The Airline Will Navigate Demand Softness And Launch Expedia Programs

Key Takeaways

• Continued macroeconomic uncertainty and weaker demand could result in revenue declines and suppressed operating margins if trends don't improve.
  
• Capacity reductions and cost discipline challenges might limit the ability to capitalize on future demand increases, affecting net margins.
  
• Southwest Airlines is enhancing revenue strategies and expanding offerings, potentially boosting profitability while maintaining resilience with a strong balance sheet amidst economic uncertainties.

Catalysts

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

• Southwest Airlines expects softer booking trends and weaker demand into the second quarter of 2025, especially in leisure travel, which could lower future revenues if the economic environment does not improve soon.
  
• The airline is facing macroeconomic uncertainty and demand weakening, making it difficult to confidently forecast future profits. This could lead to earnings coming in below expectations if trends do not change.
  
• The company is not reiterating its EBIT guidance for full year 2025 and 2026 due to current market conditions. If consumer demand stays lukewarm, this could keep operating margins suppressed.
  
• Planned capacity reductions due to reduced demand might limit future revenue growth. Flat overall capacity growth this year could hinder the ability to benefit from any potential future increase in demand.
  
• There is a potential risk of cost discipline issues if macroeconomic conditions worsen, which might impact net margins if cost reduction plans are not sufficient to counteract lower-than-expected revenues.
  

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 3.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.0% today to 4.6% in 3 years time.
• The bearish analysts expect earnings to reach $1.4 billion (and earnings per share of $2.93) by about May 2028, up from $547.0 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 8.4x on those 2028 earnings, down from 31.5x 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 4.78% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.71%, as per the Simply Wall St company report.

Southwest Airlines Future Earnings Per Share Growth

Risks

• Southwest Airlines has announced a plan to transform its revenue strategy, amend its agreement with Chase, enhance its Rapid Rewards program, and launch Expedia, which could lead to increased operating revenues and improve net margins if these initiatives continue to exceed expectations.
  
• The company is implementing a cost reduction plan that is already seeing success, as evidenced by first quarter 2025 CASM-X performance, which could lead to improved earnings and profit margins.
  
• Through the introduction of new fare structures, premium seating, assigned seating, and bag fees, Southwest Airlines is positioned to capture additional revenue streams, potentially enhancing net margins and profitability.
  
• The expanded distribution to online travel agencies has broadened Southwest's customer base, introducing new customers who have not flown with Southwest in some time, which could positively impact revenue and earnings if booking trends remain favorable.
  
• Despite macroeconomic uncertainties, Southwest has a strong, investment-grade balance sheet with significant unencumbered assets that provide flexibility and resilience, potentially supporting stable profit margins and revenue performance during economic fluctuations.
  

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 $40.0, 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 $30.3 billion, earnings will come to $1.4 billion, and it would be trading on a PE ratio of 8.4x, assuming you use a discount rate of 7.7%.
• Given the current share price of $30.28, the bearish analyst price target of $19.0 is 59.4% 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.