Southwest Airlines Co. (LUV) Earnings Call Transcript & Summary

Short introductory remarks, it's my pleasure to welcome the very first executive that I ever met in the U.S. Airline Industry in 1992, CFO of Southwest Airlines, Tammy Romo. Thank you.

Thank you, Jamie. Yes, we go way back, Jamie. So it's especially great to be here with you and Mark and everyone here. It's just -- it really does just warm my heart to be here in person. So thank you for hosting this in person, and thank you all for being here. And I also just want to thank our webcast listeners for joining in as well. So we'll go ahead and get started. So I am particularly happy to be here today because we do have an encouraging update for all of you this morning. But before I jump in, I want to mention that my presentation today will include forward-looking statements, and these are based on our current intent, expectations and projections. So hopefully, you all saw the 8-K that we put out this morning. So we provided you an investor update there. And, of course, our updated guidance that we provided is not a guarantee of future performance. This slide, I know you all have read it by now and other disclosures, and our Form 8-K outlined a variety of factors that could cause actual results to differ materially. So we'll start with a quick overview of our strategic priorities that we outlined for all of you at Investor Day in December. So first of all, we want to reinforce the tremendous strength that we have starting with enhancing our employee experience and reinvigorating our winning culture after what have been several tough years for our people. Second, we have tangible initiatives to win more customers and grow revenues, which I'll cover more here in a minute. Third, we want to modernize the operation and provide our employees with new tools and processes, so they can work more efficiently. And fourth, we intend to maintain a meaningful low-cost advantage by regaining our historical productivity levels, and by maintaining the key low-cost tenet of our business model. And that's an all-Boeing 737 fleet, our point-to-point route network, productive workforce, quick turn times and high asset utilization. And we want to do all of these on a sustained basis as we've been able to do for decades. And last, but certainly not least, we are enhancing our DE&I and ESG efforts, which are well underway. So moving to our next slide here. While our strategic priorities span multiple years, we have some basic focus areas for this year, mainly blocking and tackling items. As an extension of focusing on our people and culture, we are in the process of getting properly staffed. We plan to add at least 8,000 employees this year, which should significantly improve available staffing levels and set us up well for later this year and going into 2023 as we restore our network. Proper staffing is a key driver to getting back to historic operational reliability and efficiency. And along with the new aircraft deliveries, we should be set up well to improve our overall asset utilization as we move through the next couple of years. Our people have managed very well through the pandemic, so proud of them, and we are hopeful that we can soon stabilize our future flight schedules to minimize close-in flight adjustments. Of course, this depends on demand and other factors, but less flight schedule modifications will provide more stability for our people. And as we move beyond the pandemic, allow them to focus on our customers in a more stable environment. And finally, we strive to get back to consistent profitability and we continue to expect to be profitable in second through fourth quarters of this year. And of course, this is based on our current outlook, including higher market prices, which are meaningfully offset by our strong fuel hedge, which I'll cover for you all here in a moment. Moving on to our next chart here. We have talked a lot with you all about a network restoration. But I want to reiterate what Andrew shared at Investor Day. I've got Andrew Watterson here with us, as well as Ryan Martinez. And I want to reiterate it because I believe our network expansion and restoration plans are maybe a bit misunderstood. Our advantaged financial position during the pandemic allowed us to pursue significant new market opportunities and we reallocated roughly 125 aircraft worth of idle flying from prepandemic markets. Since 2019, we have opened 20 new airports in total, Cozumel and Hilo, which were already planned, and the 18 new airports we launched during the pandemic plus further expansion in Hawaii. One of the driving factors of pursuing the 18 airports was the opportunity to reduce cash burn through exploring new revenue opportunities, which worked right as we had designed. But our investment-grade balance sheet and more conservative leverage position allowed us to be more aggressive on the network front, while others continue to reduce service. So different from prior downturns, we accelerated our network expansion during the pandemic versus expanding to new markets for several years following periods of stress for the industry. But the result is the same, we are significantly expanding our network footprint and going after additional markets and customers. And we can now give these new markets time to mature while we invest aircraft back into our prepandemic market where the majority of our market dominance existed prepandemic. And just to say that another way, our growth plans over the next several years are rebuilding depth and frequencies in many of our strongest markets, where we had the leading market share position, which equates to a lower risk capacity additions that should come online quicker than capacity deployed to new markets. So moving along here to our next slide. We have a really robust portfolio of strategic initiatives that we expect to deliver significant value, $1 billion to $1.5 billion of EBIT contribution in 2023, with half of that value estimated to be realized this year. And to quickly recap our initiatives for you, we have our GDS expansion as part of our Southwest business efforts to expand our corporate distribution, remove friction from the booking process and win more corporate travelers. As corporate travel is expected to continue to rebound, we are well positioned to take advantage of these opportunities over a multiple year period. Next, we have our new fare product in revenue management system optimization. We continue running 2 pilot revenue management systems and monitoring the results. We are aggressively adding more travel dates under management by the new systems while we monitor to see which best enhances and maximizes revenue. We expect to choose a new system this year, which will give us better capabilities to forecast demand and optimize demand and yield. Our new fare product is still expected to roll out in second quarter and will be a fourth column to be displayed in our website, along with the 3 columns that you see today: Business Select, Anytime and Wanna Get Away. We are excited to soon share more details about the new fare offering, but think about an opportunity to upsell for enhanced attributes versus taking something away and reselling it. We're doing this in a way that is consistent with our current brand and we believe