Southwest Airlines Co. (NYSE:LUV) Q4 2023 Earnings Call Transcript

Southwest Airlines Co. (NYSE:LUV) Q4 2023 Earnings Call Transcript January 25, 2024

Southwest Airlines Co. beats earnings expectations. Reported EPS is $0.37, expectations were $0.11. Southwest Airlines Co. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, everyone, and welcome to the Southwest Airlines Fourth Quarter 2023 Conference Call. My name is Gary, and I will be moderating today’s call. This call is being recorded, and a replay will be available on southwest.com in the Investor Relations section. After today’s prepared remarks, there will be an opportunity to ask questions. [Operator Instructions] At this time, I’d like to turn the call over to Ms. Julia Landrum, Vice President of Investor Relations. Please go ahead, ma’am.

Julia Landrum : Thank you so much. And welcome everyone Southwest Airlines Fourth Quarter 2023 Conference Call. In just a moment, we will share our prepared remarks after which, we’ll be happy to take your questions. On the call with me today, we have our President and CEO, Bob Jordan, Executive Vice President and CFO, Tammy Romo; Executive Vice President and Chief Commercial Officer; Ryan Green; and Chief Operating Officer, Andrew Watterson. A quick reminder that we will make forward-looking statements, which are based on our current expectation of future performance, and our actual results could differ materially from expectations. Also, we will reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results in our press release. So please refer to the disclosures in our press release from this morning and visit our Investor Relations website for more information. With that, I’m pleased to turn the call over to you, Bob.

Bob Jordan: Thank you, Julia, and thank you, everyone, for joining the call today. As we close the books on 2023, I want to take a moment to reflect on how far we’ve come. And more importantly, I want to thank the people at Southwest Airlines for their dedication, their warrior spirit, their heart and ultimately, for their incredible resilience. At this time last year, we were getting back on our feet from the disruption following Winter Storm Elliott. We quickly mobilized to put immediate mitigation efforts in place, while simultaneously building a robust plan to prepare us for future extreme winter weather disruptions. We are also working to restore our network, address our staffing needs and return our aircraft to full utilization.

And of course, we were in the middle of negotiations with the majority of our labor unions. I’m incredibly pleased to be on the other side of 2023 and to be able to share all the progress we made last year. We completed a comprehensive winter weather action plan, which has already been successfully tested in multiple weather, winter weather events, including the extended nationwide winter storms we experienced this month, but also with other types of disruptions such as hurricanes, severe fall in Chicago and the Maui fires. Through all of those events, our aircraft and crude networks remain stable. We recovered quickly, and we were able to minimize the impact on our customers. We also got fully staffed, restored our network and reached the full utilization of our fleet.

Our network is in a healthy place, and it shows in our operational improvement. In fact, we improved in nearly every operational metric. Our completion factor performance, in particular, was fantastic at 99% for the full year, with fourth quarter being our best quarterly performance in more than a decade at 99.6%. We also made significant progress on our labor agreements, including ratification earlier this week of an agreement that secures industry-leading pay for our best-in-class pilots. We have now successfully reached ratification on nine contracts in a little over a year, demonstrating our commitment to providing competitive market compensation packages for our people. This is a huge accomplishment, and I would like to thank all those who have tirelessly supported those negotiations.

Of course, all this was in addition to a host of other accomplishments, the rollout of a new revenue management system, the launch of multiple customer experience improvements and the negotiation of a very cost-effective order book with Boeing. The order book allows us to continue the modernization of our fleet and provides the opportunity to flex our growth plans up or down over the long-term. We also made rapid adjustments to capacity for both 2023 and 2024 and put in place significant network adjustments in response to changing demand patterns. These changes reduced our planned 2024 year-over-year capacity increase to roughly 6%, all of which is carryover from 2023 network restoration. So there will be no net new additional capacity in 2024 as we work to mature our route network.

