Efficiency Will Be The Focus Of Southwest Airlines Q4 2015 Earnings

  • Southwest Airlines is due to report fourth quarter 2015 earnings on 21st January 2016 before market open.
  • The company expects to report strong EPS growth but only modest revenue growth.
  • Investor attention will, however, be focused more strongly on the company's efficiency metrics as it continues to add capacity and expand into international markets.

Low-cost carrier Southwest Airlines (NYSE:LUV) is expected to report fourth quarter 2015 earnings on 21st January 2016 before market open. The consensus amongst analysts is for the company to report EPS of $0.9 vs.$0.59 for the previous year’s comparable quarter. During its third quarter earnings call, Southwest said that it expects fourth quarter revenue to increase ~1% Y/Y, which implies the company expects operating revenue of $$4.646B. Southwest Airlines has managed to beat or exceed earnings expectations over the last four consecutive quarters and the stock has a strong buy recommendation on Wall Street.

LUV-1

 Southwest Quarterly Earnings Surprise History

Fiscal
Quarter End
Date
Reported
Earnings
Per Share
Consensus
EPS* Forecast
%
Surprise
Sep2015 10/22/2015 0.94 0.92 2.17
Jun2015 07/23/2015 1.03 1.03 Met
Mar2015 04/23/2015 0.66 0.64 3.13
Dec2014 01/22/2015 0.59 0.54 9.26

Source: NASDAQ

Effects of low oil prices

In the current environment of ultra-low fuel prices, investors have been judging airlines more heavily based on their RASM, or Revenue Per Available Seat-Mile, which is an efficiency metric. Low-fuel prices have two sides to them. On one hand, they allow airlines to realize significant cost savings which frequently trickles down to the bottom line. Fuel costs comprise the biggest cost component for major airlines and can account for more than 30% of an airline’s operating expenses.

Southwest Airlines reported EPS growth of 70% primarily due to huge fuel cost savings during the last quarter, and this trend is likely to continue in the foreseeable future. Oil prices recently slid under the $30/barrel psychological mark after Iran had its trade sanctions lifted. The world is awash in oil, and the situation can only get worse once Iran starts exporting the commodity, though carriers like Southwest Airlines are hardly complaining.

The other side of low fuel prices is not so benign because it forces airlines to cut their fares and pass on some fuel cost savings to their customers. Southwest Airlines is the lowest cost carrier in the country. But by cutting fares, an airline’s RASM automatically falls. So low oil prices really is a double-edged sword for airlines.

In the case of Southwest Airlines, its RASM reading has been dealt a double whammy by the company’s capacity addition and international expansion. Southwest opened up its hometown airport of Dallas Love Field to international and long-haul flights after the Wright Amendment of the 1979 expired in October 2014 thus allowing Southwest Airlines to operate in new routes.

During the third quarter, Southwest increased its capacity by 7.6% Y/Y, which is considered high in the airline industry. The good part though is that the company was able to realize a 3.1-percentage point increase in its load factor to 83.2%. The net effect was that Southwest Airlines’ RASM increased only 1%, which is fairly modest.

Investors will therefore be focusing strongly on how the company’s international expansion and capacity will continue impacting on RASM when it reports fourth quarter earnings. Prior to the company’s international expansion bid, Southwest Airlines was predominantly a domestic carrier with close to zero international exposure.

But this is now changing rapidly after Southwest launched six new routes to Central America and Mexico during the third quarter and another two in November. Unless Southwest’s RASM experiences a serious erosion due to the company’s capacity addition, international expansion should mean a solid opportunity of revenue growth for the company.

Southwest stock currently sports a forward PE ratio of 9.4. Southwest stock has been facing resistance whenever its forward PE ratio touches 12. So barring any nasty surprises, Southwest stock still has some room to run.

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