Increasing Costs At Southwest Airlines And What They Mean For The Carrier

The technological glitch in the third quarter left Southwest Airlines (NYSE:LUV) struggling. It saw its revenues decline 3.4% y-o-y, while the unit revenues fell 5% y-o-y. However, in its November metrics, the carrier showcased marked improvement. Its traffic growth in November has been phenomenal at 7.2% y-o-y, with the occupancy rate keeping pace. In contrast, Southwest continues to expect a 4%-5% decline in PRASM, this may be driven, in part, by the continued fall in air fares. According to data compiled by the Bureau of Transportation Services, U.S. air fares fell 2.2% on a sequential basis in October. On an unadjusted basis, fares were down 5.2% y-o-y during the month.

Although the airline stocks have been in a bull run over the last few months, helped by Warren Buffet’s investment in the sector, they have a huge hurdle to cross operationally. For instance, Southwest recently ratified a number of labor contracts with flight attendants and pilots, to give a hike to its employees to compensate for the down period until 2013. This is going to increase Southwest’s costs exponentially, bringing it at par with the legacy carriers. Additionally, on the back of the recently concluded OPEC meeting and the decision to cut oil production, the fuel costs are expected to rise. As per IATA’s forecasts, jet fuel prices will likely increase to $64.90/bbl next year, from $52.10/bbl this year. Furthermore, the headwinds in passenger yield in Pacific and Atlantic continue to plague the economy. This has led some to argue that Southwest can no longer be counted among the likes of Alaska Air and JetBlue, due to the increased scope and scale of its operations.

In a scenario of increasing costs, it becomes imperative for the company to be able to find other sources of revenue. One of the value propositions offered by Southwest is that it doesn’t charge a baggage fee. Recently, it was under fire by its investors to charge a fee on baggage, just like other airlines. However, the airline believes that this is an important differentiator for the company, and has decided to stay put on the no baggage fee.