It's Time for Southwest to Make Tough Decisions on Pricing and Revenue
Bloomberg News
Southwest Airlines (LUV) - Get Report traditionally has flown above the turbulence of the airline business, avoiding bankruptcy even as others have succumbed and typically coming out ahead in price wars. But the company sent investors scrambling for the emergency exits Thursday after reporting earnings and revenue that missed expectations and warning of tough times ahead.
Dallas-based Southwest reported a second-quarter net profit of $1.19 a share, excluding special items, on revenue of $5.38 billion, missing estimates for profit of $1.21 a share on $5.4 billion of sales. More worrisome than the miss was the company's outlook for the rest of the year, with Southwest warning that it expects unit revenue to fall by as much as 4% in the third quarter due to intense competition.
The report continues a tough week for the nation's fourth-largest carrier, as Southwest has been forced to cancel nearly 1,000 flights in recent days because of computer issues. Shares of Southwest traded down more than 10% on Thursday afternoon, coming within sight of the airline's 52-week low.
Though the quarter came in slightly below expectations, Southwest Chairman and CEO Gary C. Kelly noted that the results were a record for the company. He said demand remains strong, but warned that pricing would continue to be challenged.
"While solid traffic demand has continued into July, thus far, the fare environment remains challenging, and close-in yields have softened in recent weeks," Kelly said.
Southwest is hardly alone in warning about pricing issues, with Delta Air Lines (DAL) - Get Report and United Continental (UAL) - Get Report providing similar commentary in recent days. But Southwest, with its reputation as a pricing leader, seems to have caught investors off guard, and the company's guidance for revenue per available seat mile to be down 3% to 4% is well worse than a consensus 1.3% projected drop.
If the airline's third-quarter guidance is accurate, Southwest could report its first quarterly year-over-year decline in earnings per share since 2012.
TheStreet's Jim Cramer called the results "shocking," saying they showed once again that "there are price wars everywhere and that is very bad for this business." Cramer noted that after a run of weakness some airlines, including American (AAL) - Get Report and Delta, have trended up of late, but "I did not feel any confidence after I saw what Gary [Kelly] said."
The quarter also seemingly points to broader issues lingering inside Southwest, once the plucky upstart that ran circles around its rivals but now increasingly a commoditized giant fighting against both reorganized and more efficient legacies and a new batch of discounters including Spirit Airlines and Frontier Airlines. The Southwest of 2016 faces labor discord as well as pressure from investors due to its place as one of the last holdouts not to implement revenue generators such as fees for checked baggage.
JPMorgan analyst Jamie Baker, in a note, said that "we believe Southwest has to try harder" but said the outlook for any new initiatives was uncertain.
"Airlines guiding to [year over year] earnings declines despite surging load factors should chase revenue as aggressively as possible, in our view," Baker wrote. "Yet Southwest continues to shun most industry-accepted practices" such as bag fees, and has sat out of recent attempts by rivals to raise fares.
Costs figure to go up by as much as 4% should Southwest sign new deals with all of its labor unions with open contracts, Baker estimated, meaning the airline will struggle to produce strong returns using its current model.
"Southwest ultimately faces a simple choice: Accept lower returns, or fight more aggressively for revenue," Baker wrote. "The decision between lower returns and renewed revenue vigor unquestionably needs to be made."