Feeling low about our stock


Aug 21, 2002
By God Indiana
Southwest pays for its stability
Wednesday, March 29, 2006

By Susan Warren, The Wall Street Journal

The airline most often viewed as the strongest, healthiest and best-run of the pack may be one of the weaker bets for investors hoping to profit from a budding turnaround in the industry.

A strengthening market has sent some beleaguered airline stocks soaring in recent months, but shares in industry stalwart Southwest Airlines have been more sluggish. In the past year, the stock of American Airlines parent AMR Corp. has risen 168 percent on the New York Stock Exchange. Rival hub-and-spoke carrier Continental Airlines saw its stock price jump 142 percent on the Big Board during the 12-month period. But the same tide of good news has lifted Southwest's stock just 25 percent on the NYSE, though that gain still handily outpaced the Dow Jones Industrial Average, which was up 7 percent over the same period.

The irony is, Southwest's reliable financial strength and reputation for industry leadership have become a drag for its stock. As the industry's Steady Eddie, it just doesn't have the investment sex appeal of other down-on-their-luck airlines that are finally beginning to pull themselves out of the abyss.

"Southwest stock is a safe haven. So when things are good, you don't need a safe haven," explained Roger King, an analyst with CreditSights, an independent research firm.

In 4 p.m. composite trading Tuesday on the NYSE, Southwest's shares rose seven cents to $17.54, giving the company a market value of about $14 billion. Southwest's current price-to-earnings ratio is a lofty 26.12. Most of its rivals, including American, Continental and US Airways have been posting losses. Based on Thomson Financial's numbers, the forward P/E through December 2007 is 21.8 for Southwest, considerably richer than American's 10.6, Continental's 9.9 and USAir's multiple of 9.1. Southwest has consistently traded at a premium to other airlines because of its financial stability.

The low-cost, low-fare business model that Southwest pioneered, along with some timely fuel-cost hedging, helped the airline prove its mettle as the industry posted hundreds of millions in losses in the years following the Sept. 11, 2001, terrorist attacks. Some airlines, including United, Delta Air Lines and USAir, sought shelter in bankruptcy court, while others traded as if they were on the brink of their own filing. AMR saw its stock trade as low as $1.50 in March 2003, down from near $40 in early 2001.

Even during the industry's darkest days, Southwest continued to post a profit, earning $548 million last year, up 75 percent from the previous year. As a result, the Dallas-based carrier's stock price remained roughly flat during the industry turbulence of the past five years.

Still, Southwest shareholders were used to seeing their stock shoot for the moon. From 1997 to 2001, Southwest's stock price had more than tripled as the ground-breaking company thrived as a low-fare airline shaking up the industry status quo.

Tough times have forced big changes in the industry since then, and even traditional hub-and-spoke airlines are adopting a more Southwest-style approach to lower their costs and compete with discounters' lower fares. That low-fare competition has kept a lid on revenue just as energy prices spiked upward, raising the cost of jet fuel to a crippling average $72 a barrel in 2005, nearly double the $37 average price in 2003, according to data from the industry trade group Air Transport Association.

From March 13 to March 22, American's and Continental's stock jumped more than 14 percent while Southwest shares gained 3.7 percent on news of improving industry revenues and hints that energy supplies might be building amid cooling demand, sparking hopes that fuel prices this year will halt their steep climb.

Similarly, Southwest led a fare increase earlier this month that was quickly echoed by competitors. But competitors' stock got a bigger bang than Southwest's because they derive a bigger benefit, says J.P. Morgan analyst Jamie Baker, who remains "neutral" on Southwest stock while rating American and Continental "overweight."

"We continue to believe investors are better off owning AMR or in an environment where Southwest is pushing fares higher, rather than simply owning Southwest," said Mr. Baker, whose firm does business with several airlines, including American, Continental and Southwest, but who doesn't personally own airline shares.

Most analysts still believe Southwest has strong growth ahead. Of eight analysts tracked by Thomson Financial, six rate Southwest a "buy," and two a "hold." But many view Southwest as a buy-and-hold stock, not a stock for traders looking to turn a quick buck.

Ray Neidl of Calyon Securities, an institutional brokerage firm, recently upgraded American and Continental to "strong buys," while leaving Southwest a "buy." He doesn't own airline shares, though his firm seeks business with all the carriers. "If you're buying Southwest, you're probably not buying it for the quick trade," he notes. But of all the airlines, "It's the only one I would ever advise my grandmother to put into her IRA."

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