Months after the coronavirus stock market crash, investors continue to hunt for bargain-priced blue chips. And the initial rollout of Covid-19 vaccines from the likes of GlaxoSmithKline (GSK), Moderna (MRNA), Pfizer (PFE) and Germany’s BioNTech (BNTX) are generating more confidence among investors that the airline industry will, in time, recover.
Southwest Airlines (LUV) continues to show choppy action yet continues to rebound.
And on Friday, the stock is attempting a breakout past a proper buy point amid better price action among its peers. Shares are working on a 13.9% gain for the week and are retaking the key 10-week moving average.
After the company reported Q1 results on April 28 last year, shares slumped as much as 24% in rapid turnover and hit their lowest levels since April 2014. But since then, shares have bounced 123% from its mid-May low of 22.47. Plus, the stock has succeeded in overcoming upside resistance at its long-term 200-day moving average. That 200-day line has been rising as well.
LUV stock got smacked with selling in late January after reporting weak quarterly results. A net loss of $1.29 a share in Q4 marked the fourth straight money-losing quarter. Yet investors have applauded Southwest’s decision to take steps to reduce cash burn.
LUV stock reclaimed the key 50-day moving average on May 26 for the first time since Feb. 21 — when the IBD current outlook for stocks was still at “market in confirmed uptrend.” Go to a weekly chart, and you’ll see shares have led the nearly equivalent 10-week moving average higher for months.
LUV Stock: Still Flying Higher Since April
So at this point, is LUV stock, now trading 15% below a 52-week peak and at a 25% discount vs. its all-time high of 66.98, a buy now? Can Southwest Airlines, entering 2021 in its 50th year of service, navigate through the world’s most turbulent health crisis in generations to grow and win market share?
Let’s take a value investing angle and a growth investing perspective. This story also assesses how LUV stock is performing vs. its airline industry peers. Finally, institutional ownership, a critical ingredient in the CAN SLIM seven-point investment system, will get graded.
Southwest Airlines History: Treat Employees, Customers With ‘LUV’
The company got off the ground after winning a protracted legal battle with Texas International and Continental Airlines. It began service with $20 one-way fares from its home base of Dallas to both Houston and San Antonio on June 18, 1971.
By the end of September that year, Southwest received its fourth aircraft. Then in November, the company “closed the triangle” by launching flights between Houston and San Antonio.
Amid humble origins, Southwest touted itself as the “love airline.” Founder and longtime CEO Herb Kelleher led a culture of treating employees with love, like they’re family members. They, in turn, will treat customers with great service, Kelleher argued. He died while still serving as chairman emeritus in January 2019.
Five decades later, Southwest is a North American aviation giant. Before Covid-19 hobbled the air transport market, Southwest served 130 million passengers annually and operated more than 4,000 weekday departures through its network of 102 U.S. destinations and 10 countries.
Human Rights Campaign Foundation named Southwest a “Best Place To Work” for the LGBTQ community with a 100 rating on its 2020 Corporate Equality Index. The index rated 1,059 businesses.
LUV stock debuted on the NYSE on June 8, 1971; it priced 650,000 shares at 11 a share. That gave the young firm $6.5 million in gross proceeds.
Today, LUV stock holds a market value of $28 billion, 590.3 million diluted shares outstanding and a float (a term meaning freely traded shares on a stock exchange) of 584.4 million. That tops a 4,300-fold increase in shareholder value, even after recent coronavirus devastation.
The Worst Year For The Airline Business In Decades
In 2020, the economic plunge forced Southwest Air to cancel 1,500 of almost 4,000 flights per day, starting on April 14. The NYSE-listed firm agreed to get $3.2 billion in financial aid, including almost $1 billion as an unsecured loan, from the federal government’s CARES Act. In an April 2020 video, CEO and Chairman Gary Kelly said $2.3 billion would support staff payrolls. In return, Southwest must offer 2.6 million warrants (rights to buy shares at a sharp discount) to the government for up to five years. It agreed to limits on executive pay through March 2022.
The deal also bars LUV stock from issuing common dividends or share buybacks through September 2021.
Liquidity is of paramount importance for the airline sector.
