What Can We Expect From Southwest’s Q2 Earnings?

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Southwest Airlines (NYSE:LUV) is set to report earnings for the second quarter of FY 2017 on July 27. The company reported a rather weak start to the year, missing on both the earnings and revenue consensus estimates marginally. The earnings were hurt on the back of higher wages and increased fuel expenses, while unit revenues declined by about 2.8% due to a sustained competitive fare environment and the unfavorable timing of Easter. That said, while earnings are expected to continue their decline in Q2 on reduced margins, unit revenues could see a return to the positive growth thanks to restricted capacity allocation and a surge in holiday revenues.

Probable Factors:

  • As mentioned above, unit revenues have grown strong, sequentially, in the second quarter. The company expects operating revenue per available seat miles or RASM to increase in the band of 1-2%. This will be made possible thanks to Southwest’s continued restriction in capacity and a marked improvement in the top line thanks to the timing of the Easter weekend.
  • Ex-fuel CASM is expected to rise this quarter as the renewed labor contract with its pilots, technicians, and engineers continues to weigh on the bottom line. However, one must keep in mind that these wage costs are only temporary and that the effect of the additional costs will dissipate by the end of the year. For the full year, we expect CASM ex-fuel to rise by close to 3% year-over-year.
  • With a momentary rise in the beginning of 2017, fuel costs have fallen back to $1.30 per gallon, compared to $1.50 per gallon in the same period last year. While this fall is expected to benefit the industry as a whole, Southwest particularly could see further gains thanks to reducing hedging losses. For Q2, the airline expects fuel costs to come in around $1.95 to $2.00 per gallon.
  • On a positive note, despite the forced high capacity, the company has shown improvement in the occupancy rate, which is an indicator of how efficiently the company is using its capacity. We can expect the improvement in unit revenue, alongside the occupancy rate, to have a supporting impact on the top line.

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