Leading low cost airline Southwest (NYSE:LUV) posted better than expected results with a 29% rise in revenues in the first quarter. As the competition grows tough, the annual synergy benefits of $400 million arising from AirTran acquisition would supplement its low cost structure advantage. The company is also banking on long-term growth from international operations by launching services from Houston’s Hobby Airport by 2015. Despite facing stiff competition from United Continental (NYSE:UAL) and Jetblue Airways (NYSE:JBLU), the carrier has been able to sustain its low cost advantage through efficient hedging programs and other operational efficiency measures; cabin seat optimization program being the recent initiative.
The carrier has strong fundamentals which support its Trefis price estimate of $11.89. Here we provide some of the prime reasons that justify a higher valuation for this stock.
Southwest has beaten the competition in maintaining effective cost structures, which it has achieved through employee productivity gains and efficient point-to-point route structures. Further, it has cut down on its maintenance expenditures by employing a single-type aircraft fleet. The use of a single aircraft type has allowed for simplified scheduling, maintenance, flight operations and training activities. Moreover, it has recently launched another initiative where it plans to add six seats to 60% of the total fleet size by 2013. This exercise will add to the ASMs, and also distribute the operational costs among wider base.
The carrier reduced its exposures towards OTC derivatives to save on premium paid which positively affects the bottom-line. Though this strategy may back-fire at times considering the oil price volatility, it is paying off at the moment as WTI crude oil price has fallen from this year’s highs of $110 to $91/barrel.
Cost Synergies Through AirTran
Southwest received single operating certificate from FAA (Federal Aviation Administration) in March this year which enables the carrier to transition to a single ticketing system with Airtran and realize operational benefits. Though the carrier doesn’t charge for first and second checked baggage under its ‘Bags Fly Free’ initiative, it plans to charge for baggage fee and higher business class fares under AirTran brand until full integration by 2014. The baggage fee would boost ancillary revenues and the topline with marginal cost additions.
Expansion to International Markets
Southwest has established itself as a leading player in the domestic markets with a 17.7% market share in terms of ASMs (Available Seat Miles). The company is now spending heavily on growth opportunities in the international markets, the acquisition of AirTran being a key milestone in this initiative. AirTran provisions the carrier with additional landing slots in Newyork and Washington DC, and also opens up access to Atlanta. The carrier plans to extend service to many smaller domestic cities it did not previously serve, and provide access to key near-international markets in the Caribbean and Mexico. It also envisions launching international service from Houston’s Hobby Airport by 2015. The carrier will support this expansion plan through a firm order pipeline of 350 aircraft in the next 10 years, which is half of its existing fleet.