Before the opening bell, the largest U.S. low-cost carrier Southwest Airlines Co. (LUV) reported its third quarter 2012 adjusted earnings of 13 cents per share that slivered past the Zacks Consensus Estimate by a penny. The quarter’s earnings declined 13.3% from 15 cents in the year-ago quarter.
Though the company’s better-than-expected performance was credited to several cost-cutting measures, network optimization and All-New Rapid Reward program as well as synergies from the AirTran acquisition; headwinds related to the global economic uncertainties, rising fuel prices, weak travel demand and high maintenance costs associated with the fleet modernization program kept the profitability in check.
Southwest recorded $110 million pre-tax synergies from the AirTran acquisition in the first nine months of 2012.
Revenue
Revenue was flat year over year at $4.31 billion and missed the Zacks Consensus Estimate of $4.35 billion. Airlines traffic, measured in billions of revenue passenger miles, slid 0.6% year over year. Capacity or available seat miles fell 0.7% while load factor (percentage of seats filled with passengers) nudged up 10 basis points year over year to 82.1%.
On an annualized basis, Passenger and Freight revenue increased 0.3% and 11.4%, respectively, while other revenue decreased 7.4%. Passenger revenue per available seat mile (PRASM) inched up 1% year over year.
Operating Expenses & Operating Income
Total operating expenses, excluding special items, increased 1.9% year over year to $4.1 billion due to higher maintenance and airport costs. Fuel price (economic) accounted for $3.16 per gallon, down from $3.18 in the year-ago quarter.
Consolidated unit cost or cost per available seat mile (CASM), excluding fuel and special items, grew 5.8%. Including fuel and special items, CASM increased 5% year over year.
Operating income declined 27% to $208 million from the year-ago quarter.
Liquidity
At the end of the third quarter, the company had $3.5 billion in cash and short-term investments and $800 million in undrawn revolving credit facilities. Long-term debt reduced to $2.96 billion from $3.11 billion at the end of fiscal 2011.
Southwest generated operating cash flow of $464 million compared to negative $218 million in the year-ago quarter. Capital expenditures were $406 million, up from $276 million in the year-ago quarter.
Return on invested capital (before taxes and excluding special items) was 7% as of September 30.
Further, Southwest repurchased 37 million shares for approximately $325 million as of September 30 and paid total dividends of $22 million in the first nine months of 2012.
Guidance
Based on current traffic trends, the company expects unit revenue to grow again in fourth quarter.
Southwest expects similar year-over-year increase in the fourth quarter unit costs, excluding fuel, profit sharing and special items. Fuel price (economic) is estimated to be approximately $3.45 per gallon.
The company continues to enhance its shareholder value and expects to achieve 15% pre-tax return on invested capital.
With regard to its AirTran merger, the company remains on track to generate net synergies of more than $400 million by 2013 on full integration. The merger will also result in a one-time charge of $550 million, of which $1310 million has been exhausted until the third quarter of 2012.
Our Take
We believe Southwest Airlines is expected to benefit from the cost leadership position, strong balance sheet, low cost, flexibility, network optimization, fleet modernization, and increasing revenue initiatives.
Nevertheless, high operating costs like fuel, maintenance, salaries, wages and airport fees, new advertising policy along with intense competition from major rivals – United Continental Holdings Inc. (UAL) and Delta Air Lines Inc. (DAL), heavy investments and failure to successfully integrate AirTran are expected to limit the earnings upside potential of the stock.
We are maintaining our long-term Neutral recommendation on Southwest. For the short term (1-3 months), the stock retains a Zacks #3 (Hold) Rank.
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