• Rising fuel supports introduction of 737 MAX in October

By William DiBenedetto

May 1, 2017: Southwest Airlines’ first quarter profits fell by nearly 32% to $351m, driven largely by big increases in employee union contract expenses and fuel costs.

During a conference call with analysts, Gary C. Kelly, chairman and CEO, characterized the quarter as “another strong performance with an operating margin of almost 13% despite higher fuel prices.” He also noted that revenue expectations were reset in March, down 2% to 3% for the quarter, adding that the quarter included “a lot of noise with year-over-year union contract increases and settlements.”

Employee expenses continue rise

Excluding fuel and oil expense, special items, and profit sharing expense, the airline’s first quarter 2017 operating expenses increased 11.3%, and 6.9% on a unit basis, year-over-year. Approximately four points of this unit cost increase was due to the significant “snap up” in wage rates in year one of new Flight Attendant and Pilot contracts that became effective in the fourth quarter 2016.

Indeed, employee expenses for the quarter jumped 12.6% to $1.73bn, which far outpaced the next highest expense line — $922m for fuel and oil, an 8.2% increase. Southwest now finds itself in the uncomfortable position of having some of the highest employee expenses in the industry, a difficult trick for a “low-fare” airline to pull off over a sustained period. One could argue that it is not really a low-cost airline anymore.

3.5% growth this year

With respect to capacity, Kelly reported no change from the year-end report in January. “We’ve got 3.5% available seat mile growth planned for this year, and we’re scheduled out into the third quarter. Following the fourth quarter, I expect the first half of next year to come in less than 4% and also each quarter. And along those lines, there has been no change to our fleet plans for 2017 or 2018 other than the fact that we exercised five -800 options as planned for 2018 delivery.”

MAX 8 service begins Oct. 1

The airline started the year with a fleet of 723 aircraft. Kelly said Southwest is “on track” to launch the MAX 8 on October 1, after retiring all 79 remaining Classics in

Southwest puts its first Boeing 737-8 MAX in service Oct. 1. Photo via Google images.

the fleet by the end of September. Southwest will add 41 more NGs and 14 MAX-8s this year.

“We still plan to end this year, after grounding the Classics, with 703 aircraft. With the firm commitments that we have for deliveries for next year, that will take us to 746 aircraft at the end of 2018, which is within our fleet growth target of no more than 2% through the end of next year.”

Southwest has four unexercised options for 2018. If these are exercised, this will mean a total of 750 airplanes. Kelly said the company is approaching its 2017 and 2018 growth cautiously:

“We’re managing the grounding of the Classics, which potentially makes for some comparability noise in late 2018. But as we said, our full year growth will be below 2016, as we had previously indicated.”

The chart details the airline’s 737 delivery schedule:

Rising fuel favors fleet modernization

Tammy Romo, EVP and chief financial officer, noted that in the current environment of higher fuel prices, “our fleet modernization and other fuel saving initiatives are meaningful, especially as we get to the second half of the year and our Classics are retired. In first quarter, our fuel gallons increased less than our capacity, resulting in fuel efficiency gains year-over-year.”

Romo said Southwest’s “strong operating cash flow and manageable CapEx resulted in a record first quarter free cash flow of $1.2bn. For full year 2017, our cash flow outlook remains strong, and we continue to expect capital expenditures to be approximately $2.3bn.”

She said aircraft capex is estimated to be $1.4bn. “As you move into the fourth quarter, we’ll continue to see savings associated with the retirement of our Classic fleet. So that’s about a point, which you’ll see reflected in lower depreciation and maintenance costs.”