Southwest's Higher Fares Help Margins But Weigh On Passenger Growth

NEW YORK (Trefis) -- Southwest Airlines (LUV) released its second-quarter earnings report posting operating revenue of $4.6 billion, up 4.7% on a year-over-year basis driven by higher average passenger fares.

However, the top line was affected by declines in Revenue Passenger Miles (RPMs), an indicator of passenger traffic, and Available Seat Miles (ASMs), an indicator of capacity and load factor.

Operating income in the second quarter increased to $460 million from $205 million in the year-ago period, primarily on account of lower AirTran integration costs and lower fuel costs.

Average Operational Performance

Revenue Passenger Miles (RPM) and Available Seat Miles declined by 1.6% and 1.2%, respectively, in the second quarter from the year-ago period. The load factor also declined by 0.3 points during the same period to 81.9%. These declines impacted the top-line growth which was offset by higher average passenger fares.

Lower Fuel Costs Aid Margins

However, lower fuel costs and lower AirTran integration costs boosted operating margins for the airline during the quarter.

The airline incurred lower-than-anticipated fuels costs of $3.22 per gallon on average, including 4 cents per gallon in unfavorable cash settlements for fuel derivative contracts compared to $3.28 per gallon in the second quarter of 2011, including 3 cents per gallon in favorable cash settlements.

Based on the current fuel prices, Southwest anticipates to incur average jet fuel price in the range of $3.05 to $3.10 per gallon for the third quarter of 2012.

The airline also benefited from significantly lower AirTran integration costs. It incurred $11 million in integration and acquisition costs in second quarter of 2012 compared to $79 million the same period last year. However, the airline increased its overall estimate for AirTran integration and acquisition costs by $50 million to an aggregate total of $550 million.

Share Repurchase Program

Also, the board of Southwest Airlines has increased its previous $500 million in share repurchase authorization to $1 billion. This provides confidence to shareholders in the company's long-term growth beyond the average operational performance delivered during the second quarter.

We currently have a price estimate of $12.50 for Southwest, significantly above its current market price, and we are in the process of updating our estimates to incorporate the second-quarter earnings.

See our complete analysis of Southwest here.

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