Southwest’s Fuel Hedges Keep Earnings Up, For Now (LUV)

Southwest Airlines (NYSE:LUV) is managing to keep its earnings going and expects revenues in the coming quarter to exceed year ago levels.  The company posted $0.22 EPS and revenues of $2.59 Billion compared to First Call estimates of $0.21 & $2.58 Billion. Net income after charges was $0.18 EPS, or $133 million.  Southwest’s load factor for the quarter was 76.6%, up from 74.7% for the quarter last year.

It had favorable cash settlements from fuel hedging of $189 million, and economic fuel cost per gallon of $1.69 rose 7.6% from a year ago. It lists its contracts in place for approximately 90% of fourth quarter 2007 estimated fuel consumption, capped at an average crude-equivalent price of approximately $51 per barrel (compared to approximately 85 percent at approximately $43 per barrel for fourth quarter 2006); listed as fuel costs per gallon to be in the $1.80 range.  Unfortunately, Southwest’s fuel hedging advantages are starting to dwindle.

FORWARD HEDGES:
approximately 70% of estimated 2008 fuel at approximately $51 per barrel;
approximately 55% of estimated 2009 fuel at approximately $51 per barrel;
over 25% of estimated 2010 fuel at approximately $63 per barrel;
over 15% of estimated 2011 fuel at approximately $64 per barrel;
over 15% of estimated 2012 fuel at approximately $63 per barrel.

Shares were up 1% pre-market, but shares are up 0.4% right after theopen at $14.62.  Its 52-week trading range is $14.03 to $16.96.  If youlook over a 5-year period, Southwest has mostly been in a $14 to $18trading band.  The company was brilliant for hedging oil the way itdid.  Unfortunately, forward contracts can only be carried so far intothe future.

The discount air carrier is putting some changes into its entirebusiness model.  In his quotes, CEO Gary Kelly noted, "We began slowingour capacity growth rate this month and have trimmed our route system.We are very enthused by the response to our new Customer boardingmethod, which will be implemented system-wide on November 8, 2007. Inconnection with that, we have begun our "extreme gate makeover" toimprove the Customer airport experience with an anticipated completiondate of mid-year 2008. We will soon announce enhancements to our farestructure and Rapid Rewards frequent flyer program, supported by a newmarketing and advertising campaign. We will also begin enhancing ourrevenue management structure, technology, techniques, and processes infourth quarter 2007. We are continuing efforts to provide travel agentand professional travel manager partners with increased and costeffective access to our fares and inventory. We are particularlypleased with the recent expansion of our agreement with Travelport’sGalileo to include Worldspan, another of Travelport’s globaldistribution systems. We are very excited about these major revenueinitiatives as well as our longer term ancillary and codeshare revenueopportunities, and are determined to overcome higher fuel costs andachieve our financial targets."

Jon C. Ogg
October 18, 2007