$10.13
0.62 (+6.52%)
Southwest Airlines Co. (LUV)
CAPS Rating:
A major domestic airline that provides point-to-point, low-fare service.
Fool.com
Investment advice you can actually understand
A major domestic airline that provides point-to-point, low-fare service.
Legal Information © 1995 - 2009 The Motley Fool. All rights reserved.
Market Data provided by 
Terms & Conditions
RSS Headlines
Fool UK
Recs
I did a presentation on Southwest airlines for a class, and I found information that makes me believe they will underperform the S&P 500 within the next two to four years.
In the past, Southwest has posted profits while their competitors have been suffering. Their success comes from hedging oil prices. By the year 2010, our case study reveals that they won't be able to hedge 100%. Rising fuel prices have been a heavy burden on the competitors, and Southwest's hedging strategy provided them a large advantage that made them profitable. When the company is unable to use this strategy, their stock will decrease in value.
My second concern with Southwest is that they have new market entrants to worry about. New and growing companies are using the same low cost structure that Southwest implements. One of these new companies is JetBlue airways. They have newer planes, and more amenities for customers such as individual televisions for each passenger and more leg room. I think that new competitors will be a threat to southwest and this will contribute to the stock underperforming the S&P 500 in the next two to four years.
Would you like to explain why they cannot continue hedging 100%?As for JetBlue goes, I think because of the extra amenities and the 'luxury' offered, its ticket price will be quite higher than Southwest - So it is playing on a different market segment than Southwest (Southwest - I just need to get there cheap and fast, JetBlue - I need some 'me time', I need to be pampered, I deserved it)Please close your pick on this one and turn the thumb up, you'll feel better, I promise :))
If Southwest cannot hedge oil completely like you say, then this will be a good point to go on for an underperform call. However, considering the date you've attached to it they should be good for the next couple of years and should continue to outperform their peers and the S & P. Actually, they should ideally still be able to carry on, business as usual, for a few years past 2010 by eating up cash flows and cutting their puny dividend. The other carriers' problems have been dragging them down for a couple decades now. I think Southwest has plenty of good years in it.I am simply not convinced that JetBlue is a real competitor to Southwest, but even if it was that makes them the only competition in the industry. There is plenty of room in the market for two carriers.
As for your first concern. I don't think hedging should factor into the equation any. It just adds a slight overhead to ensure level fuel prices so they pay less in a rising oil economy, and more when the opposite is true. In the long run it hurts profits. But right now it happened to be a strategy that pays off. They really don't need to hedge 100%, just a small bit of hedging is what's needed to keeps them in the black profitable long enough while other airlines suffer. The industry as a whole will suffer and the stock price probably will suffer still. The think I like about Southwest is they're positioned very well for acellerated growth as consolidation in the marketplace happens. As for new entrants. They probably won't be so much of a problem 10 years out. The main advantage is not really their hedging, but that they can afford to hedge. In an industry that is very capital intensive, having a solid balance sheet is one of the biggest advantage you can have. Jetblue, or any new ventures will be very debt heaving and will have alot of financial overhead without scale of operations that Southwest has.JetBlue has however did well as a fairly new entrant by focusing on customer experience. I would say Southwest is like the McDonalds, very large, very well run, and consistently profitable, but everyone seems to associate them with bad food. While JetBlue is like Chipotle, young upstart, everyone likes them, but not quite profitable yet.
Above are two arguments that can be easily defeated:1. As for fuel hedges. Saying that SWA's success has come from fuel hedging completely misses the mark. If SWA's Labor and Fuel costs were the same as the other Legacy carriers SWA would still enjoy a 30% cost advantage over its main competitors. Also, if the hedges were not in place and SWA was paying for the going rate of Jet A they would then have to increase fares only 10% to break even and 18.7% to make the same profit that they made in the 1st Qtr of 2008. 2. Another bogus argument. Jetblue only competes with SWA on 1% of the SWA route system. I don't think that the Execs are losing much sleep over Jetblue's attack on 1% of WN's routes.The fact remains that SWA now enjoys a huge cash reserve of $5.8 Billion and it's debt to equity is less than 30%. On the flip side AA's debt to equity ratio is 547% and Jetblue's is 222%
Just curious when you did a presentation was it for business school. Southwest is the classic example that every business student studys. I think it is standard to use the Southwest model in every business school in the country. I think everyone studied about their successful marketing strategy which so many companies have tried to duplicate, without success. Im all about a brand new plane except the ones they are still working out all the bugs. Flying is always a panic attack producing event for me so I like the false sense of security I get when I'm using an airline with low crash/low fatal incident history. For me I dont care what movie is playing in front of me, if its being shown on an airline with high crash/high fatal incident like say Airtran, A company that underwent a reverse merger becuse by keeping the name Valujet the airline wouldnt be able to shake off a negative brand image. Southwest might use older planes but they usually are the trusty 727 which I belive are very fuel efficient. Whereas valuejet or I mean airtran prefers the DC9 or what DC# that I think statistically might be the most crashed plane ever. And last I heard i thought Jetblue was no longer with us. It is common knowledge that the southwest business model is the textbook definition of successful business model. Also i think southwest is the only airline not charging people for the 1st checked bag.
Southwest flies 737's. Their average fleet age according to this link http://www.airsafe.com/events/airlines/fleetage.htm is 9.8 years, younger than all the majors but older than Jetblue and Airtran. Southwest is purchasing 20-30 new jets per year and retiring some of their older ones. They are not 100% hedged now and never have been. I believe 70% is the most they have been hedged. This link http://seekingalpha.com/article/87052-the-secret-ingredient-to-southwest-s-success-hedged-oil shows that they are hedged 65% at $49 per barrell for 2008. One of the reasons they have been able to build an excellent hedging portfolio is because they have an outstanding balance sheet and therefore outstanding credit rating. If the brains behind their hedging program determine that it would be beneficial, they will increase their hedged amount in coming years, as need be, and as oil market prices fluctuate, just as they have over the last several years. So when you see that they are only 15% hedged in 2012 and not hedged at all in 2013, look again 3 years from now and they will probably be about 50-70% hedged in 2012 and 20-40% hedged in 2013. But fuel hedges are not the reason Southwest outperforms other airlines. They were profitable before fuel hedges were even begun. Their costs (unrelated to fuel) are lower for many reasons: more efficient use of aircraft (due to point to point versus hub and spoke). More productive aircrew (meaning less aircrew needed per aircraft). Reduced maintenance and training costs due to flying only 1 type of aircraft. There are many other ways their costs are lower and this is why they outperform other airlines.
Fonzriot,Did you get an F on that paper or was it for HS?? Southwest is constantly changing their hedges. In 2005 they were expected to be losing money because their hedges were running out in 2009. Then they used their enormous capital of $6 billion in cash to re-negotiate their hedges for the next 5 years. Additionally, their CASM is almost 20% lower than their competitors.Their entire fleet of 737s are almost, on average, 10 years younger than other airlines. Other airlines might have TVs and such but when you pay $25 to check your bag and another $25 to get a non middle seat and another $25 to change your reservation then you are paying a hefty price for that TV. The price per ticket isn't the same. JetBlue's fares are higher and they don't compete with SWA on most of their routes.Southwest will continue to make profits. Whether their stock goes up or not is a different story. It makes no sense they languish at the $12-$16 range while UAL, AMR, etc... vary 10% at a time.
In 2005 they were expected to be losing money because their hedges were running out in 2009. Then they used their enormous capital of $6 billion in cash to re-negotiate their hedges for the next 5 years.Sounds a bit like Enron.