Moving to our performance. We continue to be very pleased with the core demand for our product. We saw close-end performance strength in November and December for both leisure and corporate travel. This led fourth quarter 2023 to be yet another record at just over $6.8 billion in operating revenue. And we are seeing that strength continue into 2024. This demand strength, combined with about $1.5 billion in incremental year-over-year pre-tax profit from our network optimization efforts and the contributions from our portfolio of strategic initiatives is driving us to expect additional revenue records and year-over-year operating margin expansion despite cost pressures from new labor agreements and increased aircraft maintenance expense. Our network changes are materially in place with the March schedule, where we expect to hit a profitability inflection point.

While still early in the quarter, our initiatives are delivering towards our revenue target, and we expect to exit the quarter with a strong operating margin for the month of March. While we have significant inflationary pressures from our new labor agreements, we have initiatives underway that will begin to help counter these pressures with efficiency improvements. These include everything from scheduling techniques to digital modernization and we planned in 2024 with head count flat to down as compared with year-end 2023 as we slow hiring to levels that are at/or below our attrition rate that will drive efficiency gains in 2024 with more to come in 2025. All of this supports a solid plan with a line of sight to improve our financial returns and earn our cost of capital in 2024.

While this represents notable progress, I want to be clear, earning adequate and consistent returns, ROIC well in excess of WACC is our financial North Star, and it’s not negotiable. We will be relentless in executing against our plans, and we will continue to make adjustments, including capacity adjustments, if needed, until we deliver those results. Adequate and consistent return is how we have created decades of shareholder value, and it continues to be our key focus. Our current set of initiatives is tracking nicely and we’ll provide you a lot more detail later this year at Investor Day. In addition, we’re working on a next seven initiatives to support — in support of sustainable returns over time. In closing, we made tremendous progress in 2023, and we finished the year a much stronger company.

We will finish this year stronger again. We are fully committed to improving the customer experience, and delivering on our long-term financial targets, including generating returns for our shareholders. As always, I have confidence in our people and our business model, and I am particularly proud of our people for their dedication and their resilience. They remain our absolute greatest asset, the heart and soul of our company and the ultimate source of pride for me. And with that, I will turn it over to Tammy.

Tammy Romo: Thank you, Bob, and hello, everyone. As Bob mentioned, 2023 wasn’t without challenges, but we are stronger and ready to take on another year, and that is all thanks to our incredible employees. We delivered $996 million in profits for the year and our fourth quarter net income of $233 million, both when excluding special items, was on the better side of our expectations. We prioritize the restoration of our network and operational reliability in 2023, which has taken a lot of resources and focus. With our operations now stable and the network fully restored, we can drive much more focus in energy to consistently delivering a strong financial performance, along with delivering operational excellence. We have incredible strengths to build upon and the levers we need to optimize and regain our position as an industry leader.

We will be steadfast in our efforts to make meaningful progress this year in support of our long-term goal of generating consistent returns well in excess of our cost of capital. Ryan and Andrew will cover the headway we’ve made with our revenue and operations performance in detail. So, I’ll start with our cost performance before moving to fleet and balance sheet. Overall, our unit cost excluding special items, were down 16% year-over-year in the fourth quarter. Our fourth quarter average fuel price of $3 per gallon was right at the low end of guidance, primarily due to jet fuel prices in the L.A. market steady after significantly spiking in mid-November. Thankfully, market prices dropped as we moved into this year and our fuel price guidance of $2.70 to $2.80 per gallon for the first quarter and $2.55 to $2.65 per gallon for the full year and the welcome reduction in fuel costs compared with 2023.

We are currently 60% hedged here in first quarter and 57% hedged for the full year with more meaningful hedge protection kicking in at Brent prices around $90 per barrel. That’s a higher strike price than where our 2023 hedges began to provide meaningful protection, which was closer to $70 per barrel. This is reflective of the current market conditions and elevated cost of hedging. We continue to prudently add to our fuel hedge position for 2026, nearing 20% hedged and are currently 46% hedged in 2025 in line with our goal to be roughly 50% hedged in each calendar year. While we are not fully immune to the volatile energy market, I am grateful that our hedging positions provide meaningful protection against catastrophic increases, while also allowing us to participate fully when market prices decline.

