwest Airlines (LUV - Get Report), which operates as a passenger airline that provides scheduled air transportation, was upgraded to buy.

This change is driven by a number of strengths, which we believe should have a greater impact than any weaknesses and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, good cash flow from operations, largely solid financial position with reasonable debt levels by most measures, notable return on equity and relatively strong performance when compared with the S&P 500 during the past year. We believe these strengths outweigh the fact that the company shows low profit margins.

Southwest's revenue growth has slightly outpaced the industry average of 8.6%. Since the same quarter one year prior, revenue rose by 15.1%. However, the growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share. Net income has significantly decreased by 63.4% when compared with the same quarter one year ago, falling to $34 million from $93 million. Net operating cash flow has significantly increased by 56.23% to $964 million when compared with the same quarter last year. In addition, the company has also vastly surpassed the industry average cash flow growth rate of -5.05%.

After analyzing the firm's financial positioning, we noticed its debt-to-equity ratio is very low at 0.29 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Despite the fact that Southwest's debt-to-equity ratio is low, the quick ratio, which is currently 0.60, displays a potential problem in covering short-term cash needs.

The return on equity has improved slightly when compared with the same quarter one year prior. This can be construed as a modest strength in the organization. Compared with other companies in the airlines industry and the overall market on the basis of return on equity, the company has outperformed in comparison with the industry average but has underperformed when compared with that of the S&P 500. Southwest Airlines had been rated a hold since Nov. 9, 2007.

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