How Is Southwest’s Fleet Modernization Aiding Its Growth?

by Trefis Team
-12.26%
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LUV
Southwest Airlines
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Quick Take 

  • Southwest is modernizing its fleet to aid profit growth by:
    • Retrofitting its 737-700s with new Evolve seats which increase the number of seats on board. This is creating revenue growth opportunities through higher passenger traffic.
    • Inducting 737-800s which have higher seating capacities and lower per seat operating expenses. This is adding to revenue opportunities particularly in high demand markets.
    • Transitioning 717-200s to Delta which will bring cost advantages associated with operation of a single aircraft type.
    • Replacing older aircraft in its fleet with newer ones which will lower maintenance and repair costs.

Southwest Airlines (NYSE:LUV) is modernizing its aircraft fleet to aid growth in margins. The carrier is retrofitting all of its 424 Boeing 737-700 aircraft with new Evolve seats which is increasing the number of on-board seats without compromising on passenger comfort. It is inducting the larger 737 variant, Boeing 737-800, in its fleet which allows the carrier to serve long haul routes more economically. Southwest is also leasing out all 88 Boeing 717 aircraft, which it received as part of AirTran acquisition to Delta (NYSE:DAL). This will allow it to regain cost advantages that come with operation of a single aircraft type. Finally, the carrier also has firm orders for 321 new Boeing 737 aircraft with their deliveries ranging from 2013 through 2022. This will allow it to replace aging aircraft in its fleet with new ones and thus save on maintenance and repair expenses.

In all, through the combined effect of these fleet initiatives, Southwest is creating top line growth opportunities and saving on operating expenses, thus promoting profit growth. Currently, the carrier has 694 aircraft in its fleet – 88 Boeing 717s and 606 Boeing 737s (424 Boeing 737-700s, 128 Boeing 737-300s, 34 Boeing 737-800s and 20 Boeing 737-500s) and it is managing each type suitably to bolster its profit growth. [1]

Aircraft type

Seats

Average age (in yrs.)

Number of aircraft

Boeing 717-200

117

11

88

Boeing 737-300

137

19

128

Boeing 737-500

122

22

20

Boeing 737-700

137 or 143

8

424

Boeing 737-800

175

Less than 1

34

Total

694

We currently have a stock price estimate of $12.17 for Southwest, approximately 5% above its current market price.

See our complete analysis of Southwest here

Evolve interior in 737-700s is adding to revenue growth potential

Southwest is retrofitting its 737-700 aircraft with Evolve seats which are lighter, thinner and more durable. These seats allow for greater passenger seating space and six more seats to be placed on an aircraft. As a result, the total number of passengers that can be seated on the carrier’s 737-700s has increased from 137 to 143. This increase in the number of seats is creating revenue growth opportunities through higher passenger traffic.

As of January 22, 2013, 270 of the carrier’s 424 737-700 aircraft had been converted to Evolve interior. [1] Southwest anticipates to complete retrofitting all its 737-700 aircraft with these interiors by the end of 2013. The carrier will also introduce this interior in 78 of its 737-300s in 2013. The combined effect of higher seating capacity in over 500 planes by the end of 2013 will add significant growth potential to Southwest’s passenger traffic.

Incorporation of 737-800s is boosting economics on long haul routes and at busy airports

Southwest is also incorporating the larger 737-800s in its fleet that seat 175 passengers. This allows the carrier to improve its passenger share at high demand, slot controlled airports like Newark, New York. A slot is an approval for take-off and landing at a pre-determined time and is an essential feature of busy airports. In addition, the 737-800 with its longer range and lower operating expenses per seat is enabling Southwest to fly longer routes more profitably. The carrier can now even think of starting service to distant destinations in Hawaii, Mexico, Canada and Alaska.

On the whole, the 737-800 is improving top-line through higher passenger traffic at busy airports, reducing unit costs and providing flexibility to the carrier in introducing service on new routes. Southwest received 34 737-800s in 2012 and expects to take delivery of 20 737-800s in 2013 and 24 in 2014. [1]

Leasing out 717s will lower maintenance spend and create revenue opportunities

Southwest also entered into an agreement with Delta under which it will lease out all 88 of its Boeing 717-200 aircraft to the latter from August 2013 through 2015. This will restore Southwest’s fleet to a single aircraft type (Boeing 737s) providing it with advantages like lower spare part inventory costs and lower maintenance and training expenses that come with operation of a single aircraft type.

Additionally, these Boeing 717-200 aircraft seat 117 passengers. When these get replaced by new Boeing 737s and delayed retirement of existing 737s, all of which have higher seating capacity and similar per mile operating expenses as 717s, they will create additional revenue growth opportunities without increasing operating expenses for the company.

Replacement of older aircraft with newer ones is saving on maintenance costs

Finally, the average age of 737-300 and 737-500 aircraft in Southwest’s fleet is around 19 years and 22 years, respectively. These older aircraft incur significantly more maintenance and repair costs compared to newer ones. To replace these over the coming years, Southwest has ordered 563 aircraft of which 321 are on firm orders and the rest are on options. [1] Deliveries of these new planes will allow Southwest to retire older aircraft from its fleet and thus save on heavy repair and maintenance that older planes need.

Some of these new planes may also be used to create additional capacity in the future if the demand environment provides support. Higher capacity in turn will promote growth in passenger traffic and revenues.

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Notes:
  1. Southwest 2012 10-K, February 26 2013, www.swamedia.com [] [] [] []
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