has risen above some tough times in the airline industry.
Even as skyrocketing fuel prices led to third-quarter losses at most major airlines, Dallas-based Southwest logged a tidy profit -- for the 54th quarter in a row -- of $119 million, or 15 cents a share, thanks to its aggressive fuel price hedging program. The airline also kept a lid on nonfuel costs and filled more of its seats, even though it flew more often.
Financially, Southwest is the envy of its industry. While rivals have been burning cash, Southwest had $1.88 billion at the end of September, an increase from $1.87 billion at the end of 2003.
With Southwest's bright profile, investors may wonder how dear its stock can become. Is there room for more appreciation from the current price around $16, or do shares already account for the good news? Analysts say to expect more gains, although not stratospheric ones.
"I still think there's room for the stock to improve," said Jim Corridore, an equity analyst at Standard & Poor's, who has a $20 12-month price target on the stock and a buy rating, his company's second-highest after strong buy. (Standard & Poor's does not do investment banking business with the companies its analysts cover, but its affiliates may provide other services to them.)
The analyst noted that Southwest doesn't have the sort of debt burden other airlines do and is "financially the strongest airline in terms of being able to do whatever plans" its management conceives.
A look at airlines' third-quarter results reveals just how strong Southwest's balance sheet is compared with those in the rest of its industry. As of the end of September, the company's ratio of total long-term debt (including current maturities) to total shareholders' equity was 0.35. The lower this ratio, the less leveraged a company is. Network carriers have much higher ratios;
, for example, had a 7.97 ratio in the latest quarter. But even Southwest's low-cost competitor
had a higher ratio: 1.80.
Combine that with Southwest's generous cash position, and you have an airline poised to take advantage of rivals' stumbles, according to analysts. It can grow its market share by expanding flights in cities its competitors leave, and it can quickly purchase cheap assets from other, troubled carriers. For example, should struggling
be forced to liquidate, Southwest could keep its costs down by buying planes at fire-sale prices.
"They're the king and can do anything they want," said Vaughn Cordle, chief analyst and founder of Airlineforecasts LLC and senior 777 captain at United Airlines. "I see them picking up used aircraft and growing faster. It's what I call a leapfrog strategy."
Southwest has made no bones about its plans to dominate markets where others falter. Last month,
filed for Chapter 11 bankruptcy protection and announced plans to sell its leases to gates at Chicago's Midway Airport to
, another low-cost carrier. It didn't take long for Southwest's chief executive, Gary Kelly, to announce that Chicago Midway had become the company's No. 1 priority, even though Southwest already has a significant Midway presence with 19 gates.
The company said it planned to add 16 Midway flights in the first quarter of next year and has hired bankruptcy advisers to help it assess the ATA situation. A spokeswoman confirmed that Southwest can add as many as 45 additional flights at Midway with its existing gates but would also be interested in adding another six or seven gates at the airport. "We would be interested in possibly acquiring some of the ATA gates," the spokeswoman said.
Still, despite Southwest's strengths, it is affected by the turbulence plaguing the U.S. airline industry. The downward pressure on prices from the recent glut of capacity is one issue it can't skirt.
"While the measures in place at Southwest have helped the carrier maintain profitability and one of the strongest balance sheets and liquidity positions in the industry, the company has not and will not be immune from the problems plaguing U.S. airlines," wrote Credit Suisse First Boston analyst Jim Higgins, in a research note. (CSFB has done and seeks to do investment banking business with Southwest.)
Higgins estimates that Southwest's fourth-quarter unit revenue (as measured by revenue per available seat mile, or RASM) will be down almost 1% from a year ago, on 4.8% lower yields. Noting that Southwest executives said in a recent analyst meeting that revenue may not grow in line with capacity additions, Higgins wrote that the airline "appears to expect modest unit revenue growth in 2005 at best. We are modeling slightly more than a 2% RASM gain on flat yields, and view Southwest's outlook as unduly pessimistic."
Even with such revenue pressures, Higgins still has a $19 to $20 price target and an outperform rating on Southwest stock.
Southwest has more than 80% of next year's fuel needs capped at $25 a barrel, and 60% of 2006's needs hedged at $31 a barrel, well below crude oil's current price of about $47 a barrel. Oil prices have fallen nearly $10 from their record high late last month of $55.17. They're still high enough to bruise other airlines, however, and Southwest's hedges make it attractive should fuel rise again.
Earlier this month, when oil was trading around $50 a barrel, Merrill Lynch analyst Michael Linenberg wrote, "If oil prices were to remain at present levels or move modestly higher, we suggest investors focus on our most defensive names, which happen to be the financially strongest low-cost carriers: Southwest and JetBlue. ... Higher oil prices would likely result in the withdrawal of more expensive capacity, providing further growth opportunities for both of these names." (Merrill Lynch does and seeks to do business with companies covered in its research reports.)
Linenberg has a 12-month price target of $19 on Southwest, representing a 2005 price-to-earnings multiple of 29 times. "We realize the implied P/E is at the high end of Southwest's trading range (15 times to 20 times), but we would note that after three years of industry turmoil (recession, war, etc.), Southwest's relative position vis-a-vis its competitors has never been this strong," he wrote.