Southwest Airlines (NYSE:LUV) will announce its first quarter results Thursday, April 23. The low cost carrier is coming off an impressive 2013 in which its revenues rose by 3% annually to a record $17.7 billion, and its profits nearly doubled to $754 million, on gains from capacity expansion. 
In the first quarter however we do not expect Southwest’s results to benefit from capacity expansion, as the carrier lowered its flying capacity by around 1% annually.  Instead, the carrier’s first quarter results will be driven by higher unit revenues – amount collected from each passenger per seat for a mile of flight – reflecting higher passenger fares. In our view, the stable demand environment for air travel during the quarter enabled Southwest to raise its passenger fares. At the same time, despite lower flying capacity, Southwest’s passenger traffic grew by nearly 2% annually in the first quarter on greater demand for flights. 
In all, we anticipate Southwest to post higher passenger revenues in the first quarter on growth in its unit revenues and passenger traffic, despite a decline in its flying capacity. The carrier’s first quarter profits could also rise on cost savings realized through the phasing out of Boeing 717s from its fleet.
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We currently have a stock price estimate of $21.95 for Southwest, around 7% below its current market price.
Phasing Out Of Boeing 717s Will Lower Southwest’s Operating Costs
Southwest received 88 Boeing 717s in 2011 from its acquisition of AirTran. Prior to this acquisition, Southwest operated an all Boeing 737 fleet. Operation of a single aircraft type helped keep Southwest’s costs low through lower inventory and spare part management costs, as well as simplified scheduling and personnel training. Thus, in order to retain the advantage that came with operating a single aircraft type, Southwest entered into an agreement with Delta to transition all its 717s to the latter. This transition began last year and through the end of 2013, Southwest removed 22, 717s from its fleet and transitioned 13 of these airplanes to Delta. The remaining 66, 717s in Southwest’s fleet at the end of 2013 are expected to be removed from active service by the end of this year.  These airplanes are being replaced with new and pre-owned Boeing 737s. Thus, as more 717s are replaced with 737s, Southwest will see increasing gains that come with operating a single aircraft type. We figure cost savings from this replacement of 717s with 737s will help lower Southwest’s operating costs in the first quarter and thus grow its profits.
Additionally, the decline in Southwest’s first quarter flying capacity is in part a result of phasing out of these 717s. Unlike previous years, when Southwest grew its profits and market share by rapidly expanding its flying capacity, in 2014, the carrier plans to keep its flying capacity relatively stable as it takes out 717s from its fleet and replaces them with 737s. Thus, we anticipate more margin driven growth rather than top line driven growth in Southwest’s results in the first quarter and the remaining months of 2014.Notes: