Southwest Hits an Air Pocket

Southwest LUV shares hit an air pocket, sinking over 5% after the carrier updated investors on its first-quarter revenue guidance. In the Feb. 20 release, Southwest lowered its guidance for revenue per available seat mile to 3%-4% from 4%-5%, revealing a greater impact from January’s government shutdown than management previously expected. During its fourth-quarter earnings call, management said it expected a $10 million-$15 million top-line impact, but the updated figure is about $60 million. Management pinned the percentage point loss in unit revenue growth on continued weakness in passenger demand and bookings stemming from the shutdown. While the news is worrying, we think the market’s reaction was well overdone. We’re maintaining our $59 fair value estimate, but shares remain fairly valued.

While airlines expressed confidence around early first-quarter booking curves and close-in yields, Southwest’s guidance revision adds concerns that travel markets were more susceptible to the shutdown's impact than initially expected. That said, we are leaving our full-year RASM forecast for 2019 in place at 2% after management’s update, as we already expected top-line softness from the government shutdown and falling oil prices concurrently pulling down passenger yields. Nonetheless, we still anticipate short-term upside from Southwest’s expansion into Hawaiian markets, which usually register RASM above similar domestic stage lengths (flight distance), revenue management system implementation, and schedule optimization amid older Boeing 737 retirements.

Our long-term thesis (flat to declining passenger yields through our 2023 midcycle estimate) also remains unchanged after the guidance update, considering we believe slowing travel demand and oil-price softness will eventually lead to declining fares.

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