The stock of Southwest Airlines has experienced a recent decline, causing concern among investors. Melius Research analyst Conor Cunningham has downgraded the shares to Sell from Hold, citing the need for the airline to “reset and start to rebuild.” Despite this, Cunningham warns that this process will bring about more near-term difficulties.
Southwest’s current strategy of fully restoring its network and increasing capacity by 7% in 2024, in an attempt to “outgrow their issues,” according to Cunningham, has proven ineffective. The company now faces tough decisions as it navigates the challenging aviation landscape.
The airline had initially viewed the Covid-19 pandemic as an opportunity to expand aggressively, historically gaining market share during economic downturns. However, with the presence of government aid, existing competitors had little incentive to relinquish their market share. Consequently, 14% of Southwest’s markets are still under development, resulting in reduced profit margins. Additionally, the airline’s unit costs have increased by 21% since 2019. As a result, analysts predict that Southwest Airlines will report an earnings-per-share loss in the first quarter of 2024, marking its first loss in a year.
Cunningham presents two potential paths for Southwest: either continuing with the current plan or implementing a reset by slowing down growth. Both options pose potential risks. It’s worth mentioning that Southwest has never conducted mass layoffs in its 56-year history. Therefore, a reset would require difficult decisions in terms of network expansion and employee headcount.
Slowing Growth Presents Challenges and Opportunities for Southwest Airlines
by Callum Keown
The stock performance of Southwest Airlines has been turbulent in 2023, with a decline of 31% year-to-date. However, the journey has been a tale of two halves. From January 1st to its peak in July, the shares experienced a commendable 17% increase. Unfortunately, since then, they have plummeted by a staggering 41%. This recent slump aligns with broader sector losses marked by mounting cost pressures and a seasonal decline in leisure demand.
Assessing the future trajectory of Southwest’s stock is an uncertain task, as Wall Street remains divided. According to FactSet data, 23% of analysts rate the shares as Buy, while another 23% advocate selling. The rest have adopted a more cautious approach and maintain a Hold rating. This split sentiment conveys a significant departure from the stock’s historical trend of higher Buy ratios, highlighting the current uncertainty surrounding its prospects. The average price target of $26.89 suggests a potential 17% upside from Monday’s closing price.
Market Perform analyst Helane Becker from TD Cowen downgraded Southwest’s shares from Outperform to Market Perform at the end of October. One factor influencing this decision was the company’s inability to seize market share, as it has traditionally done during downturns. Becker emphasizes that this time is different, attributing the struggle to several key factors such as a lack of premium products, excess capacity in business-focused markets, limited international exposure, and rising costs. These concerns have eroded investor confidence, prompting doubts about the sustainability of Southwest’s business model.
Despite these challenges, there may be a silver lining on the horizon. Some experts suggest that the current deceleration in growth could create an opportunity for Southwest to regain pricing power and reassess its position in a post-Covid world. While this prospect may lead to short-term pain due to exacerbated unit cost issues, it presents a chance to redefine the company’s strategy and rebuild its reputation.
Southwest Airlines did not respond immediately to a request for comment.
