Can Southwest Airlines Continue to Meet Its High Expectations?

With shares of Southwest Airlines (NYSE:LUV) trading around $21, is LUV an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let's analyze the stock with the relevant sections of our CHEAT SHEET investing framework.

T = Trends for a Stock’s Movement

Southwest Airlines is a passenger airline that provides scheduled air transportation in the United States. Consumers and companies across the nation are now looking to travel at an increasing rates, and since air travel is quicker and is becoming less expensive, it is becoming a common transportation method for many. As costs decrease and flights become more efficient, look for business and retail customers to fly at rising rates. Southwest Airlines stands to see soaring profits as consumers and businesses look to travel more than ever.

Southwest Airlines on Thursday reported its fourth-quarter and full-year 2013 results. Gary C. Kelly, president and CEO, said in a press release: “We are happy to report full year 2013 net income of $805 million, and fourth-quarter 2013 net income of $236 million, both excluding special items. We are extremely proud of these record results and the tremendous progress made on our strategic initiatives, which produced substantial returns and contributed significantly to our superb 2013 financial performance. Our full-year 2013 total operating revenues were a record $17.7 billion, and our cost performance was excellent. We generated strong free cash flow of $1 billion in 2013, allowing us to return $611 million to our shareholders, through share repurchases and dividend payments, and reduce debt and capital lease obligations by $313 million. Our pre-tax return on invested capital, excluding special items, for full-year 2013 was 13.1 percent, nearly double the prior year’s performance. I want to thank the outstanding people of Southwest and AirTran. They deserve all the credit for producing these strong results, which earned them a $228 million contribution to the profit-sharing plan for the year 2013, up 88.4 percent, or $107 million, compared to the prior year.”

T = Technicals on the Stock Chart Are Strong

Southwest Airlines stock has been exploding to the upside in the past couple of years. The stock is currently trading near highs for the year and looks poised to continue. Analyzing the price trend and its strength can be done using key simple moving averages. What are the key moving averages? The 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Southwest Airlines is trading above its rising key averages, which signals neutral to bullish price action in the near-term.

Source: Thinkorswim

Taking a look at the implied volatility (red) and implied volatility skew levels of Southwest Airlines options may help determine if investors are bullish, neutral, or bearish.

	Implied Volatility (IV)	30-Day IV Percentile	90-Day IV Percentile
Southwest Airlines options	26.96%	80%	78%

What does this mean? This means that investors or traders are buying a very significant amount of call and put options contracts as compared to the last 30 and 90 trading days.

	Put IV Skew	Call IV Skew
February Options	Flat	Average
March Options	Flat	Average

As of Thursday, there is average demand from call buyers or sellers and low demand by put buyers or high demand by put sellers, all neutral to bullish over the next two months. To summarize, investors are buying a very significant amount of call and put option contracts and are leaning neutral to bullish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates and the conclusion.

E = Earnings Are Mixed Quarter Over Quarter

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. Also, the last four quarterly earnings announcement reactions help gauge investor sentiment on Southwest Airlines’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Southwest Airlines look like and more importantly, how did the markets like these numbers?

	2013 Q4	2013 Q3	2013 Q2	2013 Q1
Earnings Growth (Y-O-Y)	6.11%	161.54%	-19.85%	-17.97%
Revenue Growth (Y-O-Y)	1.45%	5.48%	0.86%	11.27%
Earnings Reaction	-3.63%*	3.71%	-0.14%	0%

*As of this writing.

Southwest Airlines has seen mixed earnings and increasing revenue figures over the last four quarters. From these numbers, the markets have been pleased with Southwest Airlines’s recent earnings announcements.

P = Average Relative Performance Versus Peers and Sector

How has Southwest Airlines stock done relative to its peers, Delta Air Lines (NYSE:DAL), American Airlines (NASDAQ:AAL), JetBlue Airways (NASDAQ:JBLU), and sector?

	Southwest Airlines	Delta Air Lines	American Airlines	JetBlue Airways	Sector
Year-to-Date Return	11.31%	17.69%	23.45%	7.49%	15.98%

Southwest Airlines has been an average relative performer, year to date.

Conclusion

Southwest Airlines provides air travel services to consumers and companies across the nation. The company recently reported quarter four earnings that left investors pleased. The stock has been moving higher in recent years and is now trading near highs. Over the last four quarters, earnings have been mixed while revenues have been increasing. Relative to its peers and sector, Southwest Airlines has been an average year-to-date performer. Look for Southwest Airlines to continue to OUTPERFORM.