Southwest Takes Off on Upgrade

Southwest Airlines ( LUV) missed Wall Street guidance because of rising costs on Thursday and saw its CEO suddenly resign, bowing to the pressure of helming the low-cost carrier through the worst three-year period in the history of aviation.

On Friday, shares of the carrier rose 22 cents, or 1.5%, to $14.97 after Credit Suisse First Boston upgraded the company to outperform from neutral, while a number of other brokerages maintained their current estimates and said the second half of 2004 -- and beyond -- looks good for the airline.

CSFB analyst Jim Higgins told investors that Southwest's revenue momentum was "impressive" and boosted his earnings estimates for the rest of 2004 and 2005 above current Wall Street consensus. "The company's outlook is much better than we had modeled, suggesting to us that consensus estimates are too low," he said in his note. "The outlook for third quarter and fiscal 2004 ex-fuel unit costs to be about flat is much better than we had modeled." (CSFB does and seeks to do business with the companies covered in research reports.)

In Higgins' view, the secret to Southwest is that it's showing such impressive gains in revenue generated per available seat mile, or RASM. In the second quarter, Southwest's RASM jumped 13.3% year over year, which the analyst said was one of the best performances of the last decade. While costs may be a problem, with network carriers such as US Airways ( UAIR) posting losses and struggling, Southwest could see upside in the coming years.

Other analysts agreed, arguing that the cost issues that Southwest faces do not change the fundamental outlook. Morgan Stanley analyst William Greene reiterated his outperform rating on shares, telling investors that he was optimistic that cost issues were peaking and that the industry was on the cusp of landmark change. (Morgan Stanley does and seeks to do business with the companies covered in research reports.)

"The next 12 months will see more change in the industry than the past three years combined," said Greene, who added later, "We believe Southwest is in the strongest position to benefit from what we believe is an inevitable industry restructuring."

Elsewhere, Citigroup Smith Barney analyst Daniel McKenzie maintained his earnings estimates on the company and told investors the company was "a fundamentally strong story over the long term," citing its fuel hedges, strong balance sheet and low costs. That said, McKenzie kept his neutral rating and said the company's shares were just below full valuation, citing tough competition. (Citigroup does and seeks to do business with the companies covered in research reports.)

As for the sudden departure of CEO Parker, analysts shook off the news, saying that the intense labor negations with flight attendants and three years of remaining profitable while the rest of the industry suffers had taken its toll on Parker. Given the fact that new CEO Gary Kelly has 16 years of experience at the company, Southwest's sudden management change will not affect operations.

"Since becoming CEO three years ago, Jim has successfully led Southwest through a very disruptive period," said Michael Linenberg, airline analyst at Merrill Lynch, in reaction. "The promotion of Gary Kelly and Laura Wright underscores the strength and depth of the Southwest 'bench' ... the transition is likely to be smooth and seamless." (Merrill does and seeks to do business with the companies covered in research reports.)

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