On June 3, Southwest priced an offering of $500 million in senior debt with a 4.75% coupon due 2023 as well as $1.3 billion worth of 5.125% notes due in 2027. These debt sales supplement a May 4 issuance of $750 million in 4.75% bonds set to mature in 2023.
Southwest Stock: Great Value Investment?
LUV stock has not seen this kind of correction since it dropped from 14.32 to 7.15 over a yearlong slide ended in October 2011. (Please go to MarketSmith to see a historical chart of LUV stock, all the way back to its 1971 IPO.)
With the benefit of hindsight, at that low of 7.15, Southwest stock traded at nearly 13 times the 56 cents a share earned in 2012. In 2013, LUV doubled profit to $1.12 a share. In short, the stock at one point had traded as little as six times its 12-month-forward earnings.
Top value fund managers tend to scoop up sturdy companies with price-to-earnings ratios that fall to a fraction of what the S&P 500 is priced.
Today, the large-cap benchmark trades at 3883, or almost 23 times the operating earnings estimate of $170 this year as of Feb. 1 by Yardeni Research.
Analysts think Southwest will lose $1.77 a share this year. That’s a far cry from the $6.22 a share it lost in 2020, easily the worst result in at least 20 years. But early in 2020, the Street had expected a net profit of more than $3 a share for 2021.
Value investors can make the mistake of grabbing shares in a company with weakening financials. High debt, shrinking cash flow and declining sales can force a stock to hit lower lows. If a company files for bankruptcy protection, the stock can fall to zero.
From the IBD point of view, Southwest shows financial strength.
Earnings rose slightly to $4.27 a share in 2019 as sales lifted 2% to $22.43 billion. In a Jan. 23, 2020, Q4 conference call with analysts and reporters, CEO Gary Kelly noted the grounding of 75 Boeing 737 MAX jets, or 10% of its fleet, cut annual operating income last year by $828 million. Despite this Boeing (BA)-inspired 737 MAX debacle, Southwest still scored operating cash flow of $6.97 a share, the highest in at least nine years. That topped EPS of $4.45 by 56%. In a word, amazing.
And before Covid-19, Southwest has been able to boost its operating performance without going heavily into debt. Long-term debt at the end of 2019 vs. average shareholders’ equity over the past two years stood at a low 19%. That’s down from 28% at the end of 2018 and 34% in 2017, according to IBD’s database.
LUV Stock Fundamentals Vs UAL, DAL, AAL
United Airlines (UAL), which reported disappointing fourth-quarter results, showed a long-term debt to equity ratio in 2019 of 116%. United trimmed it from 145% in 2017. Delta (DAL) cut its D-to-E ratio to 58% in 2019. But at the end of 2020, Delta’s long-term debt ballooned to $27.4 billion, including so-called “finance leases.”
American Airlines (AAL) does not have a calculable ratio; it posted a net shareholders deficit (negative equity) of $118 million in December. As of the end of 2019, American Airlines held $21.45 billion of long-term debt.
Good operating cash flow allows companies to reward long-term shareholders with cash distributions.
On March 25, Southwest paid a quarterly dividend of 18 cents per common share to shareholders of record on March 4. That marked the company’s 174th consecutive cash payout to holders. The annualized yield has been trimmed to 1.9%, roughly in line with the S&P 500.
No new dividends have been declared since then.
LUV Stock Fundamentals: The Growth Investing Perspective
IBD research into the biggest stock market winners finds they tend to show a solid string of quarterly gains in earnings and sales for at least a few quarters before they break out and go into big price runs. The only exception? Turnarounds.
But even for a growth investor, one would prefer to see at least one quarter of year-over-year increases in profits and sales before putting cash to work. This is called meeting the C in CAN SLIM, or a minimum 25% increase in current quarterly earnings per shares vs. a year ago.
In the fourth quarter of 2019, Southwest posted a penny dip in earnings to $1.16 a share. Sales inched up less than 1% to $5.73 billion.
Big stock winners also typically show a 25% increase in annual profits over the past few years (the A in CAN SLIM) before they break out to new highs. Looking at top stocks ranking in the IBD 50, IBD Big Cap 20 and IBD Sector Leaders, the latest EPS increase can well exceed 25%.
