uploads///Margin

Can Southwest Airlines Margins Expand Further?

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Jan. 28 2016, Updated 4:13 p.m. ET

Southwest Airlines’ 4Q15 performance

The fourth quarter of 2015 marked the 11th consecutive quarter of profits for Southwest Airlines (LUV). The airline saw a record $992 million in operating income, which led to the expansion of operating margins to 19.9%, the best fourth-quarter margin performance since 1978. Southwest Airlines also saw a 46% YoY (year-over-year) growth in its net income to $591 million and EPS (earnings per share) of $0.90.

For fiscal 2015, Southwest Airlines’ net income increased to $2.4 billion, and its EPS of $3.52 showed an increase of 75% YoY.

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Saving on fuel should help Southwest

Fuel costs make up almost 30–40% of an airline’s expense. The huge decline in crude prices has helped airlines decrease expenses tremendously. Southwest Airlines’ fuel cost declined to $2 per gallon in 2015, which was still higher than industry peers because of the company’s substantial hedging, as we discussed in the previous part of this series (see Part 4).

Improving utilization helps too

Southwest Airlines is the only airline to have seen eight consecutive quarters of improvement in utilization, and this has come at a time when all other major players in the industry, including Spirit Airlines (SAVE), Alaska Air Group (ALK), and Delta Air Lines (DAL), have been witnessing declining utilization.

Notably, JetBlue Airways Corporation (JBLU) is the only other carrier to see improvements in utilization. And we should also note that improving utilization also helps lower unit costs, thus aiding margin expansion.

Southwest’s expectations for fuel and margins

In fiscal 2016, Southwest Airlines expects fuel costs to further decline to $1.70–$1.75. But the company’s unit costs for 2016 are expected to increase by 1%. All put together, Southwest Airlines is set for another year of margin expansion. Specifically, the company expects its operating margins to expand to 20%, backed by a strong demand scenario and soft yield environment.

Southwest Airlines makes up 5% of the total holdings of the Dynamic Leisure & Entertainment Portfolio (PEJ).

Continue to the next part for an analysis of Southwest Airlines’ current leverage.

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