Southwest Airlines Soars

Updated from 9:24 a.m. EDT

Despite higher fuel costs, Southwest Airlines ( LUV) reported its best quarter ever, a result of fuel hedging and higher ticket prices.

The Dallas-based low-fare airline made $333 million, or 40 cents a share, for the quarter ended June 30, up from the year-ago $144 million, or 18 cents a share. Excluding a hedging-related gain, latest-quarter earnings were 33 cents a share, 7 cents ahead of the Thomson Financial analyst consensus estimate.

Revenue rose 26% from a year ago to $2.45 billion, breezing past the $2.3 billion Wall Street view.

"It has been six difficult years since our last quarterly earnings record," when the airline earned $190.6 million in the second quarter of 2000, said CEO Gary Kelly on a conference call. He attributed the airline's success to a growing economy, fuel hedging that provided a $225 million benefit, fare increases and capacity reductions by competitors, chiefly by Independence Air, whose January shutdown led to increased traffic on Southwest flights in Baltimore.

Kelly said he now feels that Southwest's target of 15% earnings growth this year, initially viewed by analysts as too optimistic, will be easily met. And he set a similar 15% earnings growth goal for 2007, though he insisted the number is a goal, not a forecast.

Southwest is seeking to buy more Boeing 737-700s, he said. He would like to buy as many as 20, though he realizes that goal is unattainable because Boeing's new planes are spoken for until 2010. Southwest will take delivery of 34 planes this year and 35 in 2007. Kelly said more are needed in many of the airline's existing markets, not to mention new markets it would like to serve.

Additionally, Kelly noted that fare increases are causing booking slowdowns in select markets, which he declined to specify.

"There have been a lot of fare increases over the last two years," he said. "It's not surprising that customers will balk at a certain point. The overall point is that we know from our experience that you can only push fares so far."

Southwest said its revenue per available seat mile, the airline industry's most closely watched performance measure, rose 17.5% to 10.70 cents. Load factor, reflecting the proportion of seats filled, hit a record 78%. Southwest's average fare rose 16% to $107.38.

Strong load factor trends have continued in July, and solid year-over-year unit revenue trends are expected in the third quarter, said CFO Laura Wright. Third-quarter RASM growth won't replicate the second-quarter level, which benefited from the move of Eastern travel to April from March, she said, but it will exceed the first-quarter growth rate of 11.3%.

The $225 million benefit from fuel hedging offset a 39.2% rise in fuel costs per gallon. Southwest is more than 73% hedged for the remainder of 2006 at about $36 a barrel and 65% hedged in 2007 at $41 a barrel. Kelly said Southwest's industry-leading fuel hedging program results from logical thinking.

"If you were sitting back in 2002 and looking at suicide bombings ... who in their right mind would not take steps to hedge fuel price increases?" he said. "Most airlines have hedges, but they waited until prices went up."

Excluding fuel, Southwest's cost per available seat mile (CASM) rose 4.9% to 6.68 cents, as profit-sharing expense rose 63% to $74 million and credit card discounts rose 22% to $73 million. The airline said it expects a smaller third-quarter increase in unit costs.

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