Southwest Arlines famously used to boast of its dozens of consecutive quarters of profits, even during past crises when its rivals bled red ink. And then a pandemic arrived and the world changed. The Dallas-based carrier reported its largest-ever quarterly loss on Thursday, of $1.2 billion.
Despite this, CEO Gary Kelly is optimistic about Southwest’s future. Revenues were down 68 percent in the second quarter, but that’s an improvement over the 83 percent decline the airline reported in July. Demand grew over the summer as people became more comfortable traveling. And underscoring that last point, more passengers are booking tickets further out from the day of travel. Especially as the Thanksgiving and Christmas holidays approach, more passengers are buying tickets more than 21 days out. “I’m happy that we’re uniquely prepared for this environment with our business model,” Kelly said. “We have low costs, low fares, no hidden fees, and nothing to hide.”
That business model may be a key reason why Southwest isn’t faring as poorly as many of its rivals. Carriers like Delta Air Lines, United Airlines, and American Airlines have watched their lucrative international networks basically idled as demand for overseas travel has collapsed and countries around the world have imposed strict quarantine rules. Southwest’s network is 97 percent domestic, which has bounced back more quickly. And the international flights Southwest operates are to beach destinations in Mexico and the Caribbean.
And this is another key to Southwest’s success, Kelly said. Leisure travel is coming back faster than business travel. It has a big presence in leisure markets, like Florida and California, that are recovering more quickly. Denver, one of its largest markets, benefited from increased tourism to mountain resorts over the summer and will see further demand growth when the ski season begins in earnest.
Still, business travel is an important market for Southwest. It expects business travel to remain about half of what it was through next year. Although 90 percent of the companies Southwest has travel contracts with are resuming business travel, they’re sending fewer employees back out on the road. Even after the pandemic recedes, Southwest expects perhaps between 10-20 percent of business travel to be gone forever, President Thomas Nealon said.
Retooling the network
Southwest isn’t sitting idly through the pandemic, and unlike its peers, has not suspended service to any of its markets. Like its peers, however, it’s retooling its network to capture as much of the leisure travel market as it can. “Snow and sun,” is how Chief Commercial Officer Andrew Watterson described the network changes. It’s adding flights to Palm Springs, California, Jackson, Mississippi., and Savannah, Georgia, along with Steamboat Springs and several other snow destinations in Colorado. The carrier will expand its Hawaii network as travel restrictions ease. It is increasing frequencies to cities in Florida.
But it’s also taking its rivals head on in some of their most important markets. Southwest has long served Chicago from that city’s secondary airport at Midway. There isn’t enough space to grow at Midway, however. Before the pandemic, getting gate space at the primary airport, O’Hare, was difficult, but flight reductions caused by the pandemic presented Southwest with an opportunity to expand into that airport, which happens to be a hub for both United and American. “If we don’t move now, we risk never getting in there,” Kelly said about expanding into O’Hare. “So we’re moving now.”
Similarly, Southwest served Houston from that city’s Hobby Airport, but it took the opportunity to grow into the city’s main airport, George Bush Intercontinental Airport, a United hub. Unlike Southwest’s play in Chicago, this move had less to do with airport constraints and more to do with reaching customers in a different part of the city. Kelly noted the city’s sprawling geography prevented Southwest from reaching as many customers as it could by operating just from Hobby.
The middle seat
Southwest was among the few U.S. carriers that continued blocking middle seats to increase social distancing during the pandemic. This will end on December 1, Kelly said. This was a good move back when science did not understand the novel coronavirus, but now that the science has improved, Kelly said it has become clearer to Southwest that blocking the middle seat is no longer necessary. Instead, the carrier is confident that its enhanced cleaning protocols and filtration systems will ensure flying is safe.
Another consideration is the cost. Early in the summer, when few people were traveling, blocking one-third of a mostly empty aircraft’s seats cost little. But the financial impact in September, when more people traveled, was significant —about $20 million. “Our customers totally get the fact that [we] are a business and can’t survive and make money if [we] are selling only two-thirds of our inventory,” Nealon said.
The mAX HEADACHE
Southwest flies only one type of aircraft — the Boeing 737. But it operates several sub-types of that aircraft. It was among the largest operators of the Boeing 737 Max before the aircraft was grounded last year in the wake of two fatal accidents, in Indonesia and Ethiopia. It has 34 Max aircraft on the ground, and it is expecting delivery of another 34 that Boeing has built but has not delivered, due to the grounding.
Because all Southwest pilots are certified to operate the 737, all pilots will need to be trained on the new Max processes. American thinks it can get the Max back in the air one month after the Federal Aviation Administration re-certifies the aircraft, but Boeing 737 pilots are only a fraction of American’s workforce. Southwest, on the other hand, thinks it will take between three and four months to return the aircraft to service after recertification as it re-trains its 7,000 pilots.
Southwest signaled strongly that it may be interested in the Airbus A220, the smallest aircraft in Airbus’ line up. Southwest is in the process of retiring its smaller Boeing 737-700s, and will need an aircraft with about 145 seats to replace it. The 737-8 Max is too large, so the company is weighing the 737-7 Max and the A220. The A220 would be a major departure for Southwest and a major coup for Airbus. Kelly stressed that no decision will be made for a year, and the earliest the airline would want new aircraft is 2025, and he warned that there would be significant pilot-training and maintenance costs in adding an Airbus aircraft. But that the company is open to it is itself striking.
The ‘f’ word
Southwest has never furloughed or laid off an employee since its founding in the early 1970s. That could change. The carrier is lobbying the federal government to extend the CARES Act‘s payroll support program through March. If that funding doesn’t come through, Southwest has warned that it will start seeking concessions from its unions, a prospect that already has the union bristling.
More than 15,000 — or roughly one-quarter — employees have taken voluntary leaves of absence or early retirement, but more concessions are needed. “We are about 20 percent overstaffed,” Kelly said. The company will seek an across-the-board 10 percent pay cut starting Jan. 1. If the unions balk at this, the “last resort” is furloughs, something Kelly says he hopes to avoid. By contrast, United and American furloughed more than 30,000 employees on October 1, when the CARES Act stimulus expired, and Delta may have to furlough pilots on November 1 unless it can wring concessions from its union.
And now, the numbers
Southwest reported a $1.2 billion third-quarter loss, on revenues of $1.8 billion, down 68 percent from last year. Passenger revenues were off by 72 percent from last year, while freight revenues were essentially flat, signaling the continuing importance of cargo revenues to airlines during the pandemic. Daily cash burn in the quarter was $16 million, an improvement from the $23 million per day in the second quarter. The company, like its peers, had no problem raising cash, and ended the quarter with $15.6 billion in liquidity, which Kelly said is enough for three years of operations.
Southwest expects to offer 60 percent of its 2019 capacity in the fourth quarter. In October, the carrier had about half the number of flights it did in October 2019. Southwest expects its load factors — or how full an aircraft is — to climb steadily for the balance of the year. It was just 43 percent in July, rising to 50 percent in October. The airline expects to see load factors of between 50-55 percent by the end of the year.
“We have a long way to go, but we will get through this,” Kelly said. “We will survive this, and we will emerge with the best balance sheet and the best business model to compete and thrive in the post-pandemic world.”