Shares of Southwest Airlines (NYSE:LUV) plunged 5% as of 1:20 p.m. EST on Wednesday, after the low-fare airline giant reduced its first-quarter unit revenue guidance. A downgrade by Goldman Sachs analysts added to the selling pressure.
That said, Southwest is still on track to deliver strong unit revenue growth this quarter, despite the guidance cut. Furthermore, it will face easy comparisons for much of the year -- particularly in the second quarter -- which gives it a good chance to continue growing its earnings. As a result, Southwest Airlines stock is likely to bounce back before too long.
The government shutdown weighs on revenue
Last month, Southwest Airlines projected that revenue per available seat mile (RASM) would increase 4% to 5% this quarter. That included an estimated $10 million to $15 million negative impact from the government shutdown that ended in late January.
While the federal government has reopened, Southwest hasn't experienced the rebound in government-related travel bookings that it expected. On Wednesday, the company said that it now expects a $60 million negative impact from the government shutdown this quarter. This caused it to reduce its quarterly RASM growth forecast to a new range of 3% to 4%.
Southwest Airlines didn't provide any more details on why it thinks the government shutdown is still hurting demand. (One possibility is that government agencies are still catching up on work that was interrupted by the shutdown and have postponed nonessential travel.) It's also not clear whether this was just a forecasting error specific to Southwest Airlines. For example, Delta Air Lines (NYSE:DAL) estimated that it would miss out on about $25 million of revenue per month due to the government shutdown. So far, Delta hasn't updated that guidance.
One analyst worries about Hawaii
The other news item that dragged Southwest Airlines stock down on Wednesday was a big analyst downgrade. Catherine O'Brien of Goldman Sachs cut her rating on Southwest to "sell" and slashed her price target for the stock by 18%, from $66 to $54. She also reduced her full-year 2019 earnings-per-share estimate from $4.70 to $4.45.
Southwest's delayed launch of Hawaii flights was the main reason for this downgrade and price target reduction. O'Brien thinks that the carrier will have to offer big discounts in order to fill its airplanes, given the short window between when ticket sales may begin and when the first flights would take off. That in turn could pressure RASM, causing Southwest Airlines' profit margin to deteriorate relative to rivals.
While the Goldman Sachs analysts think Southwest's Hawaii routes could be successful in the long run, they still believe investors would be better served owning other airline stocks in 2019.
Still poised for solid profit growth
The decline in Southwest Airlines stock on Wednesday seems like an overreaction to the day's news. First, prior to the company's guidance update, analysts had expected Southwest's EPS to surge 19% in the first quarter, to $0.89. Even with lower expected RASM growth -- and higher fuel prices -- the carrier is still in position to post a solid EPS increase this quarter.
Second, the headwind from the government shutdown should dissipate steadily over the next few months. There may be a small impact on revenue next quarter, but trends should have returned to normal by midyear.
Third, Hawaii flights will probably account for about 2% of Southwest's full-year capacity. Even if RASM is just half the systemwide average for those flights, that would only reduce the carrier's unit revenue by around 1 percentage point. Plus, if Southwest Airlines begins Hawaii ticket sales in the next week or two, it would probably need to offer deep discounts for the first half of April and during the off-peak season between Easter and Memorial Day, but there would be plenty of time to capture bookings for the busy summer travel season and beyond.
Fourth, Southwest will benefit from huge RASM tailwinds next quarter. The timing of Easter will boost revenue by $40 million, while suboptimal scheduling and a passenger fatality combined to depress the carrier's RASM in the year-ago period by 3 percentage points. Other major airlines like Delta Air Lines won't benefit from revenue tailwinds of that magnitude.
As a result, Southwest Airlines still seems likely to expand its profit margin in 2019, leading to strong profit growth. It has enough company-specific tailwinds to offset company-specific headwinds like the beginning of its Hawaii flights. That could power a relatively quick rebound for Southwest Airlines stock later this year.