Southwest Drops Post 2Q’16 Results As The Airline Restricts Its Capacity Growth For 2017-2018

by Trefis Team
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Southwest Airlines
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Like most of its peers, Southwest Airlines (NYSE:LUV), reported strong June quarter financial results this week driven by focused capacity growth and fuel cost savings. [1] However, the Dallas-based airline missed the market estimate for both revenue and earnings due to weak unit revenues and higher-than-expected fuel costs during the quarter. Further, during the 2Q’16 earnings call, the airline’s management commented that its capacity growth in 2017 and 2018 is expected to be lower than that of 2016 due to softness in the pricing environment. Hence, the investors reacted negatively to this news and the airline’s stock fell more than 11% in a single trading day to $37.32 per share.

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For the second quarter, Southwest grew its capacity by 4.8% compared to last year, in line with the airline’s full year capacity growth target of 5%-6%. With this focused capacity addition, the airline was able to attract 5% more passengers for the airline and managed to improve its load factor by 100 basis points for the quarter. Consequently, despite a notable decline in its unit revenue, Southwest’s 2Q’16 revenue grew by more than 5% to $5.38 billion.

On the profitability front, the airline’s fuel price averaged at $1.81 per gallon, in line with its guidance for the quarter, resulting in fuel cost savings of over $100 million. However, the airline’s unit costs (excluding fuel costs and special items) grew sharply due to the accelerated depreciation on the Classic fleet, advertising and technology investments, and air-frame maintenance during the quarter. Yet, the airline posted an improvement of roughly 18% in its operating income, or 250 basis points growth in its operating margin, compared to last year.

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Despite the pricing pressures, Southwest continued to deliver value to its shareholders in the form of dividends and share buyback program in the second quarter. The airline repurchased its common stock for $700 million during the quarter, by completing its previous $1.5 billion buyback authorization. Its Board launched a new $2 billion buyback program in May of this year, of which stock worth $500 million has already been repurchased. Further, the airline intends to launch an accelerated share repurchase of $250 million from this authorization soon. Southwest’s aggressive share buyback program magnified the impact of its improved operating income on its earnings per share.

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Going Forward

Based on the current market conditions, Southwest expects its unit revenue to decline by 3%-4% and its fuel price to rise to $2.05 per gallon in the third quarter. This is likely to weigh on the airline’s operating margins in the coming quarters.

As mentioned earlier, Southwest will moderate its capacity growth over the next couple of years based on the pricing pressure in the industry. While the airline has not altered its capacity guidance for the remaining half of the year, it anticipates the capacity growth in 2017-2018 to be lower than that of the current year. However, the airline is optimistic about 2017 for a number of other reasons. These include the launch of new technology and a new class of aircraft – 737-8, the opening of an international terminal at Fort Lauderdale, and approval for operating flights to three cities in Cuba.

Have more questions about Southwest Airlines (NYSE:LUV)? See the links below:

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Southwest Airlines

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Notes:
  1. Southwest Announces Second Quarter 2016 Results, 21st July 2016, www.southwest.com []
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