Southwest Is Set To Retain Its Growth Momentum In 2015

LUV: Southwest Airlines logo
Southwest Airlines

At its recently held annual investor day, Southwest Airlines (NYSE:LUV) announced that it will expand flying capacity by 6% annually in 2015, returning to a higher rate of capacity additions after modest capacity additions over the past two years. [1] Coupled with lower jet fuel prices anticipated in 2015 due to softer crude oil prices, we figure Southwest will likely retain its growth momentum in 2015. In the first nine months of 2014, the low-cost carrier has been able to grow its revenue by 5% annually and nearly double its profit to $946 million. [2] Higher passenger traffic driven by aggressive capacity expansion in 2015 will likely continue to raise Southwest’s revenue next year and, margin expansion driven by lower jet fuel prices and gains from ongoing fleet initiatives will likely continue to raise the carrier’s profit in 2015.

We currently have a stock price estimate of $39 for Southwest, approximately in line with its current market price.

See our complete analysis of Southwest here

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Southwest’s Top Line Will Rise On More Aggressive Capacity Expansion

During 2013 and 2014, Southwest was able to expand its flying capacity by only 1-2% annually as it was occupied with integrating AirTran. Converting AirTran’s 737s into Southwest livery as well as phasing out AirTran’s 717s required Southwest to keep many of its airplanes out of active service for long periods. This weighed on Southwest’s ability to expand its capacity at high rates. However, with the AirTran integration nearly over, Southwest was being repeatedly questioned if it would add capacity at higher rates in 2015, as it has done for most of its history. The carrier has put these questions to rest at its recent investor day meet announcing that it would expand flying capacity by 6% in 2015. However, most of this increase in Southwest’s capacity would come from flying longer distances and increasing number of seats on its existing airplanes. Only 1% of the targeted 6% increase in capacity would come from more flights.

Additionally, Southwest will deploy this additional capacity in those high value markets where it is already well recognized and well established. So, we figure the carrier’s new seats will find many takers. 3% of Southwest’s 2015 capacity addition will be deployed at Dallas Love Field – Southwest’s home market – as the expiry of Wright Amendment has allowed the carrier to fly nonstop flights to more U.S. cities. Since the Wright Amendment expired on October 13, Southwest has launched nonstop flights to around a dozen U.S. cities, and the carrier has seen occupancy rates of over 90% on these new flights. [3] Typically, it takes a many weeks if not months for occupancy rate of an airline to reach even around 80% on new routes. But as Southwest is well established in the Dallas market and the expiry of Wright Amendment opened a new growth window, the carrier has been able to aggressively expand along side maintaining such high occupancy rates (percentage of seats occupied by revenue paying passengers in a flight). 2% of Southwest’s 2015 capacity increase will be deployed at Washington Reagan and New York LaGuardia airports. This room for growth at these two highly busy airports opened after Southwest was able to acquire slots (specific take-off and landing timings) that had been vacated by American as part of its merger deal with the Justice Department. The remaining 1% growth in Southwest’s 2015 capacity will be deployed in international markets with new service to San Jose, Costa Rica and Puerto Vallarta. Southwest’s policy of not charging baggage fee from its fliers for the first two checked bags will help in attracting passengers on international routes and enabling the carrier to establish itself in these new markets. In all, driven by these dynamics we figure Southwest’s 2015 revenue will likely grow in line with its capacity.

Lower Fuel Costs Will Boost Southwest’s Margin & Profit In 2015

This top line growth will likely be supported by margin expansion driven by lower fuel costs. As a result of the recent fall in global crude oil prices, Southwest anticipates to spend $2.90-2.95 on a gallon of jet fuel in 2014, down from $3.12 that it spent in 2013 on a gallon. And based on current projections, the carrier estimates to spend even less – about $2.60-2.70 on a gallon of jet fuel – in 2015. [1] In addition, Southwest anticipates the fuel efficiency of its fleet to rise in 2015 driven by the retirement of its Boeing 737 classics, which are very old and burn significantly more fuel than newer versions of 737s. Gains from this higher fuel efficiency will further lower Southwest’s fuel costs next year. Given that fuel costs constitute nearly a third of Southwest’s total operating costs, these savings will significantly boost Southwest’s margin in 2015.

The carrier will also benefit from the ongoing addition of new Boeing 737-800s, which have lower operating costs per seat compared with many other airplanes in Southwest’s fleet. This will help lower the carrier’s non-fuel operating costs in 2015.

All in all, driven by aggressive capacity expansion, which has been enabled by expiry of Wright Amendment and acquisition of slots, and lower jet fuel prices Southwest will likely retain its revenue and profit growth momentum in 2015.

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  1. Southwest Airlines 2014 investor day presentation, November 10 2014, [] []
  2. Southwest’s 2014 Q3 10-Q, October 23 2014, []
  3. Southwest Airlines 2014 investor day transcript, November 10 2014, []