Shrewd Crude Hedge Spares Southwest

The carrier posts its 57th straight profitable quarter even as much of the industry struggles.
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Updated from 8:37 a.m. EDT

Southwest Airlines

(LUV) - Get Report

cruised to a higher second-quarter profit and beat Wall Street's expectations as cost-cutting efforts paid off. The carrier also offered a bullish forecast for growth next year.

In its 57th straight profitable quarter, Southwest reported net income of $159 million, or 20 cents a share. That compares with $113 million, or 14 cents a share, a year earlier. On average, analysts expected EPS of 18 cents, according to Thomson First Call.

Revenue was $1.94 billion, up 13% from a year before and ahead of the $1.92 billion consensus forecast. Shares were up 66 cents, or 4.7%, to $14.64 Thursday afternoon.

Southwest has insulated itself from the high fuel costs that are leading other carriers to spill red ink by hedging about 85% of this year's fuel needs at crude oil prices of $26 a barrel, less than half of recent levels. The hedging program saved Southwest $196 million in the latest quarter. Even so, the airline's fuel costs per gallon rose 25% as crude oil futures set new records.

"Considering soaring oil prices and the enormous operational challenges our Company and industry have faced over the past four years, our operating cost performance was exceptional and better than we expected," said Gary Kelly, Southwest's CEO, in a news release. "Even with a 25 percent rise in our jet fuel costs per gallon, second quarter 2005 unit costs decreased 3.5 percent."

Southwest is known for encouraging its employees to find ways to boost the airline's efficiency. They appeared to do just that in the second quarter, with unit costs excluding fuel declining 7.7% from a year before.

In a conference call, Southwest executives said employees are aware significant cost pressures lie ahead and are working hard to further improve productivity. Third-quarter unit costs excluding fuel are likely to be in line with second-quarter levels, they added.

The airline's revenue performance was better than Wall Street expected. Yield, which measures average fares, increased a solid 4.6% in the quarter from a year before. That partly offset the impact of emptier planes. Southwest said its load factor, or percentage of seats filled, fell to 72.5% from 76.3% a year before as passenger traffic failed to match an almost 14% increase in capacity.

Taken together, those factors resulted in a 0.3% decline in revenue per available seat mile, a key measure of unit revenue also known as RASM. But even that decline was good news, as many analysts were expecting a bigger slide.

Looking ahead, the airline expects year-over-year increases in RASM in the third quarter, based on bookings and passenger traffic trends so far in July.

During Thursday's call, Southwest executives unveiled a preliminary forecast for 15% earnings growth in 2006, a stronger pace than the 11% growth implied by Thomson First Call estimates.

Kelly acknowledged that the goal is challenging and requires the economy to continue growing enough to support improving air travel demand.

The CEO said Southwest would focus on filling more seats in order to achieve the target, rather than increasing fares. He also said achieving the goal would be easier if lawmakers repealed the Wright Amendment, which limits the states Southwest can fly to from its home base at Love Field in Dallas. Southwest has been lobbying federal lawmakers on the issue, but Kelly declined to offer a detailed prediction of when and if the amendment might fall.

Southwest ended the quarter with a balance sheet that's the envy of other airlines. Cash on hand totaled $2.3 billion, up from $1.9 billion at the end of the first quarter, and Southwest also had an untapped $575 million line of credit.

Southwest is the first airline to report second-quarter results. Other carriers follow next week, including

Continental

(CAL) - Get Report

,

Delta Air Lines

(DAL) - Get Report

and

American Airlines'

parent

AMR

(AMR)

.