Southwest Delivers Impressive 2Q Earnings Backed By Fuel Cost Savings
Southwest Airlines (NYSE: LUV), which released its second quarter operating results along with Alaska Air Group (NYSE:ALK) and United Continental Holdings (NYSE:UAL), before the market opened on Thursday, 23rd July 2015, delivered an adjusted net income of $1.03 per share((Southwest Announces Second Quarter 2015 Results, 23rd July 2015, www.southwest.com)), beating the market estimate by 2 cents per share, on the back of lower fuel prices. This caused the airline’s stock to open at $38.50 per share, before closing at $36.50 per share, gaining almost 4% during the trading day. Despite pricing pressure due to rapid capacity additions during the quarter, Southwest managed to post a small increase in its quarterly revenues, matching the consensus estimate. Based on the airline’s positive outlook for the remainder of the year, we forecast weak fuel costs and strong domestic demand to continue to be the major drivers of its growth in the next quarter. In this note, we briefly discuss the key takeaways from Southwest’s 2Q earnings release.
Source: Google Finance
Capacity Expansion Drags Down Unit Revenue
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In order to maintain its dominance in its home market, the Dallas-based airline expanded its system capacity by 7% on a year-on-year basis, resulting in a 7.9% rise((Southwest Announces Second Quarter 2015 Results, 23rd July 2015, www.southwest.com)) in its passenger traffic during the June quarter. Further, the airline also managed to fly fuller flights in the last three months, indicated by an increase of 70 basis point in its load factor (occupancy rate per flight). However, Southwest’s unit revenue dropped sharply by 4.6%, primarily due to aggressive capacity additions, longer average stage length, and higher gauge (average seats per trip). Despite this, the airline posted a revenue of $5.1 billion, 2% higher than last year, largely in line with the market estimate.
Decline in Fuel Costs Drives Solid Earnings
As global crude oil prices remained depressed in the June quarter, Southwest’s fuel prices averaged $2.02 per gallon, saving $420 million, or almost $1 per gallon((Southwest Announces Second Quarter 2015 Results, 23rd July 2015, www.southwest.com)). However, the impact of these cost savings was partially offset by a 14% increase in the airline’s salary and wages. Still, the airline’s operating expenses declined approximately 5% to $4 billion, improving its operating margin from 15% last year to 21% in the current quarter. This enabled the low cost carrier to earn a record profit of $608 million, 31% higher compared to a year ago, marking the airline’s ninth consecutive quarter with record profits.
Driven by the fuel cost savings, Southwest generated strong cash flows, returning $430 million to its shareholders in the form of dividends and share buybacks during the latest quarter. The airline aims to launch a $500 million((Southwest Announces Second Quarter 2015 Results, 23rd July 2015, www.southwest.com)) accelerated share repurchase program soon.
Going Forward
Southwest has a positive outlook for the rest of the year. For the next quarter, Southwest expects its unit revenue to decline by only 1%((Southwest Announces Second Quarter 2015 Results, 23rd July 2015, www.southwest.com)) as opposed to a large drop of 4.5%-6.5% expected by its close competitor, Delta. Further, with a challenging outlook for the crude oil prices, the airline expects its fuel prices to remain lower compared to last year and average $2.20 per gallon in the third quarter. In addition, the low cost carrier has renegotiated its credit card agreement with Chase Bank, which is expected to generate an extra revenue of $400 million in the second half of the year. Keeping all this in mind, we anticipate Southwest’s earnings to remain strong for the next two quarters driven by lower fuel costs and improvements in unit revenues.
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