By Jack Hough

I'm trapped in a cult called youth travel sports. Otherwise sensible parents fly kids cross-country in hopes of them making it to the trophy game of the Cash Grab Classic teal division regional qualifier, where they will inevitably face a team from back home. The cost, including another cult called private trainers, is a little more than college, but there are perks. Some of the lesser hotels throw in a crowded waffle iron at breakfast time. And if there are no seats left at games, parents can just sit in the empty sections marked "reserved for college coaches and recruiters."

I can't prove that Spirit Airlines is behind all of this. But it pushes itself on over-sported families with impossibly low fares. I just saw a New York City to Houston flight for about $70 per person round trip, plus $80 in airport fees and taxes. Even after another $55 or so each way in baggage fees, that's half of what some team families are paying for Southwest Airlines. I'm confident that Spirit can avoid near-term bankruptcy -- it just emerged from one last month. I've been warned that the seats are uncomfortable, but I spent part of my 20s on dusty, white-knuckle bus trips through faraway countries sitting between locals holding chickens. Maybe I'm ready.

This has to be a difficult environment for Southwest, which is attempting a turnaround while suffering an identity crisis and possibly entering an industry slump. Yet after three years of terrible stock performance, it's suddenly leading the group. Since the end of January, it's up 4%, while the S&P 500 index is down 5%, and Delta Air Lines, United Airlines Holdings, and American Airlines Group have all plummeted more than 30%.

Southwest offers two free checked bags -- as long as you fly before May 28. After that, it will start charging for bags like everyone else. Airline historians will recall that Spirit brought baggage fees to the U.S. in 2007, copying an Irish carrier called Ryanair. One after another, legacy airlines followed its lead. But Southwest held out for 18 years, to the delight of customers and shareholders.

So what changed for Southwest? And must it now try to out-Spirit Spirit? Why are legacy airline stocks doing so poorly this year? Are any of them worth buying? Or would that offer worse economics than the $20 parking charge atop the $45 entry fee at the Gotchapaycheck Spring Showcase tournament?

I put most of those questions to Melius Research analyst Conor Cunningham. He recently turned un-bearish on Southwest, if not yet bullish, raising his rating to Hold from Sell. His boldest call might be one he made to me on flying in general: "A lot of people like to complain about airlines, but the product in the U.S. domestic market is arguably the best it has ever been." On a typical Delta flight, he says, there's a screen on every seat back, plus free Wi-Fi, and you arrive on time.

What about all the nagging fees? Preferences among customers have shifted, says Cunningham. Many have gotten used to flying without checked bags. An airline that doesn't charge for them is arguably leaving money on the table -- and missing an opportunity to add free bags as a perk for its rewards credit card.

This is the view of Elliott Investment Management, which announced a big stake in Southwest last summer and began publicly agitating for change. In a series of peace offerings with Elliott, Southwest in September said it would transition to assigned seating with premium tiers, in October appointed six new board members, and just last month announced the baggage fees.

Premium seats are another nod to how the industry has coaxed a shift in preferences. Gone are the days when passengers must choose between a $300 coach seat and an upgrade straight to $2,500 for first class. "Now, the actual price difference between row 35 and economy plus, it's not that much," says Cunningham. "It's like 70 bucks." That has meant fewer free upgrades and more paid ones, fueling profit growth for the likes of Delta and United, and allowing them to compete sharply on basic economy seat prices.

Several other factors hurt Southwest in recent years. Historically, the company has used its strong balance sheet during industry downturns to invest cheaply and take market share. But the Covid downturn was so severe -- Southwest in 2020 reported its first loss in 48 years -- that the U.S. government gave carriers massive bailouts to cover payroll and other costs. That kept competition fierce, and shortages of pilots and air-traffic controllers didn't help. Neither did a 2022 software meltdown at Southwest that stranded two million passengers around Christmas.

Meanwhile, Southwest grew by expanding into markets where it could only fill planes partway. In February, the company announced the first major layoffs in its history. The string of investor concessions have supported the stock. The industry has been marching to a different cadence. Last year, when Southwest and others swore off big supply increases, the industry looked poised to profit. Delta stock jumped 52% last year, and United, 135%.

This year was supposed to bring upward earnings estimate revisions. January numbers looked solid. Then February and March fell apart. Maybe it's economic uncertainty. Consumer sentiment hit its lowest level since November 2022. BofA Securities just estimated that President Donald Trump's tariffs will ding S&P 500 operating earnings by 5% to 35% -- no one knows how much, in other words.

This explains the stock disconnect. Southwest investors are reacting to company-specific developments. Others are pre-panicking for the industry. Southwest still looks expensive, but expect Delta and United to bounce back if the economy holds up, says Cunningham. If not, Delta can at least still generate ample free cash.

Don't expect lie-flat seats and a caviar course on Southwest. "They're not going to compete on the highest of high levels," says Cunningham. They're also unlikely to turn into Spirit. "Going into markets and offering things like $49 fares or $39 fares just isn't rational anymore, " says Cunningham. "Spirit needs to change its model, and they are. They're also going up this premium ladder."

Maybe I should try Spirit before it turns too posh, and wear a weekend worth of clothes in layers to save on bags. Pride goeth before a fall, but $150 goeth round trip to the Gotchapaycheck Showcase.

Write to Jack Hough at jack.hough@barrons.com

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April 04, 2025 04:00 ET (08:00 GMT)

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