Moving to nonfuel cost. Our fourth quarter year-over-year CASM-X decrease of 18.1% was on the favorable side of our guidance range, driven primarily by elevated operating expenses and lower capacity levels in fourth quarter 2022 as a result of the operational disruption. This was partially offset by general inflationary cost pressures, including higher labor rates for all employee work groups, as well as elevated maintenance expense. Both of which are sticky as we move into 2024. I also want to congratulate our pilots on their newly ratified contract. Obviously, the market for pilot wages has increased significantly, and it is important that we keep pace to reward our employees appropriately. As a result of the new agreement, we recorded a change in estimate for the pilot ratification bonus, and you can find the details and breakout of the accounting treatment in this morning’s press release.

Looking to first quarter 2024, we currently estimate our CASM-X to increase in the range of 6% to 7% year-over-year, roughly 3 to 4 points of this estimated increase is driven by higher overall 2024 labor cost and market wage rate accruals. The remainder of the first quarter CASM-X increase is primarily due to year-over-year pressure in maintenance expense, driven by rate increases as well as an increase in maintenance activity as our 800s are coming off their honeymoon period. Speaking to full year cost. Our CASM-X guidance of a 6% to 7% increase year-over-year is also essentially driven by labor and maintenance cost pressures. Roughly 4 to 5 points is attributable to labor and roughly 2 points is from maintenance for the reasons I previously covered.

While we accrue for market wage rates, the recently ratified pilot contract, contributes the majority of the labor CASM-X increase this year due to a step-up in wage rates, work rule changes and enhanced benefits. As Bob mentioned, we are steadfastly focused on regaining efficiencies to help counter some of the structural cost pressures as we look to control what’s controllable. We are not satisfied with our current financial performance, and we will work relentlessly until we produce the financial strength and returns you should expect from Southwest Airlines. We have a solid 2024 plan, which includes the benefit of roughly $1.5 billion in incremental year-over-year pre-tax profits from our strategic initiatives. The vast majority of the initiatives delivering value in 2024 are revenue related, contributing well over $1 billion of the $1.5 billion total expected incremental benefit.

And our network optimization and market maturation efforts are providing the bulk of that revenue lift. The balance of the revenue generating benefits come from incremental managed business initiatives, primarily increased GDS participation. The incremental cost benefit relates primarily to fleet monetization and early yields from other operating efficiency efforts such as digital service modernization and our turn initiative. We will go into a lot more detail on our initiative portfolio at Investor Day later this year. While early, our plan provides significant progress towards our long-term goal to generate ROIC well in excess of our cost of capital. Again, more details to come at our 2024 Investor Day. Now turning to our fleet. During 2023, we received a total of 86-8 deliveries, more than planned and retired 39-700 to less than planned, ending the year with a total of 817 aircraft.

We consistently mentioned the flexibility in our fleet modernization efforts being a key competitive advantage and the minor shifting of deliveries and retirements throughout 2023 validates our ability to thoughtfully plan and execute given the continued supply chain challenges facing Boeing. Moving into 2024, there is continued uncertainty around the timing of expected Boeing deliveries and the certification of the MAX 7 aircraft. Our fleet plans remain nimble and currently differs from our contractual order book with Boeing. We are planning for 79 aircraft deliveries this year and expect to retire roughly 45-700 and 4-800, resulting in a net expected increase of 30 aircraft this year. Taking our current plan into consideration, we expect our 2024 CapEx to be in the range of $3.5 billion to $4 billion.

After finalizing our 2024 plans and refining capacity levels to better reflect the current environment, we now expect full year 2024 capacity to be up about 6% year-over-year. And our 2024 capacity plans do not currently include any MAX 7 flying. So, a certification of that aircraft continues to push out our 2024 capacity plans will not be impacted. In addition, we are also reducing our total fuel expense with our fleet modernization initiatives as we continue to bring on more fuel-efficient -8 aircraft and retire -700. We saw a nearly 3% year-over-year improvement in fuel efficiency in 2023 and expect continued improvement this year. In addition to fuel savings, our fleet modernization initiative is a key component in reaching our environmental sustainability goals.

Lastly, I am proud to report that our balance sheet strength continues to be a financial backbone as we move into another year. We remain the only US airline with an investment-grade rating by all three rating agencies. We ended the year with $11.5 billion in cash and short-term investments, returned $428 million to our shareholders through dividend payments in 2023, paid $85 million to retire debt and finance lease obligations in 2023, and continue to be in a net cash position. We expect to pay a modest $29 million in debt payments this year and continue to expect interest income to well exceed our expected interest expense of $249 million in 2024. So, we are pleased to have a plan for significant financial improvement to be made this year.

