Southwest Airlines (LUV -3.44%) is famous within the notoriously volatile airline industry for earning 47 consecutive years of profits and avoiding layoffs and furloughs throughout its half-century history. However, since July, management has been warning that demand isn't recovering quickly enough to enable the airline to support its current payroll.

As recently as last week, it seemed like the federal government was on the verge of providing additional relief funding to U.S. airlines, enabling Southwest to avoid painful cuts. Unfortunately, that still hasn't happened. In a message to employees this week, CEO Gary Kelly said that Southwest Airlines would approach its unions to ask for temporary concessions. If negotiations fail -- and additional federal funding doesn't arrive in time -- the airline will implement the first layoffs and furloughs in its history.

A Southwest Airlines plane preparing to land on a tarmac with mountains in the background.

Image source: Southwest Airlines.

Stimulus hopes dashed (again)

The Coronavirus Aid, Relief, and Economic Security Act that was passed in March included a payroll support program for airlines. The federal government provided grants and subsidized loans to cover the vast majority of airlines' payroll costs from April through September. In return, the airlines agreed not to implement any involuntary layoffs, furloughs, or pay cuts during that period.

Several airlines with weaker balance sheets were forced to furlough excess employees immediately after that funding ran out last week. By contrast, Southwest pledged in late July (following a successful voluntary leave or early retirement program) that it would keep all of its staff at least through year-end. Nevertheless, Kelly warned employees in a video message on Oct. 1 that without additional aid, Southwest would need to make deeper cuts to its payroll to avoid billions of dollars of losses.

Last Friday, Speaker of the House Nancy Pelosi said she would support a stand-alone extension of the payroll support program if negotiations for a comprehensive stimulus bill petered out. That removed the biggest barrier to extending the program, which has broad bipartisan support.

Alas, an attempt to pass the stand-alone extension quickly by unanimous consent was blocked. The House of Representatives went into recess for the campaign season shortly thereafter. On Tuesday, President Trump sent conflicting messages, first declaring that he was halting all stimulus negotiations with congressional Democrats until after Election Day but later demanding that the House and Senate immediately provide $25 billion of additional payroll support for airlines. In short, it is extremely unclear whether additional aid is coming -- or when it might arrive.

Concessions or furloughs?

In the meantime, air travel demand remains severely depressed. In recent weeks, the TSA has reported 65% to 70% year-over-year declines in passenger screenings. As a result, Southwest Airlines -- like many peers -- has been slashing its capacity plans. For example, it now anticipates reducing capacity 38% year over year in November.

A Southwest Airlines plane parked on the tarmac.

Image source: Southwest Airlines.

With that as context -- and the payroll support extension languishing in Washington -- Kelly told employees on Monday that the low-fare airline must reduce payroll expense further. Southwest has cut Kelly's base salary to zero effective immediately. It plans to cut other management employees' salaries by 10% for one year starting on Jan. 1, with similar pay cuts for other noncontract employees.

Southwest can't impose unilateral pay cuts on unionized employees. Instead, it is approaching its unions with the goal of quickly negotiating solutions to reduce payroll expenses. The airline indicated that it was open to suggestions for how to achieve the necessary savings, but that reaching agreements quickly was critical.

Thus far, the response from its unions has been mixed. However, Kelly made it clear that without negotiated savings -- and barring a last-minute resuscitation of the payroll support program -- Southwest Airlines will have to implement its first-ever furloughs in January to reduce its cash burn. (If the payroll support program ultimately is extended, Southwest would reverse any layoffs, furloughs, pay cuts, or other concessions.)

A brief period of pain

Southwest Airlines is known for having better labor relations than most other airlines. That offers some hope that management and the company's unions will be able to negotiate alternatives to furloughs in the event that a payroll support extension never materializes.

Fortunately for investors, even if furloughs do become necessary, they would be less disruptive for Southwest than for rivals with complex fleets. Since Southwest Airlines only operates one aircraft type (the Boeing 737), it wouldn't have to retrain workers for new aircraft types upon furloughing its most junior employees.

The other reason for optimism is that coronavirus vaccines remain on track to become widely available sometime next year. By the time 2022 rolls around, Southwest should hopefully be able to productively employ its entire workforce at full pay, going on the offense by expanding at the expense of weaker competitors.