Southwest Airlines Co. (LUV): Earnings Analysis

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Southwest Airlines Co. (LUV): Earnings Analysis

Southwest Airlines Co. (NYSE:LUV) reports preliminary financial results for the quarter ended 2012-09-30.

Southwest Airlines Co. (NYSE:LUV) recently reported its preliminary financial results based on which we provide a unique peer-based analysis of the company. Our analysis is based on the company’s performance over the last twelve months (unless stated otherwise). For a more detailed analysis of this company (and over 40,000 other global equities) please visit www.capitalcube.com.

Southwest Airlines Co.’s analysis versus peers uses the following peer-set: Delta Air Lines, Inc. (NYSE:DAL), United Continental Holdings Inc (NYSE:UAL), Alaska Air Group, Inc. (NYSE:ALK), US Airways Group, Inc. (NYSE:LCC), JetBlue Airways Corporation (NASDAQ:JBLU), SkyWest, Inc. (NASDAQ:SKYW) and AMR Corporation (PINK:AAMRQ). The table below shows the preliminary results along with the recent trend for revenues, net income and returns.

Quarterly (USD million) 2012-09-30 2012-06-30 2012-03-31 2011-12-31 2011-09-30
Revenues 4,309.0 4,616.0 3,991.0 4,108.0 4,311.0
Revenue Growth % (6.7) 15.7 (2.8) (4.7) 4.2
Net Income 16.0 228.0 98.0 152.0 (140.0)
Net Income Growth % (93.0) 132.7 (35.5) N/A (187.0)
Net Margin % 0.4 4.9 2.5 3.7 (3.2)
ROE % (Annualized) 0.9 13.1 5.6 9.1 (8.2)
ROA % (Annualized) 0.3 4.9 2.1 3.4 (3.0)

Valuation Drivers

Southwest Airlines Co.’s current Price/Book of 0.9 is about median in its peer group. The market expects LUV-US to grow earnings about as fast as the median of its chosen peers (PE of 13.3 compared to peer median of 11.7) but not to expect much improvement in its below peer median rates of return (ROE of 7.3% compared to the peer median ROE of 14.0%).

The company’s asset efficiency (asset turns of 0.9x) and net profit margins of 2.9% are both median for its peer group. LUV-US’s net margin is similar to its five-year average net margin of 2.8%.

Economic Moat

The company has achieved better revenues growth than its chosen peers (year-on-year change in revenues of 29.4%) but its earnings growth performance has been below the median (change in annual reported earnings of -61.2% compared to the peer median of -36.3%). This suggests that, compared to its peers, the company is focused more on top-line revenues. LUV-US is currently converting every 1% of change in revenue into -2.1% change in annual reported earnings.

LUV-US’s return on assets is above its peer median both in the current period (2.7% vs. peer median 2.0%) and also over the past five years (2.1% vs. peer median -1.2%). This performance suggests that the company’s relatively high operating returns are sustainable.

The company’s comparatively healthy gross margin of 32.8% versus peer median of 26.9% suggests that it has a differentiated strategy with pricing advantages. Further, LUV-US’s bottom-line operating performance is better than peer median (pre-tax margins of 4.8% compared to peer median 3.0%) suggesting relatively tight control on operating costs.

Growth & Investment Strategy

While LUV-US’s revenues have grown faster than the peer median (12.4% vs. 7.8% respectively for the past three years), the market gives the stock an about peer median PE ratio of 13.3. This suggests that the market has some questions about the company’s long-term strategy.

LUV-US’s annualized rate of change in capital of 7.3% over the past three years is higher than its peer median of 2.1%. This investment has generated an above peer median return on capital of 2.6% averaged over the same three years. Evidently, the relatively high capital investment was successful given the the relatively strong growth in its returns.

Earnings Quality

LUV-US’s net income margin for the last twelve months is around the peer median (2.9% vs. peer median of 2.7%). This average margin and relatively conservative accrual policy (10.2% vs. peer median of 8.1%) suggests possible understatement of its reported net income.

LUV-US’s accruals over the last twelve months are positive suggesting a buildup of reserves. In addition, the level of accrual is greater than the peer median — which suggests a relatively strong buildup in reserves compared to its peers.

Trend Charts

Graph of Revenues Trend for Southwest Airlines Co. (NYSE:LUV)
Graph of Net Margin Trend for Southwest Airlines Co. (NYSE:LUV)
Graph of Net Margin Trend for Southwest Airlines Co. (NYSE:LUV)
Graph of Accruals Trend (% revenues, Quarterly) for Southwest Airlines Co. (NYSE:LUV)
Graph of Accruals Trend (% revenues, Annual or TTM) for Southwest Airlines Co. (NYSE:LUV)

Company Profile

Southwest Airlines Co. operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States. It principally provides point-to-point, rather than hub-and-spoke, service. The company’s point-to-point service has enabled it to maximize the use of key assets, including aircraft, gates, and Employees, and has also enabled it to provide its markets with frequent, conveniently timed flights and low fares. AirTran Airways, Inc. became a wholly-owned subsidiary of Southwest Airlines Co. on May 2, 2011. It was founded by Herbert D. Kelleher on March 15, 1967 and is headquartered in Dallas, TX.

Disclaimer

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By: capital cube

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