Southwest to Keep Capacity Flat; May Lift Fares

Southwest Airlines(LUV Quote) said it needs to stop growing so fast and might consider hiking fares.

That would benefit other airlines, except that Southwest's hedging position is so formidable that the carrier is under far less cost pressure than any of its competitors.

Those comments came as the company beat estimates in the latest quarter thanks to its fuel hedging. In the second quarter, excluding special items, the carrier said net income was $121 million, or 16 cents a share. Analysts surveyed by Thomson Reuters had estimated 12 cents.

Revenue rose 11% to $2.9 billion and was in line with estimates.

Southwest's results included favorable cash settlements of $511 million from fuel contracts. Even with the settlements, fuel expenses grew by 35%. Without hedges, the carrier would have lost $134 million.

The current value of its hedging contracts through 2012 is about $4.3 billion. That includes hedging 80% of its third-quarter fuel needs at $61 a barrel, 80% of its fourth-quarter requirements at $58 a barrel, and 70% next year's fuel at $66 a barrel.

Nevertheless, during an earnings conference call, CEO Gary Kelly said he worries about "a boiling cauldron of issues facing our industry -- a weak economy, soaring operating costs and higher fuels [that] are dampening demand."

Southwest will likely cease capacity expansion in 2009, after growing by no more than 4% in 2008, he said. "From July forward, our flying is essentially flat."

The airline should benefit because "our competitors are in full retreat mode" and will reduce capacity in Southwest markets by 15% this fall, he said. Yet fare increases will be tricky because they could scare off passengers.