Southwest Airlines (NYSE:LUV) is under pressure to deliver improved value for shareholders and renewed growth after announcing a slate of changes that could both increase its top and bottom lines in the years to come.
Today, let’s take a look at Southwest Airlines to see if LUV is a buy, sell or hold at the moment.
Southwest Airlines’ Hopeful Turnaround Plan
One of the biggest changes Southwest is making in order to drive growth is the elimination of its longstanding policy of offering free checked bags to all flyers.
Under the company’s new program, customers with upper-tier memberships with the airline and those flying business class will still get free checked bags. Other customers, however, will be charged for checked bags, eliminating an extremely popular benefit of flying with Southwest.
The previous bag policy has put the airline behind its competitors financially and made it difficult to deliver optimal shareholder value.
Budget flyers will be jumping with glee because Southwest is also rolling out a basic economy ticket tier. This will be the least expensive class of ticket offered and so is highly touted as a strong competitive lever to match rivals offerings.
Assigned seating was another tectonic shift because, unlike other major airlines, Southwest had previously been famous for an open seating policy. The new seating scheme means passengers have the opportunity to upgrade to seats with extra leg room.
Finally, the C-suite wants to revamp the existing loyalty program so that passengers can earn more points on business fares, while earning less on the airline’s popular Wanna Get Away and Wanna Get Away Plus fares.
The big picture vision here among the top brass is clearly to increase the top line while cementing the appeal of the loyalty program to customers. This second point is crucial because the loyalty program’s benefits will surely offset some of the less popular aspects of the changes, including the removal of free checked bags and the reduced points earned on some fares.
Marginal Top Line Boost, But Profits Flat
Management reported net income of $465 million, which was essentially flat from the previous year. Revenue, however, saw an increase from $26.1 billion in 2023 to $27.5 billion in 2024.
One area where Southwest has performed quite well over the last year is in its revenue per available seat mile, which increased 8% in Q4, a number that bodes well for hopes of future growth because it shows that Southwest is making the most of the available seats on its flights.
Southwest Airlines has also spent the last few years paying down debts it took on during the 2020-21 period. Long-term debt peaked at over $11 billion in 2021. As of the end of last year, the company had reduced its outstanding debt to $6.7 billion and had a total liquidity of $9.7 billion.
Will LUV Go Into Free Fall or Soar?
The first risk investors might look at with LUV is its high valuation. While the stock trades at reasonable multiples of 0.7 and 1.8 to sales and book value, respectively, its P/E is quite high at 43.1.
Although the airline is making renewed efforts to increase its profitability that could cause earnings to grow fairly quickly, these efforts are still unproven. As such, LUV may very well be overvalued if earnings don’t rise as much or as quickly as the market is expecting.
The decision to charge for checked bags is also likely to fly much less well with consumers than it did with investors, potentially causing brand damage and eliminating one of Southwest’s historical selling points.
Free bags had in the past been popular with passengers so abandoning it means rivals can swoop in and steal previously loyal customers. A close eye on revenues is now needed to see if Southwest loses market share.
Fears of a recession this year are rapidly mounting, and some market observers are even beginning to fear a period of stagflation as the labor market cools, consumer demand weakens and inflation heats up due to massive tariff increases. These developments have the very real potential of reducing demand for air travel, putting additional pressure on all of the major airlines.
What About Southwest’s Dividend?
To some degree, a consistent dividend can make up for uncertainties about a business by offering investors a reliable and predictable return on their capital.
LUV shares undeniably come with a high dividend yield at 2.3 percent, but investors could be stuck with little to no growth in the company’s payout unless significant earnings growth occurs.
The dividend payout ratio at the moment is over 90 percent, leaving management little room to increase its distributions. LUV also hasn’t had a dividend increase since 2019, making it potentially unappealing for dividend growth investors.
Southwest is, however, returning cash to shareholders a bit more aggressively in the form of share buybacks. A $2.5 billion share repurchase authorization, of which $750 million has been slated for an accelerated buyback, is something bulls can point to as a virtual put option under the share price.
Is LUV a Buy, Sell or Hold Right Now?
Analysts rate LUV a Hold now with fair value at $31.70 per share in line with the current trading price.
While Southwest’s changes could pan out well for the company, there are also significant risks associated with removing some of its most important selling points.
Without free checked bags to differentiate it from other airlines, Southwest could lose more than it stands to gain in terms of both revenue and customer loyalty. Broader headwinds will also hit the company, making it appear to be a fairly risky investment at the moment.
None of these factors likely turn LUV into a sell, but it’s probably better to hold the stock than to buy it right now. Until management’s new changes actually start bearing fruit, the stock is trading at a fairly high earnings multiple on uncertain hopes of future growth.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
