I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.
Next up: Southwest Airlines
|Motley Fool CAPS stars (out of 5)||****|
|Bullish pitches||242 out of 286|
|Highest-rated peers||Deutsche Lufthansa, GOL Linhas Aereas Inteligentes, Republic Airways|
Data current as of Nov. 30.
Suddenly, airlines aren't the awful business they used to be. Fuel prices have moderated. Capacity is down. Fares are up. And one-time competitors are now banding together. All of it is conspiring to produce profits the industry hasn't brought in a long while.
Still, ask Fools which airline they'd choose to own if they had to own one, and chances are they'd select Southwest. Three-fourths of those I surveyed in September predict the carrier's merger with AirTran will create value.
"[Southwest] has consistently shown great management in good times and bad. Best airline business model on the planet. New labor agreements allow larger 737's, purchase of AirTran opens [Southwest] to international destinations in the Caribbean and Mexico," CAPS All-Star investor Jeffreyw wrote last month.
He goes on to point out that labor relations are crucial in any industry, but airlines especially. Southwest has forged an unusually strong bond with its employees.
The elements of growth
Past 12 Months
|Normalized net income growth||Not measurable||(17.3%)||(73.7%)|
|Shares outstanding||747.1 million||742.8 million||740 million|
Source: Capital IQ, a division of Standard & Poor's.
The company is also showing strength in its financial results. Let's review:
- Revenue and normalized net income have bounced around not so much because of anything Southwest did (or didn't) do, but because of the widespread misery inflicted by the Great Recession.
- Two things Southwest can control are pricing and capacity. Management's effectiveness in these areas is reflected in rising gross margin. Higher returns on capital also speak to executives' skill at maximizing profits in a tight economy.
- I'm also encouraged to see Southwest's cash flow growing faster than revenue, which appears to be aiding cash collections. The carrier has produced more than $1.2 billion in free cash flow over the trailing 12 months.
Competitor and peer checkup
Normalized Net Income Growth (3 years)
Delta Air Lines
Source: Capital IQ. Data current as of Nov. 30.
Southwest badly trails several of its peers in normalized net income over the past three years, including rising regional star Allegiant Travel.
And yet looking back in this way may not say much about the future. Today, Southwest is managing expenses more carefully than in years past and is about to combine operations with AirTran. Resulting efficiencies could dramatically alter the combined carrier's profit picture.
"Could" is the key word there, of course. AirTran could make Southwest a better airline. Either way, the days of heady growth in the airline business have long since come and gone. If you're going to bet on Southwest, realize you're betting that the merger will unlock value Wall Street hasn't yet priced into the stock. Nothing more. Nothing less.
Now it's your turn to weigh in. Do you like Southwest Airlines at these levels? Let us know what you think using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.
Interested in more info on Southwest Airlines? Add it to your watchlist by clicking here.