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Southwest Airlines Stock Up 18% This Year: What’s Next?

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Southwest Airlines (LUV) stock, which has been impacted by labor disputes and Boeing’s (BA) 737 MAX crisis, has managed to rebound. In fact, Southwest stock has emerged as a leader in the airline industry, with a YTD (year-to-date) return of 17.7%. It has outperformed the Dow Jones Industrial Average and the iShares Transportation Average ETF (IYT), which have gained 14.9% and 10.6% YTD, respectively. Approximately 20% of IYT is allocated to the passenger airline industry.

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Most of its peers have failed to keep up with the broader market. Among major US carriers, Spirit Airlines (SAVE) and American Airlines (AAL) have been the weakest this year, losing about 37% and 16% of their market capitalization, respectively. Major peer United Airlines (UAL) has gained 5.5% YTD. Southwest’s US peer, Delta Air Lines (DAL), has also outperformed the Dow Jones, returning 16.2% YTD.

Analysts change stance on Southwest Airlines stock

Reuters-polled analysts seem optimistic about Southwest’s near-term stock performance, can foresee it rising by a double-digit percentage. Their stance became more bullish after the airline released better-than-expected Q2 results on July 25. The company’s top and bottom lines improved YoY (year-over-year) despite the MAX fiasco.

Before Southwest’s Q2 release, about 43% of analysts covering its stock rated it as “buy” or equivalent. That proportion increased to 50% after the release. Their average target price for Southwest stock has also increased in the last two month, by $1.32 to $60.82, which suggests an 11% upside over the next year.

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Two analysts have also upgraded Southwest stock. On September 13, Macquarie analyst Susan Donofrio raised her rating on the stock to “outperform” from “neutral,” and increased its target price by $15 to $67. Meanwhile, Bank of America (BAC) analyst Andrew Didora believes Southwest has a better cost structure than rivals such as American Airlines and Spirit Airlines. He thinks its margins could improve despite the expected slower demand and higher capacity for next year.

The Street reports Didora wrote in a note to clients, “we prefer the airlines that have the cost structure to drive margin expansion, like Buy-rated UAL and LUV.” He upgraded Southwest stock to “buy” from “neutral” and increased its target price to $65 from $58.

What’s ahead for the stock?

In regards to Southwest Airlines stock, we believe the 737 MAX issues may have been overblown. Southwest, which owns 34 MAX, has faced over 20,000 flight cancellations since the planes were grounded after two deadly accidents.

Although the grounding impacted the airline’s second-quarter pre-tax income by $175 million, Southwest has shown it can still grow. The company’s Q2 revenue and earnings rose 2.9% and 8.7%, respectively, despite capacity falling 3.6%. Its revenue per available seat mile rose 6.8% YoY to $0.1478 in the second quarter. The company’s passenger yield grew 4.2%, while its load factor improved by 1.7% YoY.

Southwest stated that it benefited from healthy leisure and corporate demand in Q2. We think higher ticket fare also boosted its revenue. On June 13, JPMorgan Chase revealed Southwest had hiked its ticket fares twice in the second quarter.

Southwest’s shareholder-friendly moves make it attractive to investors. The airline returned $1.2 billion through share repurchases and dividend payments in this year’s first half.

In May, Southwest increased its quarterly dividend by 12.5% to $0.18 per share, and approved a new $2 billion share repurchase program. In the last ten years, the company’s quarterly dividend has risen 40 times, the most among its top peers. Delta’s dividend has increased seven times since 2013, and American’s has stayed at $0.10 since 2014.

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