With some major milestones behind us, such as restoring our network, becoming fully staffed, fully utilizing our fleet and so much more, our sites are set on expanding margins and covering our cost of capital in 2024. And as I close, I’d like to sincerely thank our people for another year of hard work and dedication to the mission and vision of Southwest Airlines. I am so grateful for each and every one of you. You were truly my heroes. And with that, I will turn it over to Ryan.

Ryan Green: Thank you, Tammy, and hello everyone. Let me start by sharing that I am very pleased with the overall demand for our business, the execution from our amazing people, and the engagement of our loyal customers. Fourth quarter unit revenue finished slightly better than expectations at down 8.9% year-over-year. The improvement was driven by a strengthening of close-in revenue performance in November and December for both leisure and corporate business travel, as well as the continuation of overall strong holiday performance and market share gains from our managed business initiatives. I’m pleased to report that we saw no bookings impact from last year’s operational disruption during this past holiday season, which speaks to the operational improvements we have made over the last year as well as the enduring loyalty from our customers.

In addition, fourth quarter was another quarter with multiple record set, including record fourth quarter operating revenue and passenger revenue, as well as an all-time quarterly record for passengers carry. Fares also performed well in the fourth quarter, with our average passenger fare up about 2.5% year-over-year. And all-in-all, our fourth quarter operating revenues were up over $1 billion relative to fourth quarter of 2019. And while we still have work to do on our revenue performance, I remain very pleased with our progress. Looking to our full year results, we grew 2023 operating revenues nearly 10% year-over-year to a record $26 billion accompanied by record passengers, record Rapid Rewards revenue and record ancillary revenue. And speaking of records, we set operating revenue records in each quarter of the year and for the full year of 2023.

As we move into 2024, we are seeing the momentum continue, and we’re seeing early but highly encouraging benefits from our network optimization efforts, and we expect first quarter unit revenue growth of 2.5% to 4.5% when compared to the same period last year. This represents a solid sequential improvement in year-over-year unit revenue performance even when normalized for the five-point tailwind from the prior year disruption impact. In fact, our guide would imply first quarter 2024 nominal RASM to be about five points higher than our normal seasonal sequential average when compared with nominal fourth quarter of 2023 RASM. We currently have about 60% of expected bookings for first quarter already in place, slightly above normal, and we are seeing better than normal sequential RASM performance further demonstrating that our network optimization efforts are working.

As we refined our capacity plans for this year, we’ve been able to pull in even more flying out of the shoulder periods, which we believe will be a tangible contributor in boosting our performance. While our forecast doesn’t assume any material increase in demand for domestic air travel in 2024, we do have a line of sight to double-digit operating revenue growth year-over-year, driven largely by the network and initiative-driven revenue that Tammy detail. Included in that, of course, is our efforts to drive managed business. We are very pleased with the performance of our managed business initiatives and the success of our Southwest business team. In the past year, we had a solid increase in market share, more than three points in the managed business space and I’m very proud we improved our Business Travel News ranking from fourth place in the industry in 2019 to second place in 2023.

We were the only carrier on the survey to receive an increased total score two years in a row while each of our competitors’ scores have declined over that same period. It’s another example of the progress we’re making against the industry in the managed business space. Of course, we’re also continuing our efforts to improve our customer experience and our Rapid Rewards program. We are seeing improved customer satisfaction scores with our Wi-Fi product as we proceed with our infrastructure investments there and more aircraft are joining the fleet every day within sea power and larger bins on board. We’ve made several enhancements to our award-winning Rapid Rewards program, including making it easier to reach our A-List and A-List Preferred levels and we will soon be rolling out the ability to book travel with a combination of cash plus Rapid Reward points later this spring.

