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Stock Analyst Update

The 737 Max Groundings and North American Airlines

We believe a potential FAA grounding and suspension of deliveries would pose the greatest risk to Southwest.

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We’re maintaining our fair value estimate for airlines operating Boeing’s 737 MAX 8 in lieu of potential Federal Aviation Administration-directed groundings. Plenty of uncertainty remains around what caused the March 10, 2019 Ethiopian Airlines crash that involved a newly delivered 737 MAX 8, so we don’t model a valuation impact from FAA induced cancellations. We realize the MAX 8’s second crash in five months could spook travel markets and weigh on demand, but we already bake in below Street average market softness for 2019, so our revenue passenger miles and demand assumptions are unchanged.

At the end of 2018, MAX 8 aircraft represented 4%, 2%, 8%, and 6% of each respective fleet for  Southwest (LUV),  American Airlines (AAL),  Air Canada (AC), and  Westjet (WJA). We believe a potential FAA grounding and suspension of deliveries would pose the greatest risk to Southwest since upcoming MAX 8 deliveries are the focal point of its Hawaiian expansion. In the event MAX 8s are grounded, and the 21 deliveries from Boeing (plus the 16 aircraft leased from third parties) are delayed this year, Southwest would have to curb growth and rely on costlier 737-800s to ferry passengers on Hawaiian routes, which are set to commence on March 17. Under this scenario, we expect Southwest would draw planes from weaker performing markets and slash fares to stimulate traffic growth in mainland markets. We assume routes to Hawaii already run at a considerable discount to promote traffic. Capacity growth would slip to 3% to 4% (down from 4% to 5%) in this scenario and fare concessions would weigh on revenue while unit costs would inflate on lower capacity growth. Together, these results would bring down our fair value estimate for Southwest to $56 from $59. Our scenario doesn't include compensation from Boeing, which would help offset margin pressure derived from out of service aircraft. 

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Danny Goode does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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