Last week, Southwest Airlines (NYSE:LUV) confirmed what everyone already knew: The low-fare airline's streak of 47 consecutive profitable years ended in 2020. Southwest reported another sizable loss for the fourth quarter, and the company is bracing for an equally poor performance this quarter.
That said, Southwest Airlines has the strongest balance sheet in the U.S. airline industry. Management plans to capitalize on that strength to ensure that the carrier is ready to respond quickly when demand begins to return.
The pandemic bites again
Like most of its peers, Southwest Airlines experienced improving demand trends in October, followed by a deceleration in booking momentum in November as COVID-19 case counts rose. Management noted that demand was much stronger during holiday weeks than during off-peak periods. Due to these trends, revenue plunged 65% year over year to $2 billion for the fourth quarter. Southwest posted an adjusted net loss of $761 million ($1.29 per share), narrower than the $1.68 per share loss analysts were expecting.
Importantly, core cash burn averaged $12 million a day last quarter. That was $1 million worse than the company's initial quarterly guidance, but in line with its Q3 performance. Including cash severance payments and working capital changes, Southwest averaged cash burn of $15 million per day last quarter.
Southwest Airlines' weak booking trends have continued into 2021. Even in normal years, January and February are seasonally weak months for air travel. As a result, management has forecast that core cash burn will accelerate to an average of $17 million per day this quarter. That said, Southwest expects to benefit from working capital improvements toward the end of the quarter, as customers start booking spring and summer travel in greater numbers.
Striking the right balance
While Southwest Airlines has typically been one of the most profitable U.S. airlines, it hasn't been the best in the industry at minimizing cash burn. That's partly by design, though.
Southwest has the strongest balance sheet of any airline. It had $13.3 billion of cash and investments at the end of 2020, offset by $10.3 billion of debt (and $1.9 billion of lease liabilities). That gives it lots of financial flexibility. The company doesn't have to cut costs to the bone to minimize near-term cash burn if that might compromise its ability to recover. As CEO Gary Kelly said during Southwest's recent earnings call:
... [W]e have every reason to be hopeful that this, too, shall pass. And when it does, we will be ready ... [for] a resurgence in traffic and revenues. ... So there's a balancing act here, and we're balancing a desire to conserve cash and minimize our losses, which requires that we operate at a reduced schedule, as compared to the need and the ability to achieve breakeven by generating more traffic, and we can only do that by offering more flights. So getting that balance is key, and we're intensely focused on that.
In the near term, weak air travel demand means that there's no reason to add flights. However, that could change quickly. Whereas many U.S. airlines are implementing deep structural cost reductions, Southwest has focused on adding new markets to its route network, entering new distribution channels to boost its share of business travel, and other efforts designed to get back to 2019 revenue levels as soon as possible.
The share price has already recovered
While Southwest Airlines stock remains down nearly 20% compared to its year-ago price, the company issued new shares and convertible debt last year to shore up its balance sheet. As a result, its market cap has fallen just 7% over the same period.
Going forward, Southwest Airlines' industry-leading balance sheet and market share initiatives -- along with the Boeing 737 MAX's return to service -- could potentially allow the carrier to emerge from the pandemic more profitable than ever. However, given how much other airlines slashed their costs in 2020, investors should also prepare for the possibility that Southwest's cost advantage will be smaller going forward. That could weigh on its profitability.
Thus, following the rapid recovery in its valuation, Southwest Airlines stock looks fairly valued. Unless Southwest can show more tangible evidence that it will be able to earn higher margins in the future than it did in 2019, investors should wait for a better price before investing in this popular airline.