Cutting Maintenance Doesn’t Help Southwest Shareholders (LUV)

Southwest Air (NYSE: LUV) responded today to preliminary findings of its internal investigation over safety allegations.  It looks like the allegations over safety and inspection incidents had some meat to them.  The airline is taking action and vowed to make any changes to assure full compliance with FAA Airworthiness Directives, as well as all of its own maintenance policies and procedures.

It had accelerated the internal investigation last week after Southwest received details from the FAA’s letter of civil penalty. The company has now noted concerns with some of its own findings over controls over procedures within maintenance airworthiness directives and regulatory compliance processes.  The immediate steps were as follows:

• Placed 3 employees on administrative leave and noted that those employees are cooperating with the investigation;
• Hired an outside consultant to help review its maintenance program controls, especially Airworthiness Directive compliance;
• Fully engaged with the FAA on its current audit of Southwest and committed to FAA leadership that it will investigate and address any deficiencies in its maintenance controls.

This mess is really hard to fathom, and it would be much harder to fathom this being a system-wide policy of cutting corners.  Even after that unfortunate event in Chicago, Southwest has the safest record of any major airline and that of any of the major discounters.  We have noted in the past how the airlines "isn’t so much of a discount" any longer and we have noted how its fuel hedges were helping less and less compared to the past.  But it should also be noted that the airline has a cult-like core flier base that has brand loyalty that goes above and beyond most airlines.

This is one of those issues that just feels like more negative headlines will come out over controls and procedures are described horribly in a USA Today piece.  If employees are being suspended and this is ongoing, it probably isn’t over yet on the headline front and any long-term investors should probably expect more "findings" to hit the tape.  It will have to eat some financial charges that may even go beyond the already-reported amounts and it may have some higher expenses coming as a result of whatever new procedures it puts in place. 

The airline can recover.  As long as the airline gets this back in order and has no incidents this will ultimately pass and the company shouldn’t be too tarnished longer-term.  Unfortunately, its stock isn’t doing well and it is at the very bottom of a multi-year trading range.  Cheating rarely pays off in the long-run.  At least Eliot Spitzer isn’t able to get involved.

Jon C. Ogg
March 11, 2008