Southwest On A Roll After Q4’16 Earnings Results; Future Guidance Points To The Right Path

After presenting its fourth quarter and full year earnings, Southwest Airlines (NYSE:LUV) saw its stock price jump 9%. This is not only attributable to the carrier beating its consensus estimate for both earnings and revenues, but also the general operational out performance it showcased. This is a welcome respite from previous quarter’s earnings, when the company saw its revenues decline due to the technology outage episode that occurred in July, and a consequential 8% fall in its stock price. Talking about the fourth quarter results, as expected, the company’s revenues rose at a modest pace (2% y-o-y) due to disciplined capacity growth and improvement in yields. However, the bottom line continued to suffer due to higher unit costs, although the company did manage to support its earnings by way of share buybacks.

As mentioned previously, company’s revenues were up 2% y-o-y in the fourth quarter, bringing the full year revenues to $20.4 billion (up over 3% y-o-y). The increase in revenues is mainly attributable to the improvement seen in yields and the higher demand for travel around the holiday period (November and December). In addition to this, the capacity discipline practiced by the airline in the second half of the year bore fruits with the increase in occupancy rate of 30 bps in the December quarter. This indicates that the move towards capacity reduction was the right one to follow in order to turnaround the much watched industry metric of unit revenues PRASM. The management also expects the pricing pressure on the airline to dissipate, going forward, owing to increased demand and restricted capacity growth.

On the expense side, unit costs excluding fuel were up 3.6% y-o-y, less than Q3’16. However, Southwest’s operating costs including fuel rose significantly at approximately 7%, causing margins to fall almost 400 bps. This rise in costs was largely driven by higher labor costs and union contracts ratified during 2016, as well as the accelerated depreciation associated with the retirement of its classical fleet. Furthermore, the company’s fuel expense rose almost 19%, an anomaly in the industry, primarily due to the inefficiency aircraft used and losses made on hedging. Consequently, a majority of the carrier’s profits were eroded in the quarter, causing net income to decline 2.6% y-o-y. However, the carrier assured its investors that the expenditure on fuel in Q1’17 is likely to be lower than the fourth at $1.95-$2.00 per gallon, owing to its current hedge positions and retirement of the old fleet.

Despite higher expenses, the company grew its earnings per share, even beating the consensus. This is due to the heavy buyback of shares carried out by Southwest. In Q4’16, the carrier returned approximately $300 million back to its equity owners in the form of share buybacks, providing value to its shareholders. Moreover, the company continued to pare off the debt built on its balance sheet. Going forward, we can expect the carrier to buyback shares worth $950 million until February 2017 (under its $2 billion authorization).

Going Forward

A major point of concern at this point for Southwest is its rising fuel costs. The trend has been seen to be persistent. After rising 0.5% y-o-y in Q3’16, the fuel expenses went up 19.3% y-o-y in Q4’16. If this continues, Southwest’s bottom line will be adversely affected. That said, the management is confident that it will be able to arrest this fall in Q1’17. However, its non-fuel costs are expected to peak in Q1’17, at around 6%-7% y-o-y, of which almost 4 percentage points is related to higher labor wages. Post the first quarter, these costs may normalize as wages grow in line with inflation. In terms of capacity, Southwest is expected to pare down growth in line with the GDP rate (in the long term), as opposed to the previous 5%-6%. This is in line with the goal to turnaround its unit revenues in 2017, which are expected to come in flat to down 1% in Q1’17. The future guidance is solid, and lays down a firm path for future growth for Southwest.

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

• How Did Southwest Perform Operationally In December?
• Increasing Costs At Southwest Airlines And What They Mean For The Carrier
• How Did Southwest Perform Operationally In October?
• Southwest Faces Market Heat As It Reports Disappointing Q3’16 Results; Future Guidance Bleak
• Southwest Q3’16 Earnings Preview: Labor Agreement, Rising Oil Prices To Weigh On Earnings
• How Did Southwest Airlines Perform Operationally In September?
• Will International Expansion Be A Big Part Of Southwest’s Future Growth Strategy?
• How Did Southwest Airlines Perform Operationally In August?
• What Are The Factors That Have Strengthened Southwest’s Domestic Presence?
• Has Southwest Been Able To Provide Meaningful Returns To Its Investors?
• How Has Southwest’s Cost Efficiency Improved?
• Tracking Southwest’s Capital Expenditure: How Has It Trended?
• How Has Southwest Utilized Its Cash Flows?
• How Will The New Labor Contract Affect Southwest?

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

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research