Bear of the Day: Southwest Airlines (LUV)

Southwest Airlines (LUV) is one of the largest domestic carriers in the United States, operating a fleet of more than 800 Boeing 737 aircraft. The company has spent the past year overhauling its business model, adding assigned seating, extra-legroom seats, bag fees and premium products to boost revenue.

The stock currently holds a Zacks Rank #5 (Strong Sell). It sits in the Transportation - Airline industry, which ranks in the Bottom 5% of all Zacks industries.

Fuel Is a Problem

The same surge in energy prices that is lifting oil producers is a major headwind for the airlines. Fuel is one of the largest costs for any carrier, and Southwest absorbed nearly $900 million in additional fuel expense year over year in the second quarter alone.

The company's Q3 guidance assumed jet fuel of $3.70 to $3.75 per gallon, based on the forward curve as of July 17. Oil has moved sharply higher since then, which puts those assumptions at risk and should be a major concern.

Management says higher fuel can be largely recovered through fares, but with a lag. Southwest books only about 60 days out, so when fuel prices spike quickly, ticket prices struggle to keep pace.

That gap lands directly on the bottom line.

Guidance Took a Step Back

LUV reported Q2 adjusted earnings of $0.94 per share on July 22, beating the $0.52 consensus. However, revenue of $8.43 billion missed expectations of $8.58 billion.

The company guided Q3 earnings to $0.50 to $0.75 per share, below the $0.77 consensus at the time. It also widened full-year EPS guidance to a range of $3.25 to $4.25, down from its prior call of more than $4.00.

Southwest has been forced to pull back on growth. Capacity growth for 2026 has been cut roughly in half from the original plan of 2% to 3%, and management said it could trim further if fuel stays elevated. Unit costs excluding fuel are also expected to rise 3.5% to 4.0% in Q3.

Estimates Are Falling

Analysts have been cutting numbers. Over the last 60 days, four estimates for the current year have moved lower with none moving higher.

The current-year consensus has dropped from $3.41 to $3.16 over that stretch, a decline of about 7%. Next year's estimate has fallen from $5.44 to $5.04. The Q4 consensus has slipped from $1.40 to $1.20, a drop of more than 14%.

The company reports Q3 results after the close on October 21. The Earnings ESP sits at -9.84%, with the Most Accurate Estimate of $0.57 below the $0.63 consensus. That points toward downside risk heading into the print.

To Be Fair

Management described demand as very strong at a September conference, with no sign of slowing into the holidays. Corporate revenue is up 30% year over year, and the company expects assigned seating and extra legroom to generate more than $1 billion in EBIT this year.

The problem is that those gains are being eaten by fuel. Strong demand helps, but it cannot fully offset a cost line that is moving this fast.

The Technical Take

The chart is somewhat boring, with shares trading near $42, well below the 52-week high of $55.11. The stock carries an F for Momentum in the Zacks Style Scores, and a beta of 1.16 means it tends to move more than the broader market.

With energy prices still elevated, rallies may struggle to gain traction.

The stock still is currently hugging to the 50-day Moving Average and below the 200-day MA at $43.53.

In Summary

Southwest Airlines has done a lot of work to improve its business model, but the timing could not be worse. Surging fuel costs, reduced guidance, a shrinking growth plan and falling estimates all point in the wrong direction.

Investors may want to steer clear of this Zacks Rank #5 (Strong Sell) until fuel prices come back down to earth.

For those looking for a transportation name, look to Canadian National Railway (CNI).  The stock is coming off an earnings beat, above its 200-day MA, and has a Zacks Rank #2 (Buy).

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This article originally published on Zacks Investment Research (zacks.com).

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