5 Reasons LUV Shares Could Lose Some Love

tdp2664
InvestorPlace
Southwest (NYSE: LUV ) has long been the darling of airline investors, using its low-cost business model to eat the lunch of legacy airlines like United Continental (NYSE: UAL ), Delta Air Lines (NYSE: DAL ) and American Airlines (NYSE: AMR ).  Southwest's earnings have topped analysts' consensus estimates by nearly 15% over the past year. Add to that great operational efficiency, a strong balance sheet and aggressive management of fuel costs through hedging and you have an airline that's poised to soar even higher.  Or is it?  While Southwest continues to perform well compared to its larger competitors, we're always mindful of the smart investor's mantra: "past performance is no guarantee of future results".  You can't underestimate Southwest's market savvy and competitive power.  But it's also an airline moving from one business model to another – evolving from its wildly successful roots as a low-cost carrier to become a full-fledged national competitor.  And that's why growing pains may pose a challenge to future earnings. Here are five reasons why the airline will face future headwinds as it builds on its past success:  Broader Geographic Reach .  Southwest started out as a short-haul, regional airline.  It's now become a full-fledged national carrier that operates some 3,400 flights a day to 72 cities in 37 states.  The carrier also is planning to introduce service to Hawaii and the Caribbean with new Boeing 737-800s it will acquire next year.  That means Federal Aviation Administration certifications for the planes — as well as their pilots and engineers — for extended over-water operations. New Reservations Systems.  Southwest's vaunted image as a customer-service leader took a hit last month when the launch of its new business traveler-targeted Rapid Rewards program crashed the airlines' online reservations system.  Southwest already had been negotiating with the Sabre and Amadeus global distribution systems to upgrade their internal system to handle international traffic.  While these upgrades ultimately will yield value, they will inject more complexity into the process in the short run. AirTran Employees.  Southwest's $1 billion acquisition of rival AirTran (NYSE: AAI ) will complicate operations in two key areas: labor and fleet management.  Pilots, fight attendants, mechanics and ground workers at both companies will need to choose the unions that they want to represent them.  For example, an internal union currently represents Southwest's pilots; AirTran's pilots are part of the Air Line Pilots' Association. Both unions must negotiate important points like integrating seniority lists and determining schedules and compensation. As Southwest knows from its attempt to acquire Frontier Airlines, a failure to forge agreement with both carriers' employees can kill a merger. AirTran Aircraft .  A big part of Southwest's efficiency can be chalked up to flying a single aircraft — its fleet consists of more than 530 Boeing 737s. But AirTran's fleet includes 86 Boeing 717-200s – a 100-seat jet formerly known as the McDonnell Douglas MD-95. The airline's integration of AirTran's 717s and 737-700s into its own operations will be neither quick nor effortless – particularly in the wake of fatigue-crack inspections for Southwest's older 737s.  Fuel Price Volatility.  Fuel prices are the bane of the entire airline industry's existence and Southwest's hedging policies have saved the carrier a lot of money.  But it also lost a lot of money tied up in hedges when fuel prices hit the skids in 2008. Legacy carriers aggressively hike fares and fees to make up the difference — an approach Southwest tries hard to avoid.  The airline almost single-handedly quashed three industrywide fare hikes in recent weeks and its "Bags Fly Free" promotion hammers competitors' policies.  But something's got to give and fuel costs must be recouped in some way. And if you take fares and fees off the table, there are few other options left. Bottom Line: Southwest's fundamentals are solid. It will continue to be a tough competitor in the sector and deliver value to shareholders.  But the airline is growing up and – like it or not — its business model is changing. Expect some near-term turbulence as Southwest continues its climb to a new, higher, cruising altitude.   As of this writing, Susan J. Aluise did not hold a position in any of the stocks mentioned here.