The largest U.S. low-cost carrier Southwest Airlines Co. (LUV) is slated to release its first quarter 2012 earnings on April 19 before the opening bell. The current Zacks Consensus Estimate for the first quarter is 5 cents per share, representing a substantial 266.67% decline from the year-ago level.
Southwest had positive surprises averaging 5.13% in the last four quarters. In the year-ago quarter (i.e. first quarter of 2011), the company had not surprised us by reporting earnings on par with what we had expected.
Last month, Southwest projected that it will not report profits in the first quarter of 2012 due to surging fuel prices, which is expected to be $3.50 per gallon. This is higher than its previous expectation of $3.35 per gallon provided at the fourth quarter conference call. Further, the company launched various fare sales in the quarter with discounted ticket prices to boost sales, which would hurt revenues.
In the fourth quarter conference call, Southwest projected first quarter unit costs to register higher growth from the year-ago level of 7.83 cents (excluding fuel and special item). It also estimated strong passenger revenue in the first quarter.
Fourth Quarter Flashback
Southwest Airlines’ earnings surpassed the Zacks Consensus Estimate by a couple of cents but remained below the year-ago earnings. Strong top-line growth aided by heavy traffic offset rising fuel costs in the quarter.
Airlines traffic showed an impressive growth of about 26% on strong capacity (or, available seat miles) growth, which was partially offset by a decline in load factor (percentage of seats filled with passengers).
On the cost side, total operating expense, excluding special items, spiked 38.2% year over year. Fuel expenses, which are a major threat to the airline industry and the company, surged 67.9% in the fourth quarter.
Fiscal 2011 Flashback
The airline companies, including Southwest, were hit hard by the unrelenting market turmoil and rising fuel costs in 2011 after a strong rebound in 2010. Earnings declined on a year-over-year basis due to a 63.7% rise in the fuel expenses. Fuel price represented more than 35% of total expenses in 2011 compared to more than 31% in 2010.
Healthier traffic nevertheless contributed to a healthy top-line growth, which partly compensated for the rising fuel costs.
Agreement of Analysts
Estimates for the first quarter of 2012 have been trending downward over the last 30 days, with 5 out of 10 analysts making downward revisions. None made an upward revision. For fiscal 2012, out of 13 analysts, 5 revised their estimates downward over the last 30 days while 1 moved in the opposite direction.
Although Southwest is poised to benefit from fleet rightsizing, the Evolve retrofit program, All-New Rapid Rewards, AirTran merger synergies and several ancillary revenues, the analysts are concerned about high maintenance and operating costs associated with fleet rightsizing and modernization. Coupled with surging fuel prices, Southwest expects non-fuel costs to grow modestly this year primarily due to higher salaries, wages and benefits, maintenance and airport costs.
Revamping of in-flight cabins and interiors are expected to increase maintenance expenses by $40 million this year. Additionally, replacement of old planes with the new ones would lift depreciation expenses by $50 million this year.
Further, the integration of AirTran might restrict the company’s profitability going forward. The merger will result in a one-time charge of $500 million, of which $134 million was exhausted last year.
Moreover, new advertising rules and stiff competition from United Continental Holdings Inc. (UAL) and Delta Air Lines Inc. (DAL) keep the analysts cautious on the stock. Besides, Southwest is dependent on Boeing Co. (BA) as its sole supplier of aircraft. If Southwest is unable to acquire additional aircraft from Boeing or if the latter is unable to provide adequate support, the company’s profitability will inevitably be hampered.
Magnitude — Consensus Estimate Trend
The Zacks Consensus Estimate for the first quarter remained static at 5 cents over the last 7 days but fell by 4 cents over the last 30 days.
Over the last 7 days, the magnitude of fiscal 2012 estimate revisions remained unchanged at 68 cents. It declined from 71 cents over the past 30 days.
Underperform Recommendation
We recently downgraded our long-term recommendation on Southwest to Underperform, owing to feeble macro-data points in the entire airline industry. Theentire airline industry is struggling with higher fuel prices and a slow moving U.S. economy. We expect conditions to worsen further over the year, due to the weak outlook for Europe, stemming from its financial problems, which is dragging down the global airline profits to half from the 2010 peak.
Apart from weak industry growth, Southwest is expected to incur high operating costs including fuel and non-fuel, which will dilute its profits this year.
Alternatively, based on the company’s strong growth opportunities, the stock holds a short-term Hold rating with the Zacks # 3 Rank.


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