it will help us better segment our future structure to generate more revenue and better match the buying habits of our customers. Moving to the next blue box. Our Chase co-brand agreement is in place, which is producing meaningful incremental revenue this year. And we also highlight our ongoing fleet modernization efforts, which provides better economics as we retire our older 737-700 fleet and replace them with new MAX aircraft. And as we've mentioned, our cost-effective Boeing order book allows tremendous flexibility for us as we manage our overall fleet. Lastly, at Investor Day, Andrew briefly mentioned our Southwest Vacations opportunity as a future revenue initiative beyond 2023. You will hear us talk more about this. And basically, we have an opportunity to think about how we leverage our website, broad customer base and the way we market and manage our Southwest Vacation product to better enhance the opportunity going forward. Moving to the next slide. I will recap our investor update that we issued this morning and provide some color on our trends. I'm happy to report our first quarter operating revenue outlook has improved to down 8% to down 10% versus first quarter 2019. As expected, we have seen revenue trends improve in March as we move beyond the negative impacts of the Omicron variant. Leisure revenue for spring break travel are strong and above 2019 levels. And we have seen further strength in bookings and yields as well as a stronger-than-anticipated performance from our Rapid Rewards loyalty program. We've seen a sequential improvement in managed business revenues in March as compared to January and February. And we expect March business revenues to be down 40% versus March of 2019. So this represents a 10 point improvement from December 2021 when managed business revenues were down 50% and that's following a step back in business revenues in January and February as business travel demand slowed. On March revenue trends, they bode well for what we are seeing for our bookings beyond first quarter. However, it's still early in the summer booking curve, so there isn't much more to report other than we're really encouraged by what we are seeing thus far. Based on our current trends in a fairly typical booking curve, we are optimistic about the seasonal uptick in leisure demand and a continuation of improvement in business travel demand in second quarter. Our first quarter capacity guidance is slightly changed to down 10% versus first quarter 2019. And our full year 2022 capacity guidance remains unchanged at down 4% versus full year 2019. But keep in mind, this is roughly 4 points lower than our initial 2022 capacity plans that we communicated back at our Investor Day in December. Following our planned capacity reductions in March through May of 2022 time frame, due to the challenges with available staffing, our second quarter capacity is now expected to decline 7% versus second quarter 2019, and our second half capacity is expected to be roughly flat with second half 2019. We'll continue monitoring staffing trends, demand trends and energy prices to determine if further capacity adjustments are needed beyond the cuts that we've already made. We continue to expect our first quarter fuel price to be in the range of $2.25 to $2.35, and that's primarily due to our higher and very significant hedging gains. And I'll cover more about fuel costs and our fuel hedge portfolio here in a moment. As we've seen, our operational performance stabilized since we experienced available staffing challenges in early January. We are now expecting some cost relief related to premium pay and overtime trends, which results in an improved outlook in first quarter CASM-Ex to up 17% to 21% versus first quarter of 2019. So all told, we are still expecting a net loss in first quarter. But given improving revenue trends and estimated fuel hedging gains, we are also still expecting to be solidly profitable in March. Our investment-grade balance sheet remains very strong and we currently have $15.7 billion in cash and short-term investments, and we remain in a net cash position and our current leverage is currently 55%. So moving right along, we have a multiyear fuel hedging program and we have had this for decades, which is certainly paying dividends for us as energy prices have spiked recently. This is the type of insurance we aim to build over multiple years as we structure the best hedging portfolio that we can within a budget, of course. In addition to the first quarter update we provided, I thought I would share where we are currently for second quarter and full year 2022 in terms of hedging protection. Based on market prices as of March 10, which is reflected on this chart, the average for Brent crude in second quarter was $102 per barrel. At $100 per barrel, you can see that our second quarter hedging gain would be $0.53 per gallon and grow significantly if market prices were to go up from here, as you can easily see from the chart. It's a similar story for the full year 2022 and the market value of our fuel hedge as of March 10 for full year 2022 was $883 million. So we are in a great position this year and we have a decent start to our hedging positions in 2023 and in 2024. Using 2019 gallons, we are currently 37% hedged in 2023 and 17% hedged in 2024. We intend to continue building our hedging portfolio beyond 2022 as market conditions allow. We continue to believe that fuel hedging is an important part of our balanced approach to be prepared for challenging times in an effort to mitigate energy price impacts on our financial results. Moving to the next chart. We shared this longer-term framework at Investor Day. And I want to share just a few comments on it before I wrap up and take questions. So first of all, these targets are meant to be a reasonable framework for how to think about our annual targets beyond the pandemic. 2022 and 2023 will be impacted by ramping back up and restoring the network as one example, and therefore, the year-over-year expectations will be skewed against this framework. Our 2022 CASM-Ex outlook is significantly higher than our low single-digit inflation expectation longer term. And based on current preliminary plans for 2023, we continue to expect 2023 CASM-Ex to decline versus 2022 and capacity plans play into that as well as our goal is to restore our planned network restoration by the end of 2023. As our 2022 capacity is lower than what we had originally planned, that would indicate that 2023 capacity could be significantly higher than the mid-single-digit framework outlined here. All of that said, our overarching goals are to return to solid profitability and solid returns. And our hope is that this longer-term framework is helpful in terms of how we see the outlook of the company beyond 2023. But we could vary, of course, from these annual targets for any number of reasons. So hopefully that was helpful for you all. In closing, despite the obvious challenges, we have much, much, much to be excited about here at Southwest. We have sustainable competitive advantages, we have really incredible people, and I believe our best days are yet to come. So I really appreciate everyone joining and listening in today. And with that, Jamie and Mark, I am ready to take any questions from the group here.

