Why It May Be Time to Buy Southwest Airlines

The market has a tendency to overreact to negative news. At the slightest hint of weakness, a stock will stumble downward, only to recover weeks later once speculators see the error of their ways. We Fools love yo-yo moves like these, because they give investors the opportunity to buy great stocks at great prices. For the latest example, look no further than Southwest Airlines (NYS: LUV) .

One person's trash...
Shares of Southwest plunged 30% earlier this month, after the airline reported earnings per diluted share of $0.15, down nearly 50% year over year.

The main culprit? Higher fuel costs, which rose 72% over the same time period. Despite Southwest's reputation for shrewdly managing this expense, it has nevertheless chipped away at the airline's gross margin over the last five years.

anImage

Source: RobotDough.com.

As a result, Southwest now trades at 13 times earnings, its lowest level in 10 years.

...is another person's treasure
Despite this slide, there's still no question that Southwest leads its industry. It's the largest domestic airline in terms of passengers. It has the most cost-effective business model; by flying only 737s, it keeps maintenance costs low by using the same parts and procedures across its entire fleet. It further shaves costs by flying mostly into secondary and less expensive airports. And it's the only airline, besides Alaska Airlines (NYS: ALK) , to regularly record positive earnings per share in the last four years.

Airline

Number of Positive Quarters Since 2007

On-Time Rate (%)

Southwest 15 80.7%
Alaska Airlines 12 77.7%
Delta Air Lines (NYS: DAL) 7 77.3%
United Airlines (NYS: UAL) 5 77.2%
US Airways (NYS: LCC) 5 77.8%
American Airlines (NYS: AMR) 2 75.3%

Source: U.S. Dept. of Transportation, Bureau of Transportation Statistics.

There's also no question that Southwest appeals to customers. As you can see above, it has the highest on-time percentage in the industry. Its "bags fly free" ads make up one of the most memorable marketing campaigns in the last few years. And it's regularly voted one of the most admired companies in the United States.

The only question is: How will Southwest compensate for the higher fuel costs? Most likely, that cost will either fall eventually. If it doesn't, Southwest will try to pass some, if not all, of the increased costs onto its customers. So will the other carriers. Either way, Southwest should maintain both its profitability and its position as the airline industry's low-cost leader.

A diamond in the rough
At the end of the day, I understand why investors hesitate to invest in the airline industry, given its track record of unprofitability. But Southwest shouldn't be convicted by association. Unlike the majority of its peers, it makes both customers and shareholders appreciate the value of a great bargain.

At the time this article was published Fool contributor John Maxfield does not own shares in any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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