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Analyst Blog

On Nov 12, 2013, we maintained our Neutral recommendation on Southwest Airlines Co. (LUV - Analyst Report) based on the introduction of various customer friendly programs, network expansion, fleet restructuring and capacity management. The passenger airline holds a Zacks Rank #2 (Buy).

Why Kept at Neutral?

Southwest has taken a number of initiatives that are expected to generate high revenues and reduce costs over the next several quarters. The company's All-New Rapid Rewards program, increased ancillary product offerings such as EarlyBird check-in, fleet modernization effort, pet fees and the introduction of international reservation system are expected to support its top and bottom-line growth.

Southwest continues to optimize its combined networks with the introduction of domestic and international services across various locations. In an attempt to tap the opportunities in the Caribbean, Central America, Latin America and Mexican markets, the company is building a new facility in the Houston airport, which will accommodate these flights from 2015.

The integration of the AirTran acquisition is providing substantial opportunities for future growth. Southwest expects to generate net synergies of more than $400 million by the end of 2013. Additionally, Southwest is resizing its fleet structure and has taken several efforts to improve the quality of its fleet with interior redesigning, offering of technology-based facilities and more entertainment options. We believe this is a strategic move by the company to reduce non-fuel costs and improve profitability.

However, the company remains vulnerable to economic situations and the current softness within the global economy is a concern. We believe that if the current macroeconomic situation fails to improve, the company might not be able to achieve its goal of a 15% pre-tax return on the invested capital.

Further increase in non-fuel costs like salaries and wages, airport cost, AirTran integration cost and deferred advertising are expected to affect the company’s profitability. Stiff price competition from major carriers and heavy investments remain detrimental to the upside potential of the stock.

Other Stocks

Other stocks that are worth considering within this sector are U.S. Airways Group Inc. , Spirit Airline Inc. (SAVE - Snapshot Report) and Alaska Air Group Inc. (ALK - Snapshot Report). LCC and SAVE currently hold a Zacks Rank #1 (Strong Buy), while ALK carries a Zacks Rank #2 (Buy).

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