Thank you. So I just wanted to try to dig into the new fare category a little bit more, I recognize you're not here to make that announcement, but should we be thinking more about recontenting got to get away in terms of an upsell? Or is that fare category left alone and this is a new structure with enticements to bring people up? I'm just wondering about the potential mechanics if you could share that.

Sure, be happy to. And as I shared, we are not intending to take anything away from our customers who are booking in Wanna Get Away. So really think about this as a column that has potential features above that. And we think these will be features that our customers will be more than willing to pay for, and that includes also our business customers. So we're going to be shy on the details here because we obviously want to keep all of that close to the best, but we will be providing more details to you all soon.

And then a tougher question. And just bear with me for a second here because when I think about how the industry has evolved over the last 20 years, I think of a boxing ring. And in one corner, if you will, you have your American, Delta and United's, and we know what they do for a living. In the other corner, you have your Spirits and Frontiers and Allegiants in some countries, that operating model. But somewhat competitively awkwardly, in the middle, betweeners, if you will, we have Southwest, Alaska and JetBlue. And to JetBlue's credit, they're trying to pivot to the other corner, the Northeast Alliance. Alaska also seems to be moving in that more premium direction. And that potentially leaves Southwest in that sort of awkward middle position. And oh, by the way, 2 of your ultra-low-cost athletes, if you will, are now ganging up. Why is this an unfair characterization of Southwest's competitive position? Because I'm trying to square that with your optimism that your best days lay ahead because I considered your best days to be the ones where you would enter a market and competition would flee. Why is my interpretation of Southwest flawed?

