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What Southwest Airlines’ Current Valuation Tells Us

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Jul. 25 2017, Updated 6:37 a.m. ET

Current valuation

Currently, Southwest Airlines (LUV) is valued at 6.8x for its forward EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratio. Its current valuation is slightly higher than its average valuation of 6.3x since October 2008.

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Peer comparisons

Southwest Airlines is trading at a multiple that’s higher than all its peers, which shows investor confidence in LUV. American Airlines (AAL) is trading at a similar valuation of 6.8x for its EV-to-EBITDA multiple, while Alaska Air (ALK) is trading at a multiple of 6.7x. Spirit Airlines (SAVE) is trading at a valuation of 6.3x. Delta Air Lines (DAL) has improved in the past few weeks, rising to 5.9x from an industry low valuation of 5.4x. JetBlue Airways (JBLU) is trading at a valuation of 5.8x, and United Continental (UAL) currently has the lowest valuation of 5.1x.

All legacy carriers are expected to record a fall in EBITDA for 2017. AAL’s EBITDA is expected to fall 1.1%, DAL’s is expected to fall 4.3%, and UAL’s is expected to fall 9.0%. Niche player ALK’s EBITDA is expected to rise 14.5%; however, this growth is mostly inorganic. Southwest Airlines’ EBITDA is expected to fall 3.3%, while JBLU’s EBITDA is expected to fall 7.5%. Spirit Airlines is the only carrier expected to record EBITDA growth at 9.9%.

Our analysis

Valuation multiples depend on perceived risk and thus investors’ willingness to pay.

In the short term, Southwest Airlines’ ability to outperform the industry on the key metric, unit revenues, will drive its valuation. As we already saw, a small blip in the metric sent the stock plummeting 6.0%.

The long-term valuation multiple, however, will be affected by macro trends such as economic growth (the key growth driver for airline demand) and a rise or fall in the price of crude oil, which was once a major cost for airlines and the reason for their distress.

You can gain exposure to airlines through the iShares Transportation Average (IYT). IYT holds 4.2% in Alaska Air (ALK), 3.9% in United Continental (UAL), 3.8% in Southwest Airlines (LUV), 3.6% in Delta Air Lines (DAL), 2.8% in American Airlines (AAL), and 1.7% in JetBlue Airways (JBLU).

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