I've got to admit I was more than a little surprised to see Southwest Airlines ( LUV) hit a new 52-week low in early May, especially as the markets in general headed for higher altitude. Heck, every Southwest flight I boarded in April was packed to the gills.So I decided to look at the numbers, and yes, Southwest is at the low end of a six-year trading range despite healthy financials all along the way. If I've ever known an example of an excellent performer in a ho-hum industry, it is Southwest. And that's the sort of excellence
- Operational excellence. Southwest has for years been a standout example of operational simplicity while others in the industry seem shackled with complexity. As an example, Southwest flies only one type of aircraft, the Boeing 737, greatly simplifying maintenance and aircraft turnaround. Efficiency shows up in the numbers, too, with some 15% more flights and passenger miles generated per year with no headcount increase. Effective marketing and the best booking Web site in the industry have raised load factors 14% in the last four years. Operating margins have risen from 6.4% to 10.9% over that period. Its on-time performance and asset utilization top the industry.
- Strategic airports. Avoiding the fortress hubs in New York City, Boston, Washington, D.C. and Chicago, Southwest sets another smart example by flying to places like Providence, R.I., Manchester, N.H., Chicago Midway, Islip, N.Y., Baltimore, Oakland, Calif., and Dallas Love Field. These airports offer almost equivalent access to major regions, and some like Providence and Midway have actually remodeled into first class (but still small) facilities offering good passenger amenities, minimal delays and ticket-price flexibility.
- Pricing firmness. The use of strategic airports, an excellent route structure and a solid reputation for quality have created a firmer pricing environment. Average passenger-segment fares have risen from $87 to $104 in the last three years. Price strength is likely to continue despite economic uncertainty, as people gradually accept fuel-cost increases. Southwest has also cut back on free tickets, which were once available after only four round-trip flights if purchased online.
- It's an airline. No matter how good Southwest is as a company, the fact remains it is part of an industry notorious for having little to no control over pricing (due to intense competition) or costs (like fuel and labor). This kind of control loss is a value investor's nightmare. While Southwest has done better than others in controlling fuel costs (through hedging contracts) and labor (better relations with unions), and avoids the toughest competition in large fortress markets, it's still vulnerable.
- Competitive risks. Other airlines, notably discounters like JetBlue (JBLU), may be getting it -- that is, getting the Southwest formula. But JetBlue has its problems, and the other major players' attempts, like Delta's (DAL) Song and United's (UAUA) Ted have mostly failed. But Southwest could still shoot itself in the foot. Recently it announced resumed service to San Francisco International Airport, right into the teeth of competition and service delays. It's started in Denver, too -- a great market, but again with lots of competition and delays.
- Looking overseas. Even worse, there's talk of going international, a venture spelling doom to other domestic-oriented carriers, possibly through shared routes with ATA Airlines. While it hasn't happened yet, I believe it's a risk investors should watch. It may have some cost and price advantages, but the operational model might fail because of regulations. And who cares if you can turn a plane around in 20 minutes if you're sitting in Amsterdam with an eight-hour flight ahead of you? The company and its investors would be well-served by avoiding the growth-at-all-cost imperative and staying close to home.