​Southwest: High-Quality Market Leader Trading at a Fair Price

MoneyShow  |

Southwest Airlines (LUV), the second largest United States airline based on market cap, is the first airline to be recommended as a Buy in our newsletter, notes income expert Ben Reynolds, editor of Sure Dividend.

Southwest has perhaps the best record of profitability for an airline. The company has remained profitable for 45 consecutive years in an industry marred by bankruptcy. The airline is dedicated to low and transparent pricing, a fun environment for employees and customers alike, and efficiency.

It’s scale, cost focus and brand give it a strong competitive advantage. The company specializes in short haul flights, resulting in cost savings and better margins. Southwest also employs a point-to-point model rather than a hub-and-spoke model which also results in efficiency gains.

While Southwest is remarkably recession-resistant for an airline, it is not recession-resistant compared to other businesses. The company saw earnings-per-share plummet 74% from $0.72 in 2006 to $0.19 in 2009 during the worst of the Great Recession.

It should be noted that the company did remain profitable during this period and maintained its small dividend. Southwest’s payout ratio is under 20%, giving it plenty of room to continue paying dividends even in a protracted recession.

We project Southwest will grow earnings-per-share at around 10% a year over the next several years. This growth will come from a mix of share repurchases, organic growth, and small margin improvements. The company is expected to begin flying to Hawaii in 2018, which will add to growth.

Southwest is an example of a high-quality market leader trading at a fair price. We expect total returns of around 11% a year from earnings-per-share growth and dividends.

Ben Reynolds is editor of Sure Dividend.

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