Southwest (LUV) Down 7.9% Since Last Earnings Report: Can It Rebound?

A month has gone by since the last earnings report for Southwest Airlines (NYSE:LUV). Shares have lost about 7.9% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Southwest due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

Earnings Beat at Southwest Airlines in Q2

Southwest Airlines delivered second-quarter 2019 earnings per share of $1.37, beating the Zacks Consensus Estimate of $1.35. Moreover, the bottom-line improved year over year despite higher costs from the MAX groundings.

Operating revenues of $5,909 million lagged the Zacks Consensus Estimate of $5,933.2 million. However, the top line inched up 2.9% year over year. Passenger revenues accounting for bulk (92.8%) of the top line also improved 2.4% year over year.

Operating Statistics

Airline traffic, measured in revenue passenger miles, dipped 1.7% year over year to 34.53 billion in the quarter under review. Also, capacity or available seat miles (ASMs) contracted 3.6% to 39.98 billion on account of the MAX groundings. However, load factor (percentage of seats filled by passengers) came in at 86.4%, up 170 basis points on a year-over-year basis as capacity contracted more than the decrease in traffic.

Passenger revenue per available seat mile (PRASM: a key measure of unit revenues) increased 6.3% to 13.72 cents. Moreover, in the reported quarter, revenue per available seat mile (RASM) rose 6.8% year over year to 14.78 cents owing to 4.2% increase in passenger revenue yield and revenue management strategies among other factors.

Operating Expenses & Income

In the second quarter, operating income (excluding special items) totaled $968 million compared with $972 million in the year-earlier period. The Boeing (NYSE:BA) 737 MAX 8 grounding affected operating income to the tune of $175 million. Further, total adjusted operating expenses (excluding profit sharing, fuel and oil expense plus special items) climbed 6.8% year over year. The increase in costs was due to the groundings and the resultant lower capacity during the quarter.

Fuel price per gallon (inclusive of fuel tax: economic) was down 3.6% year over year to $2.13. However, consolidated unit cost or cost per available seat mile (CASM) excluding fuel, oil and special items increased 10.7% year over year to 9.52 cents. The Boeing 737 MAX groundings pushed up costs. In fact, the scenario is likely to persist through the second half of the year.

Liquidity

The company had cash and cash equivalents of $2,446 million at the end of the second quarter compared with $1,854 million at the end of 2018. As of Jun 30, 2019, the company had a long-term debt (less current maturities) of $2,449 million compared with $2,771 million at 2018 end.

While the carrier generated a free cash flow of $736 million during the second quarter, it returned $548 million to its shareholders through $98 million in dividends and $450 million via share repurchases.

Q3 Outlook

Southwest Airlines anticipates RASM to ascend 3-5% year over year in the third quarter. Among other factors, lower capacity during the current quarter from the MAX groundings account for this bullish forecast. Economic fuel costs are envisioned in the range of $2.05-$2.15 per gallon, much lower than $2.25 reported in the third quarter of 2018.

As a result of the grounding of the Boeing 737 MAX 8, the most fuel-efficient aircraft in the carrier’s fleet, fuel efficiency is estimated to slid 1-2% in the third quarter. Moreover, CASM — excluding fuel and oil expense and profitsharing expense — is estimated to augment 9-11% in the ongoing quarter compared to that achieved in the year-ago period. Previously (before the MAX groundings), the metric was anticipated to increase approximately 2% year over year. The bearish forecast is due to lower capacity from the above-mentioned headwind.

2019 Outlook

Due to delays in the Boeing 737 MAX aircraft’s return to service, Southwest Airlines now anticipates 2019 capacity or ASMs to slip 1-2% year over year compared with 5% increase expected earlier. The carrier is taking measures to mitigate this adversity and optimize its resources. To this end, it will cease operations at Newark Liberty International Airport. Consequently, the airline’s New York City presence will be consolidated at New York LaGuardia Airport, starting Nov 3, 2019.

Moreover, CASM — excluding fuel and oil expense and profitsharing expense — is expected to expand in the band of 8-10% year over year compared with a rise of 5.5-6.5% estimated previously. This includes an approximate six-point negative impact from lower capacity due to the groundings. Meanwhile, effective tax rate is projected at approximately 23.5% in the current year.

How Have Estimates Been Moving Since Then?

It turns out, fresh estimates have trended downward during the past month. The consensus estimate has shifted -12.82% due to these changes.

VGM Scores

At this time, Southwest has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with an F. However, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Southwest has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.