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Why Southwest Excluded Hawaii from Its Fare Hike

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JPMorgan Chase analyst Jamie Baker revealed on October 10 that Southwest Airlines (LUV) had excluded Hawaiian flights from the recent fare hike across its network. It may have excluded the flights from the hike due to its aggressive expansion plan across the route. The company received approval to fly its planes from four Californian cities to the Hawaiian Islands in March this year. The Hawaii route is believed to be more profitable due to less competition.

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Hawaiian Airlines (HA) and Alaska Air Group (ALK) are the two US carriers that have dominated the route for years. However, after receiving the license in March, Southwest is trying to establish its market share. The company is offering one-way tickets for as low as $99. Before Southwest’s entry into the Hawaiian market, fares were almost double.

However, Southwest’s expansion plan in the region has been hampered by the global flying ban on Boeing’s (BA) 737 MAX planes. Earlier, the company had previously planned to fly only 737 MAX aircraft across the Hawaiian route due to their fuel efficiency. Nonetheless, Southwest is still trying to expand its operations through its older Boeing 737-800 fleets.

We believe once regulators lift the ban on MAX planes, Southwest will more aggressively expand its operations across the region. The company currently owns 34 MAX jets. Once Boeing receives safety approval for the model, Southwest will soon receive a delivery of 41 aircraft. The shipments will bring Southwest’s total MAX count to 75 and enormously increase its seating capacity. The addition of new planes should help Southwest further penetrate the market with its low-fare strategy.

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Southwest ticket fare hike

Citing Baker’s report, Business Journal revealed yesterday that Southwest raised its one-way domestic fare by $5 on October 1. The analyst further stated that Delta Air Lines (DAL) and American Airlines (AAL) had followed Southwest’s lead.

Per Business Journal, Baker said that JPMorgan doesn’t usually report fare hikes, as they may not stick around for long periods of time. However, it’s a slightly different case with Southwest, as fare hikes led by the airline usually stick.

“We are hard-pressed to identify any Southwest-blessed, broad-based fare increase that the industry didn’t adopt, having monitored such efforts for over two decades,” Baker wrote in his note. He added, “That doesn’t mean there isn’t an exception, just that we can’t find one.”

The latest move by Southwest Airlines is the second broad-based fare hike adopted by the company this year. Last time Southwest raised its fares was in May following American Airlines’ move to raise ticket prices by $5. Delta, United Airlines (UAL), and Alaska Air also increased ticket prices in May.

Baker believes that strong domestic travel demand and constrained capacity due to grounded Boeing 737 MAX planes are supporting airlines’ ticket fare hike strategies. Boeing’s 737 MAX planes have been facing a global flying ban since mid-March following two deadly accidents within five months of each other. Southwest, American, and United together own 72 MAX aircraft. According to OAG estimates, these three carriers will lose 6.3 million in seating capacity if MAX remains grounded until October.

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Stock investment opinion

Southwest Airlines stock, which has been hit by Boeing’s 737 MAX crisis and labor disputes, has managed to rebound. In fact, with a YTD (year-to-date) return of 15.5%, Southwest is one of the top performers in the airline industry. The stock has outpaced the Dow Jones Industrial Average and the iShares Transportation Average ETF (IYT), which have gained 13.6% and 9.6% YTD, respectively.

In contrast, the majority of Southwest peers have failed to keep the pace with the broader market. American Airlines is among the worst performers, with its shares falling 15.4% YTD. Delta and United stocks have gained 6.4% and 4.3%, respectively.

Analysts’ stance on Southwest Airlines stock has become more bullish following the company’s better-than-expected second-quarter results. Before its second-quarter results, approximately 43% of the 21 analysts covering Southwest rated it as a “buy” or equivalent. The bullish percentage has increased to 50% as of October 11. Analysts’ average target price has also increased since its last quarterly results by $1.87 to $60.56.

Last month, two prominent Wall Street analysts gave Southwest Airlines stock rating upgrades. Susan Donofrio of Macquarie raised her rating on the stock to “outperform” from “neutral” and increased its target to $67 from $52. Bank of America (BAC) analyst Andrew Didora upgraded the stock to “buy” from “neutral.” He now has a price target of $65, up from his previous expectation of $58.

Didora believes Southwest has a better cost structure than its rivals. In his opinion, the company’s margins could improve despite forecasts of slower demand and higher capacity for next year. The analyst wrote to clients, “We prefer the airlines that have the cost structure to drive margin expansion, like Buy-rated UAL and LUV,” according to a September 23 report by TheStreet.

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