A surge in Covid-19 cases may be putting a damper on travel plans for the Thanksgiving and Christmas holidays. Peering out further, a Jefferies analyst sees gains ahead for Southwest Airlines, initiating the carrier with a Buy rating and $55 price target.
Airline stocks have gotten a booster on positive Covid-19 vaccine news from Moderna (ticker: MRNA) and Pfizer (PFE). But a vaccine-related revenue bounce hasn’t yet materialized, according to Citigroup, and near-term booking trends may be weakening.
Revenue per mile, a measure of sales, was down 64% year over year in October, according to Citi. Tickets booked for travel in November and December over the last seven days were down 60% and 56%, respectively, with pricing “under significant pressure.”
The recent surge in Covid cases—topping more than 160,000 a day—looks likely to disrupt an end-of-year recovery, Citi analyst Stephen Trent writes. He sees demand coming under pressure due to new Covid-related restrictions in the Midwest and other regions, including states such as Michigan, California, North Dakota, Oregon, and New Mexico.
Airlines report revenue when they fly a passenger, not when they purchase tickets, he notes. If passengers cancel flights over the holidays, it could result in fourth-quarter revenues coming in weaker than expected.
Nonetheless, Jefferies sees gains ahead for Southwest (LUV). Analyst Sheila Kahyaoglu launched coverage of the carrier with a Buy on Tuesday, seeing a few key advantages for the airline over its large-network rivals.
For one, Southwest is almost entirely domestic focused, with more than 95% of sales from domestic flights. That compares to a 55% domestic revenue average for large network peers such as Delta Air Lines (DAL), United Airlines Holdings (UAL), and American Airlines Group (AAL).
Domestic leisure travel is leading the recovery and it’s expected to account for most industry revenue in 2021 as business and international fares take longer to rebound.
Kahyaoglu also likes Southwest’s strong liquidity and low leverage ratios, which she argues should position the company to outperform and take market share coming out of the pandemic. She expects Southwest’s 2023 revenue to be 1% below 2019 levels versus a 13% deficit for rival carriers. If Southwest can take two points of market share, it should be worth $1.8 billion of incremental revenue in 2023, she estimates, adding an additional 50 cents to earnings per share.
Granted, these views aren’t entirely out of consensus: Southwest is widely considered the strongest of the big airlines with the best shot at gaining share, and its multiples reflect that strength. It trades at 16 estimated 2022 earnings per share. That is well above Delta at 9 times and United at 10 times. American is barely expected to turn a profit in 2022, giving it a price-to-earnings ratio of 182.
Nonetheless, Kahyaoglu sees about 21% upside in Southwest stock. Her $55 price target values the stock at 14.4 times enterprise value to Ebitda (earnings before interest, taxes, depreciation, and amortization), based on estimated 2022 Ebitda. That would put the stock at a 50% discount to its average multiple over the last three years, compared to a 45% industry-average discount. Shares of Southwest were trading for about $45 on Tuesday.
Kahyaoglu sees scant gains for the other major carriers. She launched coverage on Delta and United with Hold ratings, and came out with an Underperform on American, expecting that carrier’s shares to decline to $10, falling from recent prices around $12.70. She sees American’s 2023 revenues coming in 17% less than 2019 levels, which would be well below the industry average.
Write to Daren Fonda at [email protected]
