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What Investors Should Know about Southwest


Jul. 31 2015, Updated 8:06 a.m. ET

Leader in its segment

Southwest Airlines (LUV) has a track record of 42 consecutive years of profitability. Apart from this, the company has a strong and low cost business model, which translates into lower fares for customers. The company is the only carrier to offer no-fee baggage checking. It also ranks among the top three airlines in terms of customer service. It is the only airline company with an investment-level ranking.

Plus, the company’s stock returns have surpassed index returns in the past. In the past five years, Southwest’s investors have gained 197%, which is better than the iShares Transportation Average ETF’s (IYT) returns over the same period.

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Increasing margins

Southwest’s focus on reducing costs and a decrease in crude prices have helped the company improve its margins. EBITDA (earnings before interest, taxes, depreciation, and amortization) margins have continuously improved for the last four quarters. For 2Q15, EBITDA margin stood at 26% as compared to 20% in 2Q14.

Improving returns

On the financial side, the company has very little long-term debt and maintains a healthy balance sheet. It has been successful in generating consistent returns, and its key indicators have been on the growth trajectory. The company’s post-tax return on invested capital (or ROIC) for 2Q15 stood at 19%, which is substantially better than last year’s 11%.

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Strong cash generation and low debt ratios

Southwest had about $3.1 billion in cash and short-term investments at the end of the first half of the year. The company was also successful in generating a strong $1.0 billion in free cash flow for the first half of the year, which indicates efficiency of its business.

The company repaid $40 million in debt during the quarter and is expected to pay $95 million in debt and capital lease obligations during the rest of the year. The company has a very low debt-to-equity ratio of about 0.39, which is indicative of successful management of debt levels.

Increasing dividends and share repurchases

The company has seen good cash flows and reduced expenses that enable it to pay better dividends. The company’s dividends are relatively small, but they have been growing consistently. The company returned $430 million to its shareholders through dividends and share repurchases during the second quarter and $811 million during the first half of 2015. During the second quarter, the company authorized a new $1.5 billion share repurchase program, along with a 25% hike in its quarterly dividend.

Investors can gain exposure to airlines that have a positive growth trend through the iShares Transportation Average ETF (IYT). These airlines include Delta (DAL), American Airlines (AAL), United Continental Holdings (UAL), Southwest Airlines (LUV), and JetBlue Airways (JBLU). IYT holds ~38% in airline stocks and ~3% in Delta. You can also invest in the SPDR S&P Transportation ETF (XTN).


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