Stock of the Day - January 8, 2009

Southwest Airlines

Southwest Airlines (LUV) is stuck in its position as the “best house in a bad neighborhood”.  Compared to its competitors, Southwest is doing relatively well.  But, instead of taking the next logical step and saying that the airline company will do well as a result of its relative advantage, I believe the fact that Southwest is doing relatively well only reveals just how poorly the airline industry has been recently and how poorly it will fare in the future.

Southwest Airlines, a company that many of you are familiar with, was the largest provider of scheduled domestic passenger air travel in the U.S. in 2007.  The company specializes in low fare, point-to-point, high-frequency service. 

Southwest Airlines is definitely the financially strongest U.S. airline, as it has posted 35 consecutive years of profitable operations.  The company has a solid foundation of cash, and it has one of the industry’s lowest cost structures.  It has kept its costs low by flying only one aircraft type, by offering mostly non-stop flights, by avoiding many congested airports, and by holding down food costs. 

The positives don’t hold much traction, though, when comparing them to the negatives that outweigh not only Southwest Airlines, but the whole airline industry.  The domestic airline industry consists of 11 major airlines, which basically means that Southwest has a lot of companies to beat out in order to attract customers.  This competition results in extremely low profit margins, as ticket pricing is also extremely cutthroat among all of the airline companies. Labor in the airline industry is also mostly unionized, which keeps companies like Southwest from making major labor cuts during tough economic times.

Without a doubt, Southwest has a competitive advantage over other airlines because it offers so many non-stop, quick flights and has such high flight frequency (less ground time and more time in the air).  It also flies to many airports that its competitors do not stop at, leaving Southwest as the main option for many travelers.  Recently, though, Southwest has made plans to begin expanding the range of its flights into Canada and more airports in the Northeastern United States.  While this may sounds exciting for people who smell growth, I think that it is unhealthy for the airline to stray from its competitive advantage of quick flights that have helped it become the leader in its industry. 

Business travel and Leisure travel – The two components of demand in airline travel – have taken a dramatic dip as a result of the global financial crisis.  As a result of the huge drop in demand, airline companies like Southwest have tried to manipulate the supply side by cutting the number of flights they offer so that they can charge more per ticket.  Thus, revenue per unit has increased while the raw number of passengers has declined.  Another factor that has helped airlines in this economy has been the drop of oil prices.  While it may seem like airlines have hit bottom, and that when the economy turns around there will be more business and leisure travelers, one must not forget that when the economy turns around, oil prices will increase as well.

So, with cutthroat competition and a never-ending cycle of high oil prices mixed with high demand followed by low oil prices mixed with low demand, it truly seems like there is not much hope for any company in the airline industry, including Southwest Airlines. 

Southwest Airlines, mired by macroeconomic problems and aggressive competition within in its own industry, just does not have the potential to be profitable enough for me to suggest buying it.  There are too many companies out there that will rebound much faster than Southwest Airlines when the economy turns around.  Those are the companies that we should be buying now.

 

-Niki Pezeshki

College Trillionaire