Southwest tumbles on bleak outlook for airfare pricing power

Bloomberg

Southwest Airlines Co. fell the most in three months and pulled down other carriers after reporting that a key revenue measure may tumble this quarter, raising doubts about a possible recovery in pricing power.
Revenue from each seat flown a mile will decline as much as 5 percent in the last three months of the year after dropping 4.1 percent in the third quarter, the Dallas-based airline said in a statement Wednesday. The figure, also known as unit revenue, is a crucial number for investors because it measures how much a carrier brings in, spread across the miles and seats it flies.
The gloomy forecast may cause investors to “question the domestic pricing recovery,” Julie Yates, an analyst at Credit Suisse Group AG, said in a note to clients. Other carriers recently have reported signs of improvement in unit revenue, which has been depressed for more than 18 months across the industry as growth has outpaced demand.
Southwest’s expectation for unit revenue “was a little lighter definitely than we were expecting,” said Savanthi Syth, a Raymond James Financial Inc. analyst who had predicted a 3 percent drop.
Southwest declined 8.7 percent to $38.29 at 3:41 p.m. in New York, the biggest intraday drop since July 21, after plunging as much as 12 percent. The carrier led most members of the Bloomberg U.S. Airlines Index lower, with those also paring losses as the day progressed.

Growth Plans
Southwest plans to trim growth next year to 3.5 percent after expanding as much as 6 percent this year, Chief Executive Officer Gary Kelly said in an interview on Bloomberg TV. The carrier joins American Airlines Group Inc. and Delta Air Lines Inc. in slowing expansion in an effort to better match demand and boost ticket prices. Southwest’s average fare per mile fell 4.9 percent in the third quarter.
Southwest said it would increase domestic capacity about 2 percent next year, moving it close to expected economic growth, which is generally seen as closely tied to travel demand.
Revenue this quarter will be affected by Christmas and New Year’s Day falling on Sundays, with more traffic shifting into January, Chief Financial Officer Tammy Romo said in an interview. Southwest may see revenue climb that month from a year earlier, and is targeting such growth for the full year.
Some investors are calling for airline CEOs’ compensation to be tied to unit revenue instead of profit.
“That’s something we’ll look at,” Kelly said on a conference call with analysts. He declined to commit to making the change “because I’m not in charge.”
‘Great Deal’
Southwest’s fares have been pressured in part by industry capacity that is expected to rise about 5 percent for all of 2016, Kelly said. Small, ultra-discount carriers increased seats 20 percent in Southwest’s markets, while major airlines added as much as 10 percent, he said.
“There’s a lot of competition on the West Coast, East Coast and every spot in between,” he said. “It’s not isolated to one competitor or one region. It’s a great deal for consumers.”
Southwest is examining the profitability of its own routes and looking at ways to boost ancillary revenue, often by adding fees for optional products and services. Kelly declined to be specific beyond saying the airline will stick to its policy of not charging for most checked bags or for changed reservations.
Climbing Costs
Investors also may be concerned that Southwest forecast costs for each seat flown a mile, a measure of efficiency, rising 4 percent to 5 percent this quarter from a year earlier, said Syth, the Raymond James analyst. Increased compensation in several new labor contracts and depreciation expenses from the accelerated retirement of Southwest’s oldest planes partly account for the higher costs, the carrier said.
Southwest expects fuel prices to rise this quarter from a year earlier, for the first increase in four years, Romo said.
“We have opportunities throughout the company to fine tune and improve efficiencies,” CFO Romo said on the conference call. “That’s exactly what we’re going to be focused on.”
The airline reported that adjusted third-quarter earnings slipped to 93 cents a share, compared with the 88 cent average of analysts’ estimates compiled by Bloomberg. Sales dropped 3.4 percent to $5.14 billion as average fares declined, Southwest said. Analysts had expected $5.16 billion. Hurricane Matthew reduced revenue by $55 million and cost $24 million.