Southwest Airlines' Capacity Gains Are Panned by Wall Street Analysts

NEW YORK (TheStreet) -- Now it is Southwest Airlines (LUV) that finds itself in Wall Street's doghouse, as the carrier continues to grow capacity.

Wall Street analysts generally resist capacity growth, believing it can lead to lower fares and lower revenue per available seat mile, not just for the expanding airline but for competitors as well.

A frequently referenced rule of thumb is that airline capacity growth should be in line with GDP growth. US GDP grew 2.4% in 2014 and 0.2% in the first quarter of 2015.

Southwest grew capacity as measured by available seat miles (ASMs) at 6% in the first quarter of 2015. It now foresees full-year growth of 7% to 8% for the full year, up from previous guidance of 7%, Chief Financial Officer Tammy Romo said Tuesday at the Wolfe Research transportation conference. That troubles some analysts.

Southwest shares closed Tuesday at $40.91, down $1.23 or nearly 3%. Most airline shares fell, but none fell as much as Southwest.  Year-to-date, Southwest shares are down 3%.

At the conference, Wolfe Research analyst Hunter Keay, a staunch advocate for capacity restraint grilled Romo about the planned growth.

Romo emphasized that most of Southwest's growth is coming at Dallas Love Field, where the carrier is expanding following the 2014 expiration of the Wright amendment, which strictly limited non-stop flying.

"We have been planning for a very long time to expand service out of Love Field," Romo said. "We have 18 of the 20 gates and we're going to fly out of those.

"The demand is there," she said. "We believe we have pent-up demand out of Love Field for our service."

Southwest will also grow at Houston Hobby Airport, where an international terminal is scheduled to open Oct. 15. Romo noted, however, that "this is a peak year.

Looking ahead,she said, "We would expect (capacity growth) to really glide down more in line with what everyone else is thinking, in line with GDP."

Southwest capacity growth will also reflect larger aircraft and longer stage length flights, which are not high-cost items, she said.

Asked whether the growth rate would be the same if oil still cost $100 a barrel, Romo responded, "I can't say for sure if it would have been tweaked down a little but it wouldn't be significantly different.

"The demand is very strong for those (new) flights," she said. "We have 20% of (capacity) in developmental markets, largely at Love Field. The fact that we are able to generate such stellar margins on that capacity, with Love Field at a very high level (means) we are confident in the capacity we are adding at Love Field."

Meanwhile, Becker wrote that, "There has been a growing concern around Southwest's capacity growth and its implications for the industry.

"Their growth has been somewhat concerning with GDP forecast continuing to trend lower in the near term," she said.

Romo also said current quarter passenger revenue per available seat mile will decline 3%, compared with an April decline of 2%. Becker cut her current-quarter earnings estimate to $1.06 a share, compared with consensus of $1.12. For the full year, she cut her estimate to $3.45 a share, compared with consensus of $3.54. DeNardi retained a buy but cut his current-quarter estimate to$1.07. He also has a $3.45 full-year estimate.

Keay's concerns about capacity growth also extend to Delta (DAL). "Delta is advertising 2% y/y ASM growth this year," he wrote. "But domestic capacity is likely up 3% (above GDP)."

He noted that Delta's growth is 12% in markets where it competes with United (UAL). "What would you do if you were UAL and DAL, whose product is clearly great, was growing 12% in your markets?" he asked. "Stand around and lose share?"

But United seems steadfast. Speaking at the conference, United Chief Financial Officer John Rainey said the carrier has "grown ASMs at less than GDP for eight consecutive years" and that "since oil prices have come down, we have decreased capacity by half a point."

As the airline industry has staged a historic improvement in its financial performance, Wall Street has been quick to criticize carriers it regards as laggards. Recent targets have included Delta, due to capacity expansion in select markets; JetBlue (JBLU), which eschewed bag fees and premium class service; and Southwest, for its "Bags Fly Free" policy.

Despite the occasional criticism, Delta is widely viewed as the industry leader in improving financial metrics. At JetBlue, under pressure from Wall Street, CEO Dave Barger stepped down in February.

Southwest was under attack last year for its lack of bag fees. At the carrier's media day in September, CEO Gary Kelly was asked whether Southwest might end the policy.

"That debate's long ended," Kelly responded. "You see the results that we have, which are affirmed by all the research that we do in marketing that say if we charged for bags, the defection rate of our customers would be such that it would more than wipe out the bag fee revenue."

Kelly noted that Southwest's market share grew after other carriers began charging for bags. The value of that increase was about $1 billion, he said.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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