Business Model Overhaul Creates Turbulence Risk for Southwest Airlines Stock (LUV)

After more than five decades of pioneering the “no frills, no fees” approach to air travel, Southwest Airlines (LUV) finds itself at a crossroads. The Dallas-based carrier is making significant changes to its business model, prompting investors to wonder if the airline can successfully reinvent itself.

The stock has been on a strong run, surging by over 46% in the past three months, and the company remains financially stable, with industry-leading operations. However, significant risks around its business model transformation and a premium stock valuation have me Neutral on the shares, waiting for more apparent signs of successful execution of those changes before I establish a stock position.

Strong Financial Foundation Fails to Deliver Profitability

Q2 earnings are upon us, and recent positive results from Delta (DAL) lifted share prices across the industry (including shares of LUV), creating heightened anticipation for the release of Southwest’s Q2 results, especially given the first quarter’s mixed results.

On the positive side, in Q1, the airline reported a record revenue of $6.4 billion. The company also posted a solid balance sheet, with $9.3 billion in available cash and credit facilities, compared to $6.7 billion in total debt.

However, despite such impressive numbers, profitability has remained elusive. The airline posted a net loss of $149 million, or about -$0.26 per share. Even after accounting for exceptional items and one-time charges, the adjusted loss was $77 million, resulting in a negative 2.3% profit margin, which reflects the intense cost pressures facing the company.

Looking ahead, management has previously provided guidance to expect the second quarter’s results to continue reflecting the challenging environment, with unit revenues potentially declining by up to 4% year-over-year.

LUV Shifts from Maverick to Mainstream

Southwest Airlines built a maverick reputation by doing things differently from most airlines. While competitors operated complex hub-and-spoke networks with multiple aircraft types, Southwest focused on keeping it simple with one plane type (Boeing 737s), point-to-point flights, no assigned seats, and free checked bags.

The strategy worked brilliantly, and Southwest grew to nearly 20% of the U.S. domestic market, making it the second-largest airline in the U.S. behind American Airlines. However, the industry is notoriously challenging, and competitive advantages quickly erode, forcing airlines to continually evolve.

After years of market leadership, Southwest now faces mounting pressure. The company has faced operational challenges, near-miss safety incidents, and ongoing flight delays. To counter its slump, the airline announced a shift in direction, abandoning the model that had worked so well for it in the past. It will now offer assigned seats and premium seating options, as well as bag fees for many ticket types. Management has also announced job cuts affecting 1,750 positions, primarily in corporate roles, as part of broader cost-reduction efforts.

Can Southwest’s Transformation Deliver an Uplift?

If Southwest can successfully execute its business model shift, the potential upside could be significant, adding fees for bags, seat assignments, and premium options could generate hundreds of millions in new annual revenue.

However, the risks cannot be ignored. The airline’s brand loyalty was built on being different from other airlines. Many customers specifically chose Southwest because it didn’t nickel-and-dime passengers with fees. Alienating this customer base while competitors potentially match Southwest’s new fee structure could leave the airline stuck in an uncomfortable middle ground.

Further, implementing assigned seating, premium cabins, and new fee systems requires significant operational changes and employee training. Any stumbles during this transition could damage both customer satisfaction and financial performance.

From a valuation perspective, Southwest stock appears relatively expensive compared to its industry peers. The shares trade at about 44x earnings, compared to just 8.22x for Delta and 7.9x for United (UAL). Any turbulence from the transition could equate to significant volatility (and potential downward repricing) for the shares.

Is LUV Stock a Good Buy Now?

Analysts following the company have expressed a cautiously optimistic outlook on the shares, with many expressing concern about near-term profitability challenges and the risks associated with the recent strategic transformation.

The consensus rating for LUV stock is Hold, based on 13 analysts’ most recent ratings. LUV stock carries a Hold consensus rating based on five Buy, five Hold, and three Sell ratings over the past three months. LUV’s average stock price target of $32.67 implies approximately 12% downside potential over the next twelve months.

See more LUV analyst ratings

Recently, Barclays’ Brandon Oglenski raised the price target for Southwest Airlines (LUV) to $34 from $26, while maintaining an “equal weight” rating. The analyst noted that higher jet fuel prices and weak U.S. leisure demand are likely to keep airline earnings outlooks subdued. However, potential capacity reductions in Q4 could be viewed positively by investors.

UBS’ Thomas Wadewitz also increased his price target for Southwest to $34 from $27, while maintaining a Neutral rating. He highlighted projections for stable demand in Q2 following a decline earlier in the year and expects Q2 earnings reports to align with expectations.

Conversely, Bernstein’s David Vernon lowered his price target for Southwest to $30 from $31, keeping a Market Perform rating, citing higher fuel prices and uncertainty about the duration of the current transformation. He noted that while airlines can pass on fuel costs through fares, this becomes particularly challenging during supply-driven fuel shocks, which could potentially impact the summer travel season.

The Bottom Line

Southwest Airlines benefits from a strong operational base, a healthy balance sheet, and high customer loyalty—factors that support its continued market presence. However, the outcome of its strategic pivot is still uncertain, and the upcoming quarterly results will be the first real test of its ability to adapt its business model.

Given the stock’s premium valuation and the execution risks involved, a cautious, wait-and-see approach may be the most prudent stance for now.