We introduced customer bag tracking to reduce friction in our customers’ travel experience and we look forward to sharing more on our larger digital hospitality modernization plan in the coming months. All of this is designed to make it easier to fly with us and give customers even more reasons to choose Southwest. As we enter 2024, we have a very solid plan that leverages the unparalleled strength of our people, our product, our loyalty program and our route network, and we look forward to delivering on continued progress towards our long-term financial goals. With that, Andrew, over to you.

Andrew Watterson: Thank you, Ryan, and hello, everyone. I’d like to start out by recognizing our people for their efforts in successfully managing through four different named winter storms, which was spread over 11 days and impacted a wide portion of our route network with intense weather conditions and frigid temperatures this month. These overlapping winter systems definitely put our winter operations fairness plan to the test. Overall, I’m very pleased with how well we manage the storms. The sheer magnitude of these weather systems resulted in significant cancellations, the vast majority of which were proactive on our part. Our cancellations were made 14 hours in advance on average and 70% were canceled with at least six hours in advance.

As you can imagine, providing that much notice improves the customer experience. In fact, we have found that it can result in MPS scores that approximate, those with customers with no disruption to their itinerary. Overall cancellation rates were in line with the industry and were primarily isolated to the operations directly impacted by the storms. With fewer than 2% of our cancellations tied to crew scheduling challenges. This is a significant contrast to what we experienced with winter storm Elliott in December 2022. The improvement is directly the result of last year’s winter operations investments and protocols. I echo Bob’s sentiments that we are in a much better spot today than a year ago. In the past year, we not only completed the winter operations preparedness plan, we also delivered on a long list of initiatives to modernize our operation with benefits for both our customers and our employees.

Our people have the staffing, equipment, tools and infrastructure to operate safely and at pace in winter weather. The good news is that, all the hard work showed up in our operating performance. We closed out 2023 with only about 1% of our total flights canceled and we improved in basically every metric. Our completion factor, on-time performance, early morning originators, turn compliance and turn differential and mishandled battery, all showed substantial year-over-year improvement, which in turn led to a year-over-year improvement in our Trip Net Promoter Score. As we enter 2024, we will focus on continuing to build on our 2023 priority of operating quality. We ranked fourth place in the 2023 Wall Street Journal Airline Quality Metrics despite several of the metrics covering the winter storm Eliot period.

Our goal is to move up this ranking and ultimately be ranked number one. We will also double down on three additional priorities: bringing out operating inefficiencies increasing asset productivity and creating operating leverage by reducing structural costs. These are multiyear initiative-based efforts, which will begin yielding material benefits in 2025. We’ll share more on these in the coming months. Finally, I’d like to close by congratulating our pilots on our new contract. I’d also like to thank all the negotiating teams who have worked so hard to reach nine agreements since October of 2022. These teams work tirelessly and I am pleased we can reward employees with well-deserved pay increases and quality of life enhancements. We remain in negotiations with two union represented groups, TW555 and TW556 and we look forward to reaching agreements to reward those employees for their contributions.

So with that, I’ll turn it back over to Julia.

Julia Landrum: Thank you, Andrew. This completes our prepared remarks. We will now open the line for analyst questions. We would like to speak with as many of you as possible, so we ask that you limit yourself to one question and a brief follow-up if necessary. Please go ahead with the first question.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Ravi Shanker with Morgan Stanley. Please go ahead.

Ravi Shanker : Thanks. Good afternoon everyone. Maybe we can start with the $1.5 billion kind of initiatives. And any chance you can share more detail there, kind of details on what the different contributing items are, and also how much visibility do you have into that? Trying to get a sense of how much of that may be in the bag, so to speak?

Bob Jordan: Hey, Ravi, it’s Bob. I’ll start, and then maybe Ryan can jump in. Obviously, a lot of the year-over-year improvement counts on the initiatives delivering, and I feel very confident about that. I mean, some of this is our Investor Day initiatives continuing to perform. And then on top of that, you have new things, a lot of which — the majority of which are the network improvements, which, as you know, are in place materially beginning in March and then fully in place by early summer. And so we have a lot of confidence in, though, certainly, the Investor Day initiatives delivering. And while it’s early in the quarter, we have some line of sight into, obviously, March and how will the network change and optimization is delivering, and we’re on track there.

