Southwest Airlines reports 46% drop in profits

Southwest Airlines reported its second quarter results, with profits declining 46% for the quarter on a year-over-year basis. While revenues rose to a record $7.35 billion, a 4.5% increase YoY, unit revenue decreased with capacity growth outstripping demand. RASM was 15.9 cents this year, down from 16.53 cents last year. Net profit at the carrier was $367 million for the quarter, compared to $683 million in 2023. That will add to pressures for change from an activist investor, Elliot, just as the FAA is opening an investigation of operations after three recent unsafe descents, a take-off from a closed runway, and a “Dutch roll” incident with a 737MAX. With calls for management changes, a financial downturn, and operational problems, Southwest is in trouble. The carrier has now outgrown the competitive financial advantage it once had. Capacity and right sizing its fleet has come home to roost at Southwest, whose markets would be right sized for the 737 MAX 7. The carrier has orders for more than 300 of these aircraft, but Boeing has been unable to certify the new model on a timely basis. This has forced Southwest to take on larger 737 MAX 8 aircraft as it replaces aging 737-700s, resulting in roughly 25% more seats on each aircraft. Many of Southwest’s markets need the smaller aircraft, resulting in lower fares to fill empty seats and the resultant drop in revenue. The company is changing its strategy and will be introducing assigned seating, replacing the cattle call queues that have been in place for fifty years, as Southwest has finally recognized that times have changed. The carrier also plans to introduce “red-eye” flights in transcontinental markets, which it has eschewed until now. Those flights should increase aircraft utilization and lower unit costs in key leisure markets like Las Vegas and Phoenix to Baltimore and other east coast destinations. The Bottom Line Southwest is in trouble largely because of its fleet, which no longer matches its markets. That problem results from Southwest’s outdated strategy for a single fleet type from a supplier that can no longer reliably supply aircraft. Boeing is now six years behind schedule for the 737 MAX 7, which is unlikely to arrive before early 2025. Had Southwest management acted prudently and chose the A220 or E2-195 instead of the 737 MAX 7, the company would have more profitable operations today and a more efficient and sustainable fleet. But they made the mistake of believing Boeing and their ever-changing delivery delays. Fixing that problem will require Southwest deviating from its single aircraft type strategy, which was fine for a start-up low cost carrier. But 50 years later, Southwest is a major carrier operating to a variety of markets that need a variety of airplanes, something Boeing can’t supply on a timely basis. It also operates as if it were a low cost carrier, but its unit costs are as high as legacy network carriers. An LCC service model doesn’t cut it in many markets, and Southwest now understands that fundamentals like seat assignments are essential to compete with the majors. But the majors, with premium seating options, can generate additional revenues that Southwest can not, and those revenues can make the difference between profit and loss on many routes. Southwest still hasn’t bought into the concept of a premium price for a premium seat, and what it can do for revenue generation. Southwest has a revenue generation problem. Without premium seats and a premium product, Southwest is not competitive against the majors. Without right sized aircraft, Southwest has aircraft with too many seats in too many markets, resulting in the need to lower yields to unprofitable levels to maintain load factors. Those two issues have doomed Southwest to mediocre performance until they can be rectified, which may take several years and a new management team.

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