Southwest Airlines Co. (NYSE:LUV) is navigating through a tumultuous year, reminiscent of what Queen Elizabeth II described as an “annus horribilis” in 1992 for the royal family. Southwest’s challenges began before the end of 2022, with a mix of self-inflicted and unforeseen issues. However, the airline is handling these difficulties with grace, much like the British monarch.
Truth be told, the 2020s have not been kind to Southwest Airlines. Celebrating its 50th anniversary during the global COVID-19 pandemic has presented numerous obstacles for the company. As the U.S. airline industry enters earnings season and provides end-of-year guidance, it is crucial to assess Southwest’s current challenges and prospects for recovery.
Moving Past the Christmas 2022 Meltdown
One of Southwest’s defining moments in its history was the operational meltdown that occurred between Christmas 2022 and New Year’s. Severe weather conditions in multiple major Southwest locations led to a breakdown in the airline’s operations, resulting in flight cancellations. Southwest attributed the meltdown to crew schedule changes and inadequate technology.
Since then, Southwest has worked diligently to enhance its operational systems, implementing automation fixes and taking a more cautious approach to pre-canceling flights during inclement weather. With increased scrutiny from the U.S. Department of Transportation, Southwest has shown improvement in its operational performance.
According to the DOT’s Air Travel Consumer Report data through May 2023, Southwest ranks fourth out of 10 U.S. airlines in terms of operational performance. While the airline has made progress, its complaint ratio remains higher than historical levels.
Southwest acknowledges that it was ill-prepared for winter weather and will need to adjust its operations to reflect its expanded geographical presence. Nevertheless, the chances of another operational meltdown on the scale of a billion dollars seem remote. Southwest has diligently worked to regain passenger trust and revenue and has made progress in recapturing its position in the domestic airline market.
Challenges of High Fuel Costs
Fuel costs pose a significant challenge for Southwest, even though the airline has implemented successful crude oil hedging strategies. Currently, there has been an increase in jet fuel costs due to higher refining expenses. Southwest’s hedging efforts cannot fully offset these refinery-related costs. However, Southwest’s fuel cost management remains comparably stronger than other airlines.
Labor Cost Challenges
In addition to fuel costs, labor expenses present another hurdle for Southwest. The airline’s labor groups have sought improvements in pay and benefits after enduring setbacks during the pandemic. Negotiations with pilot unions and other labor groups have been ongoing, with some progress made. However, delays and challenges in reaching agreements have created tensions among employees.
Southwest’s ability to manage its increasing labor costs will impact its financial performance. The airline must overcome these challenges to ensure sustainable growth.
Delays and Stalled Growth from MAX 7
Southwest has faced significant delays in receiving its Boeing 737 MAX 7 aircraft due to certification issues. The grounding of the MAX following two fatal crashes required Boeing to make design changes. These delays have forced Southwest to hold onto its aging 737-700 fleet, resulting in higher costs and reduced efficiency.
While Southwest has substituted larger aircraft, such as the MAX 8, the economics of flying these models are unfavorable. The airline’s operational model, which focuses on point-to-point flights with high percentages of local passengers, is not optimized for larger planes. The delays in MAX 7 deliveries have slowed Southwest’s revenue growth and hindered its ability to compete in certain markets.
Delayed Solutions for Revenue Challenges
The introduction of the MAX 7 into Southwest’s fleet will help address the airline’s revenue issues. Supply chain disruptions and slow growth within the low-cost carrier sector have affected Southwest’s revenue growth, lagging behind its larger competitors.
Once the MAX 7 is certified, Southwest has the potential to regain market share, particularly in regions experiencing supply chain issues. The reduction in low-cost carrier capacity will help improve industry yields, especially during the winter months when domestic travel demand is pressured.
Financial Resilience via Strong Balance Sheet
Southwest’s strength lies in its robust balance sheet, which sets it apart from other airlines. The company’s consistent profitability has allowed it to maintain a positive liquid asset position. The delays in MAX deliveries have inadvertently helped Southwest’s balance sheet as Boeing compensates the airline, reducing future aircraft costs. With a solid balance sheet, Southwest is poised to weather the current period of higher costs and reduced revenue.
Southwest has a history of successfully adapting to changing market conditions. While the airline’s egalitarian model faces challenges in an environment where some travelers seek premium experiences, Southwest’s strong balance sheet positions it for future growth. The resolution of MAX 7 certification issues will play a crucial role in improving Southwest’s financial performance and overall strategic outlook.
Southwest has faced significant challenges due to its loyalty to Boeing and its reliance on a single aircraft type. The company’s stock has suffered, although its prospects will likely improve once the MAX 7 is certified. Southwest Airlines Co. is well-positioned to address its financial performance and strategic concerns.