What's to Love About LUV?

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The airline industry is not for the faint of heart. All of the legacy airlines have gone bankrupt at least once during their history with American Airlines being the latest to do so, filing for Chapter 11 in 2011. Delta Airlines (NYSE: DAL), Northwest Airlines, and Air Canada have all restructured through bankruptcy in the last decade and US Airways (NYSE: LCC) has done it twice.

Much of this stems from the implied volatility of a capital intensive industry necessitating the carriers to take on massive debt loads and constantly fluctuating input costs of both jet fuel and labor. With a rising trend in airline mergers, Delta and US Airways have each considered buying each other in the last several years. US Airways launched a failed takeover bid for then-bankrupt Delta in 2006 and the Wall Street Journal reported in January of 2012, Delta was considering a takeover offer for US Airways. Despite not merging with each other, merger activity is affecting the stock prices of each airline with Delta completing an acquisition of Northwest Airlines in 2008 and speculation of an US Airways - American Airlines merger lifting US Airways shares. Both airlines are aware of the benefits of a well-executed merger and both are looking to take the place as the world's largest airline ever since United Continental Holdings captured the crown in a merger that has encountered turbulence.  

While I am bullish on US Airways and Air Canada for their future prospects, they remain speculative high risk/ high reward companies as airlines often do. Indeed, this industry makes steady returns difficult and many carriers are eventually forced to restructure to confront rising costs and/or debt levels. But one airline has achieved decades of straight profitability, is growing its network, and recently made a well planned acquisition. That airline is Southwest Airlines (NYSE: LUV).

Building a Better Airline

While other airlines fought with high oil prices in 2007, Southwest looked like the smartest guy in the room for its fuel hedging position. Despite the recession dampening air travel demand, Southwest has recovered much of its losses and is growing again, all while paying a small dividend to its shareholders.

Operating an all Boeing 737 fleet, Southwest is able to save on maintenance costs while continuing to provide its passengers the service required. The airline has also been very proactive in acquiring a modern fleet of the latest generation of 737s to keep fuel and maintenance costs down. Even as Southwest integrates the Boeing 717s it took on in the Airtran merger, it should still see the cost benefits of its 737 fleet while being able to shift the 717s to where they would best serve their purpose.

Southwest has not stood by on the sidelines as the industry consolidates though. The airline acquired discount rival Airtran for over a billion dollars in cash and stock and has begun to integrate the new airline. The acquisition gives Southwest a larger network allowing it to serve more destinations while at the same time reducing discount airline competition. Southwest is also hoping to expand overseas and to Central and South America where the economy and demand for air travel is growing at a rapid pace. For this, Southwest may add some large planes to its fleet as most transatlantic flights utilize aircraft such as Boeing 747s, 767s, and 777s. However, the latest generation of extended range 737s has the range required to fly transatlantic flights so it remains to be seen what action Southwest will take.

Southwest also benefits from a more positive image in the minds of air travel customers and its own employees. With the exception of the PR debacle when maintenance issues surfaced, customers generally think of Southwest as a better airline. For one thing, they offer free checked bags, something customers constantly complain about at the legacy carriers, and Southwest also advertises its lower flight change fees, another thing customers dislike about traditional airlines. Like most of the airline industry, Southwest is unionized, but unlike much of the industry, it enjoys harmonious labor relations. This stands in stark contrast to Northwest Airlines, now owned by Delta Airlines, which has experienced frequent strikes, and Air Canada, where workers staged wildcat strikes despite government orders to the contrary.

Going where there is less turbulence  

As an airline, Southwest operates differently than its competitors. It sheds many of the typical maintenance costs and has a fairly modern fleet. But for this carrier, the track record speaks for itself. With 39 straight years of profitability according to S&P, Southwest has bucked the trend of airline failure repeatedly and continues to grow through acquisitions and international expansion. Southwest is also one of the few airlines to have a rating better than one star here at The Motley Fool, signaling many average investors agree with the airline's potential as well. While there is nothing wrong with speculating on the growth or recovery potentials of traditional airlines, Southwest offers an airline even the risk adverse investor can buy, a rarity in this industry.

 


TulipSpeculator1 owns shares in Air Canada. The Motley Fool owns shares of Southwest Airlines. Motley Fool newsletter services recommend 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. If you have questions about this post or the Fool’s blog network, click here for information.

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