Insanely Oversold Stock Could Deliver Another Massive Gain

Despite the fact that Southwest Airlines’ (NYSE: LUV) fundamental metrics are the strongest they have been in a long time and the shares are dirt cheap, the stock has spent most of 2015 torturing the bulls.

While oil prices are still relatively low, their recent jump helped knock the stock 25% off its January highs in less than four months. Then, after a brief bounce, LUV was driven to a new year-to-date low following a slew of negative stories.

First, the airline launched a huge, “unexpected” fare sale on June 2. The aggressive sale went viral and brought millions of people to the Southwest site to look at tickets. Overwhelmed by traffic, the website crashed. It was not functioning properly for nearly a day and a half, leaving thousands unable to book travel online, and phone lines were busy as well.

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Southwest extended the sale in the hopes of capturing additional business, but in the end this blunder was a huge positive catalyst that got shot down.

More selling hit airlines when American Airlines (NASDAQ: AAL) lowered its second-quarter outlook this week. Meanwhile, Southwest CEO Gary Kelly said that due to weaker-than-expected economic growth the company will be vigilant in making sure it doesn’t grow capacity too fast and cut into profits.

A few airlines got downgraded as a result. Southwest was not one of them — in fact, several analysts reiterated their “buy” ratings while adjusting their annual earnings estimates slightly lower — but investors sold nonetheless.

This was particularity painful for me, as I had just recommended readers of my Profit Amplifier service take a long position in the airline. But I still love LUV. It is insanely oversold here, and I think traders have an opportunity to make huge profits.

I am intimately familiar with LUV. First, as a pilot, my background and experience give me a deeper understanding than the average analyst or investor. I also have a number of friends who work for the company. While I certainly don’t deal in “inside” information, I do have my finger better positioned on the pulse than most.

I’ve also traded the stock successfully many times in the past.

For example, in August, I recommended a long trade in LUV. The stock was at trading at $32, and I thought it could reach $35 in a few months. Southwest climbed steadily and hit my target in less than one month.

Had I simply recommended buying shares, we would have been looking at a 9% gain. But when all was said and done, those who followed my advice made a 62% gain, which worked out to an annualized return of more than 700%.

That’s because we bought call option contracts on Southwest instead for $3.70 per share ($370 per contract), which soared to $6 per share ($600 per contract).

LUV Stock

I am even more bullish on LUV than I was back then.

The recent rally in oil and subsequent sell-off in Southwest shares make for an advantageous entry point, as I believe oil prices will more than likely move lower.

OPEC’s recent decision to stick with its high production levels, coupled with near-record production from U.S. shale fields and the potential for more supply as sanctions against Iran are eased, should keep oil in a range between $50 and $65 per barrel for the balance of 2015.

Lower oil prices mean lower jet fuel costs. In 2014, Southwest’s fleet consumed 1.82 billion gallons of fuel at a total cost of $5.52 billion, for an average cost of $3.03 per gallon. For perspective, that’s more than half the company’s total operating costs for the year.

Thankfully, Southwest is known for its fuel-hedging prowess. The company successfully navigated the big oil booms (and busts) from 2007 to 2013. Its hedging and strong management helped make Southwest one of the only major American airlines to avoid bankruptcy during the Great Recession.

It seems the company’s knowledge and experience is paying off again. CEO Gary Kelly removed all of Southwest’s fuel hedges in December. By removing hedges (which would have locked the company into paying a higher price for fuel), Kelly bet that oil would fall further from its November dip. He was right.

Even with the recent rebound in oil prices, jet fuel is currently priced at only $1.79 per gallon, well under Southwest’s average per-gallon price in 2014.

If oil jumps to $70, that would put wholesale jet fuel somewhere around $2.30. And even if we mark that up $0.16 — the difference between the average spot price and what Southwest paid in 2014 — that’s still a $0.57 discount to what the airline paid last year.

Assuming Southwest uses 1.82 billion gallons of fuel (same as 2014), the company could conservatively be looking at $1.04 billion in fuel savings alone.

We are already halfway into 2015 and fuel prices have been much lower than the prices I used in my example, which means Southwest is actually saving much more. And since these are hard savings, the results are going right to the bottom line, as anyone could see from the company’s first-quarter earnings announcement. In the first three months of 2015, LUV’s net income was 263% higher than the same period a year ago on just a 6% increase in revenue.

A conservative $1.04 billion fuel savings in 2015 would result in a 60% increase from 2014 earnings –and that’s just from reduced fuel costs. Over the past 10 years, a period during which oil prices were pretty consistently above $70 per barrel, Southwest was able to grow earnings at an average rate of 57.6% per year. There’s nothing to suggest that the company won’t continue to see that same non-fuel-related growth in 2015.

Analysts expect EPS to increase 69% in 2015 to $3.40, giving LUV a forward price-to-earnings (P/E) ratio below 10, which is near a 10-year low.

Furthermore, the PEG ratio, which compares a stock’s P/E ratio to its EPS growth rate, is at 0.4. A PEG of 1 is considered fair value, and the 10-year average PEG for Southwest is 2.2. This signals how deeply undervalued LUV is at current levels.

After the recent selling, my revised target for LUV is the resistance level at $41.95, which I think will be hit before or immediately after the company’s next earnings report, set for July 23. Investors who buy now could make almost 20% on a move to that level.

Profit Amplifier subscribers who bought call options on my June 2 recommendation stand to make at least 38% on a move to that level. And if you were to buy that option now, you could wind up doubling your money.

Since I launched Profit Amplifier in late February, I’ve used options to turn an 11% move in Keurig Green Mountain (NASDAQ: GMCR) into a 34% return in 56 days, a 13% move in Yelp (NYSE: YELP) into a 40% gain in 29 days, and an 11% move in Valero Energy (NYSE: VLO) into a 91% profit in 15 days.

If you’re interested in getting my next trade or learning more about how I go about selecting winning options, check out this short presentation.