Southwest Airlines (NYSE:LUV) is scheduled to announce its third quarter earnings on Thursday, October 18. The airline is expected to benefit from the fare hikes it implemented during the quarter.  Even though the passenger traffic declined, indicated by a 0.6% y-o-y decline in Revenue Passenger Miles (RPMs), its passenger revenue is expected to post growth on account of higher fares.  The fare hikes were primarily driven by higher fuel prices as Brent crude increased from $95 per barrel at the end of the second quarter to remain above $110 per barrel for most part of the third quarter.  In addition, Southwest’s acquisition of AirTran has allowed it to leverage the latter’s operations on Latin international routes to drive growth.
All in all, Southwest is expected to post good numbers in its third quarter earnings on account of higher passenger fares which were supported by a stable demand environment and growth from Latin American operations of AirTran.
We currently have a stock price estimate of $9.62 for the company, approximately 10% above its current market price.
Higher passenger fares drive growth
Southwest increased passenger fares on several routes during the third quarter driven by higher fuel prices. At the end of the second quarter, the carrier expected to incur average jet fuel price in the range of $3.05 – $3.10 per gallon for the third quarter.  This estimate was based on fuel prices of $100 per barrel (Brent crude) seen towards the beginning of July. But, as oil prices increased significantly from these levels to remain above $110 per barrel for most part of the third quarter, we anticipate the airline to incur a higher average jet fuel price per gallon.
In addition, the carrier adopted a cautious capacity stance. Its Available Seat Miles (ASMs), an indicator of capacity, declined 0.7% y-o-y in the third quarter. This impacted passenger traffic for the airline with a 0.6% y-o-y decline in RPM. However, Passenger Revenue per Available Seat Mile (PRASM) increased 1% y-o-y on account of higher fares.  The fare hikes were supported by a stable demand environment.
AirTran’s Latin American operations add to top-line growth
AirTran, which became a fully-owned subsidiary of Southwest in May 2011, has provided growth to Southwest by means of its operations on Latin American routes. Passenger traffic on these international routes along with the Pacific international routes has shown impressive growth over the past few years driven by emerging economies of Latin America and Asia Pacific, respectively. In comparison, demand for flights has declined on Atlantic international routes due to the impact of the European sovereign debt crisis, and has shown moderate growth on domestic U.S. routes. Thus, the AirTran acquisition has provided Southwest with strong growth opportunities, which were otherwise not available to it. Operations on these routes are expected to add to overall growth during the third quarter as well.
On the whole, Southwest’s Q3 earnings will be driven by higher passenger fares supported by a stable demand environment, and aided by growth from AirTran’s Latin American operations.Notes:
- Southwest Hikes Passenger Fares On Rising Fuel Prices, Others Follow Suit, August 21 2012, www.trefis.com [↩]
- Southwest Airlines Reports September Traffic, October 5 2012, www.swamedia.com [↩] [↩]
- Oil price performance in the last YTD, www.moneyweek.com [↩]
- Southwest Airlines Reports Second Quarter Results, July 19 2012, www.swamedia.com [↩]