I think this is a more accurate portrayal of how the fuel hedges work. Read it carefully. This was written by one of our captain's with a very extensive knowledge of airline finance.
....Let's look at the concept “this airline is doing fairly well, but
without fuel hedging we would be ‘losing’ money.” In the following I
am not disputing the fuel hedging program has been awesome here at
SWA, just that how you have been presented the information is in error.
Income statements subtract revenues from expenses
to get operating income. From operating income other
adjustments are made to yield “income before taxes.” As
an aside, at SWA these other expenses actually add $54M
to income mainly because of our large cash hoard.3 The
income-before-taxes figure is reduced by taxes to achieve
net income. The rub is that in the “Just Plane Smart”
presentations, management compared net income to an
expense called fuel hedging gains. Then the presentation
inferred to subtract one from the other. Roughly, $500M
- $500M = $0, correct? Well, not at all. If fuel costs were
higher in the operating expenses by $500M then the
operating income is reduced by $500M making the tax
burden less by around $200M. Therefore, if the fuel
hedges were not present, the accounting effect is not:
5 – 5 = 0, but 5 – 5 (times the effective tax rate of around
40 percentish) = 3.
“Just Plane Smart” then infers with “$0” in net income,
we cannot continue to expand and hire. We don’t have any money correct?
$0 is $0, right? This airline is refocused and running down the rails at a high
rate of speed. In 2005, SWA produced a net income of $548M.4 Think for a
second: How in the world did this airline purchase $1.2B in property and
equipment in 2005 with only $584M on hand? Specifically, buy 33 aircraft,
purchase gates, other capital equipment, plus retire debt, repurchase SWA
common stock, and add a load of cash to our fabulous CFO Laura Wright’s
petty cash account? It seems the math here is $584M minus (a ton of money)
= a ton more money? What in the world? Remember the reality the airline
industry requires a high degree of operating leverage discussed earlier? Those
expensive assets get to be written off over the life of the asset. For example,
a $20 million aircraft that lasts 20 years is allowed $1M of depreciation per
year. SWA still possesses this $1M in cash, it just gets to lower its income
similarly to the various write-offs we put on our IRS Form 1040. Last year
SWA produced a little over $2.36B in cash flow from operations.5 In the
airline business, cash is king. Remember in the recent past reading in the
Wall Street Journal or the fish-wrapper (USA Today) that some of the mainline
folks were burning cash at a rate of $3, $4, or even $5 million per day? How
does our little LUV-jet Company producing cash at a rate of $6.5 million per
day sound? Like the place to work is how it sounds! This is why our SWA
Executive team was given the stupendous bonuses and raises for 2005 they
recently received…because they rock!