Southwest Airlines: We See Fall Sale and Competition Crimping Yields; Lowering Fair Value Estimate

We’ve lowered no-moat Southwest Airlines’ LUV fair value estimate to $36 from $39 to reflect lower yields over the coming season and slightly higher average fuel costs in 2024 than we previously anticipated. The biggest impact to our valuation comes from lowering our estimate of the average selling price of a ticket for Southwest in the coming travel season, which, combined with elevated fuel costs that airlines would normally seek to pass on to customers in the form of higher average ticket prices, puts a further crimp on Southwest’s near-term profitability.

Southwest occupies a somewhat precarious position in the north American airline market—as the largest airline in the country by passengers and by far the largest operating a no-frills business model, it competes directly with numerous low-cost operators like Frontier, Spirit, and startup Breeze Air, and increasingly vies for marginal fliers against the full service airlines Delta, United, and American.

We already updated our assumptions following Southwest’s second-quarter earnings to reflect increased labor costs, and we cautioned that low fuel prices and unusually full planes will pay for these increases in wages and capacity over time, but once either wavered, we expected lower profitability and the return of risky price competition. Both fuel prices and passenger demand seem to have wavered—jet fuel prices rose 37% between May 2023 and August 2023 (though they are still 37% lower than the $4.12 per gallon price of June 2022) and Southwest management recently noted that for the fourth year running, last-minute bookings were softer in August than they had anticipated, chalking this up to evolving habits especially among business travelers. All told, higher costs and competitive ticket price discounts will force Southwest, in our view, to sacrifice near-term profits for longer-term market share, exactly the return to the cutthroat competitive dynamic that we have been anticipating.