Southwest Airlines Co.LUVNYSE

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DCF Valuation

DCF Valuation Summary

Strong Buy

Fair Value: $94.13 per share(market-calibrated)

+99.3%

Upside to Fair Value

Current

$47.23

Pure Model

$97.23

Fair Value

$94.13

Bull Case

$124.47

Bear Case

$73.98

Market Reality Check

Model Terminal Growth

2.25%

Market-Implied Growth

0.50%

Calibrated Growth

1.64%

Fair value uses 65% model / 35% market-implied terminal growth. Pure model: $97.23.

What's Driving This Ratingfor LUV

↓

CapEx normalizing toward maintenance

Historical CapEx is 9.10% of revenue (heavy investment phase). Model fades this to 3.50% by Year 10, freeing up ~$2.6B in annual FCF. This is the biggest driver of long-term cash flow improvement.

↑

Margin expansion modeled

Current EBIT margin is 4.83% — below the sector mature average of 13.00%. Model expands margins as the business scales and operating leverage kicks in. Year 10 EBIT reaches $4.8B (10.32% margin).

↑

Strong near-term revenue growth

Analyst consensus projects 12.90% revenue growth in Year 1, fading to 5.25% by Year 5 and 2.25% by Year 10. Revenue reaches $46.6B by Year 10 (vs $28.1B today).

↔

Perpetuity and exit methods disagree

Perpetuity growth gives $74.39/share (17.0x terminal FCF) while exit multiple gives $120.07/share (29.2x terminal FCF). The 18x EV/EBITDA exit reflects current market multiples, while the perpetuity method with 2.25% growth is more conservative. The base case averages both methods.

🎯

Market pricing in lower growth than model

The market implies only 0.50% perpetual growth — 175bps below the model's 2.25%. This suggests the market sees headwinds or risks not in the model.

✓

Strong cash flow conversion

Year 10 FCF/EBITDA conversion of 61.74% indicates efficient cash generation. FCF reaches $4.5B by Year 10 (9.61% FCF margin).

Weighted Average Cost of Capital (WACC)

Cost of Equity (CAPM)

Risk-Free Rate (Rf)4.50%

Beta (β)1.09

Market Risk Premium4.50%

*Using current implied premium (4.5% per Damodaran 2026), not historical (6.5%)

Cost of Equity (Re)9.42%

Cost of Debt

Pre-tax Cost of Debt4.33%

Tax Rate21.67%

After-tax Cost of Debt3.39%

Equity Weight (E/V)81.00%

Debt Weight (D/V)19.00%

WACC Calculation

WACC = (E/V × Re) + (D/V × Rd × (1-Tc))

WACC = (81.00% × 9.42%) + (19.00% × 3.39%)

= 8.28%

10-Year Free Cash Flow Projections(showing years 1, 3, 5, 7, 10)

Year	Year 1	Year 3	Year 5	Year 7	Year 10
Revenue	$31.7B	$34.6B	$39.4B	$42.9B	$46.6B
EBIT	$1.5B	$1.7B	$1.9B	$3.3B	$4.8B
Tax	$331M	$362M	$412M	$722M	$1.0B
NOPAT	$1.2B	$1.3B	$1.5B	$2.6B	$3.8B
+ Depreciation	$1.7B	$1.8B	$2.1B	$2.2B	$2.4B
- Capex	$2.9B	$2.7B	$2.6B	$2.3B	$1.6B
- Δ NWC	$362M	$131M	$196M	$167M	$103M
Free Cash Flow	-$384M	$276M	$756M	$2.4B	$4.5B
Discount Factor	0.924	0.788	0.672	0.573	0.451
Present Value	-$354M	$218M	$508M	$1.4B	$2.0B

FCF Formula: Free Cash Flow = NOPAT + Depreciation - Capex - Change in Net Working Capital

Terminal Value Calculation

Perpetuity Growth Method

Year 10 FCF$4.5B

Terminal Growth Rate2.25%

WACC8.28%

TV = FCF₁₀ × (1+g) / (WACC-g)

Terminal Value$76.0B

PV of Terminal Value$34.3B

Exit Multiple Method

Year 10 EBITDA$7.3B

Exit Multiple (EV/EBITDA)18.0x

TV = EBITDA₁₀ × Exit Multiple

Terminal Value$130.7B

PV of Terminal Value$59.0B

Valuation Summary

Perpetuity Growth Method

PV of Projected FCFs$8.6B

PV of Terminal Value$34.3B

Enterprise Value$42.9B

(-) Net Debt$2.8B

Equity Value$40.2B

Shares Outstanding540M

Price per Share$74.39

Exit Multiple Method

PV of Projected FCFs$8.6B

PV of Terminal Value$59.0B

Enterprise Value$67.6B

(-) Net Debt$2.8B

Equity Value$64.8B

Shares Outstanding540M

Price per Share$120.07

Pure Model Fair Value

$97.23

Average of perpetuity growth and exit multiple methods (before market calibration)

Sensitivity AnalysisPrice per Share

WACC ↓ / Growth →	1.25%	1.75%	2.25%	2.75%	3.25%
6.28%	$124.73	$130.00	$136.58	$145.02	$156.25
7.28%	$106.54	$109.85	$113.82	$118.67	$124.71
8.28%	$92.44	$94.66	$97.23	$100.28	$103.93
9.28%	$81.06	$82.61	$84.37	$86.41	$88.78
10.28%	$71.61	$72.73	$73.99	$75.41	$77.04

How to read: This table shows how the valuation changes with different WACC (discount rate) and terminal growth rate assumptions. Green = undervalued, Red = overvalued.

Scenario Analysis

Bear Case

$73.98

56.6% vs current

• -25% vs analyst consensus
• Terminal growth: 2.0%
• Beta: 1.37

Base Case

$97.23

105.9% vs current

• Analyst consensus
• Terminal growth: 2.3%
• Beta: 1.09

Bull Case

$124.47

163.5% vs current

• +25% vs analyst consensus
• Terminal growth: 2.8%
• Beta: 0.93

Key Assumptions & Drivers✓ Using Analyst Consensus Estimates• Industrials Sector

Growth Assumptions (Select Years)

Year 1 Revenue Growth12.90%

Year 3 Revenue Growth3.92%

Year 5 Revenue Growth5.25%

Year 7 Revenue Growth4.05%

Year 10 Revenue Growth2.25%

Terminal Growth Rate2.25%

Margin & Efficiency

Current EBIT Margin4.83%

Terminal EBIT Margin13.00%

Tax Rate21.67%

Historical Capex / Rev9.10%

Terminal Capex / Rev3.50%

NWC / Revenue10.00%

Key Drivers: Revenue growth, operating margin expansion, capex efficiency, and working capital management are the primary drivers of cash flow generation. Terminal value assumptions significantly impact final valuation.

Institutional-Grade Methodology

Actual Company Data: Revenue, EBIT, Capex, NWC, Tax Rate, Interest Expense, Beta

Market Assumptions: Risk-free: 4.5% (10Y), MRP: 4.5% (Damodaran 2026), Exit: 18x EV/EBITDA (Industrials sector)

This DCF model is for informational purposes only. Projections are based on assumptions that may not materialize. Past performance does not guarantee future results. Consult a financial advisor before making investment decisions.

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