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Why Did Southwest Airlines Stock Outperform Its Peers?

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On Wednesday, Southwest Airlines (LUV) stock rose 1% and outperformed most of its peers’ intraday gains. Delta Air Lines (DAL) and American Airlines (AAL) stocks both fell 0.1%. United Airlines (UAL) shares gained 0.3%.

The stock outperformed the broader market as well. The Dow Jones and the S&P 500 each rose nearly 0.1%. The iShares Transportation Average ETF, which invests in Dow Jones transportation stocks, fell 1.2% on Wednesday. About 20% of the ETF’s portfolio consists of passenger airline stocks.

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Why did Southwest Airlines stock gain?

The upswing in Southwest Airlines stock came after the company reaffirmed its third-quarter outlook for a crucial revenue metric. In an investor update yesterday, the company said that it witnessed strong demand and passenger yield throughout the third quarter.

Therefore, the company reiterated its third-quarter unit revenue growth guidance despite the negative impact of Boeing’s (BA) 737 MAX grounding and Hurricane Dorian. The company still expects the operating revenue per available seat mile, also known as the “unit revenues,” to increase 3%–5%.

Southwest Airlines lowered its estimate for the unit cost growth for the quarter. The airline expects the ex-fuel unit cost to rise 8%–10% instead of the previous guidance range of 9%–11%. The lower unit cost estimate is mainly to shift some maintenance and technology expenses into the fourth quarter.

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MAX grounding to hurt capacity

Boeing’s 737 MAX planes have been facing a global flying ban since mid-March following two fatal accidents within five months. Southwest Airlines has 34 737 MAX planes. The company was supposed to receive 41 more 737 MAX planes this year. Due to the grounding, Southwest Airlines faces thousands of flight cancellations every month. Also, Hurricane Dorian caused nearly 600 flight cancellations in September.

In the investor update, Southwest Airlines said that massive flight cancellations would have a negative impact on its overall seating capacity. The company expects the total capacity to fall 3% YoY in the third quarter compared to the previous forecast of a YoY fall of 2%–3%.

Southwest Airlines thinks that removing its most fuel-efficient 737 MAX jets would have a negative impact on its fuel efficiency. Therefore, the company expects its fuel efficiency to fall 1%–2% in the third quarter.

We expect the MAX grounding to have a negative impact on Southwest Airlines’ third-quarter pre-tax income by over $175 million. Similar to the current quarter, airlines’ MAX fleets were grounded in the second quarter. During the second-quarter earnings announcement, the company revealed a negative impact of $175 million due to MAX cancellations. In the second quarter, Southwest Airlines faced over 15,000 flight cancellations due to the MAX grounding.

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Southwest Airlines isn’t alone. American Airlines, which owns 24 MAX planes, faced over 7,800 flight cancellations in the last quarter. The company also revealed a negative impact of $175 million on its second-quarter pre-tax income. United Airlines owns 14 MAX jets. In the second quarter, United Airlines canceled 3,440 MAX flights.

Analysts’ third-quarter estimates and recommendations

Analysts have a mixed view of Southwest Airlines’ third-quarter financial results. The third-quarter estimates suggest a marginal YoY increase in revenues. Analysts expect the company’s earnings to register a YoY decline. They expect the airline’s third-quarter revenues to increase 1.4% YoY to $5.66 billion. However, the EPS will likely fall 1.4% to $1.06. Analysts expect the pre-tax profit to fall 4.4% YoY to $749.9 million, while the margin is forecast to fall by 80 basis points to 13.3%.

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Despite the unimpressive earnings forecast, the analysts polled by Reuters provided a consensus “buy” recommendation on Southwest Airlines stock. Among the 20 analysts covering Southwest Airlines, about 45% have a bullish stance. Meanwhile, nearly 45% recommend a “hold,” while 10% have a bearish view. The target price of $60.12 represents an expected return of 7% over the next year.

Southwest Airlines’ YTD performance

With a YTD (year-to-date) return of 21%, Southwest Airlines is the top-performing airline stock this year. The company has been able to gain investors’ confidence despite ongoing troubles with its 737 MAX fleets. In the last quarter, Southwest Airlines showed its ability to improve its revenues and earnings despite massive flight cancellations.

During the second quarter, Southwest Airlines’ total seating capacity fell 3.6% YoY due to the MAX grounding. The company’s unit revenues increased 6.8% YoY due to the higher passenger yield and load factor. Southwest Airlines’ second-quarter EPS rose 8.7% YoY. The company expects strong demand and the passenger yield to keep driving its top and bottom-line results in the third quarter.

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