A Marginal Miss for Southwest - Analyst Blog

Before the market opened today, low-cost carrier Southwest Airlines Co. (LUV) reported its fourth quarter adjusted earnings of 15 cents per share, missing the Zacks Consensus Estimate by a penny.

Adjusted earnings shot up 50% from the year-ago earnings of 10 cents per share. Despite higher fuel prices, earnings rose on strong revenue and a revival in the airline industry.

The company incurred $3 million charges related to consulting and legal fees in connection with the proposed acquisition of AirTran Holdings Inc. (AAI). Combined with other special items, earnings per share increased 12.5% to 18 cents from 16 cents in the year-ago quarter.

Fiscal 2010 adjusted earnings showed a massive improvement of 289.5% year over year to 74 cents per share from 19 cents in the prior year.

Revenue

Total revenue climbed 14.8% year over year to $3.1 billion in the fourth quarter and was marginally ahead of the Zacks Consensus Estimate of $3.0 billion driven by higher ticket prices. On an annualized basis, Passenger revenue, Freight revenue and Other revenue showed increases of 14%, 3.2% and 41.2%, respectively.

Airlines traffic, measured in revenue passenger miles, climbed 10.1% year over year on the capacity or available seat miles growth of 5.5%. Load factor (percentage of seats filled with passengers) rose 340 basis points year over year to 80.7%.

Fiscal 2010 revenues were $12.1 billion, up 16.9% year over year on capacity increase of just 0.4% as well as load factor increase of 330 bps.

Operating Expenses

Total operating expenses, including special items, increased 13.9% and 10.2% year over year in the fourth quarter and fiscal 2010, respectively.

In the fourth quarter, consolidated unit cost or cost per available seat mile (CASM), excluding fuel and special items, upped 5.8% year over year. CASM, including fuel, grew 7.6% from the year-ago quarter.

Operating Income

Operating income in the fourth quarter was $216 million compared with $167 million in the year-ago quarter. Excluding special items, operating income leaped 32.8% year over year to $263 million compared with $198 million in the year-ago quarter. 

Southwest reported an operating income of $988 million in fiscal 2010, up from $262 million in the prior year. Excluding special items, operating income show a whopping growth to $1.2 billion from $540 million in 2009.

Liquidity

Southwest Airlines exited fiscal 2010 with cash and short-term investments of $3.5 billion compared with $2.6 billion in 2009.

The company generated cash from operations of $269 million and $1.6 billion in the fourth quarter and fiscal 2010 compared with $492 million and $985 million, respectively, from the prior year levels. Capital expenditure declined 18.3% and 15.7% year over year to $94 million and $493 million, respectively, in the fourth quarter and full year 2010.

Our Analysis

We believe Southwest Airlines, which is in the process of acquiring its rival AirTran, is well positioned for growth due to its cost leadership position, strong balance sheet, low cost and increasing revenue initiatives such as new frequent flyer programand the introduction of Boeing 737-800 fleet into its network. The company is replacing its reservation system in order to enter the international markets.

Further, the pending acquisition of AirTran represents a unique opportunity for Southwest Airlines to expand its presence in key markets and provide healthy returns based on expected synergies and benefits. The transaction is expected to generate net synergies of approximately $400 million by 2013.

However, we remain cautious due to higher fuel prices, which may adversely affect the ongoing recovery of the airline industry. The failure to successfully integrate AirTran, heavy investments, and reliance on a single aircraft may limit the upside potential of the stock.

We are currently maintaining our long-term Neutral rating, supported by the Zacks #3 Rank (Hold).