Southwest Airlines executives want investors to be clear about big thing: U.S. travel demand is “healthy.” Southwest leaders repeated the word several times during the third-quarter earnings call Thursday.
Healthy is OK in a normal market. It means airlines can fill their seats.
But in a market with rapidly growing supply — with many more airplane seats — steady demand is not enough to boost profits. Add in rising labor costs and the pressure gets worse.
That was clear in Southwest’s results. It was profitable, but barely. Its operating profit margin excluding items was just 3.4%. Capacity grew 12.5% from a year ago, but passenger traffic grew only about half as much. That contributed a 6.4% drop in passenger unit revenue.
“Travel patterns are changing,” said CEO Robert Jordan. “While it’s still strong, they’re changing for leisure, [and] they’re also changing for business — we’re seeing gains, but that last 10 to 15 points of business recovery is a little bit stubborn here.”One change Jordan highlighted is that return-to-school dates for many Americans are moving earlier in August. That contributed to weak off-peak demand in August and September.
The business travel recovery, as Jordan noted, remains stalled at roughly 80-85% of 2019 volumes. And blended leisure and work trips have increased since the pandemic, which has shifted when and where people are flying.
This has U.S. domestic-focused airlines rethinking where and when they fly. Frontier Airlines, JetBlue Airways, and Spirit Airlines have all indicated that they are looking at making network changes.
For Southwest, that includes cutting growth to allow the many new markets it added during the pandemic to mature — Chief Operating Officer Andrew Watterson named Hawaii as one such market.
Orlando’s Gain is Fort Lauderdale’s Loss
Southwest unveiled its largest network change to date Thursday: Moving its southeastern international gateway to Orlando from Fort Lauderdale. The airline will add six new nonstops from the central Florida airport in June: Cancun, Grand Cayman, Nassau, Providenciales, Punta Cana, and San Jose (Costa Rica). It already serves Aruba and Montego Bay from Orlando.
“The international destinations … actually are modest-sized markets, that require a decent amount of connectivity to fill them up,” Watterson said. “Orlando being a little bit further north and having more flights for Southwest Airlines north of Orlando allows us to have the good complement of the local plus the flow.”
Southwest serves 22 U.S. cities from Fort Lauderdale, including Orlando and Tampa, in October, according to Cirium Diio schedules. It serves 47 cities from Orlando, excluding Fort Lauderdale and Fort Myers to the south.
Asked whether this marked a new focus on connecting traffic for Southwest, Watterson said: “Connectivity has always been the icing, not the cake, but we were very intentional about how we use it.”
The airline has long focused on travelers flying direct between cities, rather than connecting over a few hubs like at American Airlines, Delta Air Lines, and United Airlines. Roughly 25-30% of all Southwest passengers connect at airports across its network, Watterson said.
Southwest also has a crew base in Orlando, and not in Fort Lauderdale, that should help it lower costs on international routes.The carrier will end flights between Fort Lauderdale and six international cities — Cancun, Grand Cayman, Havana, Nassau, Providenciales, and Punta Cana — at the beginning of June, a spokesperson said. Southwest will only serve Montego Bay on Saturdays from the South Florida airport. The airline will continue to serve Havana daily from Tampa.Southwest’s Profit Margin Question
All of the talk of Southwest’s network changes was really about one thing: Profitability. The airline’s historic profitability eroded during the pandemic as costs rose. This year, supply of airline capacity outpaced the growth in demand.
Jordan reiterated to Wall Street analysts that the network changes next year would drive roughly $500 million in incremental pre-tax profit. This, coupled with other cost initiatives and slower growth aimed at boosting revenues, were all part of a “relentless” focus on boosting profit margins.It “is absolutely the plan to improve margins in 2024, and we’re committed to getting back to our long term outperformance and operating margin,” Jordan said.
Southwest posted an 11.5% operating margin excluding special items in the June quarter, and negative 5% in the March quarter thanks to the overhang from its December 2022 holiday meltdown.
Evercore analyst Duane Pfennigwerth, however, pushed Jordan, asking if Southwest was unable to raise margins, if it would consider adding more ancillary fees that are standard at other airlines. For example, checked bag fees and or assigned seating — free items that Pfennigwerth described as “sacrosanct” for the air
