Buy Southwest Airlines Ahead Of Strong Recovery (NYSE:LUV)

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Introduction & Thesis

As was the case for all airlines around the world, Southwest Airlines (LUV) saw a significant hindrance to its operations since the start of the pandemic. Today, however, the company along with the industry is recovering rapidly creating an attractive buying opportunity for investors. Fears from the Omicron variant were mostly overblown as the current data suggests that the Covid infection rates are rapidly decelerating creating a strong recovery in demand. Operational efficiencies are improving as staffing shortages are alleviating leading the company to confidently guide to strong operations throughout 2022. Further, I believe the operational disruptions from a Covid variant will not occur going forward. Finally, although the oil prices are at their recent historic highs, I believe the price is set to marginally decrease throughout 2022. At the least, I believe that the increase in the oil price from current levels is not likely. Therefore, I believe Southwest Airlines is a buy ahead of strong recovery expectations throughout 2022.

The Last Wave Of Damaging Infections

Covid infection cases led primarily by the Omicron Variant are dramatically decreasing potentially signaling the end of the wave of infection, and I believe this to be the last wave of infection that will have a materially negative impact on the airline industry. Starting with the current state of the Covid cases, the chart below shows that the infection rate in the United States is showing a dramatic decrease signaling the end of the wave of infections. This trend has been seen throughout the world.

US Covid Cases Graph

Worldometer

[Source]

Apart from the end of the current wave of Covid infections, I have two reasons to believe that the next wave of cases, if there are any, will not have a material impact on Southwest Airlines’ operations. First, Covid-19 is becoming less lethal throughout its evolution. In the midst of the record-breaking Covid cases during the Omicron variant wave, the fatality rate did not see a significant increase. Omicron is less deadly. As such, it is likely that the fatality levels will decrease even further if there are any new variant that causes another record-breaking wave of Covid cases. A virus tends to either increase its transmissibility while decrease fatality to maximize its chances of survival. Further, as vaccination levels increase while Pfizer’s (NYSE:PFE) Paxalovid is distributed to high-risk personals, I believe the world is prepared to move on. With this recent development combined with economic and political interests, few countries including Sweden, Denmark, the UK, Norway, and Finland have announced an end or nearly an end to Covid related restrictions. If this transition proves to allow support from the general public while providing stronger economic recovery and a low fatality rate, I think it is likely that the US and other nations will follow. In fact, the US, in my opinion, has moved toward an end to Covid regulations when the CDC decreased the quarantine requirement from 10 days to 5 amidst the spread of Omicron cases while New York drops indoor mask mandates and easing restrictions. Therefore, I believe Southwest Airlines will most likely see a nearly uninterrupted recovery in 2022.

Strong 2022 Forecast & Earnings Report

Southwest Airlines is expected to show a strong recovery in 2022 as demand for air travel returns. During the 2021Q4 earnings call, the company has laid out a few optimistic forecasts. As disruptions from the Covid infections decrease, the company is expected to see more normalcy and profitability starting from March. Given this strong demand, the management team confidently announced their plan to hire 8,000 new employees throughout 2022 to return its operations back into full. Thus, the company guided a revenue that will be nearly on par with 2019 or at -4% levels compared to 2019. Apart from the company’s management team, BofA has also said that the booking trends for both leisure and businesses are improving. I think the trend is clear. If there are no disruptions to the recovery trend, the airlines will eventually recover to their full operations.

oil

With oil prices at their recent historic highs, the problem of consistent oil price increase may be a concern for some investors. However, I think it is likely that the current price is at or near its peak. The US Energy Information Administration, or EIA, suggests that as supply and demand imbalances get solved, an oil price in 2022 and 2023 is likely to see a continual decline. In EIA’s view, the supply increases will be sufficient to meet market demand because the OPEC+ and the US combined are expected to increase production by 5.5 million barrels per day toward the end of the year.

Further, there is a wild card in the oil price prediction: Iran. The Biden Administration has restored the Iran sanction waiver as the administration races toward reaching a potential deal with Iran. As both countries are finally inclined to reach a deal, I see that sanction and restrictions removal for key companies including oil producers and firms in Iran may be possible. Biden Administration is facing steep fallout in approval rating primarily due to high inflation. Thus, before the mid-term election, it may be in the administration’s interest to stabilize the oil price. Although the Iranian oil never hit the market, I think an idea or the chance of the Iran deal may pressure the oil market.

Southwest Airlines Advantage

Southwest Airlines is one of the most efficient airlines in the world potentially benefiting the company’s recovery from the depths of the pandemic in comparison to other airlines. The primary reason for this is that the company only has one type of aircraft under operation: multiple variants of the Boeing (BA) 737. Southwest does not operate any long-haul routes including trans-Atlantic or trans-pacific routes. The company solely focuses on short to medium-haul routes on a single airplane model to achieve maximum efficiency. Many benefits including maintenance, employee training, and international travel will be advantages today where there are significant labor shortages, supply shortages, and international travel restrictions. Therefore, I believe this unique advantage of Southwest Airline can act in favor of the company during the period of bumpy air travel recovery.

financials

Southwest Airlines has one of the strongest financial positions in comparison to its peers including Delta Air Lines (DAL), United Airlines (UAL), and American Airlines (AAL). Southwest Airlines is the only airline with a net cash position. For example, Delta Airlines has a net debt of about $20 billion dollars. As such, leveraging the healthier balance sheet, the company may be able to more aggressively seek opportunities to full recovery.

Southwest Airlines had cash and short-term investments of about $15.5 billion with about $10.7 billion in debt bringing a net cash position with total assets of about $36 billion and a total liability of about $26 billion. Further, on top of the strong financial position, the company is expected to report profitability for FY 2022 through efficient operations and demand recovery.

Summary

There are two major hurdles to the recovery of Southwest Airlines causing fears in the market; however, although the recovery may be bumpy, I think the airline is still clearly in the right projectors. Southwest Airlines continue to reiterate its profitability goals in 2022 as leisure and business demands start to pick up. Also, as Covid becomes less fatal and countries and individuals adapt, I believe there will be no significant hindrance to Southwest’s operations going forward. Therefore, I believe Southwest Airlines is a buy today.

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