Southwest Airlines (NYSE:LUV) is flying high. The latest quarter, the 54th straight quarter of profitability, yielded a 12.3% increase in net income despite higher fuel prices, hurricanes, and a weak airline environment. Analysts were expecting no increase in net income.
The company is warning that its "revenue environment has softened since July," and the passenger revenue yield per revenue passenger mile is below year-ago levels. Said plainly, revenue increased 7.8% while expenses rose 8.4% -- not a good trend.
Those looking for positive free cash flow will be disappointed. Net cash provided by operations was $1.21 billion, while capital expenditures were $1.37 billion.
Still, the company is "pleased with its competitive position." Really? With 80% of fuel costs hedged through 2005 at the equivalent of $25 a barrel of oil, why wouldn't you be pleased? But, with such an operating cost advantage, where's the free cash flow? Remember, this is the airline industry, and the company's trailing return on equity (ROE) is a mere 6.7%.
There is no disputing that Southwest is making money quarter after quarter. What is worth discussing is whether that earnings power is worth 32 times estimated 2004 earnings.
Some will be quick to note that Motley Fool Stock Advisor recommendation JetBlue (NASDAQ:JBLU) sells for 40 times 2004 estimates. With a ROE that is 2.5 times higher and a significant advantage in filling seats -- September's load factor was 63.2% at Southwest and 76.6% at JetBlue -- a marketplace premium is warranted.
Short term, low-cost airlines such as Southwest and AirTran (NYSE:AAI) are making pricing miserable for legacy airlines such as AMR's American (NYSE:AMR), Delta (NYSE:DAL), and Northwest (NASDAQ:NWAC). Bankruptcies at United parent UAL and US Airways will cause those airlines to shrink in size and help build load factors for the survivors.
But, long term, it seems as though every airline wants to morph to the discount business model. Add in a well-funded Virgin venture ready to launch, and the competitive landscape gets even more complex.
Southwest is flying high now, although cost trends are not favorable. The stock, because of its industry's history, hardly warrants a premium earnings multiple to the market.
Fool contributor W.D. Crotty does not own stock in any of the companies mentioned -- as you might have guessed.
