Southwest (NYSE:LUV) and JetBlue (NASDAQ:JBLU) will announce their second quarter earnings Thursday, July 25 and Tuesday, July 30, respectively. These two leading low-cost carriers are coming off of a good first quarter where they posted top line growth on higher passenger traffic driven by capacity expansion. In the second quarter, we anticipate the trend to continue with JetBlue raising its flying capacity at rates higher than Southwest’s due in part to its smaller size.
However, higher top line growth will likely be impacted by different factors for the two carriers. Southwest’s profits will face pressure from higher maintenance costs driven by plans to retrofit its cabins with Evolve seats, and JetBlue’s profits will show the impact of growing aircraft repair costs.
Southwest’s Earnings Preview
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Southwest increased its flying capacity by 3% annually to 34.2 billion seat miles in the second quarter. This raised its passenger traffic by 2.7% annually.  However, top line gains from higher passenger traffic will likely be partially offset by a decline in the carrier’s unit revenues – the amount collected from each passenger for a mile of flight. In each of the three months of the second quarter, Southwest’s unit revenues declined year-over-year due to lower demand driven by sequester.
We currently have a stock price estimate of $14 for Southwest, marginally above its current market price.
Additional costs from retrofit of Evolve seats will weigh on profits
Apart from lower unit revenues, Southwest’s second quarter profits will also be impacted by additional expenses incurred from fleet modernization. Southwest continued to retrofit its 737-700s with the Evolve interior during the quarter. At the end of the first quarter, the carrier had installed these interiors in over 90% of its -700s with the remaining expected to be retrofitted by the end of the second quarter.  The additional expenses from these retrofits will inflate Southwest’s maintenance expenses in Q2.
However, in the long term, the retrofitted cabin interiors will provide the carrier with revenue growth opportunities, as Evolve seats allow for installation of six more seats on a -700. (See How Is Southwest’s Fleet Modernization Aiding Its Growth?)
Synergies from AirTran integration will aid growth
On the bright side, Southwest is expected to continue to realize greater synergy benefits from its AirTran integration in the second quarter. In the previous quarter, the carrier had reached an important milepost in its AirTran network integration that allowed customers to fly connecting itineraries to the extent that all 97 destinations under the combined networks of both carriers could be flown on a single itinerary. Bookings driven by such connection capabilities will provide upside to Southwest’s revenues in the second quarter. For full year 2013, the carrier anticipates to realize $400 million (pre-tax) synergy benefits from AirTran integration, up from $142 million in 2012. 
JetBlue’s Earnings Preview
JetBlue, on the other hand, raised its flying capacity by nearly 8% annually to 10.7 billion seat miles in the second quarter. This lifted its passenger traffic by over 7% annually.   Further, similar to Southwest, JetBlue also saw its unit revenues decline in the second quarter on weak demand. This decline will partially offset the carrier’s top line growth from higher passenger traffic.
We currently have a stock price estimate of $7.50 for JetBlue, around 10% ahead of its current market price.
Rising Aircraft Maintenance Costs Could Impact Margins
Additionally, we anticipate JetBlue’s second quarter profits to continue to get impacted from higher aircraft maintenance and repair costs. In the previous quarter, the carrier’s repair costs had risen by 30% annually – surpassing single-digit growth in its top line to weigh on profits.  Even though the rise in these costs is expected to be more moderate in the second quarter, it could again exceed top line growth to squeeze margins.
The issue arises from the aging JetBlue fleet that now requires more frequent, heavier maintenance checks and repairs. At the end of 2012, the average age of the carrier’s fleet was around 6.7 years – the youngest among the six largest airlines in the U.S.  However, with increasing age, these new aircraft require greater checks and repairs which is increasing JetBlue’s maintenance costs.Notes:
- Southwest’s June traffic results, July 9 2013, www.swamedia.com [↩]
- Southwest’s Q1 2013 earnings form 8-K, April 25 2013, www.southwest.com [↩]
- Southwest’s Q4 and full year 2012 earning results, January 24 2013, www.swamedia.com [↩]
- JetBlue’s June traffic results, July 11 2013, www.jetblue.com [↩]
- JetBlue’s March traffic results, April 10 2013, www.jetblue.com [↩]
- JetBlue’s Q1 2013 earnings release, April 25 2013, www.jetblue.com [↩]
- JetBlue’s 2012 10-K, February 21 2013, www.jetblue.com [↩]