Southwest Airlines Beats

Airlines have been suffering from soaring jet fuel prices, although Southwest has fared better than most by hedging a majority of its fuel needs. Kelly said hedging had "greatly mitigated" record-high fuel prices, helping Southwest keep unit costs from jumping. The airline's cost per available seat mile, or CASM, came in at 7.61 cents, up 1.3% year over year. Excluding fuel, unit costs were flat from a year ago. Without its hedging program, Southwest said operating expenses would have been $131 million higher.

The airline did a "superb" job on the cost side, wrote Merrill Lynch airline analyst Michael Linenberg in a research note. "Unit cost increased only 1.3% to 7.61 cents despite a 10% increase in the price of jet fuel. ... The sequential improvement from the June quarter's 7.99 cents gives us confidence that Southwest is well on its way to lowering its costs. Also, we think part of the cost improvement is a function of the fact that the carrier is growing again -- capacity increased 7% for the quarter." (Merrill Lynch does and seeks to do business with companies covered in research reports.)

Looking ahead, Southwest said it has hedged more than 80% of its fuel needs for the current quarter and next year, with prices capped below $24 a barrel for the fourth quarter and at $25 a barrel for 2005. For 2006, it has hedged 60% of fuel costs, with prices limited to $31 a barrel.

Kelly said the airline is "on track" with its cost reduction targets and expects fourth-quarter unit costs, excluding fuel, to decline from last year's fourth quarter.

Jamie Baker, a J.P. Morgan analyst, wrote in a note that while the third-quarter results were "genuinely" stronger than expected, Southwest's outlook suggests this quarter's estimates are likely to decline from current levels. "Cautious management guidance appears to endorse our 8-cent estimate for the fourth quarter," the analyst wrote. "Specifically, management believes fourth-quarter RASM may decline year over year; we're currently modeling for flat." (J.P. Morgan does and seeks to do business with companies covered in research reports.)

The Wall Street consensus is for fourth-quarter earnings of 10 cents a share.

Look for more quarterly results from airlines next week, but expect lots of red ink from network carriers, who have higher costs than Southwest and weren't as aggressive with fuel hedges. Continental (CAL) is set to release Tuesday, followed by Delta Air Lines (DAL) and Northwest Airlines (NWAC) on Wednesday.

Quarterly results from Southwest's low-cost peer JetBlue (JBLU) are scheduled for Oct. 28.

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