No, thanks for the question, Jamie. And first of all, I really don't think we're in an awkward position at all. We are very well positioned to compete. And as we have always been, we're obviously a very aggressive competitor as evidenced by the fact that we carry 1 in -- roughly 1 in every 4 customers here in the United States. And so that's why I really don't think we're in an awkward position at all. I do think that Southwest Airlines appeals to the masses. We are a beloved brand. And one of the significant strengths that I think maybe is misunderstood is just the breadth and depth of our network. It really is like a spider web and no other carrier has the network that Southwest has and you can't just put that together in a day. This has taken us decades to build. And I'm really excited about where we are today because, as I mentioned, we -- because of the strength of our balance sheet, and all the many strengths that you know that we have from a liquidity position, we really use this opportunity to invest further in that incredible network that we have. As I mentioned, we added 18 new cities to the network. And when you think about we're -- how we're positioned as we head out of the pandemic, we've already -- we've made those investments. Now we're very focused on maturing those markets. And at the same time, we know that we have pent-up demand in the markets that we were serving prepandemic. So we have ample growth opportunities to go back into those markets and add frequencies and depth into those markets. And when you just -- so that's kind of on the network side. And then when you combine that with our low cost structure, which we will -- we are working to get back to our 2018 productivity targets. So we -- so what that means is we can pass that along in terms of lower fares to our customers. So it's an incredible value proposition for our customers as well. So we, of course, you know we don't charge for bags. We don't have change fees. We just -- we are just -- we work really hard to take the friction out of booking on Southwest Airlines. And then you combine that with our incredible frequent flyer program, which again has taken us a long time to build, it is just an incredible value proposition for our customers. And last but not least, we have the best people on Earth when -- and we hear that over and over from our customers. When they fly Southwest, we treat them as our guests. We serve them with a friendly smile. And all of these combined make our customers very, very sticky to Southwest. So I don't think we're in an awkward position at all. And that is why I could keep talking, you can tell my passion about Southwest. I could go on and on, but that's why I believe we have exciting times ahead. And I'm just talking about domestic now. So now you think about the -- you think about beyond that and really what we're focused on is growing for the time being on as far as the 737 can fly. So and that's a lot to keep us busy here for quite some time. And then the world is a much bigger place than just here in the U.S.

Tammy, I want to ask you a question on ESG. And I did want to get into it on your Investor Day, but hey, it's my conference, so I can get into it here. We've done a lot of benchmarking on carbon efficiency of fleet. And when we compare Southwest to American, Delta, United, your carbon efficiency doesn't look as good for obvious reasons, right? You don't have larger gauge aircraft. You're not flying stage-linked as long and so forth. That's kind of outside of your control unless you dramatically change the business model. But one thing you can control is with your Boeing order book, whether you take delivery of more of MAX 8s or MAX 7s, and you've been pivoting more towards MAX 7s as of late. And so that sort of flies in the face of sort of ESG logic, right, because that carbon footprint on the smaller gauge aircraft, right, is not as efficient, if you will. And it sort of ties into, I'm sure Boeing would love to sell you MAX 9s or MAX 10s. And I want to tie this into sort of whether or not Southwest is at a point now where you can start to sort of maybe rip off the old playbook and start to consider some new things like with the fleet, like whether or not you want to -- and I know you don't want to get too complicated with other fleet types, but within the MAX family, there are other options, and they might fit into a carbon goal. Does that even come up in discussion? Is that something that you think about? Or is it just all about we know a MAX 7, for example, can be very, very efficient on thinner routes. So that's why we've been pivoting to more of those.

Yes. So thanks, Mark. Yes, no, we -- of course, first of all, we think about everything. And certainly being an all-737 provider and staying in that family provides significant efficiencies for us. So it's certainly an eligible idea. But for where we are right now in the network, at least looking out, let's call it, over the next 5 to 10 years, probably fairly over the next 10 years. We do believe that the MAX 7 and MAX 8 is well suited for our network when you look at our mix of short-, medium- and long-haul of flights. So we -- as we go here, we'll -- we have substitution rights between our MAX 7s and MAX 8s, so obviously, our network needs are going to largely dictate what the ultimate mix in those 2 aircraft types will be. But as you said, you said it well for the types of markets that we serve, which, keep in mind, when you're serving business customers, frequencies and depth and markets matter. And often, the MAX 7 will serve those market needs better because we're wanting to put more frequencies into those markets to serve the needs of our customers. So we'll decide here as we go if the mix between the MAX 7 and the MAX 8s. But it's probably plus or somewhere in the 50-50% range. And obviously, time will tell in terms of what those exact percentages need to be. So a long-winded way of saying, for now, we're very -- we're just focused on the MAX 7 and the MAX 8 because it really serves the needs of our customers quite well.

