What Does Southwest Airlines’ Current Valuation Tell Us?

Southwest Airlines' 1Q16 Results: What the Analysts Are Saying

(Continued from Prior Part)

Current valuation

As of April 8, 2016, Southwest Airlines (LUV) was valued at 5.1x its forward EV-to-EBITDA ratio. As can be seen from the chart below, Southwest’s valuation has closely tracked the industry median since 2008.

Southwest managed to move above the industry median for a brief period between 2009 and 2010. The airline achieved this feat at the start of 2014 due to improving utilization and yields.

Peer comparison

As of April 8, 2016, United Continental’s valuation (UAL) was 3.6x, Delta Air Lines’ (DAL) valuation was 4x, Alaska Air Group’s (ALK) valuation was 4.9x, and American Airlines (AAL) was trading at 4.5x. In addition, JetBlue Airways’ (JBLU) valuation was 3.8x, Spirit Airlines’ (SAVE) valuation was 6.5x, and Allegiant Travel’s (ALGT) valuation was 6.8x.

The market is expecting Southwest Airlines’ EBITDA to grow by 10% in the next four quarters. In the same period, UAL’s EBITDA is expected to grow at 5%, DAL’s at 24%, ALK’s at 13%, AAL’s at 9%, JBLU’s at 21%, SAVE’s by 7%, and ALGT’s by 5%.

Our analysis

Valuation multiples are dependent on the perceived risk and thus investors’ willingness to pay. In the short term, earnings results, LUV’s ability to maintain its industry-leading utilization and yield performance and, in turn, its margin performance should impact its valuation multiples.

However, Southwest Airlines’ (LUV) long-term valuation multiple could be affected by macro trends. Airlines are a cyclical industry, with typical boom and bust cycles. If industry fundamentals deteriorate or investors’ risk appetite falls, valuation multiples can fall too.

Also, in a downturn, companies with high leverage become riskier. Companies with low leverage could be rewarded in such times. On the other hand, if fuel prices fall further or if demand continues to grow at high rates, airline stocks could actually see their valuation multiples improve.

Southwest Airlines forms 1% of the iShares Russell Mid-Cap Growth ETF’s (IWP) portfolio. For a deeper look into Southwest’s peers, you can also read our 1Q16 pre-earnings analysis reports on Delta Air Lines (DAL), American Airlines (AAL), and United Continental (UAL).

Browse this series on Market Realist:

• Part 1 - Southwest Airlines’ Stock Continues to Gain in 1Q16

• Part 2 - Majority of the Analysts Recommend a ‘Buy’ on Southwest Airlines

• Part 3 - Analysts’ Estimates: LUV’s Revenue Growth to Slow in 2016