Investment research summary
Key drivers that has worked in the past likely to drive Southwest Airline sales in the future
(A) Business description
Southwest Airlines is a major passenger airline that provides scheduled air transportation in the United States and near-international markets. It is also largest domestic air carrier in terms of fleet size and number of domestic origination passengers boarded in the US and the airline provide access to the top 50 markets across the 48 contiguous United States.
(B) Macroeconomic trend
1) Falling unemployment rate
With a lower unemployment rate, more people would be earning wages which would be used for daily necessities and leisure. Since commuting via the airline domestically may be considered as leisure, the airline business would improve with more people being employed (Figure 1).
2) Increasing real disposable income
It is a positive sign for the airline industry when the real disposable income of people increases (Figure 2) as it would positively affect the propensity to consume. Consumers would be more willing to pay more to travel which would lead to better business for the airlines.
3) Increasing oil price
Oil price has been on a slow climb (Figure 3) since 2016 and this is driven by the increased output worldwide. Since oil is a major source of energy producer, the increased production activities would require a larger demand for oil which would increase its price. This would negatively affect the airline’s profit as the major expense for an airline is the oil price.
(C) Industry overview and competitive positioning
1) Rise in competitive pricing activities
While major US carriers continue to lead the industry profitability, they were faced with a rise in competitive pricing activities. This could be caused by the improved online sales platforms (Figure 4) within the airline industry as consumers could conveniently compare prices across all airlines. This could be a boon for Southwest Airline as they offer low price airfare that could win over more price-conscious travellers.
2) Cease of operations and merger activities
Consolidation continue to take place in the airline industry which expanded the carrier’s geographical reach that allows them to serve more US consumers. In late 2016, the merger between Alaska and Virgin America improved Alaska’s daily flights in the North America region by approximately 6 times. On the other hand, Eastern Air Lines and Island Air ceased operations in 2017 (Table 1). All in all, this has led to a more concentrated industry.
3) Competitive positioning
Being the leader in the frequency of flights at a reasonable fare price with no hidden fees, Southwest Airline has definitely capture many price-conscious travellers. Despite some carriers who offers lower fare than Southwest, there are many hidden fees behind it that would render the price to increase (Figure 5).
4 ) Leader in market share
Within the domestic Low Cost Carrier (LCC) market, it is dominated by Southwest Airline which holds more than 50% of the market share in terms of revenue (Figure 6) while it holds 24% market share in the US airline industry. This market dominance within the LCC market is beneficial to Southwest Airline as they would have higher bargaining power over suppliers and airports which would bring down their costs. Furthermore, a wide range of information data could be collected from the large amount of passengers flying with Southwest Airline and these insights would definitely help fuel the business efficiency of Southwest Airline in the future.
It is unlikely that other LCC could snatch away significant portion of the market share away from Southwest Airline as the barrier of entry is high in the airline industry given its high level of concentration and cost of entry. Thus, Southwest Airline would continue to serve this large group of consumers and with the new reservation system (Amadeus Altéa Passenger Service System), implemented in 2017, Southwest Airline would operate more efficiently and competitively.
5) Large fleet size
Southwest Airline has the largest fleet among the LCCs (Figure 7) and is the fourth largest when compared to the whole US airline industry. With 3x fleet size more than the closest competitor, JetBlue Airline, Southwest Airline could have more destinations to deploy to and has more flexibility in their deployment plan. This flexibility would allow Southwest Airline to cater to the demand of flights to the area quickly at a lower opportunity cost as they could reduce the number of flights to areas that is currently facing declining demand. Additionally, the size of the fleet would provide economies of scale as the overhead cost per passenger declines.
It is likely that Southwest Airline would remain as the leader in terms of fleet size in the coming future a significant of time and capital is needed to purchase a lot of airplanes. Thus, Southwest Airline would continue to benefit from the increased flexibility and economies of scale in the future.