Do you have any lanes or airports where a larger gate aircraft would unlock more revenue for you? Are you bumping up against any airports where you can't add more frequency, where the only way you could really grow your revenue base would be if you had something like a MAX 9 or 10?

Yes, certainly. When you look across the nation at airports, there are certainly airports that are gait-constrained. So time will tell us if we need to upgauge and that could be a consideration for us in the future. But for right now, those markets would lend themselves more to the MAX 8, as you pointed out, as opposed to the MAX 7. But again, we'll continue to evaluate that. And obviously, with the long-term partnership that we've had with Boeing, I think we could certainly pivot should we need to. But again, I think we're well served for the moment or at least for the next few years with the MAX 7 and MAX 8.

Let's see, with regards to the fuel hedges, have you been active in adding to those fuel hedges over the last 3, 4 months? And as oil falls, at what price do you think you'd be really aggressive locking in maybe the next 2, 3 years?

Yes. We've -- the percentages that I shared with you have not changed significantly here over the last 3 months. We're a little bit heavier in our hedge position here in the first quarter, but that's really more of a function of the tweaks that we made to capacity. So for 2022, we've been set here for quite some time. And obviously, adding to 2023 and 2024 at the current period is challenging given that prices have gone up on us here and the market is quite volatile, so we'll continue to look for opportunities to add to those positions. And we'll just have to see what the market brings to us. But if you look at our current hedge book, we've been locking in, call it, $75, $80 per barrel. I'm not really trying to predict that for you going forward because, obviously, we have to see what we're able to accomplish in the marketplace. But admittedly, it will be more challenging to add to those positions at the current market prices. So -- but clearly, if we get a dip in the market, our intention would be to continue to bolster what we already have in place.

Sorry to focus on the hedges again, but can you discuss how interconnected your pricing strategy is with your hedges, if at all? So when you look to pricing the summer and the fall, and you know you have these hedges locked in, to what extent do you use that to your advantage? Or you try to ignore it and just prices if you were a market taker on fuel?

Yes. In terms of our fuel hedge, we really look at that as insurance to protect us when there's a spike, and just really give us time to work towards market prices. It really gives us time to make adjustments that we would need to adjust to market prices. It's just, in the moment, we don't have to really have a knee-jerk reaction because we have that protection in place. We really view fuel as it's just -- it's like all of our input costs, right? All of that goes into the equation and certainly demand is key in terms of ultimately what the market will bear in terms of pricing. But certainly, the fuel hedge gives us protection. And so that we can adjust more thoughtfully as we move forward. But it really -- when you think about pricing, that's more of a function of what will customers pay and fuel is just one of many of our costs, but it's really just to provide us some cushion as we adjust to whatever market is.

And Tammy, just quickly, as a follow on to that, and I know we're hitting up against time, but perhaps another contributing answer to that question. Year-to-date, I believe you have participated in broad-based fare increases.

We have, yes. Yes. Thank you, Jamie, for bringing that up. Yes. We had a system-wide fare increase on February 1. So -- and actually, if you look at the updated guidance that we provided today, our load factor guidance really did not change. But obviously, our revenue did improve. All that to say is that the pricing environment has been healthy with -- as demand has been returning following the Omicron variant.

And did we have another quick one in the audience that I cut off inadvertently? Or -- okay. Mark, keep it short and punchy.

Given your confidence in the market and your excess cash right now and liquidity, how are you thinking about liability management for your high coupon debt?

Yes. So we do want to use -- as we have opportunities, we do want to return our leverage to maybe not quite as low as it was prepandemic, actually going into the pandemic, our leverage, if I remember correctly, it was 24%. So our historical kind of targets for leverage have been in the low to mid-30% range. So we have been -- as the market has allowed opportunities, been repurchasing the converts. We have $450 million that we will be repaying this year. But -- so where it makes sense, we'll continue to pay down our debt. That's clearly a goal for us as we look out over the next several years.

Thank you so much.

All right. Well, thank you. Thanks for having me again.