What: Put plainly, Southwest Airlines (NYSE:LUV), one of the most-respected national airlines within the United States, had its wings clipped in June. Shares of the airline giant fell 11% in June, based on data from S&P Capital IQ, following the release of its May traffic data and an update to its full-year growth and expansion prospects.
So what: On the bright side, the traffic report for May showed that passenger revenue miles increased 8.5% year-over-year, and Southwest's load factor hit a record of 84.4%. On the flipside, an important measure of margin for the airlines, passenger revenue per available seat mile, also known as PRASM, was estimated to have fallen by 6%.
CEO Gary Kelly did his best to uplift investors by estimating a record profit in the second quarter, helped in part by the expectation of rising fares, but Kelly also noted that Southwest is taking steps to curb its capacity growth to just 6% in 2015. Previously, Southwest had been on record expecting capacity growth of as much as 7%-8% in 2015. Additionally, PRASM is expected to continue falling, with Q2 PRASM estimated to fall by 4% to 5% from the prior-year quarter.
Now what: Although record profits are a good thing, Wall Street and investors have to be at least a little bit concerned about Southwest's capacity expansion when it's not helping the company's bottom line.
On one hand, expansion could allow it to chip away at the majors which have generally been tight with their capacity expansion since oil prices bottomed a few months prior. For instance, Southwest noted that daily departures from its Dallas, Love Field hub will have jumped by more than 50% to about 180 by the end of 2015 from 118 in Oct. 2014.
But, the concern with expanding despite a falling PRASM is that it could incite a price war between Southwest and the other majors. If this were to occur we could be looking at margins being creamed across the board – not just for Southwest. In other words, it's been a pretty long time since I can recall there being any hint of doubt coming into the picture concerning Southwest's growth prospects, but the potential winds of change are certainly in the air.
What should investors do? As long as Southwest doesn't lower its planned expansion any further in 2015 and passengers don't offer any pushback to recent fare hikes, then Southwest's premier position as one of America's most-liked airlines should help buoy its falling stock price. I'd still remind investors that this is a very capital intensive business and the long-term hasn't been kind to the airline industry, but this recent dip in Southwest could represent an intriguing buying opportunity for investors with an above-average risk profile and a three-to-five-year investment horizon.