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

All right, folks. Moving right along. I am very pleased to turn the spotlight at this point to Southwest Airlines. I just saw Bob speak at ISTAT last week. So I certainly have an idea of some of what we can expect this morning. We're also joined up on stage by Tammy Romo. I think we can now refer to you as long-time CFO. Have you been in your seat long enough -- I know long term employee.

I may be not exactly long.

Yes, but in this seat.

We've worked together a long time.

Yes, that is true. So without -- yes, without anything further, let's turn it over to Southwest and see what they have to say. So Bob, thanks for joining us yet again.

Everybody, how are you doing? A little subdued. And Tammy, long time doesn't mean old, right?

That's what I was thinking.

Yes, I never say that. Well, it's good to be with everybody today. I've got some prepared remarks here. I'll roll through those, and then we'll leave plenty of time for Q&A. But Jamie and Mark, thanks for hosting the conference and for having us here today. It's great to be here with everybody in-person and on the webcast. I was kind of thinking back the last time I was here with all of you, we were coming off the Winter Storm Elliott disruption. And I don't want to go back and rehash that. But since that time, we have accomplished a ton at Southwest Airlines. We completed a comprehensive winter weather action plan, which has been successfully tested in a lot of winter weather events so far this year and also other types of disruptions. Through those events, our crew and aircraft networks remained stable. We've been able to recover quickly and minimized the impact on our customers. And I'm just really proud of the accomplishments last year to restore our network to get and remain fully staffed, and to reach our full utilization of our aircraft. We also made a lot of progress on our labor agreements. We were in active negotiations last year with 8 of our labor groups, and we have now successfully ratified agreements with 6 of those including SWAPA, who represents our pilots. That brings us to 9 ratified agreements out of 11 that we have, so 9 ratified in the last 16 months. We also reached a tentative agreement with our TWU 555 Union, who represents our ramp operations, cargo and provo employees. And the results of that voting for TWU 555 will come in later this month. And we are actively negotiating and optimistic about timing on getting the last contract that's open, which is TWU 556, and they represent our wonderful flight attendants as well. So I'm optimistic. And the main point is just to tell you, we're here today, in my opinion, a much better company than a year ago, and we intend to end this year a much better company again. We just got a lot of things underway that are very exciting for our people and our customers, things like larger bins, upgraded WiFi, in-seat power. If -- you may have seen it a new interior. So just all kinds of things going on. We have a lot of exciting things that are underway to drive efficiency improvements as well like turn modernization, electronic flight deck, which launches in April, it actually takes 60 million pieces of paper out of the turn and out of the flight deck, integrated crew and aircraft recovery systems, just to name a few. I can stand here and go on for an hour in terms of the efficiency improvements. And while we have not yet met our financial goals, we're making progress. And I just want to tell you, we are fully and I mean fully committed to our long-term goal to deliver ROIC well above our cost of capital. It may not be a straight line to get there. It really works out that way in this business but we're making progress. And we will be absolutely relentless in doing the work until we get there. And before I jump in, I got to say this, I want to quickly mention that my presentation today includes forward-looking statements. I think the verbiage on this slide gets longer every time I see it. And it represents the other disclosures. We filed an 8-K this morning in this slide and other disclosures in our 8-K outlined a variety of factors that could cause actual results to differ materially from our projections. So turning to the first quarter and the updates. You all saw that we issued an investor update this morning. And so I just want to start to give you some color on that update and our current trends. Starting with the operation. I'm just really, really pleased with the way our operation is running. The work that we did to add resiliency and recoverability in the operation over the past year is nothing short of exceptional. I want to personally commend all of our Southwest warriors for all the work, both on the front line and in our headquarters, nearly every single operational metric has improved over the past year. And when we've had tough operational days like multiple winter storms in January, the operation has been absolutely resilient with almost no, and I mean no operational hangover from those events into the next day. Since February 1, we've run a stellar 99.3% completion factor. In fact, February has its highest completion factor on record going all the way back to 1997, which is, I think, the first year we kept records in that category. As a result, we now