Shareholders at AMR
That being the case, there was much less hoopla around Southwest's earnings report yesterday, but the company managed to post double-digit sales and earnings gains. Our Fool by Numbers will walk you through the fourth-quarter specifics; on a full-year basis, the company grew revenues 20% to $9.1 billion, while net income grew 38% when including the benefits from hedging jet-fuel costs.
So what is it that allows Southwest to post consistent profitability in an industry known for destroying shareholder value over the long term? Well, according to the company's 2005 10-K (look for the 2006 release within the next couple of months): "The company's low-cost competitive advantage, protective fuel hedging position, and excellent employees will allow Southwest to continue to react quickly to market opportunities."
The company's low-cost bias is a thing of wonder, subject to numerous case studies and often compared to other well-respected company models such as Dell's
Southwest's employees are also seen as key advantages, as their work ethic and friendly attitudes help keep customer satisfaction high. Then there are the fuel hedges that have allowed the company to stay in the black as record-high oil prices and terrorist attacks make industry conditions even more challenging.
In its recent earnings release, CEO Gary Kelly detailed that Southwest is 95% hedged for oil prices of $50 per barrel for 2007 and has various hedge percentages through 2012. Oil price concerns may have eased for the time being, but at least investors have visibility into Southwest's fuel costs for another five years.
The company also has firm commitments or options to grow its airline fleet nearly 50% over the next decade. That means it has plenty of room to keep expanding its business, something that has occurred steadily since its first flight in 1971.
It's also worth noting that Southwest's net income numbers are not the best reflection of its cash-generating capabilities. Over the past four fiscal years, operating cash flow has exceeded net income by a wide margin. Nearly all those internally generated funds are reinvested into purchasing new aircraft and growing the business, but that is to be expected of a firm with plentiful growth opportunities.
In other words, the forward P/E of 17.4 is not the most accurate way to determine whether the shares are a good value. As free cash flow is currently minimal due to the high levels of capital expenditures, one way to back into a cash flow number is to add depreciation and amortization to net income to differentiate between growth and maintenance capex (as explained by Whitney Tilson back when AMR last posted positive EPS). Based on the just-reported 2006 figures, that would more than double reported net income, implying that Southwest is trading for about 12 times trailing cash flow.
And that doesn't take into account the company's projected growth going forward. I have more tire-kicking to do, but Southwest Airlines is flying on my own radar screen, as it has plenty of remaining investment appeal after 34 years of steady growth.
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Fool contributor Ryan Fuhrmann is long shares of Dell but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.