Should Southwest Airlines Co. (LUV) Be the Next Warren Buffett Buy?

Source: Finviz

Southwest provides the cash that Buffett wants to use buy other assets, rather than have to pay debt.  Unlike competitors such as Delta Air Lines, United-Continental, and US Airways, Southwest does not carry nearly as much debt, as shown by the table below.  Buffett abhors debt: the debt-to-equity ratio for Berkshire Hathaway is just 0.34.

Source: The Motley Fool CAPs and YCharts.

The table above reveals how efficient the cash management is at Southwest Airlines, as it required only $0.50 of borrowing to produce every $1 of equity.  For Delta Air Lines, by contrast, $11.86 in debt has been needed to create $1 in equity.  For United-Continental it has taken $6.70, and $6.02 for US Airways.  It should be noted that if US Airways ends up with American Airlines in an arrangement, its debt-to-equity ratio is likely to rise much higher.

These factors all result in a broad economic moat for Southwest Airlines, which is something that’s highly valued by Buffett.  In a book about Warren Buffett by Alice Schroeder, “The Snowball Warren Buffett and the Business of Life,” an economic moat is described as the factors that protect a business against competition and time.  The economic moat of Southwest Airlines is manifested in that it is the only airlines that has been profitable since 1973, and has never filed for bankruptcy.

Moreover, earnings should continue improving for Southwest.  The costs of assimilating AirTran have been borne.  Greater revenue is being generated from more fees such as charging for early boarding passes and priority seating.  EPS is up by more than 140% this year as a result.

Back in July, Southwest Airlines was recommended.  On July 25, 2012, Southwest Airlines was trading for under $8.50 a share.  Now it is around $11.60.  A return of more than one-third in less than 8 months for “a wonderful company” should appeal to even “The Oracle of Omaha.”

The article Should This Major Airline Be the Next Warren Buffett Buy? originally appeared on Fool.com and is written by Jonathan Yates.

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