The Market Is Overlooking Southwest's Ability To Withstand A Recession

Credit Suisse's Julie Yates has reiterated an Outperform rating on Southwest Airlines Co LUV, with a price target of $55.

Reaffirming that Southwest Airlines was the Top Pick on the Credit Suisse Focus List, Yates mentioned that "LUV is the most compelling multi-year story in the sector and is also one of the better positioned airlines in 1) a recession, or 2) a rapidly rising fuel environment."

In addition, the analyst believes that the company's capital returns and cash flow are the most sustainable in the sector.

However, Yates pointed out that the market has been focused "myopically" on the risk of the company missing its Q1 unit revenue guidance, apart from a few other concerns.

Southwest Airlines is one of the few companies in the sector to be unaffected by margin compression, ex-fuel.

"Even when embedding a worst case scenario on LUV, it still is holding on to non-fuel margins better than peers. LUV's derating has been just as severe as other carrier's despite the fact that it is overearning the least on fuel," Yates noted.

In fact, the analyst believes that given the company's higher quality earnings and RASM outperformance, a higher multiple is justified.

There is scope for margin expansion at Southwest Airlines during 2017/2018, even if oil prices rise, given the company's cost and revenue opportunities, as well as its hedging position.

According to the Credit Suisse report, "LUV's new reservations system will unlock $1B-1.5B in revenue opportunity over time but there are additional, often neglected revenues from other IT investments."

Also, other upgrades would significantly enhance the company's network optimization and revenue management capabilities, while improving operational management.