Southwest Airlines (LUV -1.25%) reported a solid performance in the third quarter, bolstered by record summer travel demand and improving business travel trends. Despite fears of a recession, demand for travel has shown no signs of slowing.
With a strong holiday travel season anticipated, let's take a closer look at this airline stock and why it's likely time to buy the dip.
Insatiable travel demand
The Dallas-based carrier reported strong demand for both leisure and business travel during the third quarter, a trend Southwest expects to continue into the fourth quarter and beyond. Even with an $18 million impact from Hurricane Ian taken into account, the company managed to earn record revenue of $6.22 billion in Q3, a nearly 33% jump year over year.
In September, Southwest released an investor update outlining robust leisure travel demand and also hinting that business travel might be picking up. Demand for air travel picked up significantly this summer when Southwest noted a "surge in leisure demand, especially in June." As a result of robust bookings and fuller flights, the company set a new all-time high for quarterly profit in the second quarter.
The low-cost carrier has also seen recent signs of improvement in business traffic, which saw revenue rise between 8% and 10% from August to September. Delta Air Lines observed a similar increase in business travel, citing a spike in post-Labor Day business bookings. And leisure demand has shown no signs of stopping, with a strong holiday season expected by American carriers.
Airlines like Southwest remain optimistic despite investor concerns over a potential recession. CEO Bob Jordan expressed that Southwest hasn't seen "any noticeable impact on our booking and revenue trends" as far as recession fears go.
Sky-high revenue but low profitability
Although revenue set a new record in Q3, profits actually plummeted year over year. The airline reported a $277 million profit for the third quarter, a nearly 58% drop from the same period in 2021 when Southwest reported $659 million in profit.
Supply chain disruptions, staff shortages, training delays, and higher fuel prices all took a toll on Southwest's profit margin in the third quarter, curbing the airline's ability to improve operations quickly enough to meet the spike in demand. Although Southwest has raised fare prices to address narrowing margins, profits nonetheless took a major hit in Q3.
Stepping up to the challenge, Southwest expressed being "on track" to hire 1,200 additional pilots this year and another 2,100 next year. The airline anticipates being back to pre-pandemic levels by December 2023.
Looking ahead
For Q4, Southwest anticipates revenue to exceed 2019 levels by 13% to 17%, albeit at 2% lower capacity. The company expects strong travel demand to not only continue in the fourth quarter but to accelerate in 2023.
By December 2023, Southwest forecasts having its network restored to pre-pandemic levels along with lower fuel costs. However, the airline also predicts that aircraft delivery delays will linger into 2024. Southwest is technically due to receive 114 new 737 MAX jets from Boeing this year, but the plane manufacturer has endured numerous supply chain and regulatory challenges that have slowed the process.
To appease shareholders, Southwest intends to reinstate a dividend, which CFO Tammy Romo describes as a "high priority." As we saw from the snapback recovery in leisure travel, demand for business travel could ramp up quickly when it does. If Southwest can resume pre-pandemic business travel levels while maintaining its sky-high level of leisure demand, this airline stock could soon be on a steep ascent.