expect first quarter capacity to increase approximately 11% compared with our previous estimate of approximately 10% both year-over-year. That increase is due entirely to the higher completion factor from running a better operation. Turning to revenue. We've updated our expectations for the first quarter RASM to a range of up roughly flat to 2% year-over-year, and that new guide implies a 2.5-point move in the midpoint from our prior expectation of up 2.5% to 4.5%. Of that 1 point is due fully to higher-than-planned completion factor and running a great operation, as I just described. The remaining 1.5 points is driven by close-in leisure volume coming in lower than expected. That said, first quarter revenue performance still represents a very nice sequential improvement. In other words, our fourth quarter unit revenue came in at $0.1499 and our updated first quarter guidance would suggest that we are outperforming the typical seasonally adjusted trend by almost 3 points. We're also on track to have another quarter of record revenue. So demand has really held up and we're seeing evidence that our network actions, which are now fully in place as of March are accretive. Further, our GDS initiative is also on track and our managed business revenue is coming in nicely and right on our plan. Looking forward, we like what we're seeing with forward bookings. We're seeing nice improvement in bookings taking in March for travel in the second quarter. And as a reminder, our optimization efforts started in earnest with the March schedule. So second quarter benefits from having all months materially restructured in the network. Second quarter is set up to have a strong peak season performance and is on track to an all-time revenue record. Bookings are right now where they need to be, and they're actually slightly ahead of expectations for this point in the booking curve. That's for the second quarter. Moving to nonfuel costs, we're doing a very solid job of managing to our cost plan and overall remain on track for the year. While we now expect CASM-X for the first quarter to be roughly 6% higher on a year-over-year basis, which is on the high side of the prior expectation of up 5% to 6%, the change is driven entirely by movement in spending across quarters, mainly some salary, wages and benefits and maintenance expense timing like engine inductions but the changes are neutral for the year. However, given the news on Boeing aircraft delivery delays, which I'll discuss in a moment, managing to our plan just is not enough. Going forward, we are actively and urgently focused on further cost reductions. And here's just some examples. We had already stopped all of our hiring for CS&S, which is the group that supports our reservations team. And we recently announced that we would stop pilot hiring classes effective April 1, with the exception of pilots that have an opportunity from our Destination 225 pilot program, which is a partnership with CAE. Other than that, we have stopped our pilot hiring classes effective April 1. And now with this morning's announcement, our flight attendant hiring classes will also be stopped, starting April 8 rather than later in the year, as previously planned. And to just give you an idea, the updated plan reduces our hiring for pilots this year by more than 50% and for flight attendants by more than 60%. And again, that's for the full year 2024. Altogether, we now plan to end the year solidly down in staffing versus 2023 compared to our prior guidance of flat to down. The main point is just to give you an indication that we're moving very quickly to adapt to the Boeing changes that I'll talk about here. We're also actively evaluating additional opportunities to reduce costs as we consider all hiring plans, including our corporate support. And these efforts are supplemental to the work that we were already doing on initiatives to improve our efficiency, things like removing paper from the turn, providing self-service capabilities from our digital modernization efforts, applying generative AI and chat in customer support because this is not business as usual. We're being very aggressive in controlling what we can control despite the fact that some of these changes are very recent, like the Boeing delays. Regarding fuel, market fuel prices have risen over the recent weeks, both for crude and for jet differentials. So we're also feeling pressure on first quarter fuel costs. So we now expect our first quarter fuel price to be in the range of $2.95 to $3 a gallon. And our current hedge will protect us from extreme spikes but it doesn't materially kick in until we cross about the $90 per barrel Brent cost -- Brent prices. So while we're now expecting a net loss in the first quarter, we're optimistic that March continues to represent a profitability inflection point. And we have an intense focus on delivering margin expansion and driving ROIC for the balance of the year. And speaking of the year, considering the significant change in expectations for aircraft delivery schedules, we are not providing a full year 2024 outlook at this time. The news is very recent. So we just need some time to work through our plans to best adjust to new delivery expectations, a lot of that being in the schedules and how we plan to mitigate the risk of