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On May 9, 2013, we maintained our Neutral recommendation on Southwest Airlines (LUV - Analyst Report), based on its operational excellence, cost-efficient business model, strong liquidity position and better-than-expected first quarter results, partially offset by certain risk factors. The passenger airline holds a Zacks Rank #2 (Buy).

Why Kept at Neutral?

We believe that Southwest is favorably positioned to generate high revenues and earnings in the coming couple of quarters owing to a number of profit-inducing initiatives. Additionally, the company’s All-New Rapid Rewards program, increased ancillary product offerings plus the introduction of international reservation system and new revenue management program are expected to support its profitability.

Southwest continues to optimize its combined networks with the introduction of new national and international services across various locations. The integration of the AirTran acquisition is providing substantial opportunities for future growth.

We expect this merger to be accretive to Southwest’s earnings with net, annualized, pre-tax synergies of $70 million realized in the first quarter. The merger is expected to generate net synergies of more than $400 million by year-end 2013.

Being one of the most profitable low-cost global airlines, the company remains focused on cost control. Southwest’s attention on fleet resizing seems to be the appropriate strategy to lower non-fuel costs. The company is taking several efforts including interior redesigning, offering of technology-based facilities and more entertainment options to enhance the quality of its fleet so as to generate increased profitability.

However, high operating costs like fuel, maintenance, salaries, wages and airport fees plus a new advertising policy along with intense competition from another economic airline – JetBlue Airways (JBLU - Analyst Report) – and heavy investments are expected to limit the upside potential of the stock.

For the second and third quarters of 2013, the Zacks Consensus Estimates for earnings are 41 cents and 28 cents per share, respectively. This reflects a respective year-over-year growth of 12.9% and 117.6%.

Other Stocks

Other stocks operating within the airline sector that are worth considering are Alaska Air Group Inc. (ALK - Snapshot Report) and Bristow Group Inc. (BRS - Snapshot Report). Both the companies currently hold a Zacks Rank #2 (Buy).

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