Is Southwest Stock Undervalued?

The pandemic has not been kind to the travel industry, and airlines were some of the market’s hardest hit companies. Businesses eliminated most in-person events, and leisure travelers elected to stay home. As a result, US airline revenues declined by more than 65 percent year-over-year in 2020.

Even Warren Buffett, the head of Berkshire Hathaway (BRK.B), gave up on airline stocks. In early May, he reported that his holding company sold its Southwest (LUV), United (UAL), Delta (DAL), and American (AAL) shares – a position worth roughly $4 billion. 

The silver lining is that COVID-19 vaccine distribution is well underway, giving the world hope that life will return to normal in coming months. The bad news is that airlines were among the first to realize losses due to the pandemic, and they may be among the last industries to recover.

Some analysts have indicated that regular business and leisure travel may not see former price levels until 2024 or later. 

Of course, Southwest has always been a company that bucks trends, and it isn’t shy about doing things differently than its industry peers. It’s unique in its position as a large, low-cost carrier – competitors tend to be one or the other but not both. 

Southwest passengers are exceptionally loyal, and that is primarily due to Southwest’s employees. The company focuses on hiring for cultural fit, and every team member is passionate about customer service.

Southwest also inspires loyalty through its flexible policies. It’s easy and inexpensive to reschedule a flight. Those sorts of customer-friendly practices ensure that when it is safe to travel, Southwest should quickly reclaim market share. 

With that in mind, investors are looking at Southwest’s current share price. It remains well below its 52-week high of $58.83. Is Southwest stock undervalued? Is now the right time to buy? 

Why Southwest Stock Went Down

Prior to the March 2020 market crash, Southwest stock was looking good. It was valued at nearly $60 per share, and analysts expected it to go even higher as the year progressed. Alas, those hopes were dashed when the pandemic took hold of the global economy. By mid-May, Southwest shares were priced at just $22.46. 

In short, demand for airline travel was decimated by COVID-19, and the collapse occurred practically overnight. Overall, US airlines reported losses topping $34 billion for the year, and Southwest had its first losing year since 1972. 

Despite these challenges, Southwest stock has been resilient, closing out January 2021 at just under $44 per share. The question investors are asking is whether Southwest is undervalued. Specifically, does it have potential to reach and exceed former heights in the near-term, or will investors wait years to see share prices rise further?

Southwest Financials Nosedived

Southwest was better able to navigate the challenges of 2020 as compared to its peers, because it started off in a stronger financial position. With that said, it’s always discouraging when a formerly profitable company has four consecutive quarters of losses. 

In late January, Southwest reported fourth quarter and annual results, and they were slightly better than expected. The company lost a net $908 million, which comes out to $1.59 per diluted share for the quarter. However, that’s better than analyst predictions of losses closer to $1.69 per share.

This occurred, in part, because operating revenue per available seat mile dropped a full 40.8 percent. At the same time, operating expenses went up by 5.8 percent, making losses inevitable. 

For the year, Southwest’s net loss came in at $3.1 billion, which totals a loss of $5.44 per diluted share. Fortunately, the company closed out the year with $14.2 billion in liquidity, which exceeds outstanding debt by a comfortable margin. 

Does that mean Southwest stock will rise? And if so, when?

Will Southwest Stock Rise?

Though management is hard at work on a strategy that will return Southwest to profitability, that won’t happen this quarter. In fact, the company is unlikely to see profits at any point this year.

Demand for air travel is always low in January and February, and continued concerns around COVID exposure are driving demand down further. 

With that said, fewer people are canceling trips once they have booked air travel, so the company has been better able to minimize waste. January may be slightly more successful than expected, and the company is hopeful that this is the start of a positive trend. 

Southwest projected January revenues would come in about 75 percent lower than the same period in 2019. Now, it appears the drop may be in the range of 65 percent to 70 percent. For the moment, estimates for February indicate a revenue drop between 65 percent and 75 percent as compared to the same period two years ago. 

If Southwest stock is to rise in any sort of meaningful way, the company will have to get a handle on daily cash burn. During the fourth quarter, those figures came in at $12 million, but that’s expected to increase to $17 million for the first quarter of 2021. 

During the earnings call, management indicated that revenues will need to double from where they are today for the company to break even. That means revenues will have to more than double for profits to return. The company set a goal to hit break even by the end of the year, but many analysts are skeptical. 

Is Southwest Valuation Too Low?

Any examination of Southwest’s valuation requires a look at the pandemic itself. Those who believe the world is close to extinguishing the virus see Southwest’s valuation as too low, while those who assert that the world is months or years away from a COVID-free lifestyle say Southwest’s valuation is too high. 

A lot depends on the rollout of an effective COVID-19 vaccine – and not just in the United States. The vaccine has to reach every corner of the globe, or new strains will keep popping up.

Once travelers feel confident in their protection against COVID-19, domestic travel will begin to rise, driving Southwest’s revenues up.

Of course, the vaccine rollout has been anything but smooth so far, and it isn’t clear whether or when most of the population will be protected. 

Once a majority of people are vaccinated, demand for air travel will return, but that poses another heavily debated question: How quickly will demand recover?

Some believe the increase will be gradual, with pre-pandemic levels several years away. Others insist that there is pent-up demand from isolated travelers who will flock to the skies the moment it feels safe. 

In other words, there is no definitive answer to the question, “is Southwest valuation too low?” Among US airlines, Southwest is well-positioned to see a return to profitability more quickly than peers, but a lot depends on external factors that can’t be predicted quite yet.

Is Southwest Stock Undervalued? The Bottom Line

The bottom line is that Southwest is likely priced just right for the moment – neither undervalued nor overvalued. Most industry experts and market analysts agree that the company will be profitable again – it’s simply a matter of time.

Investors in search of a long-term investment will get their money’s worth by purchasing Southwest stock now. However, it may be years before they realize any notable returns. 

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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.