Southwest Airlines posts unusual loss in USD345m negative swing as bookings remain strong

It is clear that passenger volumes, fares and business and leisure travel are remaining strong now that three airlines have reported strong forward bookings as well as a strong quarter.

“Like every other business leader I talk to, they say their business is fine, and we see the same at Southwest,” CEO Gary Kelly told analysts. “We are planning very cautiously because we are not hitting our costs so we are planning 2012 ASMs to be flat to down.”

Passenger volumes as well as October and forward bookings remain strong but the company is taking a cautious approach to capacity and growth as it heads into winter. Mr Kelly reported, based on October traffic and booking trends, so far, business travel is remaining stable and the company expects solid passenger unit revenue growth, year-on-year to continue into the fourth quarter.

He also said that unit revenue growth at AirTran surpassed Southwest on easier comparables with 2010. However, he pointed out that AirTran lagged behind Southwest’s 8% margin.

Total operating revenues rose 35.1% to 4.3 billion while record passenger revenue reached USD4 billion. Operating income reached USD225 million in the quarter, down from the USD355 million in the year-ago quarter. Excluding special items in both periods, operating income was USD285 million for 3Q2011, compared to USD389 million for 3Q2010, and compared to USD447 million for 3Q2010 on a combined basis.

Excluding special items, 3Q2011 net income was USD122 million compared to net income of USD195 million in the 2010 quarter, a 37% decline, largely owing to a 38% rise in fuel per gallon.

“If not for that, earnings would have been outstanding because of stellar revenue performance which included record yields, load factor and revenues,” said Mr Kelly, who emphasised he has seen no evidence of weakening demand or softening in business travel.

Mr Kelly reported that progress has been made in bringing the B737-800 on board with its Sky Interior and the company is looking at changing to that interior for future deliveries and even retrofitting its current fleet.

Special items reverse its fortunes for the quarter

Special items in the quarter included USD227 million (net) in unrealised, non-cash, mark downs on fuel hedges for future periods. Actual net cash settlements paid to counter parties for the 3Q2011 hedging activities were USD13 million, according to CFO Laura Wright. Ms Wright told analysts a more meaningful metric is on an “economic” basis because it reflects actual net cash outlays for fuel consumed during the period.

Operating revenues were helped by outstanding returns from its new Rapid Rewards programme launched last March and Early Bird Check-In revenues. These two items pushed other revenues up 18% as membership in Rapid Rewards jumped almost 50% and flight activity of old members outpaced system activity.

Mr Kelly also reported that the premium paid by members increased as did the number applying for the credit card. Credit card activity increased as well, as partnerships grew providing healthy revenues on the sale of points. He indicated it validated the changes to the programme and confirmed the increasing revenue impact the new programme will have as it matures.

Growth in business partners accounted for a USD13 million increase while Early Bird was up USD8 million for a total of USD37 million. Ms Wright reported the company has already exceeded the USD100 million target set for the programme for 2011. She said the results “fortified our expectations that the new program will contribute hundreds of millions in incremental and other revenues by 2014”.

Third quarter revenue per available seat mile for the combined Southwest/AirTran operation rose approximately 6.7% to USD12.94 cents. Passenger RASM jumped 6.5% to USD12.05 cents. Other revenue grew 17.5% to USD262 million over the 3Q2010 period. The combined companies flew 4.7% more available seat miles during the quarter when it fielded 33.3 billion ASMs. Load factor rose 0.5 points to 82%. Yield rose 5.7% to USD14.69 cents.

In July combined PRASM was up 2% while it jumped 6% in August and 13% in September. Third quarter revenue was boosted by USD44 from the fare increase when the federal authorisation to collect federal ticket taxes lapsed for two weeks. Southwest’s average fare rose 10.4%. The business mix, however, was down two points to 17% owing to a growth in passengers and load factor and a change in consumer and business booking behaviour in which business travellers now book further in advance, exceeding three weeks.

October PRASM is expected to be up in the mid-single digits compared to Oct-2010. The company expects the fourth quarter results to be similar, according to Ms Wright.

Expenses

Operating expenses reached USD4.1 billion a significant jump from the USD2.8 billion posted in 3Q2010. Excluding special items, unit costs in the third quarter rose 10.1% to USD12.06 on a 34% increase in economic fuel costs per gallon of USD3.18 per gallon. CASM grew 10.5% to USD12.26.

It is expecting fourth quarter economic fuel costs, including fuel taxes to be USD3.30, with fourth quarter combined unit costs to rise modestly from the USD7.72 cents in 4Q2010. Meanwhile, Ms Wright reported operating expenses, ex fuel and special items rose 6.5% on a unit basis on rising salaries, benefits and revenue-related costs of USD11 million on 11% increase in passengers.

Ex fuel and special items unit costs declined 1.2% to USD7.38 from 3Q2010. Based on current cost trends, the company expects another modest year-over-year increase in its 4Q2011 unit costs, compared to fourth quarter 2010's combined unit costs of USD7.72 cents, excluding fuel and special items. The increases will come from higher airport, salaries and revenue-related expenses.

It ended the quarter with USD3.7 billion in unrestricted and a USD4.1 billion cash balance. The company finished the quarter with net cash of negative USD218 million compared to the USD385 million in the year-ago period.

The company has already realised USD30 million in cost synergies since closing on AirTran in May from renegotiating contracts at a lower Southwest rate. Annualised, this amounts to USD60 million with much more to come as the two airlines become more integrated. It projects ultimate cost synergies at USD400 million.

In addition, the revenue potential once network optimisation and synergies and connecting patterns are realised through codesharing between the two, expected in the first half of 2012, will far exceed the USD200 million it will lose in baggage fees when the two are finally integrated. The companies have also not seen any decline in the frequent flyer transfers to Southwest even with elites.

Mr Kelly also clarified the fate of the 88 AirTran B717s which he had earlier indicated would be transitioned out sooner than the 2018-2020 lease expirations. He confirmed they will remain in the fleet for a long time but the company is seeking ways to reduce the additional complexity of a two-aircraft fleet sooner rather than later.

Indeed, the airline is talking to Boeing about the B717s as well as the B737-Max. While no deal has been made, Mr Kelly expressed confidence that since Southwest has been discussing the next generation narrowbody with Boeing for several years, it will be able to command earlier, rather than later, delivery positions.