What Southwest Airlines Investors Should Watch in 2015

Southwest Airlines Starts the Year on a Great Note (Part 4 of 5)

(Continued from Part 3)

Successful integration of AirTran Airways

Southwest Airlines (LUV) acquired AirTran Airways 2011, and it obtained a single operating certificate from the FAA in late February 2012. This significant step allowed AirTran employees to integrate into the Southwest training and employee culture. Plus, this meant that the AirTran fleet could be repainted in Southwest livery and reconfigured to integrate into Southwest’s fleet.

Southwest and AirTran became fully integrated on December 28, 2014. The acquisition of AirTran Airways expanded Southwest’s route network by adding 25 destinations. The efficient integration of AirTran is expected to boost Southwest’s operational and financial performance in the near future.

Fleet modernization

Southwest is in the process of modernizing AirTran’s fleet. AirTran’s 737 aircraft are being modified and converted to match Southwest’s lively interior, as seen in the Boeing 737-800. This modification helped Southwest to realize, on average, a 2.7% increase in seats per trip in 1Q15. This is expected to add further revenues to the company for the rest of 2015.

Anticipated decline in unit cost

Southwest estimates that the unit cost in 2015’s second quarter will decline further by 1%–2%, which is in line with the cost trend of the first quarter. This decline excludes fuel expenses, profit sharing, and special items.

A concern about fuel derivative contracts

Traditionally, fuel derivative contracts have helped Southwest in lowering costs and staying afloat when the airline industry struggled to cope with adverse conditions. These challenges included high fuel costs, as well as slow economic growth that led to low traffic demand. These factors affected airlines in 2011, 2012, and part of 2013.

Southwest hedged against high fuel prices for its fuel needs up to 2018. However, the sudden drop in global oil prices by more than 46% took Southwest and many of its peers by surprise, including Virgin America (VA), Spirit Airlines (SAVE), and JetBlue Airways (JBLU). This resulted in derivative losses for many airlines.

In 1Q15, Southwest had losses of $26 million. These losses pertained to premium costs associated with the fuel derivative contracts against losses of $16 million in 1Q14. For 2Q15, the premium costs associated with fuel derivative contracts are currently estimated to be $22 million.

Investors who want to participate in the growth of airline companies can do so through ETFs such as the iShares Transportation Average ETF (IYT) and the SPDR S&P Transportation ETF (XTN), which hold 38% and 11% in airline stocks, respectively.

Continue to Part 5

Browse this series on Market Realist:

• Part 1 - Southwest Airlines 1Q15 Earnings, Revenues Beat Estimates

• Part 2 - What Were Southwest’s Key Performance Drivers for 1Q15?

• Part 3 - Southwest’s International Operations Continue to Blossom