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The move is paying off. On Sept. 11, Southwest announced that its Web site had generated more than $1 billion dollars in ticket sales this year. The company expects to get 30% of its total revenues from online bookings in 2000 -- a much higher percentage than other carriers -- and estimates that will save it $80 million. Turning its Spartan site into such a booming success earned Southwest a spot in Business Week's "Web Smart 50" (Cover Story, Sept. 18, 2000). But as easy as Southwest is to love, investors have good reason to let their ardor cool in coming months. Not only are airlines' fortunes tied to the economy, which shows signs of finally starting to slow, but their stocks are inextricably linked to energy costs -- and jet fuel is one of their major expenses. EMBROILED IN OIL. After OPEC approved a smaller-than-expected increase in crude-oil production on Sept. 10, few analysts were willing to predict that oil prices might fall anytime soon (Daily Briefing, Sept. 11, 2000, "Warm Homes Will Scorch Americans' Wallets This Winter"). Some even think there could be shortages this winter that would cause prices to spike from $35 a barrel to $40. Prices have tripled in less than two years. And jet fuel has the potential to rise at a faster pace than crude oil this winter if companies turn from jet-fuel production to home heating oil, says John Garrity, associate research director at Investec Ernst & Co. Already, there is near panic about low storage levels of home heating oil. There's an irony here: Southwest is unlikely to face higher costs due to rising prices. Of all the major airlines, analysts agree it has done one of the best jobs of protecting itself from runaway energy costs by using hedging strategies to lock in prices well below current market levels. "It is probably one of the most immune carriers," says Julius Maldutis, an analyst with CIBC Oppenheimer, who rates Southwest a "strong buy." The company projects it will be able to report lower jet-fuel prices in the second half of 2000 than it did in the first half. The problem is that, as a member of the transportation sector, Southwest's shares will decline with those of other airlines. "Southwest is the best airline stock and has outperformed the group," admits Stephen Klein, a Standard & Poor's equity research group analyst. Klein advises investors to sell. "But that's not going to stop it from falling when the group corrects," he adds. Even analysts who advise investors to buy the stock concede it could decline with other airlines as investors react to rising oil prices. Ray Neidl, an analyst with ING Barings, acknowledges: "When it comes to oil prices, investors do seem to kind of follow in a herd." Nonetheless, in the near term, he rates the stock a "buy" with a $28 price target now and a $30 price target over 12 months. TURBULENCE AHEAD. Southwest's stock price has already started to slip -- from a high of $25 in mid-August to around $22 now. Garrity believes Southwest, which is still up about 40% this year, is at a level where many money managers will want to lock in profits. "They won't want to wait for a correction in the sector," he says. "With the end of the quarter coming up, they may want to sell the stock and book the profit." Along with rising oil prices, the other issue Southwest faces is its valuation. Although it has historically traded at a price-to-earnings multiple more than twice as high as other airlines', its current p-e is about 2 1/2 times that of competitors. That's the main reason Klein rates it a "sell." "It is not a Southwest issue," he says. "It is a valuation issue. It's a great company, but maybe it needs to correct 20%." If it got down to $18, he believes it would be properly valued and he would probably change his rating. Then it would be trading at a p-e of 14, still about twice as high as other major airlines. Garrity also points to a spate of insider sales this summer, which could indicate that "people in the know" also think the stock may not have much higher to rise in the near term. But of the Wall Street analysts who cover the stock, Klein is very much in the minority. Many sell-side airline analysts say it is a mistake to compare Southwest's p-e with those of other airlines because it is growing so much faster than its competitors. "It is the only one that you can refer to as a growth story," says Jim Parker, an analyst with Raymond James & Associates. He expects earnings to rise 23% this year and thinks they could rise as much as 22% next year if Southwest cuts back on travel-agent commissions the way other airlines have. BEYOND THE HEDGE. Parker concedes that many investors won't take the time to investigate which airlines are hedged against rising fuel prices and may simply sell their Southwest stock. But he thinks that could amount to a buying opportunity in coming weeks. Southwest's third-quarter earnings are due out on Oct. 17, and he thinks investors will be impressed with the continued growth, despite higher jet-fuel costs. For its second quarter, reported on July 18, Southwest's profit increased 21% over the prior year, to $191 million, or 36 cents a share, trouncing analysts' estimate of 31 cents. Revenues grew 20% in the quarter, to $1.5 billion. For the third quarter, Parker expects Southwest to post earnings of 30 cents a share, up 27% from the third quarter in 1999, and revenues of $1.4 billion, up 15% from the year earlier. Indeed, for long-term investors, concerns about fuel prices reflect short-term thinking. Klein still has long-term worries that Southwest won't be able to maintain its low-cost structure as it adds longer flights and expands into more markets. Still, Neidl predicts Southwest has "a good 10 years' worth of growth" ahead of it. In that context, the current oil shortages could give investors an opportunity to get in on this growth story at a cheaper price. But before jumping in, you might want to wait until the outlook on oil prices is a little more sanguine. Stone is an associate editor of Business Week Online EDITED BY BETH BELTON |
