Jefferies downgraded shares of Southwest Airlines on Thursday, citing persistent inflation weighing on profitability. "We continue to like LUV's network and strategy; however, we see the potential for outperformance compared to the industry to be limited given higher exposure to inflationary pressures than peers," Jefferies' Sheila Kahyaoglu said in a note. The firm lowered its rating on Southwest to hold from buy. Jefferies also cut its price target on the stock to $45 per share from $60 per share. The new projection is in line with Southwest's close Thursday at $45.27. Shares fell 2% in the premarket. Southwest is in a worse position than its peers to battle rising costs, according to Jefferies. The company's pricing power is lower than normal as supply has expanded, the firm noted. "LUV's LCC (low cost carrier) model seems to be more exposed to inflationary pressures, given a distributed network and fewer new efficiencies," Kahyaoglu said. Southwest operating leverage is limited as its outlook on cost per available seat mile — a measure of efficiency in the airline industry — is higher than expected, Jefferies said. The company also has constrained free cash flow as its capital expenditures remain high. Jefferies projects just $3.2 billion of free cash flow usage from 2022 to 2024. Plus, "recent labor shortages combined with general inflation have pressured profitability," Kahyaoglu said. Southwest made headlines in October after staffing issues led to mass flight cancellations that cost the company $75 million . Shares of Southwest have underperformed the market this year, down 2.9% in 2021 compared with the S & P 500's 25% gain. —CNBC's Michael Bloom contributed reporting.
A Southwest Airlines jet sits at a gate at Orlando International Airport in Orlando, Florida, U.S., October 11, 2021.
Joe Skipper | Reuters
Jefferies downgraded shares of Southwest Airlines on Thursday, citing persistent inflation