To say this has been a year of change for Southwest would be a notable understatement. Partially under its own initiative and largely under the influence of its activist investor Elliott Management, the airline has been furiously working to get out of the dark place where former CEO Gary Kelly left it. Some of the moves are long overdue and welcome while others are, well, let’s just be generous and call them a shock to the system.
Most of these initiatives have been focused on fixing the airline’s anemic revenues, something that improvements in revenue management have already started to impact positively. There really is no question that short-term revenue would increase based on these changes, but there has been a great deal of skepticism about the airline’s ability to execute. The most recent financial guidance suggests that things are indeed going rather well despite the absolute chaos that the federal government brought in Q4.
Southwest had previously said after its Q2 results that it would have earnings before interest and taxes (EBIT) of $600 million to $800 million for the full year. That was largely scoffed at by Wall Street as being likely, and the stock dropped. In fact, JP Morgan analyst Jamie Baker called it “Very Aggressive and Seemingly Unobtainable,” or VASU for short. Despite the unnecessary dig at former American Chief Commercial Officer Vasu Raja, Jamie had a point. It looked like a heavy lift.
Data via Yahoo! Finance
Southwest had limped through the first half of the year with a mostly breakeven proposition. Then in Q3, it did turn positive, but not by all that much. Still, Southwest stuck to its $600 to $800 million guide. Even with another quarter in the books, analysts were not willing to believe that number and put out a consensus well south of that point. The stock dropped again. That being said, everyone did expect Q4 to see big improvements and easily be the best quarter of the year.
After all, Southwest hurt itself when it botched its implementation of Basic Economy in summer, but it has fixed that problem since. Bag fees didn’t even start until the end of May, and it only applied for tickets going forward. So those numbers still haven’t been fully realized, though it’s a whole lot closer now considering when people tend to book. And assigned seats don’t start until January, so we are still far off from getting meaningful seat revenue for extra legroom and all that. In other words, Q4 was going to have to be a true monster in the best way possible despite the initiatives not being ready to fully pay off just yet.
It has not turned out to be quite what Southwest — or any airline — had hoped. Thanks to the impact of the government shutdown as well as higher fuel prices, Southwest has now decreased its projection to $500 million in EBIT for the year. This may not sound good, but in fact, it is quite good and, shock, Wall Street was actually pleased.
Savi Syth with Raymond James called it “positive” and said that this should be about a 14 cent reduction in earnings per share compared to the expectation of 25 cents thanks to fuel and the shutdown. Tom Fitzgerald at TD Cowen said “we were impressed by [Southwest] given [Delta] noted the shutdown only impacted domestic flying….”
The general consensus was that the shutdown was bad, but it was truly a temporary blip. Once things got back to normal, so did booking trends. Southwest sees the same thing, and that’s good news, but for Southwest, this is particularly notable since, as Tom mentioned, the airline is almost entirely domestic and took a greater hit than a carrier with a more diversified network.
Southwest’s stock has responded, now at the highest point it’s been in more than three years. And you’re probably wondering… why am I talking about share price? I don’t usually do that. But for Southwest, this is the most important number that exists right now by far. If the share price goes high enough, Elliott will take its gains and liquidate its holdings. That’s the whole point of the investment. The day that happens will be a huge celebration, because it means the airline can actually run itself instead of being run by money people who don’t care about its long term health. So, keep watching that stock….
