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Even Southwest Feels Economic Pinch

Updated from 10:45 a.m. EST

For Southwest (LUV - Get Report), decades of steady growth will come to an end this year.

The carrier, which beat fourth-quarter estimates, said Thursday that it will shrink capacity by 4% in 2009 -- including a 4.4% decline in the first quarter -- and that it will further reduce scheduled aircraft deliveries for 2010.

"Our fleet growth plans are suspended indefinitely," said CEO Gary Kelly on an earnings conference call, adding later: "We've been saying for the last several quarters that we don't want to grow the fleet for '09. The report today is we're extending that for 2010."

For the quarter, excluding special items, Southwest earned $61 million, or 8 cents a share. Analysts surveyed by Thomson Reuters had estimated 5 cents. A year earlier, Southwest earned $87 million, or 12 cents. This year's gain included cash settlements of $32 million from fuel contracts.

Shares of Southwest closed at $9.81 Thursday, up $1.43, or 17%.

With charges including noncash, mark-to-market hedge accounting, Southwest lost $56 million, or 8 cents a share. Revenue rose 9.7% to $2.7 billion, slightly ahead of estimates.

In terms of revenue per available seat mile, a key industry metric, the fourth quarter was a strong one, showing 8.8% growth. RASM grew 14% in October, and by 7% in November and December.

"Because the industry has reduced capacity aggressively, we're absorbing the reduction in demand without destroying unit revenues completely," Kelly said. "These are decent unit revenue gains in any environment, much less a recessionary environment. The question is, 'Will demand hold up or will it worsen from here?' I don't think any of us know."

Current quarter trends are disturbing, but preliminary, said CFO Laura Wright. The 7% RASM gains are continuing in January, but bookings turn soft after that. "We do not expect that January's strong run rate will continue into February and March," Wright said, particularly because Easter shifts to April this year from March last year. So far, February booking revenue is down 12%, she said. However, she noted, "we saw lots of late bookings in December and January."

In a report Thursday, Avondale Partners analyst Bob McAdoo said RASM trends, like earnings, beat expectations, with most network carriers "able to muster 2% growth on significant capacity cuts." He said: "LUV's RASM trends and planned capacity cuts, combined with low oil, point to strong earnings in 2009." Southwest shares traded higher Thursday afternoon, up $1.27 to $9.65.

Regarding deliveries of new Boeing 737-700s, Southwest has reduced 2010 orders to 10 from 22. In 2011, the carrier will take 20 aircraft, down from 32. In 2012, it will take 23 aircraft, down from 40. Deliveries are expected to be paired with the removal of older aircraft from the fleet. In 2009, Southwest will take 13 new aircraft, while returning or retiring 15 aircraft.

Meanwhile although it has been a longtime beneficiary of an aggressive fuel hedging program, Southwest said Thursday that it has substantially reduced its net fuel hedge position to approximately 10% of estimated usage from 2009 to 2013, as energy prices have collapsed.

Currently, the value of net fuel derivative contracts for 2009 through 2013 reflects a net liability of about $1 billion. "If current prices become future prices, then (we're) going to lose a lot of money," Kelly said. "(But) when the bear market turns, and becomes a bull market for energy, we'll need to have protection in place."

On the cost side, cost per available seat mile excluding fuel rose by 6.9% to 6.86 cents. For the full year, excluding special items, net income was $294 million, which included $1.3 billion of fuel hedging cash settlement gains.

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