Southwest Airlines‘ (NYSE:LUV) low-cost model has historically been the cornerstone of its business strategy. The carrier designed its low-cost model in order to profitably charge lower fares from customers that in turn enabled it to eat into market shares of legacy carriers such as United (NYSE:UAL), Delta (NYSE:DAL) and American. However, over the past few years, as these legacy carriers have lowered their cost structures through restructuring during bankruptcies, the relative cost advantage that Southwest possessed has shrunk. Faced with a challenge to one of its key business strategies, Southwest has undertaken a number of fleet initiatives in order to lower its costs and preserve its relative cost advantage. In recent months, the carrier has retrofitted its airplane cabins with slimmer seats, installed winglets on its airplane wingtips, added more fuel efficient airplanes to its fleet and retired less efficient, older ones from its fleet, as part of these measures. The carrier continues to take such measures to further lower its costs. Here we a take a look at the major fleet initiatives that Southwest is currently undertaking.
In our opinion, these measures are important for Southwest to not only retain its cost advantage compared to legacy carriers but also maintain healthy margins while charging lower fares from customers. We currently have a stock price estimate of $21.95 for Southwest, marginally below its current market price.
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Ongoing Addition Of Larger 737-800s Lowers Per Seat Costs
From late 2012 through 2013, Southwest added 52 Boeing 737-800s to its fleet. These planes with a seating capacity of 175 passengers (in an all coach seating) are the largest planes in Southwest’s fleet. On a per seat basis, these planes are more cost efficient than many of their counterparts in Southwest’s fleet. As a result, they help lower the carrier’s cost on a per seat basis, which is the standard way of measuring costs in the airline industry. Additionally, due to their larger seating capacity, these -800s are helping Southwest expand its passenger traffic at high density airports like Washington Reagan and New York LaGuardia where flight frequency is constrained by slots. Thus, in addition to lowering costs on a per seat basis, these planes are growing Southwest’s passenger revenues. In the current year and next, Southwest plans to add 33 and 19 -800s, respectively, to its fleet in order to further expand on their gains. 
Transition Of 717s To Delta & Installation Of Advanced Winglets Will Bring Further Cost Savings
Additionally, Southwest continues to transition its 717s, it acquired as part of its AirTran acquisition, to Delta. Transitioning of these planes will restore Southwest’s fleet to an all 737 type and thus enhance simplicity in its scheduling and personnel training. Operation of a single aircraft type – the Boeing 737s – has been a key element of Southwest’s low-cost model. In 2013, the carrier delivered 13 of its 88 717s to Delta. These 717 deliveries to Delta are expected to continue through 2014 and 2015 at a rate of approximately three aircraft per month. These 717s which seat around 117 passengers are currently the smallest airplanes in Southwest’s fleet. Consequently, their replacement with larger 737s brings revenue opportunities with more seats per aircraft, while costing the same on a per trip basis.
Looking ahead, Southwest also plans to install split scimitar winglets on all its 737-800s by the end of 2015. Conventional winglets, which feature a single upward-shaped curved extension at aircraft wing tips, reduce fuel consumption by around 3.5-4% on long haul routes.  In comparison, these new split scimitar winglets with an additional downward-shaped curved extension at wingtips reduce aircraft’s fuel consumption by an additional 2%.  Earlier this month, United for the first time flew an airplane installed with split scimitar winglets. Currently, Southwest has conventional winglets on all its 737-700s and -800s, which together constitute around 70% of the its 680 strong airplane fleet.  Upgrade of these conventional winglets to split scimitar winglets on the carrier’s -800s will further reduce its costs.
Separately, Southwest has on order 200 Boeing 737MAX airplanes, which are an upgraded version of the current 737s. In December last year, an internal audit from Boeing (NYSE:BA) contended that the 737MAX, scheduled for entry in service in 2017, would be 14% more fuel efficient compared to the current 737 Next Generation airplanes.  737MAX is also estimated to be as fuel efficient if not more than its competing model from Airbus – the A320neo. Southwest will take deliveries of its 200 737MAX airplanes beginning in 2017 through 2024. These new airplanes will in our opinion allow the carrier to retire the old 737-300s and 737-500s in its fleet, which are on average over 20 years old.  Replacement of these old airplanes with significantly more fuel efficient 737MAXs will reduce Southwest’s vulnerability to fuel costs, which currently constitute around a third of its total operating costs.
In all, these initiatives from Southwest around its aircraft fleet will lower its costs and help preserve its historic cost advantage relative to legacy carriers.Notes:
- Southwest’s 2013 10-K, February 4 2014, www.swamedia.com [↩] [↩] [↩]
- Meet United’s New Fuel-Saving ‘Split Scimitar’ Winglets, February 18 2014, online.wsj.com [↩]
- United Airlines is the First to Fly with New, Fuel-Efficient Split Scimitar Winglets, February 19 2014, www.unitedcontinentalholdings.com [↩]
- Boeing 737MAX, February 27 2014, www.wikipedia.com [↩]