It’s things like — it’s basically adjusting for new demand patterns. It’s adjusting — you know what they are. The Tuesday, Wednesday, shoulder flying, those kinds of things. But no, I feel like we’re on track to hit that incremental $1.5 billion. Again, most of that is revenue. About two-thirds of that is revenue related. Ryan, do you want to add anything?

Ryan Green : Yes. Of the revenue initiatives there, a lot — most of that is the network optimization and the continuing maturation of some of our development markets, development market percentage of mix continues to get more back to normal ranges by the end of 2024. So that certainly will help. And obviously, we’ve been able to watch those development markets mature throughout their curve here over the last few years. As it relates to the other revenue initiatives that are in place, they will continue to mature and then also provide additional benefit as we — as the airline grows. A significant portion of that is the managed business initiatives that we’ve been talking about. And I’m very confident in how that those sets of initiatives continue to perform.

We’re definitely on track. Managed business got better in the fourth quarter from how it was performing in the third quarter, and then we’re expecting another sequential improvement here in the first quarter with managed business. We can see that in place and how bookings are coming in, in January, and as we begin to get into the February booking curve here. So yes, everything that we can see, how we finished the fourth quarter and then what we can see here in the first quarter and going forward makes me very confident.

Ravi Shanker : Very helpful. And maybe as a quick follow-up. I’d love to get your thoughts on the apparent premiumization of the domestic product. Obviously, you guys are committed to a single cabin, but does that give you kind of more room to raise RASM across the product or kind of just what your response to that be?

Ryan Green : Well, premium certainly is a hot topic in the industry, and it’s something that we watch — that we’re watching closely. We also talk to our customers on a regular basis. This is one of the things that we continue to get their feedback on. And I think we talked about it some on the last call. As you think about premium, historically in the industry, premium revenue has been highly cyclical. This is one of those times where carriers are adding premium seats into the cabin. But when the economic cycle shifts, they’re pulling seats, premium seats out of the cabin. And so as we see kind of the recovery here from the pandemic, we’ll have to see how these trends persist and go forward. I think overall RASM, obviously, we follow that and how we compare relative to the industry, and we’re working on working on improving that as we go forward here.

I will say that ancillary revenue, the majority of which is boarding products, our early bird product as well as our upgraded boarding product is doing very well. We’re having record ancillary revenue performance. And so I think, yes, we have a single cabin, but we’re able to improve RASM and grow ancillary revenue through some of those boarding products as well.

Ravi Shanker: Very helpful. Thank you.

Operator: The next question is from Jamie Baker with JPMorgan. Please go ahead.

Jamie Baker: Hey good morning everybody. Obviously, a launch of discussion about domestic capacity — woah, sorry, I’m still there, right?

Ryan Green: You’re there.

Jamie Baker: Yes. Sorry about that. It was probably the Temis expletive that I’ve ever said. Lots of discussion about domestic capacity cuts, your own and others. Just curious, though, in markets where you overlap with lower-cost competitors, have you seen any changes in how they’re competing other than just the capacity cuts. I mean there’s been speculation of lower OA pricing as some of those airlines try to regain profitability. I’m not seeing any of that, but it’s that sort of thing that I’m asking you about.

Bob Jordan: Yes, Jamie, obviously, there are — I mean, there are probably as many moving parts right now as I’ve ever seen. You’ve got — as Ryan talked about, you’ve got a focus on parts of the cabin that are outperforming our route network that are outperforming, you’ve got — you’ve got a lot of capacity moving around in the industry right now. You’ve got mergers. So it’s tough to tell that — and on top of that, obviously, you’ve got capacity impacts due to aircraft delivery, the DTF issues, all those things. So I think it’s not to tease out. My guess would be that all of those factors probably get worse across the year. The impact of those are going to continue to increase, especially as you see more impacts on capacity and aircraft due to potential Boeing impacts, obviously, the geared turbofan.

So more to follow. On our end, obviously, we’re focused on Southwest Airlines. I’m really pleased with 2023 and all that we got accomplished that we talked about. We ended the year a much better carrier than we were the year before. The area of course, where I’m not satisfied is our financial performance. We’re running roughly four points under our cost of capital right now. And that is our focus here at Southwest, and we’ve got a really good plan here in ’24…