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While the travel industry continues to be decimated by the pandemic, the majority of this, is and has been, priced into these types of stocks for some time now. Most investors are actually looking towards the eventual reopening of economies and borders and therefore are investing in this sector way before it actually materializes. That is why it is so important not only to pick the right sector, such as airlines, but to know which companies will rebound the quickest! Looking throughout the sector, we see multiple candidates, although only a few truly shine above the rest.
While Southwest Airlines (LUV) did recently report as expected poor EBITDA numbers, management's commentary on forward looking projections match closely with how we are forecasting a pick up in global travel. We are therefore initiating an overweight rating for the stock and is one of our strongest picks in the airlines sector next to Delta Airlines (DAL).
Looking through their recent earnings report we see as expected EBITDA numbers and EBITDA margins. However, Q4 EPS was -$1.29, which was ~20% better than anticipated.
While this is positive news, in the short term, management also said they expect YoY (year over year) revenue to be down ~70% in Q1 of 2021!
So, while you would expect news like that to have investors everywhere selling, like we mentioned above, the stock market is looking towards the rebound and already pricing in this terrible short term forecast. All in all though, LUV (relative to the landscape) did have another solid quarter. This just goes to show the strength of the business and their ability to still perform above the pack in what is a terrible macro environment.
Looking forward though, the key theme here is that we are long the stock because of their strength of the business, the strength of their management team and the strength of their brand (dedicated to customer loyalty). But how does this translate to a better/quicker rebound? Looking more closely at this, we see brand loyalty specifically driving the rebound quicker than the other categories mentioned. We also see the route focus (domestic travel vs. international) as another key determinant into a quicker rebound as international carriers will have a hard time resuming this type of travel.
Specifically we believe these two factors, should contribute to a PRASM (Passenger Revenue per Available Seat Mile) rebound. PRASM (one of the gold standards of airline analysis) is obtained by dividing operating income by available seat miles. Generally, the higher the PRASM, the more profitable the airline. PRASM is important because it is often used as a proxy for pricing power. Pricing power is the ability of the airline to raise prices in order to respond to higher costs (and keep customers buying tickets) or to improve margins. During the pandemic we saw PRASMs fall drastically as airlines had to reduce costs just to entice customers to fly on their routes.
However, we believe based on the factors above, that LUV should be able to increase PRASM quicker than other airlines. If they can do this then they can either increase revenue and/or increase margins faster their competition. This makes LUV an attractive investment opportunity as their business should rebound faster than the others once travel picks back up.
While travel may take some more time to resume, Southwest Airlines (LUV) will be in a position to seize the opportunity better than others as soon as it opens. Therefore we believe Southwest should offers outsized returns relative to the sector and therefore are overweight the stock! We believe, based off of our growth projections and factoring this into our models, that Southwest should be able to attain a price of $60 by the end of this year!
Target Date: 8-10 Months
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