Southwest Airlines May Be On The Edge

The airlines industry should serve as a reminder just how quickly and dramatically things change on Wall Street. Publicly traded stocks of major airline carriers were the toast of the town during 2013 and 2014. Southwest Airlines Co. (NYSE:LUV) saw some of the biggest gains in the sector. Throughout most of 2012, LUV stock was trading under $10 a pop. Now, shares have quadrupled in value. However, LUV hasn’t gone anywhere in the trailing year-and-a-half period. On top of that, things could get a whole lot worse.

Last Friday was the third straight day in which the airliner was forced to cancel or delay scores of flights. According to information provided by the AP, by mid Friday afternoon, “about 300 Southwest flights had been canceled and 1,200 more delayed. Southwest canceled nearly 1,500 flights and 4,500 others were delayed Wednesday and Thursday.” That’s almost 2,000 flights canceled and 5,700 others delayed in less than a 72 hour period.

The administrative and logistical crisis was said to be caused by a computer router failure, which caused other systems to break down. Backup mechanisms that were supposed to address the problem failed to work, thus creating a domino effect. To further complicate matters, several Southwest crews were stranded in different cities, and were unable to service their normal routes.

As if that wasn’t enough, Southwest had a very rough showing for the second quarter of fiscal year 2016 earnings results. LUV registered $1.19 earnings per share, which was down two cents from analysts’ consensus target. Southwest saw top-line sales of $5.38 billion, which also fell short of expectations of $5.41 billion.

Southwest Airlines May Be On The Edge

Industry guidance was also weak, with Southwest stating that rising competition would negatively impact air fare. This stems from airliners desperate to gain market share, which would squeeze margins for just about everybody. It also doesn’t help that Southwest will have to find some way to regain consumer trust. Whatever path they choose, it won’t come cheap.

The company CEO has emailed out an apology for the disruptions, citing the events as “unacceptable.” In return, Southwest is offering a 50% discount on future flights that are booked within a fairly narrow time frame. The cheapskate image that this apology gives off – why not provide free tickets? – underscores the difficulty Southwest, and the entire airlines industry, is facing.

With these bearish fundamentals in mind, LUV stock likely faces serious technical challenges. Since the beginning of 2015, LUV has gone nowhere. Upside potential was mostly capped at $48, while there was downside support between $32 and $35. While LUV does have the appearance of a pennant formation, and thus, a continuation pattern, I believe that conventional wisdom doesn’t apply here.

The whole industry is under substantial pressure. The most likely scenario of a breakout move is if Southwest was acquired by, or merged with another company. But we’ve already seen many mergers among the major airliners. Therefore, it may be difficult to have such a measure approved by regulatory agencies.

More likely, investors will view the incredible technical performance of LUV back a few years ago, and realize that valuations today don’t make much sense given today’s broader bearishness. This is a company that has warning signs all over it. Investors may be better served waiting this one out before committing any capital towards Southwest.