further reductions to the delivery schedule from Boeing. So starting with those delivery expectations, Boeing has provided us with updated guidance on our delivery schedule. They now expect to deliver 46 MAX 8 deliveries in 2024, which is 12 fewer than our previous expectation of 58 MAX 8 aircraft. This is, again, of course, different from our contractual order book that we included in our January 25 8-K. And back in January, we're expecting to receive 21 MAX 7 aircraft, even though they were not planned for service in 2024, but we no longer expect to receive any MAX 7 aircraft this year. And of course, it's immaterial to our schedules since we already had excluded them from the 2024 schedules. In terms of how we will adjust, as you know, we have a lot of flexibility in our fleet plan. But as we weigh our options between delaying planned retirements and making capacity reductions, I want to you to -- I want to make sure you understand our bias and thinking. Our bias will be to: one, avoid additional maintenance costs; two, retain the initiative benefits of our fleet modernization plan; and three, take advantage of opportunities to aggressively manage the network and further reoptimize late summer and fall schedules, thus driving RASM benefits. The bias in these decisions is laser-focused on supporting our commitment and plan to work towards covering our cost of capital. To provide some context around what to expect with capacity for the year, which is still very fluid, and we're working on it. Note that the impacts are expected to be primarily focused on post peak summer schedules. In terms of the magnitude, we estimate that at the high end, we could expect full year capacity to grow now at most between 4.5% and 5% year-over-year. So around 1 point to 1.5 points cut from the impact of the delays. As you would expect, this is all very fluid. We're still in the process of determining our internal planning assumptions around the number and timing of deliveries, and that we will plan around and that could be different from what Boeing has provided. So none of this is yet meant to be guidance but hopefully, it provides you some color as we rework our plan and we reoptimize our schedules as a result of the Boeing delays. As we reoptimize our schedules, we will be, of course, continue to be focused on our overall revenue and RASM production and margin expansion. The good news is that we are seeing benefits from the network adjustments that we made and we see more opportunities to further refine and improve the revenue efficiency of our network. And just a reminder on what that is, the network opportunities that are already in place here in March include things like accelerating the pace of reductions to short-haul flying to allow for more profitable, medium and long-haul flying; executing deeper cuts on Tuesdays and Wednesdays in order to match -- better match our capacity to demand, and allow more of the schedule to move out of the less profitable shoulder periods; nurturing and optimizing development markets and reduced flying in lower demand periods and a variety of other tactics to better match supply and demand and reduce lower profitability flying. So while we're not ready to provide an update full year guidance until we report first quarter earnings in late April, we are not backing off on our focus on margin expansion, on ROIC performance and on delivering shareholder returns. We are working aggressively to make changes with those goals in mind. We've overcome many, many challenges in the past over our history, and we will not stop and we deliver -- until we deliver against those goals, period. So in closing, we continue to have so much to be excited about at Southwest and remain very optimistic about the future. We have sustained competitive advantages, everything from our world-class culture of hospitality and our powerful network with points of strength in all the right places. And of course, we have a fortress, industry-leading balance sheet, investment grade rated by all 3 credit agencies. Our best competitive advantage, however, always has been, always will be and continues to be our absolutely best people. We have a lot of momentum right now and while we will continue to work through some turbulence, we're optimistic about the inflection in financial performance that we're seeing in March. Southwest is a terrific company, and we are fully committed to become even better and deliver the financial results that you expect from us. To that end, we are hard at work on our top 5 priorities, which align with our long-term goal to consistently achieve ROIC well above our weighted average cost of capital. We're currently planning towards a fourth quarter Investor Day where we will be providing a full update but in the meantime, I want to be very clear about the commitment to our ROIC goals for 2024 and beyond. What I said in December and what I said in January stands. Producing ROIC well in excess of our cost of capital is our financial North Star. It is nonnegotiable, and we will continue to be relentless in focus and actions until we achieve that goal. And I appreciate everybody joining us today and listening in. And with that, Jamie and Mark, I would be happy to take any questions -- or Tammy and I would be happy to take any questions.

