Why Southwest Airlines Earnings Are Disappointing Investors

Southwest Airlines Corp. (NYSE: LUV) reported second-quarter 2016 results before markets opened on Thursday. The low-cost carrier said it had adjusted earnings per share (EPS) of $1.19 on revenues of $5.38 billion. In the second quarter of 2015, the airline posted $1.03 EPS on revenues of $5.11 billion. Analysts were expecting Southwest to post EPS of $1.21 and $5.41 billion in revenue.

The airline’s adjusted fuel costs were lower year over year, falling from $1 billion to $930 million, but this year’s costs included $187 million in non-performing hedges. Total adjusted operating expenses rose from $3.96 billion to $4.12 billion. Adjusted operating income rose from $1.15 billion a year ago to $1.27 billion and adjusted net income rose from $691 million to $757 million, largely due to a $121 million gain related to the airline’s fuel contracts and the exclusion of $206 million in profit-sharing expense.

Revenue passenger miles rose by 6% to 32.34 million 6% and available seat miles rose by 4.8% year over year. Load factor rose by a percentage point to 85.6%. Unit revenue, as measured by passenger revenue per available seat mile, fell 3.5%.

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Fuel costs averaged $1.81 per gallon in the quarter, down from $2.02 a gallon a year ago. The totals include $0.42 in the 2016 second quarter for non-performing hedges, compared with a $0.08 in the year-ago quarter. The airline expects fuel costs to rise to $2.05 per gallon in the third quarter.

Southwest said in June that it will defer delivery of new Boeing 737 planes from 2019 to 2022 until 2023 to 2025. This year’s capacity growth is expected to be 5% to 6%, while growth for the three-year period ending in 2018 is forecast at “no more than” 2%. The airline’s current fleet numbers 719, and Southwest expects to end the year with 723 planes, all 737s.

Results were just short of consensus estimates and that will not please investors. A more serious issue may be rising costs and lower unit revenue.

Shares traded down about 3.1% in Thursday’s premarket session at $40.72 in a 52-week range of $32.94 to $51.34. The consensus price target on the stock is $52.54.

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