According to MarketSmith, mutual funds stood at 1,490 in the December-ended quarter vs. 1,720 at the end of 2019. Parnassus Core Equity Investor (PRBLX), Fidelity Growth Company (FDRGX), Calamos Growth (CVGRX) and Optimum Small-Mid Cap Growth (OISGX) own shares. IBD ranks them all with an A or A+ for outstanding three-year performance.
LUV Stock Chart Analysis
Since the IBD current outlook for stocks darkened fast from “uptrend under pressure” on Feb. 24 last year to “market in correction” in the Feb. 25 Big Picture column, LUV stock has suffered a terrible drop.
On Feb. 24, 2020, the stock gapped down and fell 4.3%. It also tripped below the 50-day moving average in heavy volume. That triggered a key sell rule. The next day, LUV stock got bombarded by institutional selling. LUV sank 8.2% to 49.66; turnover accelerated. By day’s end, volume jumped 119% above its 50-day average of 4.3 million shares.
In a nutshell, large fund managers were storming the exits. When institutions take profits en masse, savvy individual investors do the same.
How about now?
Southwest Airlines stock has clearly bottomed out and has completed a well-formed base. Meanwhile, the IBD current outlook for stocks stands at confirmed uptrend since a Nov. 4 follow-through day by the Dow industrials.
Since December, LUV stock showed a much milder decline while getting support at the 10-week moving average; it had the look of a handle.
A handle identifies the final shakeout of uncommitted shareholders; a relatively light number of shares move to stronger hands. Now, the supply of shares that investors are anxious to surrender has shrunk even more. So when heavy institutional demand returns, the stock jumps sharply, triggering a breakout.
In a good cup with handle, find the proper buy point by adding 10 cents to the highest price within that handle. In a strong breakout, LUV stock should glide past that buy point and keep running. A 40% minimum jump in volume vs. the 50-day moving average indicates that mutual funds, hedge funds, banks, pensions, insurers and the like are hopping aboard. They’re anxiously grabbing shares and building a large position over time.
The top of this handle, 49.53, plus 10 cents, offers a potential breakout point at 49.63. But even if Southwest flies past that price, it would still be trading well below its 52-week high of 58.83.
Surely, the handle is showing improvement; for starters, it had wedged higher along the lows, a no no. But in the past few weeks the handle features a solid shakeout and a downward slope along the lows. The two recent down weeks showed just a mild pullback. This points to strengthening institutional demand.
Relative Strength Analysis
LUV stock shows a relative strength line that started plunging in late February. In recent weeks, this useful technical tool has been treading water. The RS line, drawn in blue in all IBD stock charts, tracks a stock’s daily price performance vs. the S&P 500.
A rising RS line means a stock is beating the key large-cap benchmark, even during market declines. True stock market leaders show a rising RS line at the start of a big rally. And some even show an RS line hitting new high ground even before the stock itself makes a powerful breakout past a correct buy point.
According to IBD Stock Checkup, Southwest stock gets a 22 IBD Composite Rating on a scale of 1 (horrid) to 99 (heavenly). The IBD Composite Rating assesses fundamental, technical and fund ownership factors. In a new bull market, stocks with a 90 Composite or higher tend to lead the run.
The Accumulation/Distribution Rating is now at C on a scale of A to E. A C grade indicates that buying and selling among fund managers is neutral over the past 13 weeks. An E grade means that institutional investors have been net sellers.
Southwest’s 65 Relative Strength Rating, up from 29 five months ago, is improving quickly. The biggest stock market winners tend show an RS Rating of 80 or higher before they break out to 52-week highs. But among companies that have built longer bases and moved sideways or lower over a period of 12 months or more, it’s common for turnaround stocks to break out while the RS Rating is in the 50s or 60s.
The relative strength line has risen sharply in the past couple weeks, a good sign.
One More Way To View The Chart Action
In Friday early afternoon trading, shares gained more than 3% to 50.62; volume boosted nearly 39% above usual levels. The 50-day moving average is 7.5 million shares exchanging hands each day.
So, despite poor IBD ratings overall, as a turnaround play, LUV stock is a buy now. From a 49.63 entry, the 5% buy zone goes up to 52.11.
Also, keep watching to confirm that the stock rallies out its deep bottoming pattern with heavy volume and power.
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