Before the opening bell, the largest U.S. low-cost carrier Southwest Airlines Co. (LUV) reported its first quarter 2012 adjusted loss of 2 cents per share. The quarter’s results were better than the Zacks Consensus Estimate of a loss of 5 cents but remained below the year-ago earnings of 3 cents per share.
Despite surging fuel prices, the better-than-expected performance in the quarter was credited to robust revenue growth driven by fare hikes, cost-cutting measures, network optimization, All-New Rapid Rewards and synergies from the AirTran acquisition. Southwest recorded $40 million pre-tax synergies from the AirTran acquisition in the quarter.
Revenue
Revenue climbed 28.6% year over year to a record $3.99 billion and was on par with the Zacks Consensus Estimate. Airlines traffic, measured in billions of revenue passenger miles, spiked 23.4% year over year. Capacity or available seat miles increased 25% while load factor (percentage of seats filled with passengers) fell 10 basis points year over year to 77.3%.
On an annualized basis, Passenger, Freight and Other revenues increased 27%, 19.4% and 70.7%, respectively, in the reported quarter. Passenger revenue per available seat mile (PRASM) grew 1.6% year over year.
Operating Expenses & Operating Income
Total operating expenses, excluding special items, surged 33% year over year, primarily due to higher fuel expenses (up 45.2%). Fuel price accounted for $3.44 per gallon, which was lower than management’s expectation of $3.50 per gallon.
Consolidated unit cost or cost per available seat mile (CASM), excluding fuel and special items, crept up 1% and CASM, including fuel and special items, increased 6.2% year over year.
Higher operating cost led to the decline in adjusted operating income, which plunged to $10 million from $110 million in the year-ago quarter.
Liquidity
At the end of the first quarter, the company had $3.9 billion in cash and short-term investments, and $800 million in undrawn revolving credit facilities. Long-term debt reduced to $3.05 billion from $3.11 billion at the end of fiscal 2011.
The company generated operating cash flow of $1.2 billion, up from $965 million in the year-ago quarter. Capital expenditures were $127 million compared to $57 million in the year-ago quarter.
Further, Southwest repurchased 33 million shares for approximately $275 million as of March 31, 2012 under its $500 million share buyback plan announced previously on August 5, 2011.
Guidance
Southwest expects second quarter unit costs, excluding fuel and special items, to increase from the year-ago level. Fuel price, including taxes, is estimated to be in the range of $3.40-$3.45 per gallon
With regard to its AirTran merger, the company remains on track to generate net synergies of more than $400 million by 2013 on full integration. The merger will also result in a one-time charge of $500 million, of which $155 million has been exhausted until the first quarter of 2012.
Our Take
Notwithstanding higher fuel prices and uncertain economic growth, we believe Southwest is poised to benefit from fleet rightsizing, Evolve retrofit program, steady capacity growth, All-New Rapid Rewards, AirTran merger synergies and several ancillary revenues.
However, high maintenance cost associated with the fleet modernization, new advertising rules, successful integration of AirTran, heavy investments and stiff competition from United Continental Holdings Inc. (UAL) and Delta Air Lines Inc. (DAL) keep us cautious on the stock.
Following better-than-expected earnings results and strong growth opportunities, we have upgraded our long-term recommendation on Southwestto Neutral from Underperform. The stock holds a short-term Hold rating with the Zacks # 3 Rank.
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