Elliott's 11% Stake in Southwest Amid $231M Loss, Boeing Woes

Key Takeaway

• Elliott Investment Management has acquired an 11% stake in Southwest Airlines, pushing for CEO replacement and board reconstitution.
• Southwest faces operational challenges, including a $231 million net loss and Boeing delivery delays impacting capacity.
• Boeing's financial struggles, with nearly $58 billion in debt and potential junk status downgrade, complicate Southwest's recovery.

Elliott's Stake in Southwest Airlines

Elliott Investment Management has recently taken a significant position in Southwest Airlines, acquiring a $1.9 billion stake, which translates to an 11% ownership in the airline. This move comes at a time when Southwest's stock has been underperforming, having lost over 10% of its value in the past year and more than 50% over the past three years. The stock closed at $27.25 on Friday, below its pre-pandemic level, but jumped 7% in morning trading to $29.80 following Elliott's announcement.

Elliott is advocating for substantial changes at Southwest, including the replacement of CEO Bob Jordan and a reconstitution of the board of directors. The activist investor has criticized Jordan for "unacceptable financial and operational performance quarter after quarter," citing rising costs and lagging revenues compared to other airlines. Elliott's letter to the board also highlighted an "insular culture" within the company, noting that only one of Southwest's eight most senior executives had experience at another airline.

Elliott believes that Southwest's stock could reach $49 per share within 12 months, a 75% increase from its current level. The fund has suggested that Southwest should adopt practices from its rivals, such as charging for assigned seating and other premium options, and overhaul its outdated IT system, which led to an operational meltdown in 2022, stranding over 2 million passengers.

Operational and Financial Challenges

Southwest Airlines has been grappling with several operational and financial challenges. Despite achieving record revenues in the first quarter, the airline reported a net loss of $231 million. The company has announced plans to cut 2,000 jobs and discontinue service at four U.S. airports by the end of the year to reduce costs. Additionally, Southwest has lowered its revenue growth expectations due to delays in aircraft deliveries from Boeing.

Southwest's reliance on Boeing 737 planes has been both an advantage and a disadvantage. While it helps keep maintenance costs low, the airline has had to reduce capacity due to insufficient plane deliveries from Boeing. The manufacturer is only delivering 20 of the 46 single-aisle jets it had pledged, as it works to improve product quality.

Despite these challenges, Southwest benefits from a strong balance sheet. The airline's debt, including operating lease liabilities, stood at $8 billion at the end of March, well below its total cash and short-term investments of $11.5 billion. However, the company's turnaround will remain dependent on Boeing resolving its safety and production issues.

Boeing's Financial Struggles

Boeing, a key supplier to Southwest, is facing its own set of financial challenges. The aerospace giant is at risk of having its debt rating downgraded to junk status due to weak aircraft deliveries, high debt levels, and an unclear recovery picture. Boeing's overall debt stands at nearly $58 billion, and the company has struggled with free cash flow, using nearly $4 billion in the first quarter and expecting an outflow for the year.

Boeing's credit rating is currently at the lowest level of the investment-grade universe, with Moody's, S&P, and Fitch all lowering their outlooks on the company to "negative." This has led to Boeing's bonds trading between the bottom of the investment-grade world and the top of the high-yield ladder. A downgrade to junk status could make it more expensive for Boeing to borrow and could spark price swings in its bonds.

The company has been working to maintain its investment-grade rating, with CFO Brian West emphasizing the importance of managing the balance sheet and improving manufacturing and the supply chain. However, Boeing's leverage, measured as the ratio of total debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), remains high. Fitch Ratings analyst Nicholas Varone noted that Boeing's leverage is expected to fall from the "mid-teens" in 2024 to four times EBITDA by 2026.

Street Views

• Elliott Investment Management (Bullish on Southwest Airlines):

  "Southwest shares could be worth $49 in 12 months, up 75 per cent."