For much of its 50-year history, Southwest Airlines (LUV -2.18%) has been one of the most profitable airlines in the world. Indeed, from 1973 to 2019, the company put together a string of 47 consecutive annual profits: an amazing feat in such a volatile business. Most of its main competitors went bankrupt over that period (some more than once).
However, Southwest Airlines has posted subpar results since the COVID-19 pandemic upended the airline industry last year. The carrier continued that trend this week, reporting a loss for the third quarter and projecting an even bigger loss for the current quarter.
An empty earnings beat
On Thursday, Southwest reported an adjusted net loss of $0.23 per share on $4.68 billion of revenue for the third quarter. It beat the analyst consensus on both measures. (Analysts had expected an adjusted loss of $0.27 per share on $4.58 billion of revenue.)
Investors shouldn't be impressed, though. Three months ago, management and Wall Street analysts both expected the company to be profitable in the third quarter. Southwest Airlines reduced its guidance in August and again in September, dramatically lowering the bar for an "earnings beat."
Objectively, Southwest's results were quite bad. Revenue declined 17% compared to the third quarter of 2019, largely due to a 16% plunge in unit revenue. Clearly, management's plan to restore capacity to just shy of 2019 levels last quarter backfired. As a result, Southwest Airlines recorded an adjusted pre-tax margin of -3.5%: well shy of breakeven.
Some investors might argue that Southwest's results weren't too bad in the context of the pandemic. However, the airline's domestic focus and big presence in the Sun Belt should have positioned it to capitalize on a rebound in summer leisure travel. For comparison, Alaska Air just reported an impressive Q3 adjusted pre-tax margin of 12%, with unit revenue down less than 1% from two years earlier.
No relief in the near term
Southwest Airlines' financial results are set to weaken further this quarter. In addition to the pandemic-driven downturn in bookings the airline experienced beginning in August, Southwest suffered a self-inflicted wound in the form of an operational meltdown earlier this month. While demand has started to recover, management expects revenue to fall 20% to 30% from 2019 levels for the month of October.
Looking ahead, Southwest has significantly trimmed its capacity plans for December in order to build a greater margin of safety into its staffing plans. It now expects to reduce fourth-quarter capacity by 8% compared to 2019, including a 12% decrease in December. Unit revenue is set to decline significantly, too, causing total revenue to fall 15% to 25% compared to two years ago.
Making matters worse, Southwest expects adjusted unit costs (excluding fuel, profit sharing, and special items) to increase 8% to 12% relative to 2019 this quarter. Furthermore, a recent spike in fuel prices will likely increase economic fuel costs per gallon to between $2.25 and $2.35: up from $2.09 in Q4 2019. (Better fuel efficiency will partially offset the impact of higher prices.)
Even if Southwest Airlines were to hit the high end of its (extremely wide) revenue guidance range this quarter, it would probably lose nearly as much money as it did last quarter. At the midpoint of the guidance range (let alone the bottom), it would post a much wider loss.
Has Southwest Airlines lost its mojo?
After years of being an industry leader in terms of profitability -- especially during crises -- Southwest appears to have fallen back toward the middle of the pack this year. Perhaps it can turn things around in 2022. However, it's starting to seem like the low-fare airline is less nimble than many of its rivals. It also hasn't implemented permanent cost cuts to the same extent as many other U.S. airlines.
As a result, Southwest Airlines may continue to report middle-of-the-pack profitability over the next few years. That wouldn't be good enough to support the airline's premium valuation. Unless Southwest shows that it can return to the top of the industry in profitability, investors should probably avoid the stock.