6) Social media
With near 6 million Facebook fans, over 2 million Twitters followers and over 400 thousand Instagram followers, Southwest Airline has the largest social media footprint compared to the rest of the airline in the industry (Figure 8). Managed by a small but yet efficient social media team, Southwest Airline has been ranked the top in the airline industry in regards to the user base, engagement and sentiment by Unmetric. For instance, the Listening Center introduced by Southwest Airline allows interaction with nearly 2 thousand customers across social media platforms. Thus, through this thoughtful action, together with the creative ways to engage the customers, it would allow Southwest Airline to gain customer traction more easily and create a more effective marketing effort.
This competitive advantage of Southwest would definitely be strongly challenged by the competitors as the social media platform is transforming in such a rapid pace such that what is popular together may not be in the future. Thus, this uncertainty could allow the competitors to overtake Southwest Airline in terms of providing engaging and creative social media content.
7) Customer service excellence
Customer service is one of the keys in building strong brand loyalty for Southwest Airline. Not only Southwest provides a low airfare with little hidden fees, they are consistently ranked at the top in customer satisfaction based on 7 factors (Cost & Fees; In-Flight Services; Aircraft; Boarding/Deplanning/Baggage; Flight Crew; Check-In; and Reservation). Additionally, the Rapid Rewards programme, renowned as the best loyalty programme in the US, provides additional customer satisfaction with the attractive rewards advantages.
Losing this excellent customer service advantage would be difficult because Southwest prides itself on this factor and furthermore, disposing of an entire culture is difficult. Thus, Southwest Airline could continue to build a strong brand loyalty in the airline industry in the coming years.
(D) Potential catalyst
1) Improved Latin America economy
With the annual travel rate per capital of less than 1% in the Latin America region, there is a real growth opportunity to increase air traffic. Plagued with political instability and poor economy situation, the number of air travellers would definitely be small. However, the outlook for Latin America’s economic recovery is gaining momentum together with the world’s economy according to the IMF projections. Thus, when the economy and society improves, there could be demand for air travel towards these places which would improve the business for Southwest Airline.
2) Improved America economy
The recent tax cuts in 2017 could help support job creation which would in turn lead to high employment rate in the US. Thus, in this tighter labour market, wage growth would be expected to grow as a result and when this occurs, people could be more able to afford to spend on air travel.
(E) Risks
1) Rise in oil price and labour cost
This 2 main component of Southwest Airline’s expenses are dragging the firm’s profit down. Southwest Airline’s unit cost ranks the highest among the LCCs and this is attributed to the hedging losses and rising labour costs. If Southwest Airline do not succeed in hedging effectively and negotiate down the labour wages, these costs could continue to hinder the growth of the company.
2) Occurrence of natural disasters
When natural disaster strikes, it could affect the operation of the airline business. For instance, storm Harvey has resulted in more than 25 thousand flights being cancelled. The disruptions of flights and the damages caused onto the airplanes could raise the e its revenue as a result.
3) Merger of airlines
When mergers occurs within the LCCs, it could threaten the dominance of Southwest Airlines. When airlines merged, they would have an increased of flight destinations which would increase the competition with Southwest Airlines. Furthermore, when airlines merged, they would combine their competitive advantage that could further make the industry more competitive. For instance, the merger been Alaska Airline and Virgin America brought together the Virgin’s facilities and customers while increasing its daily flights to the North America region.
(F) Corporate Governance
The board of consists of all outsiders except for the Chief Executive Officer (CEO) and a previous Executive Vice President & Chief Legal & Regulatory Officer of Southwest Airline which indicates that it is mostly an independent board and they are elected annually. Also, none of the board members have any relationship with the key executive of Southwest Airline and all of the board members has attendance of at least 75% and are not paid over the market average. Additionally, the compensation committee assists the board with its annual review of succession planning. Lastly, Southwest Airline’s executives are paid based on performance.
Conclusion
In conclusion, Southwest Airline’s existing strengths and technological improvements would allow Southwest Airline to continue to fly high.
Jia Yang
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.
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