Southwest Airlines Beats

The low-cost leader overcomes an oil price spike in the third quarter.
Publish date:

Updated from 7:58 a.m. EDT

Southwest Airlines

(LUV) - Get Report

shares rose after the airline reported higher income in the third quarter, as revenue grew and the company kept a lid on costs even as fuel prices spiked.

The low-cost carrier reported its 54th consecutive quarter of profitability Thursday, beating Wall Street earnings estimates.

Southwest, the first airline to announce third-quarter earnings, reported net income of $119 million, or 15 cents a share, an increase of 12.3% from the $106 million, or 13 cents a share, it had a year ago. The consensus Wall Street estimate was for earnings of 12 cents a share, according to Thomson First Call.

Total operating revenue came in at $1.67 billion, up 7.8% from the $1.55 billion it had a year ago, but shy of the $1.69 billion Wall Street expected.

Shares of the low-cost airline gained 42 cents, or 3.1%, to $13.99.

"Despite the weak airline industry revenue environment and higher fuel prices, Southwest achieved a double-digit improvement in earnings," said Gary Kelly, the company's chief executive, in a statement. "Our third-quarter operating cost performance was excellent, which significantly contributed to these results."

Traffic, a demand metric measured in revenue passenger miles, rose 10.4%, while capacity, a supply metric measured in available seat miles, increased at a smaller rate, 7%, a rare combination in the industry these days.

The carrier's load factor, or the percentage of seats filled on every flight, came in at 72.7% in the third quarter, up from 70.5% last year. But as airlines slash prices to stimulate demand, the amount of money Southwest took in per paying customer, measured in yield, continued to decline. The airline said yield fell 2.8% in the quarter to 11.38 cents per revenue passenger mile.

The revenue environment remains soft, and current trends "suggest" fourth-quarter unit revenue -- measured in revenue per available seat mile, or RASM -- may decline from last year's fourth-quarter figure of 8.29 cents, Kelly said.

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.


(CAL) - Get Report

is set to release Tuesday, followed by

Delta Air Lines

(DAL) - Get Report


Northwest Airlines


on Wednesday.

Quarterly results from Southwest's low-cost peer


(JBLU) - Get Report

are scheduled for Oct. 28.