The airline industry has faced severe challenges recently, primarily due to the COVID-19 pandemic, which caused a drastic drop in global passenger demand and significant financial losses. 

Major U.S. airlines, even with government aid, lost over $34 billion in 2020. 

Recovery has been slow, with international travel rebounding but business travel lagging and higher fuel prices squeezing margins.

Southwest Airlines (LUV) has struggled more than its competitors. 

Despite cost-cutting measures, Southwest’s ROA fell from 11.5% in 2017 to just 2.1% in 2023, leading to a 50% drop in its stock price. 

Activist investor Elliott Investment Management has taken a substantial stake in Southwest, pushing for strategic changes to improve its performance.

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The airline industry has faced immense turbulence over the past few years. What was once a relatively stable sector has now encountered headwinds threatening even the strongest carriers.

The COVID-19 pandemic delivered an unprecedented blow in early 2020. With international borders closing virtually overnight, global passenger demand plummeted by over 90%. 

Airlines slashed routes and parked hundreds of planes as billions in revenue vanished. Carriers large and small burned through cash reserves just trying to stay aloft.

It was undoubtedly the industry’s worst crisis ever. 

Major U.S. airlines like American (AAL), United (UAL), and Delta (DAL) scrambled to cut costs through layoffs and early retirements. Even with $38 billion in government aid, the six biggest U.S. airlines combined lost over $34 billion in 2020 alone.

Now, two years later, the recovery remains bumpy. 

While international travel rebounds, business travel – a key revenue driver – lags behind pre-pandemic levels. Labor shortages and jet fuel prices over 40% higher than 2019 further squeeze margins.

One carrier facing particularly troubling conditions is Southwest Airlines (LUV). 

The airline hit peak profitability with an 11.5% Uniform return on assets ‘ROA’ in 2017 as it dominated the U.S. low-cost market. 

However, pressure was building from intensifying competition from rivals adopting the same business model. Rising fuel costs from volatile oil markets were also squeezing margins.

Then the COVID-19 pandemic struck in early 2020, creating a perfect storm. With lockdowns and travel bans, Southwest saw passenger demand evaporate overnight. 

Revenues collapsed as the airline burned through cash. Vast cost-cutting measures and debt issuance were needed just to avoid bankruptcy.

While larger carriers like American (AAL) and Delta (DAL) started and continued their recovery throughout 2022 and 2023, reaching 5% – 8% ROA, Southwest struggled. 

Its ROA only reached 2.6% in 2022, far below pre-pandemic levels. And in 2023, ROA declined further to 2.1%, showing its turnaround was stalling.

This multi-year slump has weighed on Southwest’s stock, falling 50% since the beginning of 2020.  

With doubts around leadership’s strategy, activist investor Elliott Investment Management has accumulated an almost $2 billion stake in Southwest and plans to push for changes.

Elliott is likely pushing for strategic changes and cost cuts like renewing Southwest’s fleet with more fuel-efficient aircraft, restructuring routes to focus on profitable markets, and negotiating better labor contracts.

Only time will tell if Elliott’s activist campaign can finally solve the company’s problems. Still, strong actions are needed to strengthen its competitive position amid ongoing industry headwinds.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research