Just a few weeks ago, U.S. airlines were flying high, boasting about a strong demand recovery. Indeed, leisure travelers have returned to the skies in massive numbers over the past couple of months, particularly in the domestic market and nearby international destinations. During July, passenger throughput at TSA checkpoints tripled year over year and declined just 20% compared to July 2019.
Unsurprisingly, though, the rapid spread of the delta variant has started to dent demand. That led Southwest Airlines (LUV 0.46%) to reduce its third-quarter guidance this week.
The pandemic vs. pent-up demand
U.S. COVID-19 case counts began to rise precipitously in early July, due to the rapid spread of the extremely contagious delta variant. Hospitalizations for COVID-19 surged starting around the middle of the month.
Nevertheless, when Southwest Airlines reported its earnings on July 22, CEO Gary Kelly said that the airline was "not detecting any impact at all" on demand from the delta variant. Several other Southwest executives made similar statements during the company's earnings call.
In some ways, this isn't surprising. At the time of Southwest's earnings call, the U.S. case count had nearly quadrupled in three weeks but remained lower than the levels of March and April -- let alone the peak case numbers recorded in January. Meanwhile, many Americans were desperate to travel this summer after having to cancel travel plans in 2020 and early 2021.
However, nationwide COVID-19 case counts have nearly tripled again since July 22, rising to the highest level since early February. Hospitalizations have more than doubled over that period. That's making many people more nervous about air travel.
On Wednesday, Southwest Airlines warned investors that booking activity had slowed and the volume of last-minute cancellations had increased in recent weeks. The low-fare airline attributed this shift to the sharp increase in COVID-19 cases associated with the delta variant. This forced the airline to reduce its quarterly guidance.
For the month of July, revenue declined 12% compared to July 2019, which was in line with the carrier's previous forecast for a 10% to 15% drop. By contrast, Southwest now expects revenue to fall 15% to 20% relative to 2019 in August: worse than its previous projection of a 12% to 17% decline. In September, it expects revenue to fall 15% to 25%, despite some revenue shifting from August into September due to the timing of Labor Day. And for the full quarter, revenue will likely decrease 15% to 20% compared to 2019.
Southwest's cost projections for the third quarter haven't changed. As a result, it says that the downturn in near-term demand "will make it difficult" to earn a profit this quarter, excluding the benefit from the final round of federal payroll support grants for airlines.
Reacting too slowly
While Southwest Airlines is the first airline to cut its third-quarter guidance, other airlines are likely experiencing similar demand trends.
That said, Southwest has made things worse for itself by offering too many flights relative to demand this quarter. Even after the latest guidance cut, the carrier estimates that third-quarter capacity will be in line with Q3 2019. Thus, Southwest's updated guidance implies a 15% to 20% unit revenue decline relative to the third quarter of 2019.
Airlines that are more proactively balancing capacity with demand generally had stronger unit revenue forecasts than Southwest before the recent inflection in demand. Those carriers will likely outperform even more in the current environment. Southwest Airlines needs to become more nimble if it wants to return to the head of the pack in terms of profitability.