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By Chris Sloan

Sept. 30, 2024, © Leeham News: Southwest Airlines outlined significant moves in its quest to return to sustained profitability at its investor day on September 26 in Dallas. Widely reported revenue and financial initiatives include assigned and premium seating, network realignment, capacity growth cuts, and staffing reductions.

Billed as Southwest Even Better, the plan is the most transformational program in the company’s 53-year history, according to Chief Executive Officer Bob Jordan. “The plan includes a robust set of tactical and strategic initiatives and elements uniquely available only to Southwest Airlines. The plan is capital efficient and supports achieving our financial goal of ROIC [Return on Invested Capital], well above our cost of capital,” he said. Yet, he acknowledged that recent financial performance is not up to anyone’s expectations. “Our model is not broken, but it needs continued calibration and enhancement.” By 2027, the plan is expected to add approximately $4 bn in cumulative incremental earnings before interest and taxes (EBIT).

Jordan pointed to external factors as a significant culprit, notably Boeing. “It’s no secret that Boeing’s delivery delays have created significant issues for us, making it very difficult for us to run a business. Boeing has delivered very few MAX aircraft on time, and we are still waiting on the MAX 7 certification.” Though compensation agreements remain confidential,  “Past financial issues caused by Boeing delivery delays and other Boeing issues have largely been resolved through the application of credits on future deliveries,” said Jordan.

Southwest is taking dramatic steps to mitigate “operational risk” by reducing hiring and cutting annual capacity growth to 1-2 percent through 2027. “We expect production issues at Boeing and issues related to the (Pratt & Whitney) Geared Turbofan engine to continue to constrain industry growth for years to come,” Jordan noted.

Fleet Optimization, not Future Deliveries, to Power Growth

Southwest is pegging its capacity, RASM growth, and CASM reductions to more efficient existing fleet utilization, resulting in equivalent capacity growth of 34 aircraft by the end of 2025. The carrier endeavors to reduce turn times by an average of five minutes, with the productivity increase translating to an additional 16 airframes. The company is making similar claims propelled by the highly touted new red-eye flights beginning in February 2025 and expanding throughout the next few years, including to and from Hawaii. “We anticipate redeyes driving roughly two points of new capacity, the equivalent of about 18 aircraft (in 2025). This will generate revenue obviously without additional aircraft or employee growth,” said Chief Operating Officer Andrew Watterson.

Premium LOPA Details

The company unveiled its unusual new Layout of Passenger Accommodations (LOPA) for its new Extra Legroom seating. The company looked closely at blocking a middle seat “Eurobiz” or going to a two-by-two first-class seat configuration but landed on extra legroom. “The results here clearly maximize revenue potential, mitigate operational complexity, and align with our brand. It generated roughly the same amount of revenue as the two two-by-two seating model or a model where we blocked the middle seats but was far less complex to implement, and the speed to market was much quicker.”

The Boeing 737 MAX-8 and -800 will boast a premium-heavy 68 seats at 34” pitch (39% of the cabin) without losing any of the total 175 seats by reducing the remaining standard seat pitch to 31”. The Extra Legroom seats are located in two different zones, interrupted and bookended by the regular pitch seats. The 737 MAX 7 and 737-700 configurations will result in 32% and 29% premium seat share with a negligible loss of two and six seats, respectively.  The retrofit will begin with the existing Collins Meridian seat, followed by a new custom Recaro seat product on new deliveries in late 2025.

Following FAA certification, Southwest expects to begin the conversion at a rate of 50-100 -800s and MAX 8s in the first quarter of 2025. The -700s will follow, with project completion set for year-end 2025. Once fully deployed in 2026-27 with the associated seat assignment ancillary revenue, the carrier projects $1.5bn in incremental EBIT.

Monetizing The Fleet

As some airlines rationalize their capacity growth, deferrals, if not outright cancellations, are creeping into the picture. Southwest, however, in a page perhaps ripped from its famously profitable fuel hedging program, is using its order book as a revenue generator.

“We will extract every dollar of value out of that order book whether we need those aircraft or not because we owe that to our shareholders,” said Jordan. Chief Financial Officer Tammy Romo asserts that the company has access to nearly 700 aircraft in its order book at “attractive pricing” via 497 firm orders for the MAX 7 and MAX 8 and 197 options for either. “We have a unique opportunity to capture value and our earnings on excess aircraft we do not need with our moderate growth plans,” said Romo. The company will likely not sell delivery slots but utilize leasebacks and outright sales. “The combination of a favorable secondary market and our attractive aircraft pricing provides a unique opportunity to significantly reduce our aircraft CapEx and drive earnings accretion,” she added. The $2.1bn in contractual CapEx orders from 2024-27 will be reduced to $500m.

The company announced RFPs for approximately 65 737-800NGs for sale and leaseback as it moves to an all-MAX fleet by 2031, which currently stands at 27%. Once the 571 NGs are retired and the fleet is fully renewed, Southwest’s average fleet age will be five years old throughout the 2030s, setting it up for sharply reduced CapEx in the next decade. Romo asserts, “We do not view our fleet strategy as part of our core operations. We will be opportunistic in the market where it makes sense,” leaving the door open for flexibility with retirements should they need additional lift.

Cracking Open the Door to A Multi-Type Fleet

Capacity cuts seem to have taken some heat off the interminably delayed MAX 7 delivery for now, though questions again persist if Southwest would consider a second fleet type, of similar gauge to the MAX 7, such as Embraer’s 195-E2 or Airbus’s A220-300. “We’ve been fine taking MAX 8s instead of MAX 7s up until this point,” said Watterson, whose boss added,  “It doesn’t become a critical question for several years. So I anticipate that they’ll get the seven certified, and we won’t reach that question.”

Southwest continues to defend its single fleet-type strategy. “If we had, at the moment, ordered MAX 7 instead ordered a geared turbofan-powered aircraft, whether that was an Embraer or an Airbus or the former Bombardier, those would be grounded right now. It perversely would’ve not created more diversification,” said Watterson. For the perhaps first time, Jordan is opening the door to a second fleet type, though not anytime soon. “We’ll look at what aircraft is appropriate. That may be 10-15 years away, but you know for sure that a dual fleet or a multi-fleet is in our future. It must be,” he mooted.

The Elliott In The Room

Elliott Investment Management, which is now calling for a full-fledged proxy fight, has exhausted Bob Jordan’s diplomatic persona. The exasperated and emboldened Jordan, who enjoys the unequivocal support of the Board, didn’t mince words: “For Elliot to call that plan rushed and haphazard, in my opinion, is inane. I refuse to let Elliot distract me from executing our plan, which I believe will create substantial value for Southwest and our shareholders.”  Elliott, unsurprisingly, was unimpressed, firing back immediately with its own heated rhetoric. Elliott said, “The Board continues to evade the most critical question facing Southwest: Why is Mr. Jordan – who has delivered years of unacceptable financial results and, until very recently, was dismissive of the actions announced today – the right leader to execute these “transformative” changes?”