Okay. Hopefully, we'll see some hands go up in the audience but until such time. So to my surprise, and I realize you weren't in the room at the time, but to my surprise this morning, United leaned pretty heavily into the decision that they made to waive change fees during the pandemic. And they cited that as a competitive positive for them, the implication being that came at Southwest's expense. And of course, that change was made during some of the darker days of COVID, so it's probably hard to pull out what impact, if any, that it's had in the Southwest brand but would you agree that the industry's migration towards your change fee policy has been a modest negative for the Southwest value proposition? And if so, does that heighten the need for you to come up with some new revenue initiative as you've been coming up with revenue initiatives now here and there for the last several years?

Yes, Jamie, I think I would separate it into 2 things. The lean into the customer and the policies and then the revenue question and it's hard to tease any one attribute of a product apart. But I would tell you, if you think about our brand, and we talk a lot about what do we stand for at Southwest Airlines? We stand for having the best hospitality, the best people, the best customer service, treating people as you would like to be treated yourself. But we also stand for common sense policies that lean to the customer and make sense. A change fee, and I'm not sure it's a strict -- actually, I'm not sure it's a complete one-to-one comparison, by the way but we'll hold that until later, but change fees is one example. We have bags fly free. We have Rapid points that never expire. A little more than a year ago, we put into place flight credits that never expire. We just put in a 70 -- it's coming in April, a $75 credit if we have an extended delay outside of our control that a customer can request. And as far as I know, no one, United included, has followed those policies. So it's a very broad set of things that Southwest looks at. We start -- I promise you, we start every decision and you're thinking about a policy with what makes sense to our customers, what will make sense. Now -- so we have seen no one follow in those other areas. So I think those points of difference collectively will remain. As you think about revenue opportunities, yes, we're constantly looking at those. And whether it's related to Rapid Rewards, it's related to how we board, and I will just tell you, as we always have, we always have a set of initiatives. You've got GDS and other things at play right now. We always have a new set and an ongoing set of initiatives, and we will be sharing a number of those things at the Investor Day here in the fourth quarter of this year.

So I'll jump in. Tammy, no complaints on the balance sheet with negative net debt still and so forth, right? So let me ask a Boeing question. And when you had the risk factor slide up there, I noticed just having my eyes like went directly to it, it was basically saying the risk factor of Southwest reliant on Boeing for airplanes. And we've had discussions before at this forum and at your Investor Day, especially when you were considering MAX 7s versus 220s and you decided to go with the MAX 7. Bob, have you and the Board in light of what's going on at Boeing, had any future discussions about whether in the best interest of all stakeholders, it's in -- that Southwest will consider a second fleet type at some point in time?

You bet. Maybe I can break it into Boeing. How are we thinking about Boeing, the risk mitigation and then the sort of the how we think about the market and orders question. And there is a lot going on at Boeing right now. I don't think anybody would deny that. And I just want you to know how we're thinking about Boeing, how I am personally talking to Boeing. We have these delays here in '24. It is not unlikely the aircraft that remain are backloaded in terms of deliveries. It's not unlikely that, that 46 number changes. I don't know that. I wouldn't be surprised. It's not unlikely that, that creeps into '25. There's just a lot to do. I just want you to know how I'm talking to Boeing. A strong Boeing is great for Southwest Airlines. It's great for our industry. It's great for our country. And so I and I know other CEOs have told Boeing get your -- get the issues understood and get the issues fixed. We're -- they're embracing the work with the FAA. We appreciate that. This is Boeing's view as well, stop, take the time, understand what's going on, fix the culture, whatever is at work here but fix this because we all need Boeing to be stronger, 2 years from now, 5 years from now, 10 years from now. And that takes precedent over delivery delays. We've got to make -- Boeing needs to become a better company and the deliveries will follow that. So I just want you to know how I'm talking to Boeing. We need Boeing to -- as they're doing understand, address their issues and become a better company. Now as you go to the risk and what can we do about it? We -- there is no such thing as derisking your fleet plan because even at best, you might be 50-50, parking 50% of your fleet or 30% of your fleet is disastrous. So I think the idea that you can fully derisk your fleet, your deliveries or your fleet plan is a fallacy. So we've approached it that way just generally. Obviously, the efficiencies we get by having the single aircraft type, single-type rating, one type of ramp and all kinds of efficiencies from the 737 and single aircraft type. So it would be a big leap to move beyond that. And we have calculated the cost of transitioning to multiple fleet types, and I'll just tell you that it's significant. So there isn't such a thing as fully derisking this question. So last, I will tell you that -- and you know this, we do, on a regular basis, talk to other manufacturers and compare our options. And on sort of in every so many year basis, which -- that was the -- I think the question related to the A220, we do look at our options and have very rigorous discussions with Boeing and with Airbus about what could be done there. So it's a complex issue. I really start with we all need Boeing to be better, a reliable Boeing, a Boeing that cannot just deliver but deliver with quality is good for all of us. And that's where my whole focus is right now at this point.

