Southwest Hits Profit Estimates, Faces Continued Rising Costs

Southwest Airlines Co. plunged the most in almost a year after warning of higher-than-expected costs, pressuring the carrier’s earnings and countering gains from a surge in early-summer travel.

(Bloomberg) — Southwest Airlines Co. plunged the most in almost a year after warning of higher-than-expected costs, pressuring the carrier’s earnings and countering gains from a surge in early-summer travel.

Adjusted profit was $1.09 a share in the period, the airline said Thursday in a statement, matching the average of analyst estimates compiled by Bloomberg. Operating revenue of $7 billion was also roughly in line with Wall Street’s expectations.

The mixed results underscore the increasingly uncertain environment for US carriers, which have grappled with elevated labor costs, weather-related disruptions and signs of a possible moderation in domestic travel. Southwest, which derives most of its revenue from US flights, cited “strong leisure demand” during the second quarter and into July, but offered few predictions on travel trends for the rest of the quarter or full year.

The quarterly figures were “unexciting” compared with rivals, Helane Becker, a TD Cowen analyst, said in a note. Southwest’s disappointing guidance, meanwhile, “will amplify concerns around slowing domestic air travel demand.” 

Investors are keeping a close watch on US demand, particularly after Alaska Air Group Inc. this week noted a “discernible” shift from domestic to international flights and said fares have dropped from 2022’s record levels. Larger rivals Delta Air Lines Inc. and United Airlines Holdings Inc. have benefited from a recovery in overseas travel after countries lifted pandemic-related travel restrictions.

Southwest’s shares tumbled 8.4% as of 9:36 a.m. in New York, the biggest intraday slide since last July. The stock rose 7.7% this year through Wednesday, the worst performance in a Standard & Poor’s index of the five-largest US carriers.

Chief Executive Officer Bob Jordan pushed back against concerns of weakening demand, saying in an interview that about 70% of Southwest’s seats flying this quarter are already booked, about five percentage points ahead of normal. Still, he’s not sure if business travel will pick up enough after Labor Day to make up for a possible seasonal slide in leisure demand.

“It’s just the uncertainty over normal pre-pandemic patterns and what those are going to look like here in 2023,” he said. “Booking strength doesn’t indicate there’s an issue.”

Costs Rise

Non-fuel unit costs this quarter will rise as much as 6.5% from a year ago, Southwest said. It expects record operating revenue and another profitable quarter. Analysts predict a 95-cent adjusted profit for the period, according to estimates, and $6.97 billion in revenue.

Southwest raised its cost expectations for the year. Non-fuel expenses to fly each seat a mile, an industry gauge of efficiency, will decline 1% to 2% in 2023, compared with a prior prediction of as much as a 4% drop.

The carrier’s cost guidance for this quarter and 2023 look “a little concerning,” Stephen Trent, a Citi analyst, said in a report.

Flying capacity will increase about 12% this quarter, and as much as 16% in the first three months of 2024. Beyond that it will decline sequentially each quarter next year as Southwest changes its flight schedule to emphasize leisure flights and away from corporate travel that remains muted. 

Changes starting in January include trimming short-haul flights that normally appeal to business travelers to 38% of trips from 41%, reducing flights before 6 a.m. or after 10 p.m. and shifting more capacity away from Monday and Tuesday, when demand typically falls.

The schedule changes are expected to produce $500 million in incremental pretax profits next year, are designed to “better reflect the current business environment.”

Southwest said unit revenue declined 8.3% last quarter, but still reached the upper end of its prior guidance due to a surge in leisure travel in June. Fuel costs were higher than expected, and the increase in non-fuel expenses was near the “unfavorable end” of its forecast due to accruals for open labor contracts.

The Dallas-based company has yet to reach new agreements with its pilots and flight attendants to help solidify labor costs going forward. The Southwest Airlines Pilots Association has asked a federal mediator to declare an impasse in talks and release it from further negotiations — an action that would move them closer to a possible strike. The carrier and flight attendants haven’t resumed negotiations since union leadership rejected a proposed agreement last month.

(Updates with analyst, CEO comments beginning in fourth paragraph)

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