Will Escalated Costs Dampen Southwest's (LUV) Q2 Earnings?

Southwest Airlines Co. (NYSE:LUV) is slated to release second-quarter 2019 results on Jul 25, before the market opens.

Last quarter, the company delivered a positive earnings surprise of 14.7%. Operating revenues also outpaced the Zacks Consensus Estimate and increased year over year as well. However, the bottom line declined year over year. Results were partly affected due to flight cancellations, effects of the government shutdown and softness in bookings.

However, with the Zacks Consensus Estimate for second-quarter earnings being revised 1.5% downward in the last 60 days, things do not look too bright for the company in the soon-to-be-reported quarter.

Factors at Play

The prolonged period of Boeing (NYSE:BA) 737 MAX grounding has hampered the carrier’s operations, causing numerous flight cancellations each day during the second quarter. Consequently, the airline with 34 such jets in its fleet suffered capacity constraints. For the second quarter, the company anticipates capacity to decline approximately 3.5% year over year.

The contracted capacity in turn, pushed up Southwest’s non-fuel unit costs. Operating costs per available seat mile (CASM) excluding fuel and oil expense and profit-sharing expense are estimated to ascend an alarming 11.5-12.5% year over year in the to-be-reported quarter.

Moreover, with the carrier’s most fuel-efficient plane being grounded, its fuel efficiency is predicted to slide 1-2% in the second quarter. This is likely to add to the company’s overall fuel-related expenses. The escalation in costs might affect the company’s bottom-line growth in the to-be-reported quarter.

However, Southwest witnessed robust demand and solid passenger yields during the second quarter. Evidently, the carrier anticipates operating revenue per available seat mile (RASM) to increase 6.5-7.5% year over year in the quarter. Additionally, the Zacks Consensus Estimate for second-quarter passenger revenues stands at $5,521 million compared with $5,358 million reported in the second quarter of 2018. This upbeat scenario should boost the company’s top line in the quarter.

Fuel prices largely remained at modest levels during the second quarter. The carrier anticipates fuel costs in the band of $2.10-$2.20 per gallon in the aforementioned quarter. The Zacks Consensus Estimate for fuel costs per gallon including fuel tax (economic) is pegged at $2.14, much lower than $2.21 reported in the year-ago period. The likely lower fuel prices are anticipated to partially mitigate the adversity associated with rise in non-fuel unit costs, thereby aiding bottom-line growth.

Earnings Whispers

Per our proven model a company needs the right combination of the following two key ingredients — a positive Earnings ESP and a Zacks Rank #3 (Hold) or better — to increase the odds of a positive earnings surprise. However, that is not the case here as highlighted below.

Earnings ESP: Southwest has an Earnings ESP of -0.34% as the Most Accurate Estimate is pegged at $1.34 per share, lower than the Zacks Consensus estimate of $1.35. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Zacks Rank: Southwest carries a Zacks Rank of 3, which increases the predictive power of ESP. However, the company’s negative ESP leaves surprise prediction inconclusive.

We caution against all Sell-rated stocks (#4 or 5) going into an earnings announcement, especially when the company is seeing negative estimate revisions.

Stock to Consider

Investors interested in the broader Transportation sector may consider American Airlines Group Inc. (NASDAQ:AAL) , Canadian National Railway Company (NYSE:CNI) and Golar LNG Limited (NASDAQ:GLNG) as these stocks possess the perfect mix of elements to beat on earnings this reporting cycle.

American Airlines has an Earnings ESP of +0.85% and is a Zacks #3 Ranked player. The company will report second-quarter 2019 results on Jul 25. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Canadian National stock is a #3 Ranked player and has an Earnings ESP of +0.25%. The company will post second-quarter 2019 earnings numbers on Jul 23.

Golar LNG has an Earnings ESP of +5.91% and a Zacks Rank #3. This company is scheduled to announce second-quarter 2019 financial figures on Aug 22.

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