Southwest's Holiday Travel Woes Don't Affect Our Long-Term View of the Airline; Maintain $56 FVE

Southwest Airlines’ stock traded lower on Dec. 27 as the no-moat carrier struggled to normalize its operations after a wave of systemwide flight cancellations and delays. While inclement winter weather was certainly a main contributor to Southwest’s issues, other U.S. airlines reported far fewer cancellations, which suggests company-specific factors may be involved. In our view, this event demonstrates a weakness of Southwest’s point-to-point service model as opposed to the hub-and-spoke model employed by most other U.S. airlines. However, we’ve heard other explanations as well, from overbooking to inadequate operating systems. Southwest’s disruptions were significant enough to draw the attention of the U.S. Department of Transportation, which said it will review the root cause of the issues. Nevertheless, our long-term outlook for Southwest is unaffected by these current woes. We continue to model revenue exceeding $28 billion by 2026 with an operating margin improving to around 14.5% (compared with our estimate of $24 billion of revenue in 2022 with about an 8%-9% operating margin). We are maintaining our $56 fair value estimate and continue to believe the stock is undervalued.