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Southwest Airlines Has Another Ominous Warning for Airlines

By Adam Levine-Weinberg – Jul 15, 2020 at 8:21AM

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After initially planning to rebuild its schedule to 2019 levels by year-end, Southwest Airlines is now warning employees that it will have to shrink and implement the first layoffs and furloughs in company history.

Back in late May, Southwest Airlines (LUV -2.53%) released an aggressive schedule for the fall, which called for the low-fare airline to operate about as many flights in November and December as it did a year earlier. The plan even called for double-digit year-over-year growth in some of the carrier's top markets.

At the time, this scheduling move seemed like a sign of growing confidence that people would be back to traveling on airlines in large numbers by the end of 2020, at least domestically. However, Southwest acknowledged in a letter to employees this week that a quick return to normal is seeming increasingly unlikely. As a result, the airline will almost certainly be forced to implement the first involuntary layoffs and furloughs in its history later this year.

The demand recovery is tapering off

Air travel nearly ground to a halt in April. On several days in mid-April, the TSA reported that it screened fewer than 100,000 passengers, down about 96% year over year. However, demand started to recover in May and accelerated between Memorial Day and the July 4 holiday weekend.

Indeed, passenger throughput at TSA checkpoints was still less than 10% of 2019 levels as recently as May 20. By contrast, during the first week of July, TSA passenger throughput averaged 27.3% of year-ago levels. Obviously, that's far short of a full recovery, but it represented a substantial sequential improvement over a month and a half.

Unfortunately, COVID-19 case counts are rising rapidly across much of the U.S. That has led many states to pause or reverse their economic reopening plans. Furthermore, several cities and states are requiring 14-day quarantines for anyone arriving from COVID-19 hotspots. The list of hotspots on the tri-state quarantine list for New York, New Jersey, and Connecticut has grown to encompass 22 states, accounting for more than half of the U.S. population.

A Southwest Airlines plane preparing to land, with mountains in the background

Image source: Southwest Airlines.

Not surprisingly, these measures are undermining the travel recovery. On Monday, the TSA screened 697,985 passengers: 26.7% of the year-ago figure. That represented only a modest improvement from two weeks earlier, when TSA throughput had already reached 25.5% of 2019 levels. That sequential improvement looks especially small considering that Disney World reopened last weekend.

Job cuts on the way at Southwest

Up until now, involuntary layoffs and furloughs have been off the table for airlines, due to the terms of the CARES Act payroll support grants they accepted. However, those conditions expire at the end of September (along with the grants), forcing airlines to take self-help initiatives to align staffing with projected demand.

In a recent staff memo, Southwest Airlines CEO Gary Kelly said that demand would have to roughly triple from current levels by year-end for the airline to avoid layoffs. Based on recent demand trends, that's extremely unlikely to happen. Kelly's statement implies that if demand continues to recover slowly, Southwest will cancel many of the flights it had previously scheduled for November and December.

Southwest Airlines must give 60 days' notice to employees who might be furloughed or laid off. For job cuts to go into effect at the beginning of October -- when the CARES Act conditions expire -- these "WARN" notices would have to go out by the end of July. As a result, the airline has set a Wednesday deadline for employees to apply for voluntary buyouts. Southwest has been encouraging employees to seriously consider taking the buyouts, in order to limit the number of involuntary layoffs and furloughs.

Storm clouds looming

Last week, United Airlines told investors that industry ticket sales plateaued in mid-June and began to slow toward the end of the month, following a sharp recovery between late April and early June. That makes Southwest Airlines' warning about severe overstaffing just the latest evidence that the airline recovery is already stalling out.

This is bad news for Southwest's employees, as the airline has no reasonable way of avoiding some level of layoffs or furloughs come October. However, Southwest Airlines itself is not in danger. As of mid-June, the airline had a manageable debt load and nearly $14 billion of cash on hand: enough to cover nearly two years of cash burn at recent rates. It also had $12 billion of unencumbered assets that it could borrow against, if necessary.

By contrast, there's more at stake for airlines with weaker balance sheets -- such as United and American Airlines. The longer it takes for demand to recover to a reasonable level, the greater the risk that they will be forced to raise capital on unfavorable terms or will exit the pandemic with unsustainable debt loads.

Adam Levine-Weinberg owns shares of Southwest Airlines. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool recommends Southwest Airlines and recommends the following options: long January 2021 $60 calls on Walt Disney and short July 2020 $115 calls on Walt Disney. The Motley Fool has a disclosure policy.

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