Southwest Airlines has always been a popular choice for US domestic travelers. With a business model focused on domestic travel only, it could give its customers exactly what they wanted without worrying about the burden that comes with international travel.
This trend is now slowly changing. Due to rising costs, it isn’t the cheapest airline anymore. And by being a budget airline, it doesn’t offer the comfort of bigger airlines like Delta and American Airlines. After bossing the post-COVID travel, the company now finds itself in a sport that is neither here nor there. And it is hurting its business big time.
Southwest Airlines was founded in 1967 and is headquartered in Dallas, Texas. It is a popular American airline known for providing affordable air travel options while minimizing operational costs.
To attain its goal of cheaper travel, the company connects locations directly without the need for a central hub, avoiding intermediary stops and reducing travel time.It also uses secondary airports that usually have lower landing fees. Quick turnaround times between flights ensure the return on each aircraft is maximized. Moreover, it only uses one aircraft type: the Boeing 737. This simplifies maintenance and training, helping the company reduce costs.
The company offers 3 main products: passenger air transportation, cargo services, and travel packages, including hotel and car rental options.
Passenger revenue accounts for approximately 85% of the total revenue while cargo and freight revenue represents around 5%. The remaining 10% comes from other services such as travel packages.
The airline operates across the United States as well as in some international destinations like Aruba, Jamaica, Costa Rica, Mexico, the Dominican Republic, the Cayman Islands, and Belize. The end market primarily consists of cost-conscious travelers seeking affordable air travel options.
In June this year, Elliott Management, an activist investor firm, took a stake in LUV in order to bring about some changes in the company. It proposed things like premium options and assigned seating. The most recent quarterly results were able to beat expectations, coming in at an EPS of $0.15 against expectations of $0.11 on the back of improved pricing and premium options.
However, digging deeper into the income statement showed how the company was struggling with non-fuel costs, especially maintenance and labor. These costs have already hurt LUV in previous quarters but their reappearance means they might be here to stay, affecting the company’s future valuation.
The reason this hurts the company is because competitors like Spirit and Frontier are beating LUV when it comes to traveling on a budget. If Southwest Airlines cannot beat these companies on cost, and also doesn’t have the luxurious travel options associated with larger airlines, it will eventually lose its identity in the eyes of customers.
Elliott Management’s proposed changes are not innovative enough to create any major impact. But even if they do, it will take a few more quarters for those changes to take effect. By then, LUV will have lost significant market share to competition. If the company then has to sacrifice profits to bring back customers, it could further push the point of profitability into the future. Investors are unlikely to pay for all that today, which makes the company a sell at today’s price levels.
Southwest Airlines is not on our latest list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 23 hedge fund portfolios held LUV at the end of the second quarter which was 33 in the previous quarter. While we acknowledge the pitfalls of LUV as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than LUV but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published at Insider Monkey.
