No Tutorial Needed

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I remember the first time I flew on Southwest Airlines (NYSE: LUV). The seating was like nothing I had ever seen before. I didn't understand why everyone was lining up so early, and then when they explained the open seating, I figured it out and was left standing at the back of the line.

While other airlines had customers choose their seat paying extra for first class seats, Southwest was a refreshing change from the normal way of doing things. Unfortunately, as the company has grown, Southwest is becoming like their competition -- and that's not a compliment.

The airline industry has its share of problems to overcome already. Southwest faces a host of competitors from smaller airlines like JetBlue (NASDAQ: JBLU) to larger well known competitors like Delta (NYSE: DAL) and United Continental Holdings (NYSE: UAL). The unpredictable nature of oil prices can cause carriers to raise fares in short order. The additional security measures that have been adopted since the terrorist attacks of 9/11 are necessary, but add a level of inconvenience that didn't exist before.

Baggage fees have become a hot topic, with companies like United and Delta charging $25 for one bag and $35 for an additional bag. JetBlue allows you one bag free, but the second one will cost you $40. Southwest has stayed above the fray by allowing two checked bags for free. The company even ran a series of successful commercials about their competition's bag fees. While the company has not changed this policy, there is a disturbing change in the culture of boarding passengers, and Southwest needs to make a choice to clarify their intentions.

The company recently announced that they would begin allowing passengers to pay $40 extra to be one of the first 15 to board the plane. The company already offers the ability to pay $10 extra for the privilege of using their Early Bird Check-In system, and there are other ways to get on the plane first as well. If a customer purchases a Business Select Fare, or if they are Rapid Rewards Members with A-List or A-List Preferred status, they get preferential boarding. All of these exclusions from the norm causes a problem. In fact, according to the article I linked above, the company's, “boarding practices are unusual enough compared to other airlines that they have an online tutorial.”

For a company that used to pride itself on its wacky and unpredictable spirit, this pay-for-where-you-sit idea sounds like most airlines, but Southwest needs to make this official. There is nothing wrong with customers who pay more getting preferential treatment. If you pay more you get better seats at sporting events. Customers with more money in a financial institution are likely to enjoy special rates or benefits. Higher-value clients come first in nearly any business. Southwest needs to change to traditional ticketing and seating and avoid ugly situations later on.

Under the current system, customers who want to sit together have no guarantee of that happening. In addition, families who used to have preferential boarding now are boarded after the A group. This causes some uncomfortable situations where passengers have chosen their seat and have to move to accommodate special circumstances. Other airlines don't have these issues.

When it comes to Southwest's financial performance, they already are outperforming several of their peers. If you compare the carriers based on gross margin, Southwest comes in second only to United Continental. United Continental has a gross margin of 55.81% and Southwest reported a gross margin of 48.99%. Keep in mind, Southwest is still in the process of converting over the AirTran fleet. Investors should expect Southwest's margin to improve once these expenses die down. Looking at Delta and JetBlue, neither company can match Southwest, with margins of 47.71% and 48.7% respectively.

When it comes to Southwest's balance sheet, it's clear the company is the industry leader. In fact, Southwest is the only airline we have mentioned that has a net cash balance. Southwest has a net cash balance of over $270 million, versus most of their competition has a net debt balance of at least $1 billion.

Last but not least, Southwest represents a compelling value if analysts are correct. The company sells for just 11.83 times projected earnings, yet is expected to grow EPS by 27.77% in the next few years. Delta and JetBlue have similar valuations with P/E ratios around 10, and growth expected above 20%. In an interesting twist, only United Continental is expected to grow at a rate of less than 10% in the next few years.

Investors looking for an airline stock could easily pick Southwest. The combination of a high margin, fast growth, and a strong balance sheet are positives in any industry. The stock is a relatively easy pick, but their boarding setup is far too complicated. Southwest needs to simplify their passengers lives and go to traditional ticketing. This would increase customer satisfaction, avoid the last minute transactions at the airport, and speed up boarding.

Ticketed seating is the right move for investors and passengers alike given how complicated the current system is. Management shouldn't need a tutorial to understand that faster boarding, and satisfied customers, should mean better profits.


MHenage has no position in any stocks mentioned. The Motley Fool recommends 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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