Southwest Airlines: The Best For Less

I've never owned an airline stock; always thought it was a poor industry. Warren Buffett waded into U.S. Air a decade or so ago and reminded himself that, even if cheap, a poor company in a lousy industry isn't necessarily a good investment.

But I've always tried to fly Southwest when possible, both because of fare pricing and service, and found LUV to be an excellent experience. I've flown all the others and rarely find myself pleased. Even if ticket pricing is good, service isn't. The experience is clumsy and often irritating. So I've always watched Southwest's equity since it was the best operator in a tough industry. 

Several days ago the company reported their latest results and beat analysts expectations handily, pre-one time items. They walked investors through the capping of their fuel hedge program, reported on curtailing underperforming routes, and using the freed up aircraft on newly opening slots in Minneapolis and LaGuardia. All of their load factors and yields were good. And they hadn't forgotten about their customer experience as they remained adamant about not charging for baggage and other customer irritants.

The market heard Southwest's message and the share price went up several dollars. I was on the cusp of breaking my internal rule of investing in a bad industry and I was rescued by a rally in the stock. My potential book value purchase of the country's leading airline was derailed.

Today the market doesn't like Southwest and has pounded it down to the pre announcement  price range. You can buy the nations pre-imminent airline for .8XBook and at about 4.5 X Cashflow. You get sound management, an up-to-date fleet, happy customers, a reasonable cost structure, and a lid on the impact of rapid decreases and increases in fuel. 

As this piece is being written LUV is $7.90 and I've pushed the "buy" button. The industry will suffer during this  economic slowdown, but LUV has the balance sheet, operating margins, and management to do well at the expense of their competition.

I'm hopeful  that I don't learn the same lesson that Buffett must have as he no longer has any positions in the airline industry. 

Who pays a special dividend in a credit crisis?

Werner Enterprises may be stupider than their, stereotypical, over-the-road drivers. Time will tell, but Werner's latest decision is a blue beauty.

One December 5th the company paid a $2.10 per share special dividend, or about $150M. They had slightly less than that amount on hand in cash. The dividend effectively wiped out their cash and required borrowing under the company's line of credit.

In face of the effects of the recession, less freight hauled and increased competition, most companies would find some solace in having $150M of cash and an unused credit line. But not Werner. Evidently the Werner family had better uses for the cash than the company. It hasn't helped anyone's net worth as the share price has dropped more than the amount of the special dividend since it was announced.

Now that the cushion is gone, Werner has to accumulate cash as quickly as possible. Earnings alone won't fill the till fast as they only make about $75M per year so capital expenditures and SG&A are going to need a trimming. Werner's operating margins aren't as stellar as some of their competitors so they probably have fat available to cut, however, they should have cut the fat and forgot the special dividend.

While cash and short term loans don't carry high rates of interest, WERN will miss the interest income and now be adding more interest expense. That's on top of a noticeably slowing level of freight and some pricing pressure as competitors attempt to keep trailers, tractors, and drivers utilized. The company, due to the special dividend, has set itself up for a disappointing quarter or two. It also limited its ability to be among the largest consolidators as weaker competitors fail over the next six months.

The special dividend was so stupid, in my mind, that I've sold a few shares short. Werner isn't going to fail or drop to the low single digits, but the recessions impact over the next 6 months will impact earnings and impact its share price downward before the benefits of a consolidating industry improve matters.