And second question, I am one of your latest and newest Rapid Rewards Credit Card -- Chase Credit Card offers...

What took you so long?

What took me so long? It took my #3 kid to go to school in Indiana, and I'm going to fly a lot to Midway Airport for the next 4 years. So I said, I might as well bite the bullet.

It was personal.

It was personal. But as a corporate traveler and someone who travels corporate normally on your competitors and so forth, I wanted to tie that into my own personal experience with where do you stand, we're spending so much time talking about loyalty with American Delta, United is -- you don't need to borrow against loyalty. You don't really need to spend loyalty off like they're looking at, right? But when we think about your economics from loyalty and Rapid Rewards, what is the opportunity? Do you feel like you're under earning there? Do you feel like that is a source of getting back to a return on capital and margins where you want to be that, that is one of the areas in which you have a lot of room to run?

Well, I'd just start with the performance of the program. We -- the Rapid Rewards program, whether that's card, loyalty members, revenue is doing extremely well. We had -- if you go back to the fourth quarter, we had record memberships and additions and record loyalty program revenues. And so I would sort of start with the overall program is performing very, very well. And our offering to consumers is really strong, whether that is how you earn, how you burn, it's easy, every seat is available. Our -- we tend to be obviously, because we have low fares, lower in terms of the cost of the redemption in terms of point. So it's a very attractive program to our consumers and our customers, and we see significant growth in the program. Now if you think about opportunity, you always have opportunities to do things like we're in a period here where card approval rates with just higher interest rates, maybe a little higher default rate, card approval rates for everybody. It's just -- it's a banking question, are off a little bit. So you have the opportunity to do things like secondary programs. And so you always have things that you can do within the program and we're looking at all of those. The bigger question is the opportunity to negotiate the economics of the program. Our deal is up. I don't know if we've been public about this. Our deal is up.

In several years.

In several years. There are things you can do along the way. you have a few airlines that their deal is up sooner. So as we did last time, and it was a substantial increase. We will take that opportunity to look at the market, look at the opportunity and do exactly what you're saying. The opportunity in between to me are things like the ability to work with them to produce more cards. We talked a little bit earlier about the flight attendant contract that is not quite there. I'm optimistic. But it has some things in there that potentially make it easier to offer cards applications on board. So you can always work on the tactics. The larger issue, of course, is renegotiating the economics of the program.

Yes, Mark. And along the way, we are continuing to roll out new features, new opportunities. For example, you can purchase a ticket on Southwest using points and cash as an example. So we're continuing...

It's coming in April.

In April, yes, we're continuing to roll things like that out, and adding new partners, new ways to use your point. So those are ongoing efforts for us, of course, in addition to the bigger opportunities that Bob described.

Yes, I think the coming -- it's coming here in roughly 6 weeks, I guess. The opportunity because it's -- our customers and members have wanted it. The ability to -- because you don't quite have enough points -- redeem points for cash, I think there's a lot of opportunity in that change that's coming. What else?

So just as an aside...

You realized you all have the whole forum. I'm just kidding with you.

Oh, there's a hand.

It wasn't though complete. I'm happy to talk to you, too. I am...

Can you just talk a little bit more about the reduction in close-in leisure that you cited from sort of the quarter-to-date that has not been sort of the theme of this conference so far. And I'm just wondering if you could share if it's more of a forecasting error or just a change in trend?

Yes. Thank you. I'd be happy to do that. I think what's different is, again, you had the full point that is just because capacity is up. Of the 2 point -- 2.5-point gap, you got a point of that, which is capacity is up because the operation is running so well and completion factor. The other 1.5 point really is that close-in demand coming in just a little lower than expected. I think it's really -- it's more a matter of our expectations because the network changes, the reoptimization of the network really -- it's substantial. The moves between sort of think about the Tuesday, Wednesday, the high day, low day, my memory is it used to be 3% or 4% capacity difference between the days, and now it's upwards of 15%. So these are big moves. So those are fully in place in March. And you published 9 to 10 months early. So -- and then we'll continue to see momentum in the value of those changes in March and in April and then May, it will accelerate across the year. So we had forecasted that benefit. And I would argue fairly aggressively forecasted that benefit. There's a scoring process of those network changes. I think it's a lot more about we are just off of that forecast then there is somehow weakness in close-in demand. If that makes any sense. It really is more about we're off of our own projections. And again, it's relatively modes. Thank you. And don't let me go over. I don't know what -- make sure we're...

