Strong Buy of the Month - LUV
Southwest Airlines (LUV)
Current Price = $13.80
12 mo target = $18.00
Investing in the airlines, are you nuts? But there is one gem among this mess. We have been watching Southwest Airlines (NYSE:LUV) with interest the last couple weeks as the airline industry has dropped over oil concerns. But why Southwest? They have 85% of their oil hedged at $26/barrel until 2008! In other words, Southwest need not worry about the price of oil for another 3 years. On the otherhand, oil has surpassed labor costs as the #1 expense for all other airlines. Even in the face of increasing labor, fuel & maintenance costs, Southwest margins are actually widening in 2005.
This has been known for quite some time, though. But two events happened yesterday that has turned our interest into a screaming buy:
1) Delta & Northwest filed for Chapter 11 bankruptcy after yesterday's close.
2) OPEC is expected to increase its production quota when it meets Monday.
Southwest Airlines is dominating the price wars against the legacy carriers, driving them into bankruptcy. As more carriers file for Chapter 11, Southwest will continue to steal marketshare & increase routes. Last year Southwest bought several routes from bankrupt ATA Airlines in Chicago. And with many carriers strapped for cash, Southwest should be the most likely candidate to buy new routes from Delta & Northwest.
We have a strong buy recommendation on LUV, reflecting our belief that it is the financially strongest and operationally best positioned U.S. airline, as well as our expectations of increased investor interest in the sector if industry conditions improve. LUV has posted 32 consecutive years and 57 consecutive quarters of profitable operations, and we see the quality of those earnings as high, since LUV has no pension issues. In our view, LUV has ample cash, and its debt to total capitalization is significantly below peer levels. We think these measures warrant a premium valuation to the S&P 500.
With little debt, a conservative 23 PE, a 14.5% forecasted earnings growth rate, coupled with today's catalysts, its time for Southwest to make a run.