No bashing nor praise here, I just found it interesting how cyclical this industry is...
Southwest: The Street's Love Fades
Its earnings and stock are down while those of Continental and AMR are way up. Has the majors' reorganization erased the low-cost carrier's edge?
by Christopher Palmeri
Passengers were queued in three long rows to board the 5:05 p.m. Southwest Airlines (LUV) flight from Las Vegas to Burbank, Calif., on a recent Sunday as a gate agent tried to coax seven people into relinquishing their seats on the overbooked flight. He was offering an overnight hotel room, a flight in the morning, and $300 additional credit toward a future Southwest flight. "Come on, folks," the agent pleaded. "Somebody must want to leave Las Vegas with some money."
You'd be hard-pressed to find evidence that Southwest is out of favor by visiting airports at rush hour these days. But on Wall Street, the nation's largest low-fare airline has indeed been losing altitude. The stock is down nearly 5% for the year, even as old-school carriers such as Continental Airlines (CAL) and American Airlines' parent, AMR Corp. (AMR), have seen their share prices soar 65% and 25%, respectively, in 2006. Worse, Southwest reported on Oct. 19 that its third-quarter earnings slid 77% to $48 million, due to higher fuel costs and traffic slowed by the latest restrictions on carry-on items.
It's generally been a brighter earnings season for other airlines, however. AMR reported on Oct. 18 that its profits hit $15 million, a $168 million swing from the prior year's loss and the company's second-quarter-in-a-row of profitability. Continental reported earnings of $237 million on Oct. 19, up from $61 million in the same quarter last year. JetBlue Airways (JBLU) reported a loss of $500,000 on Oct. 24, about what analysts had been expecting.
In an interview, Southwest Chief Executive Gary Kelly acknowledged that his company is battling an image problem on the Street. "There is a theme of more turbulent air for some of the low-cost carriers," Kelly says. "That's just not factually correct. On any basis that you compare our results, we're still easily the leader."
Majors Matching Low Fares
What's happening is a shift in fortunes in the airline industry. When business fell off in the wake of the September 11 attacks, the major airlines cut back on domestic flights and renegotiated their labor contracts, in many cases through bankruptcy court. The industry is now enjoying the fruits of those reorganizations. Traffic has returned, planes are running fuller, and fares have risen sharply. The major airlines are taking more advantage of those fare hikes than the lower-cost carriers. The average revenue per seat among the major carriers is expected to rise nearly 15% this year vs. only 9% for the low-fare airlines, according to the brokerage firm Calyon Securities.
The thinking now is that major airlines, with their cost structures much lower, will have more flexibility to match low-fare rivals. With less difference between their ticket prices, perks such as assigned seats, first-class cabins, private lounges, and frequent-flier miles good for international trips will keep customers choosing the major carriers. "It used to be a low-cost carrier could go into a market and the legacy carriers would either not match it or match one flight per day," says Scott Kirby, president of US Airways Group (LCC). "Now all the airlines match that price."
With low-cost rivals such as JetBlue and AirTran Airways' parent, AirTran Holdings (AAI), continuing to add flights, albeit it at a slower pace than in recent years, Southwest may have trouble raising fares. Lehman Brothers airline analyst Gary Chase estimates that the industry as a whole will see gains in revenue per seat of only 1%-2% next year. He figures that Southwest's return on capital isn't likely to hit previous highs of 12% and will likely hit only about 8% next year.
Business Costs Still Cheap
Southwest's Kelly is having none of that. "We're trying to get back to record profitability," he says. "It's true (the major airlines') costs are coming down, they're coming from extremely high to high. We're going from low to extremely low. The employees at these bankrupt carriers will be clamoring to get back what they feel they deserve as soon as profitability returns."
Indeed, Dallas-based Southwest still enjoys some of the lowest costs, the best balance sheet, and the highest profit margins in the industry. And Kelly has still found new opportunities for growth, starting up service in Pittsburgh, Philadelphia, Denver, and Washington-Dulles International Airport in recent years. A phase-out of the controversial Wright Amendment that went into effect on Sept. 29, he notes, will allow more flights from Dallas, and the continuing rebuilding of New Orleans will do the same for that city.
Last summer, Kelly experimented with changing one of the core components of Southwest's business model. He tested assigned seating in the San Diego market. Kelly says the results were mixed, with the company's famous cattle call-like boarding process still the fastest way to load the plane and make the quick turnarounds so critical to the company's low-cost operations. "There are some people who like one brand of soft drink, some who like another," Kelly says. And judging by the crowds at the Southwest gates in Las Vegas recently, there are still plenty of people who like the company's product as well.
Palmeri is a senior correspondent in BusinessWeek's Los Angeles bureau.
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Alaska Air Feels Heat from Wall Street
Alaska Air Group's (ALK) shares sank 8.5% on Oct. 24 after the airline posted disappointing results for the third quarter.
The Seattle-based company on Oct. 24 reported a third quarter net loss of $17.4 million, or 44 cents per diluted share, including charges related to the buyout of five MD-80 jet leases, a voluntary severance program, and fuel hedging losses. In the third quarter of 2005 the company had net income of $90.2 million, or $2.71 per diluted share, including fuel hedging gains, a refund of Mexico navigation fees, and an adjustment to previously recorded restructuring charges.
Excluding the impact of such items, the company would have reported net income in the 2006 third quarter of 2006 of $77.9 million, or $1.93 per diluted share, compared to $71.5 million, or $2.16 per diluted share, in 2005. But any way you cut it the recent quarter missed the median analyst estimate of $2.10 per share, according to the San Francisco research firm StarMine.
While another U.S. carrier, JetBlue Airways (JBLU), also reported a loss Tuesday, it beat analyst expectations. Investors punished Alaska shares 8.5% to $40.77 per share on the New York Stock Exchange, vs. a 3.4% rise to $11.52 per share for JetBlue on the Nasdaq.
A foiled terrorist plot triggered new security rules at airports in recent months, forcing consumers to keep liquids and gels -- even large bottles of baby milk -- out of their carry-on luggage.
"Alaska Air had the misfortune to have the recent terror warnings come in its seasonally best period," Standard & Poor's equity analyst Jim Corridore said in a research note. The company's earnings missed his $2.50 EPS estimate for the third quarter, but he expects them to have strong profit growth in 2007 and hiked his target price on the stock by $3 to $47. (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Companies.)
While the recent decline in fuel prices has caused the value of the airline's hedging portfolio to decline, the program nonetheless continued to save Alaska Air Group about $27.4 million in economic fuel expense during the third quarter.
Bill Ayer, chairman and chief executive officer said in a press release that the company's slower revenue growth toward the end of the quarter "underscores the need to continue to reduce costs and improve processes in order to offer our customers a product they prefer at a price they are willing to pay."
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