When you were answering Mark's question about a second fleet type, I remember, and this was quite some time ago that Gary had a CRJ200 in Southwest colors, a model in his office. So I commend you for showing restraint.

I would tell you those people who want our business send a whole lot of things in our colors.

I bet you have some cool stuff. But my question is actually for Tammy, I'm trying to better understand the comment that you've made in regards to bookings momentum at this point going into the second quarter and how it's ahead of last year because there's a side of me that wants to interpret that as a bullish indicator. On the other hand, anybody buying now for the summer is probably getting your very, very best deals. Is your comment solely a volume observation? Or is booked revenue running slightly ahead of where it would have been this time in prior years?

Yes, it's booked revenue.

It's booked revenue, okay.

Yes, yes.

Then it's a bullish indicator.

Yes, when we're speaking about our bookings, yes, absolutely.

Bob, great pitch. Tammy, always good to see you. This is more philosophical but what about the industry journey to net zero? We were seeing Robert Isom came up and said GDP -- our revenue to GDP is actually moving up, and there's some upside there that Mark talked about. But as more and more people fly, you're creating more and more emissions. You probably have the youngest fleet with the most fuel efficiency, you can't get enough airplanes. How do we get to net zero?

It's -- first, it's -- we've got multiple goals. Goal one is to have 10% of our usage be SAF by 2030. Our net zero goal is further out there in 2050. So I think it's going to take -- you've been reading the headlines, it's going to take everything. Obviously, it's going to take -- to me, the -- and I can't speak like Boeing or Airbus but I think the new aircraft, whether that's hydrogen, electric, whatever it is, is further out there than anybody thinks. There was a thought at one point that that's kind of 10 years out. It's 2035. It feels like it could be 2045 or 2050. So we're -- that's my guess. So we're going to be using more traditional aircraft that have more traditional engines, which means that the -- that this leans very heavily on SAF and SAF production. So it's all about getting SAF production up to the point, at least today, where you can meet the demand. I think there are 2 components to that. One, of course, is the technology and building plants and those kinds of things, and I'll talk about an initiative that we have. The second is because it is more expensive. It is working very hard to make sure that we have the credit structure, whether that's federal or state, the credit structures in place to mitigate that difference. I think depending on the type SAF today is roughly $12 a gallon as compared to the $3 the jet is that will come in as -- you get volume, that will come in but it's substantially different. So it depends on the credit structure, at least today, to make that viable and to, therefore, drive investment. I'm really excited. We just -- we've announced a couple of ventures. We formed a couple of weeks ago, a company called -- it's a wholly owned subsidiary, Southwest company called SARV, Southwest Airlines Renewable Ventures, to invest exactly in these kinds of projects. We have an investment in a company called SAFFiRE and the intent is to take a process that drives corn stover. So it's sort of the after you harvest the corn, the stalks that animals, I think, eat is feedstock. It's sort of all the other stuff left over underground, take corn stover, bail it, dry it, use a process to turn it into ethanol and then turn that ethanol into sustainable aviation fuel. We have a -- we just announced a partnership with a company called LanzaJet. And what they do is they upgrade ethanol to SAF. So that's a piece of that journey. And we also have a -- have now a commitment to build plants, the first experimental plants around turning the corn stover into ethanol. So it's actually moving along quickly. The issue is the ability to hit the production levels required to get to the 10% SAF by 2030. It just takes a lot of investment. But no, we're highly invested in the processes that will get us there. And -- but it's going to take the government airlines, states, it's going to take everybody in this process to get to those goals. The biggest thing we can do right now outside of that is continue to upgrade our fleet. The difference in -- I believe, Tammy, the difference in emissions between an older 700 and a MAX 7 or 8 -- or MAX 8 is about 17% is my memory?

Yes.

So that is the most -- that's the thing that we can do today that's very tangible, which is why we continue to invest in our fleet. And why I would like to continue to retire these aircraft and take my -- take our Boeing aircraft as we can get them. Thank you, though. Thanks for the question.

Rob and Tammy, thank you so much.

Thank you.

Jamie, thank You.

Thanks for having us.