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Bear of the Day: Southwest Airlines (LUV)

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Southwest shares plunged more than 8% yesterday after Q3 results, as the airline provided a downbeat guidance for unit revenue, which is an important metric in the industry. What lies ahead for this low cost carrier?
About the Company
Dallas-based Southwest Airlines (LUV) is the nation's largest carrier in terms of originating domestic passengers boarded. They operate more than 3,900 flights a day, focusing primarily on short-haul, high frequency, point-to-point and low-fare services.
Third Quarter Results
The airline beat both on the top and bottom lines. Adjusted earnings of $0.93 per share were above the Zacks Consensus Estimate of $0.88 per share. Revenues of $5,139 million were also ahead of the Zacks Consensus Estimate of $5,132 million.
However, unit revenue fell 4.1% during the quarter and the management expects this trend to continue with unit revenue expected to decline between 4% 5% during the current quarter.
Results were also hurt by a computer outage in July which had resulted in cancellation of more than 2,000 flights.
While low fuel prices benefit airlines’ earnings, they also put pressure on pricing, particularly due to heavy discounting mainly by low-cost carriers. Many airlines expanded capacity in the wake of lower fuel prices, which has now led to a fare war.

Southwest had expanded capacity by 5% to 6% this year. It faces stiff competition from other low-cost airlines, which have aggressively boosted capacity for the same routes. As a result, average one way fare fell 4.8% during the quarter.

Further, the fuel costs have started rising now and are expected to be $2.10 per gallon in the current quarter, up from $2.02 per gallon in the reported quarter.

Falling Estimates

Analysts have been quite bearish on the stock and slashing their estimates in the past few weeks. Zacks Consensus Estimates for the current and the next year had fallen to $3.77 per share and $3.83 per share, down from $3.90 and $4.04 respectively, 90 days ago.

The Bottom-Line
After two years of impressive profitability, thanks mainly to record low fuel prices, US airlines are facing rough weather now. Airlines industry is currently ranked 242 out of 265 Zacks industries (bottom 9%). Investors looking to play this industry could look at Copa Holdings (CPA) which carries a Zacks Rank #1 (Strong Buy).
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