Remote Work Shifts And High Costs Will Erode Margins

Key Takeaways

• Declining business travel, regulatory costs, and rising labor expenses threaten margins, while reliance on a single aircraft type heightens operational risks.
  
• Competitive pressures, capital-intensive upgrades, and supply chain vulnerability challenge Southwest's ability to sustain historical returns and robust free cash flow.
  
• New revenue initiatives, operational enhancements, and agile adaptation to customer trends position the company for improved profitability, resilience, and expansion in both earnings and market share.

Catalysts

Operates as a passenger airline company that provides scheduled air transportation services in the United States and near-international markets.

• The structural shift toward remote work and virtual meetings is likely to result in permanently reduced demand for domestic business travel, a segment Southwest heavily relies on for high-margin revenue, which could prevent revenue and earnings from reaching prior peak levels in future years.
  
• Intensifying and persistent regulatory and consumer pressure on carbon emissions is expected to significantly increase compliance and operational costs for Southwest, particularly as sustainable aviation fuel and emissions abatement remain expensive, threatening margin expansion despite fleet modernization efforts.
  
• The company's sole reliance on the Boeing 737 family exposes Southwest to ongoing operational risk and supply chain vulnerability, as any disruption, certification delay, or safety crisis at Boeing could materially impact capacity, growth plans, and revenue realization for multiple years.
  
• Accelerating labor cost inflation and continued workforce shortages, especially in the context of union contract renewals, are set to drive sustained upward pressure on wages and benefits, risking net margin compression even if topline demand eventually rebounds.
  
• The capital-intensive need for technology upgrades, network expansion, and ongoing fleet renewal-combined with rising competition from ultra-low-cost carriers and legacy airlines increasing point-to-point offerings-undermines Southwest's ability to maintain historical return on invested capital and could lead to prolonged free cash flow weakness.

Southwest Airlines Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Southwest Airlines compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Southwest Airlines's revenue will grow by 4.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.4% today to 4.7% in 3 years time.
• The bearish analysts expect earnings to reach $1.5 billion (and earnings per share of $3.57) by about September 2028, up from $392.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 7.2x on those 2028 earnings, down from 41.7x today. This future PE is lower than the current PE for the US Airlines industry at 10.5x.
• Analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.42%, as per the Simply Wall St company report.

Southwest Airlines Future Earnings Per Share Growth

Risks

• The company's broad suite of new revenue initiatives-including bag fees, assigned seating, basic economy, and a revamped credit card partnership-are tracking ahead of expectations, and management anticipates these will collectively deliver a substantial EBIT expansion through late 2025 and into 2026, supporting an increase in earnings.
  
• Demand for both leisure and corporate travel is showing clear signs of stabilization and sequential improvement, with management citing recent booking trends as evidence of a broad-based recovery that could bolster revenues over the medium term.
  
• Southwest's ability to maintain an industry-leading balance sheet, cost discipline, and strong investment-grade credit profile provides resilience and flexibility, enabling continued capital returns through a new $2 billion share repurchase program and strengthening shareholder value.
  
• The successful and rapid rollout of multiple product enhancements and technology upgrades-including increased connecting itineraries, fleet modernization, and digital optimization-are expected to expand the addressable market and improve unit economics, likely lifting both revenue and net margins over time.
  
• Management's ongoing commitment to evolving the company further in response to changing customer preferences-such as potential premium offerings and new network expansion-indicates a willingness to invest for growth and diversify revenue streams, which could drive higher long-term earnings and market share.

Valuation

• The assumed bearish price target for Southwest Airlines is $19.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Southwest Airlines's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $46.0, and the most bearish reporting a price target of just $19.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $31.7 billion, earnings will come to $1.5 billion, and it would be trading on a PE ratio of 7.2x, assuming you use a discount rate of 10.4%.
• Given the current share price of $31.11, the bearish analyst price target of $19.0 is 63.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.