Thinking of Buying LUV's Dip? Consider This First.

Standing out among the Street's worst performers today is Southwest Airlines Company, a airlines company whose shares slumped -3.6% to a price of $24.86, 19.21% below its average analyst target price of $30.77.

The average analyst rating for the stock is hold. LUV lagged the S&P 500 index by -3.0% so far today and by -42.0% over the last year, returning -24.0%.

Southwest Airlines Co. operates as a passenger airline company that provide scheduled air transportation services in the United States and near-international markets. The company is a consumer cyclical company, whose sales and revenues correlate with periods of economic expansion and contraction. The reason behind this is that when the economy is growing, the average consumer has more money to spend on the discretionary (non necessary) products that cyclical consumer companies tend to offer. Consumer cyclical stocks may offer more growth potential than non-cyclical or defensive stocks, but at the expense of higher volatility.

Southwest Airlines Company's trailing 12 month P/E ratio is 26.4, based on its trailing EPS of $0.94. The company has a forward P/E ratio of 11.2 according to its forward EPS of $2.22 -- which is an estimate of what its earnings will look like in the next quarter. As of the first quarter of 2023, the average Price to Earnings (P/E) ratio for US consumer discretionary companies is 22.33, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

A significant limitation with the price to earnings analysis is that it doesn’t account for investors’ growth expectations in the company. For example, a company with a low P/E ratio may not actually be a good value if it has little growth potential. Conversely, companies with high P/E ratios may be fairly valued in terms of growth expectations.

When we divide Southwest Airlines Company's P/E ratio by its projected 5 year earnings growth rate, we see that it has a Price to Earnings Growth (PEG) ratio of 0.41. This tells us that the company is largely undervalued in terms of growth expectations -- but remember, these growth expectations could turn out to be wrong!

An analysis of the company's gross profit margins can help us understand its long term profitability and market position. Gross profits are the company's revenue minus the cost of goods only, and unlike earnings, don't take into account taxes and overhead. Here's an overview of Southwest Airlines Company's gross profit margin trends:

Date Reported Revenue ($ k) Cost of Revenue ($ k) Gross Margins (%) YoY Growth (%)
2023-02-07 23,814,000 -17,711,000 26 -23.53
2022-02-07 15,790,000 -10,403,000 34 585.71
2021-02-08 9,048,000 -9,683,000 -7 -121.88
2020-02-04 22,428,000 -15,226,000 32 -3.03
2019-02-05 21,965,000 -14,706,000 33 -5.71
2018-02-07 21,146,000 -13,674,000 35
  • Average gross margin: 25.5 %
  • Average gross margin growth rate: -0.2 %
  • Coefficient of variability (lower numbers indicating more stability): 63.7 %

Southwest Airlines Company's gross margins indicate that its underlying business is viable, and that the stock is potentially worthy for investment -- as opposed to speculative -- purposes.

When we subtract capital expenditures from operating cash flows, we are left with the company's free cash flow, which for Southwest Airlines Company was $7.74 Billion as of its last annual report. The balance of cash flows represents the capital that is available for re-investment in the business, or for payouts to equity investors as dividends. The company's average cash flow over the last 4 years has been $4.53 Billion and they've been growing at an average rate of 0.0%. LUV's weak free cash flow trend shows that it might not be able to sustain its dividend payments, which over the last 12 months has yielded 2.1% to investors. Cutting the dividend can compound a company's problems by causing investors to sell their shares, which further pushes down its stock price.

Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (its share price divided by its book value). The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method. Southwest airlines company's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 1.37, but is still below the average P/B ratio of the Consumer Discretionary sector, which stood at 3.12 as of the first quarter of 2023.

Southwest Airlines Company is likely fairly valued at today's prices because it has an average P/E ratio, a lower P/B ratio than its sector average, and irregular cash flows with a flat trend. The stock has poor growth indicators because of its decent operating margins with a negative growth trend, and a negative PEG ratio. We hope this preliminary analysis will encourage you to do your own research into LUV's fundamental values -- especially their trends over the last few years, which provide the clearest picture of the company's valuation.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.