SOUTHWEST AIRLINES CO quarterly report, Q3 FY2019

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Southwest Airlines Co. — Q3 2019 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2019. Unless otherwise noted, financial amounts are in millions of dollars. Southwest operates scheduled passenger air service in the United States and near-international markets.

Financial performance

  • Third quarter: Operating revenue was $5,639, up 1.1% year over year. Operating income was $819, up 2.6%, and net income was $659, up 7.2%; diluted EPS was $1.23 versus $1.08. Operating margin was approximately 14.5%, compared with 14.3% a year earlier.
  • Passenger revenue increased 0.7% to $5,230; freight revenue declined 2.3% to $42; other revenue rose 8.6% to $367. Higher passenger yield and co-branded credit-card revenue supported results.
  • Operating expenses rose 0.9% to $4,820 despite a 2.9% decline in capacity. Salaries, wages, and benefits increased 4.7% to $2,002; fuel expense declined 9.5% to $1,090. Cost per available seat mile (CASM) rose 4.0%; CASM excluding fuel, special items, and profitsharing rose 7.6%.
  • First nine months: Revenue was $16,698, up 2.7%; operating income was $2,292, down 3.9%; net income was $1,787, down 1.3%; diluted EPS was $3.29 versus $3.13. Operating expenses rose 3.8% to $14,406, while capacity declined 1.8%. CASM increased 5.8%.
  • Fuel costs per gallon, including tax, were $2.07 in Q3 and $2.09 for the nine-month period, down 7.6% and 4.1%, respectively. The company estimated economic fuel cost at $2.07 per gallon in Q3 and $2.09 for nine months.
  • Cash flow: Operating cash flow was $1,091 in Q3 and $3,163 for nine months, versus $1,271 and $3,904 in the comparable 2018 periods. Nine-month capital expenditures were $766, compared with $1,384. Net cash used in financing was $2,082, including $1,450 of share repurchases and $372 of dividends.
  • Liquidity and debt: At September 30, cash and cash equivalents were $2,488 and short-term investments were $1,528. The company reported $4.0 billion of unrestricted cash and short-term investments. Current assets were $5,650 versus current liabilities of $8,629; management attributed the usual airline working-capital deficit largely to advance ticket and loyalty-related obligations. Reported debt, including current maturities, was $3,035; operating lease liabilities were an additional $1,346. A $1.0 billion revolving facility was undrawn, and the company was in compliance with its covenant.

Material changes and balance sheet

  • Q3 passenger traffic and capacity declined: revenue passenger miles fell 3.3%, available seat miles fell 2.9%, and load factor eased 0.4 points to 83.5%. Passenger yield rose 4.1%; revenue per available seat mile increased 4.2% to 14.32 cents.
  • For nine months, operating cash flow was lower year over year, while lower aircraft deliveries associated with the MAX grounding contributed to reduced capital expenditures. The company reported $2,488 of cash at September 30, up from $1,854 at December 31, 2018.
  • Southwest adopted the new lease standard on January 1, 2019, recording operating right-of-use assets and lease liabilities. The transition also removed prior build-to-suit assets and obligations; management said the adoption did not significantly affect results or cash flows. Prior-year balance-sheet and income-statement periods were not restated.
  • Stockholders’ equity was $9,931, compared with $9,853 at year-end 2018. Treasury stock increased to $(9,893), reflecting repurchases. The company paid $500 in Q3 under an accelerated share repurchase; $1.9 billion remained under the May 2019 authorization at quarter-end.

Outlook, risks, and unusual items

  • 737 MAX grounding: All 34 MAX aircraft in Southwest’s fleet remained grounded. Management estimated the grounding reduced operating income by approximately $210 in Q3 and $435 for the first nine months. No Boeing compensation was included in results; discussions were ongoing, with no settlement reached.
  • As of the filing, the company expected seven MAX deliveries in Q4 2019, with 34 other aircraft originally scheduled for 2019 shifting into 2020. MAX flights were removed from the schedule through February 8, 2020, with further removal through March 6 planned. FAA timing was uncertain; Southwest said it could take one to two months after approval to meet requirements, including pilot training.
  • Management expected Q4 2019 ASMs to decline 0.5%–1% year over year and full-year 2019 ASMs to decline approximately 1.5%. Q4 RASM guidance was flat to up 2%. Q4 unit costs excluding fuel and profitsharing were expected to rise 4%–6%, with reduced capacity from the grounding a major driver. Updated Q1 2020 capacity guidance was not provided.
  • Estimated 2019 capital expenditures were $1.1–$1.2 billion, subject to uncertain MAX deliveries. Management estimated Q4 fuel cost at $2.05–$2.15 per gallon based on market conditions as of October 18, 2019; fuel hedges covered up to 65% of remaining 2019 estimated consumption as of September 30, depending on prices.
  • Management cited annual 2019 effective tax-rate expectations of 22.0%–22.5%. A clarification of tax rules regarding bonus depreciation reduced Q3 tax expense by $31.
  • Other operating pressures included higher wages and headcount, maintenance timing, technology costs, and expenses related to MAX-related passenger disruption. Q3 revenue per ASM benefited from reduced capacity; management noted no expected net MAX-related RASM benefit in Q4, as capacity-related benefits were expected to be offset by schedule-adjustment effects.
  • Risks include further MAX delays or additional FAA directives, lost revenue and elevated unit costs from cancellations, aircraft-delivery disruption, fuel-price and hedge volatility, economic and demand changes, weather, and operational disruption. Southwest relies on Boeing as its sole supplier of new aircraft.
  • Legal matters include a proposed U.S. capacity-collusion class-action settlement for $15, subject to an appeal, and a separate MAX-related class action that Southwest moved to dismiss. The company denies wrongdoing and said ongoing proceedings and IRS matters were not expected to have a material adverse effect.
  • Management reported effective disclosure controls as of September 30, 2019, and no material change in internal control over financial reporting during the quarter.

Most important facts for investors to verify

  • FAA and Boeing progress toward MAX return-to-service approval, Southwest’s schedule and delivery assumptions, and any compensation actually agreed or recognized.
  • Whether Q4 and 2020 capacity, RASM, and unit-cost expectations hold as aircraft availability and schedule adjustments evolve.
  • Cash generation, capital spending, lease and aircraft commitments, and the extent to which lower capital expenditures reflect delayed deliveries rather than lasting savings.
  • Fuel prices, hedge coverage and settlement outcomes, including potential accounting volatility or counterparty exposure.
  • Share repurchase pace and dividends relative to liquidity needs and the remaining authorization.
  • Developments in the capacity litigation appeal and MAX-related litigation.