Warren Buffett has for years decried airline stocks as lousy investments, and small wonder. Airlines are notorious for giving headaches to shareholders, employees and passengers alike. Fuel costs are high, profit margins are thin and labor can be burdensome.
That's why many on Wall Street were stunned to discover that Buffett's Berkshire Hathaway in the fourth quarter of 2016 made a major bet on airline stocks. Berkshire invested $2.1 billion in American Airlines (AAL - Get Report) , $2.2 billion in United Continental Holdings (UAL - Get Report) , $2.4 billion in Southwest (LUV - Get Report) , and $3 billion in Delta Air Lines (DAL - Get Report) .
Does Buffett know something the rest of us don't?
To get a window into Buffett's thinking, we spotlight Southwest, which is scheduled to release its first- quarter 2017 operating results on April 27. Southwest also made major announcements on Friday that bear attention.
The average analyst projection is that Southwest's earnings per share will come in at 63 cents, a dip from EPS of 88 cents in the year-ago quarter. The major factor for the projected EPS decline is higher oil prices, which hits all transportation companies.
However, Southwest benefits from several tailwinds that you should keep in mind. Analysts, on average, expect LUV's year-over-year earnings growth to come in at 21.6% next year and 10.6% over the next five years on an annualized basis.
Southwest's trailing 12-month price-to-earnings ratio is 15, a modest premium to the airline industry's average trailing P/E of 10.9. LUV's growth prospects make the extra price worth it.
Southwest entered 2017 with momentum. The carrier reported record annual earnings in 2016 of $2.24 billion, or $3.55 a share, vs. 2015 earnings of $2.18 billion, or $3.27 a share. The company also reported record annual operating cash flow of $4.29 billion, and record annual free cash flow of $2.25 billion.
Fact is, the aviation industry is enjoying a global resurgence, as continued economic growth and rising consumer confidence spur travel and tourism. Among its peers, Southwest remains a case study in how to operate consistently profitable routes in an often punishing industry.
With a market cap of $32.8 billion, Southwest Airlines is the country's largest carrier in terms of originating domestic passengers boarded. Southwest controls lucrative, well-traveled routes and enjoys resilient brand loyalty.
After fuel, labor is the most expensive cost for airlines. Carriers have historically grappled with restive labor unions, putting pressure on already thin profit margins. However, Southwest appears to be on the verge of making peace with a crucial part of its unionized workforce, which is a huge plus.
Southwest announced on Friday that the carrier and the International Brotherhood of Teamsters, the union that represents Southwest's "material specialists," have finalized the wording from a tentative agreement reached in early March. The collective bargaining agreement covers more than 300 material specialists that deliver, store and stock aircraft parts. The contract now goes to union members for a vote; a date is yet to be scheduled.
Back in November, Southwest inked an even bigger union contract with its 8,400-member Southwest Pilots' Association, under which pilots' pay would increase by 30% by 2020. In return, Southwest was able to put an end to a protracted and acrimonious union conflict and obtain greater flexibility to expedite the carrier's plans for international expansion.
Southwest also announced on Friday that it flew 11.3 billion revenue passenger miles in March, a year-over-year increase of 3.9%. Available seat miles reached 13.4 billion last month, a year-over-year increase of 4.5%.
Based on these results, the company continues to estimate its first-quarter 2017 RASM will decline in the 2%-3% range, as compared with first quarter of 2016. However, management said that bookings and unit revenue trends for the second quarter of 2017 remain robust.
Southwest is up 7.10% year to date, with further upside ahead. Analysts offering 12-month price forecasts for Southwest Airlines have an average target of $69.80, implying an upside of roughly 31% from current levels.
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