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Southwest Airlines Navigates Near-Term Turbulence

Posted: Jan 28, 2009 14:49 PM by Ryan C. Fuhrmann

Tickers in this Article: DAL, UAUA, AMR, LUV

Southwest Airlines (NYSE:LUV) celebrated its 36th year of profitability when it announced full-year results late last week. This is no small feat given the number of competitors that have entered the airline industry over the past three and one-half decades, and it is even more impressive considering the many rivals that have either had to reorganize or liquidate their operations through bankruptcy proceedings. But is it enough to consider Southwest a worthy investment candidate?

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Flying Through The Quarter
Southwest stated that it was "very pleased" with its fourth-quarter sales, which improved 9.7% to $2.7 billion as seat miles increased 0.8%. This came despite a 1.4% decrease in revenue passenger miles, which led to a 1.5 point drop in the load factor to 67.8%. Business Select - the initiative Southwest rolled out recently to woo business travelers with priority seating, point credits and similar perks - reported miniscule sales of $19 million for the quarter. Management is working on other incentives to help build this market to offset what will likely be challenging industry conditions over the near term. (Learn more about how to evaluate airlines in The Industry Handbook: The Airline Industry.)

Total operating expense expansion exceeded top-line growth, expanding 12.6% for the quarter on double-digit growth in maintenance and repair costs, airport landing and rental fees and fuel costs. The latter category has been an important financial driver for Southwest, as it successfully hedged all-time highs in fuel costs in recent years with gains reported from fuel hedges that greatly reduced expenses. However, the recent and stunning reversal in prices of oil per barrel have offset these hedges, and rather than reporting a $246 million gain as in last year's Q4, this quarter resulted in a $48 million loss and sent total fuel and oil expense ahead 23.4%.

Near-Term Turbulence
Management has quickly unwound its net hedges to 10% to more fully benefit from lower fuel costs. For 2009 it expects $1.5 billion in annual savings. Unfortunately, the

U.S.

is in the midst of an economic recession, which meant top-line growth trends did not prove sufficient in offsetting higher costs. The result was a reported loss for the Q4. Furthermore, Southwest said it has seen "notable softness in post-January bookings" and is slowing new jet orders for the foreseeable future. It currently expects 4% lower capacity for the coming year.

Too Many Outside Factors To Deal With
Adding it all up, Southwest continues to be one of the best operators in the airline industry. Arch rivals such as AMR (NYSE:AMR), owner of American Airlines, posted a net loss of 77 cents per share excluding one-time items in its most recent quarter. United Airlines (Nasdaq:UAUA) and Delta Airlines (NYSE:DAL) habitually post losses, have much higher debt levels as a percent of overall capitalization and are experiencing lower sales growth compared to Southwest. Yet despite Southwest's favorable industry positioning and ability to stay profitable all these years, it simply has too many outside factors, including economic fluctuations, fuel costs, low barriers to entry for new competition and high fixed costs to deal with. (Earnings per share helps investors analyze earnings in relation to changes in new-share capital. Read more in Getting The Real Earnings.)

Bottom Line
In other words, it takes flawless execution for management to control what it can, and although Southwest has done an enviable job for 36 years, the runway does not look like it will get much smoother any time soon. In my mind, there are better industries for investors to spend their time on.

By Ryan C. Fuhrmann

Ryan C. Fuhrmann, CFA, has a background in portfolio management, overseeing assets for high-net-worth individuals and covering a broad array of industries from a generalist perspective. An active student of investing, he focuses on communicating his ideas as an investment writer and learning from the financial community. Ryan is also actively involved with the CFA Institute. Feel free to visit his website at www.rationalanalyst.com.

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