Unscrambling Monday's Egg

Unscrambling Southwest Airlines (NYSE: LUV)
by Chick Karin

NOTE: For the month of June, we will be going into detail on the companies that we recently considered for our quarterly Chick "buy." June was the month of buying. We ended up purchasing stock in Medtronic (MDT) on June 3, 2001, but there were many many great companies that didn't get our majority vote. We wanted to highlight them as it was a close call and they are still up for consideration for our next buy in September. Southwest Airlines was a hot contender right up until the final, final, final vote. We'll start the month with Southwest's Chicks' Dozen! For more on the companies that were considered, and what we'll be featuring all month, check out our summary.

1. Buy What You Know  I fly sometimes more than I walk. If you've never flown Southwest Airlines, it's an experience in itself. The flight attendants joke while doing their flight presentation by saying, "For those of you living in the dark ages that have never seen a seat belt, look up at the flight attendant. She will now show you how to buckle and unbuckle one." Or, "Pay attention to where the exit locations are because if there is an emergency landing, don't look for a flight attendant... we'll be the first ones outta here." That's the kind of fun that Southwest brings to each and every one of their no-frill flights. I like fun, and I'm a no-frill person. (I hope my husband doesn't read this.)

2. Keep it Simple Sister  Southwest Airlines Co. is a major domestic airline that provides primarily short-haul, high-frequency, point-to-point, low-fare service. As of December 31, 2000, they operate 344 Boeing 737 aircraft and provide service to 58 airports in 57 cities in 29 states throughout the United States. Southwest focuses principally on point-to-point, rather than hub-and-spoke, service in short-haul markets with frequent, conveniently timed flights and low fares. Southwest serves many conveniently located satellite or downtown airports such as Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Burbank, Manchester, Oakland, San Jose, Providence, Ft. Lauderdale/Hollywood and Long Island airports, which are typically less congested than other airlines' hub airports. BRILLIANT!!

3.  Industry  Airlines. Do we understand this? Duh. Do we feel it will grow faster than any other industry? This is where I had a problem yesterday when we chose Medtronic over Southwest Airlines. I didn't feel that the airline industry was going to grow faster than medical supplies. I could be wrong.

4. Leader in its Field  Southwest Airlines has for the past few years been on Fortune's list of most desirable companies to own stock in. It is currently #4 on Fortune Magazine's Most Admired Companies, #4 on Fortune Magazine's Best Companies to Work For, and is #316 of the Fortune 500 Companies. It is definitely a leader in airline stocks to own.

5. Repeat Profitability  Millions fly Southwest Airlines over and over and have since its inception. Matter of fact, Southwest has been repeatedly profitable since they turned their first profit in 1973! I fly them at least once a year... and I don't even live in the cities that they serve. Chick Susie has friends that told their kids that they were only allowed to pick a college to attend by the cities that Southwest flew in to. That's repeat profitability.

6. Gross Margin: 76.9%  Here's how I got that.

Revenues - Cost of Revenues/ Revenues1428.6 - 308.1/ 1428.61098.9/1428.6 = .769

Change to a percentage = 76.9% Can't beat that!!7. Net Margin: 8.5%  Here's how I calculated that...

Net Income/Sales121/1428.6 = .08469Change to a percentage = 8.5%

8. Cash to Long Term Debt  The downside to LUV's numbers is that they only have .91x the amount of cash as they do long-term debt. The numbers for this are... 

Cash - 684.7 divided by Long-Term Debt - 754.7

687.7/754.7 = .9072

9. Flow Ratio: 0.24
I'm kinda freakin and am going to re-check my numbers 'cuz I can't believe it can be this good! Let's see:

(Current Assets - Cash)/ (Current Liabilities - Short Term Debt)
(1044.4 - 684.7)/ (1488.4 - 0)
359.7/1488.4 = 0.24

Yep... it's that good!10. Increasing Growth  The quarter ending in March had a 2.64% decrease in sales from the quarter before. And the quarter ending in December also had a decrease in revenues. But, if I did the numbers year over year Southwest Airlines has continually grown. In the year 2000, their sales increased by 19% over 1999. In 1999, they increased 13% over 1998. And in 1998 they grew 9% over 1997. So, they have grown considerably each year. This year being a slower year in everything, I don't think we'll see 19% growth, but, if you take this past quarter and compare it to the same quarter last year...Southwest Airlines has still increased their sales by 15%!! That's amazing when you think of how slow this first quarter has been for every other industry.

When digging further into LUV's numbers, I saw a trend, and it bothered me. Here was the Income Statement I used, and here is the Balance Sheet. Here they are quarter to quarter, staring with the most recent quarter ending March 31, 2001. Do you see the trend?

Do you see what I see? A chiiiiiiiiiiiild, a chiiiiiiiiiild. Woops. I mean, do you see the decreasing margins? They started back in June of last year with Net Margins of 13% and at the end of March, those have been dwindled down to 8.5%. Gross Margins have gone the same route. Their sales also have seen a noticeable decrease from quarter to quarter. It concerned me, so this was when I changed my vote from Southwest to Medtronic.but believe me, I will be watching closely for their next earnings announcement.

11. Management  In 1966 Herb Kelleher conceived of the idea of a low-cost, no-frills airline that would fly into the smaller airports in larger cities. Herb is retiring this June and is leaving the company to his two right hand people. Jim Parker, will be the CEO and plans to continue what Herb started. Parker has been with the company for the past 15 years. He was instrumental in getting an unprecedented ten-year contract deal done with Southwest pilots. Typically, airlines lock in labor costs for three to four years, but Southwest pilots are locked in until 2004, and are happy about it. This is part of Southwest's philosophy, "Treat your employees well, and they will be loyal." Southwest has never laid off any employees. Parker also got the company online and selling tickets over the Internet, which as of late is showing enormous growth. Online sales account for more than $1 billion of revenue.

Colleen Barrett will replace Herb as President, which will make her the highest-ranking woman in U.S. Airline History!! (Chicks gotta like that.) Barrett, 56, began her career as Kelleher's secretary 34 years ago, and has been with him ever since: through fare wars, oil crises, and every court battle. Herb would come up with the ideas and she would make them happen. "Herb could have a dream in the middle of the night and say, 'Okay, this is what I want to do.' But he wouldn't have a clue, God love him, what steps have to be taken to get there," says Barrett. "I'm not the most brilliant person in the whole world, but I can see systematically from A to Z, and I know what has to be done."*

When asked how they were going to replace Herb and his legacy after her leaves, Jim Parker replied, "I'll do the drinking, and Colleen will do the smoking."

Gotta love Southwest's attitude.

12. Buy on Sale
52 Week High - 23.32
52-Week Low - 12.37
Sale Price - 17.84
Current Price - 18.80 Close to being on sale.

I simply LUV LUV LUV this company, and will be watching it closely over the next quarter. If not for the Chicks, for my own personal portfolio!!