Southwest’s Earnings Triple Backed By Strong Domestic Demand and Lower Fuel Costs

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Southwest Airlines (NYSE: LUV), which released its first quarter operating results along with Alaska Air (NYSE: ALK) and United (NYSE: UAL) on Thursday, posted a record earnings of 66 cents per share for the quarter, beating the market estimate of 65 cents per share. The airline earned a net income (excluding special items) of $451 million [1], almost thrice the net profit posted a year ago. The low-cost carrier continued to expand its capacity at a high rate which contributed to a considerable rise in its passenger traffic. Consequently, the airline recorded total revenue of $4.41 billion [1], 6% higher on a year-on-year basis, largely in line with the analysts estimate.

We currently have a price estimate of $48 per share for Southwest, 10% ahead of its market price.

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Strong Revenues And Fuel Cost Savings Drive Southwest’s Profits

With the expiration of the Wright Amendment (a federal law restricting the number and destination of nonstop flights operated to and from Dallas), Southwest launched a number of nonstop flights to and from its home base at Dallas Love Field, increasing its daily departures from 115 to 166. As a result, the Dallas-based airline’s flying capacity increased by 6% on a year-on-year basis, which enhanced its passenger traffic by 7.1% to 25.86 billion revenue passenger miles [1]. The airline’s newly launched flights from Dallas have been received with strong market demand which helped the airline achieve a load factor (percentage of seats occupied by passengers) of over 90% on these flights. This, in turn, improved the airline’s overall load factor from 79.3% in the first quarter of 2014 to 80.1% [1] in the latest quarter. Southwest’s unit revenue also increased 0.3% on a year-on-year basis. The addition of new flights coupled with strong domestic demand helped Southwest to boost its first quarter revenue to $4.41 billion, up by 6% on a year-on-year basis.

On the cost side, Southwest benefited from the prevailing weakness in crude oil prices. The airline’s fuel expense averaged $2 per gallon [1], a significant fall from $3.08 per gallon recorded in the same quarter last year, resulting in cost savings of more than $450 million during the quarter. Further, the use of larger Boeing 737-800 jets, longer flights, and lower maintenance costs reduced the total operating costs by 8% to $3.6 billion [1]. This enabled the low-cost carrier to scale up its operating income to $770 million from $242 million posted a year ago, posting an operating margin of 17.4% during the quarter.

Outlook For Second Quarter

Despite delivering an impressive performance in the first quarter, Southwest expects its passenger unit revenue to decline by 2% year-on-year in April [1] due to the exceptional performance in the second quarter of 2014, along with the ongoing increase in stage length (length of average flight) and gauge (seats per airplane). For the full year, the airline plans to grow its capacity about 7% on a year-on-year basis [1]. With these capacity expansions, Southwest expects to increase the number of flights from Dallas Love Field to 180 by August this year. These expansions will increase 2016′s capacity by about 5%. Further, the airline aims to grow its fleet by 2% in 2016 above the 700 airplanes that it expects to be flying at the end of 2015 [1]. The airline will continue to reduce its units costs further by 1-2% during the next quarter.

Southwest’s return on invested capital (before taxes and excluding special items) for the trailing twelve months stood at 25.6% [1], compared to 14.2% for the same time a year ago. The airline generated free cash flows to the tune of $859 million, of which $381 million were returned to the shareholders through dividends and share repurchases [1]. The airline aims to complete its $1 billion stock buyback program in May with the purchase of the last $80 million in shares authorized. The low-cost carrier also paid down its debt and capital lease obligations by $51 million [1].

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Notes:
  1. Southwest Announces First Quarter Results, 23rd April 2015, www.southwest.com [] [] [] [] [] [] [] [] [] [] [] []