2018 has been a challenging year for Southwest Airlines (NYSE:LUV). The low-fare airline got off to a good start, but it suffered a blow to its reputation in April, when a customer died after debris from an engine malfunction broke the window next to her. This was the first accident-related fatality of a Southwest Airlines passenger in the airline's history.

As a result, Southwest's revenue growth slowed to a crawl in the second quarter, and its adjusted net income declined slightly year over year, despite the benefit from a big tax reform tailwind.

On Thursday morning, Southwest Airlines reported significantly better revenue and earnings trends for the third quarter. It anticipates further improvement in the fourth quarter.

Southwest Airlines results: The raw numbers


Q3 2018

Q3 2017

Year-Over-Year Change


$5.58 billion

$5.30 billion


Total unit revenue

13.74 cents

13.58 cents


Adjusted cost per available seat mile excluding fuel

8.81 cents

8.55 cents


Adjusted net income

$614 million

$554 million


Adjusted operating margin



(2.3 percentage points)

Adjusted EPS




Data source: Southwest Airlines Q3 earnings release.

What happened with Southwest Airlines this quarter?

During the third quarter, Southwest Airlines began to recover from the effects of the April accident. Nevertheless, the carrier experienced a modest unit revenue headwind last quarter related to an aggressive fare sale it ran in May to reinvigorate bookings. Fleet constraints and an accounting change added another 1.5 percentage points of unit revenue pressure, offset by a 0.5-percentage-point benefit from weather-related cancellations during the quarter.

Despite these headwinds, revenue per available seat mile (RASM) rose 1.2%, compared to a 1.6% decline in the first half of the year. This exceeded Southwest's initial guidance for the quarter, but was in line with the updated outlook it provided last month.

Non-fuel unit costs increased 3% last quarter after declining in the first half of the year. However, Southwest Airlines executives noted that a shift in the timing of costs played a big role in that increase.

In other news, Southwest Airlines raised the price of its popular EarlyBird check-in option for many routes in August. (EarlyBird allows customers to board earlier -- and thus get a better seat, since the carrier doesn't assign seats.) This fee change should boost ancillary revenue going forward.

One notable thing that didn't happen this quarter was the launch of ticket sales for Southwest's highly anticipated Hawaii flights. This suggests that Hawaii service won't begin until 2019.

What management had to say

CEO Gary Kelly was quite pleased with the company's results: particularly its double-digit earnings-per-share growth. He stated:

I want to congratulate our Employees on an excellent third quarter 2018 performance, resulting in record third quarter earnings per diluted share. The significant increase in our third quarter 2018 earnings per diluted share was driven by record third quarter operating revenues, lower federal income taxes, and a 4.8 percent year-over-year reduction in share count. Despite higher jet fuel prices and other cost pressures, we grew our third quarter 2018 net margin, year-over-year, which is a notable accomplishment.

Kelly also sounded optimistic about 2019, noting, "Based on our second half 2018 revenue trends, we are well-positioned for year-over-year unit revenue growth in 2019, with easier year-over-year comparisons in first half. ... Given our healthy revenue outlook, and despite expected cost increases, our 2019 goal is to expand margins year-over-year."

Looking forward

For the fourth quarter, Southwest Airlines expects RASM to rise 1% to 2%, driven by benefits from its new reservation system. That would be roughly in line with its Q3 unit revenue growth. Meanwhile, adjusted non-fuel unit costs are on track to increase just 0% to 1%, before the impact of profit-sharing.

A Southwest Airlines plane preparing to land

Image source: Southwest Airlines.

Rising fuel prices represent a bigger cost headwind, but Southwest's hedging program is taking most of the bite out of runaway oil prices. The carrier expects to pay between $2.30 per gallon and $2.35 per gallon for jet fuel this quarter, up from $2.16 per gallon a year earlier.

Based on this guidance, Southwest Airlines' operating profit should be roughly flat year over year in the fourth quarter. That would drive strong growth in net income and EPS, due to the lower corporate tax rate in effect for 2018 and Southwest's share repurchase activity.

The outlook for 2019 is less certain. The airline hopes that its growing unit revenue momentum will allow it to expand its profit margin next year. But to make that happen, Southwest Airlines will need to overcome a significant cost headwind from rising fuel prices and investments that the carrier is making to support its long-term growth.

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