Southwest Airlines (LUV) has been very focused on its capacity growth. Airline capacity is measured using available seat miles (or ASM). ASM is calculated as the number of seats available multiplied by the number of miles traveled.
The airline expanded its capacity in 1Q17 by 4.1% year-over-year (or YoY) to 36,700 million miles, slightly lower than the 5.7% YoY growth in 2016. While capacity growth is an important revenue driver, what’s more important is the airline’s ability to fill up those extra seats.
In the first quarter of 2017, LUV’s traffic grew 3.3% YoY to 29,341 million miles, as the airline carried 2.7% more passengers than in 1Q16. This was slightly lower than Southwest’s capacity growth in the period.
Airlines traffic is measured by revenue passenger miles (or RPM). RPM is the number of revenue passengers multiplied by the total distance traveled.
Higher capacity growth resulted in lower utilization of existing capacity. The airline’s utilization, or load factor, fell by over 0.6 percentage points to 79.9% in 1Q17 from 80.5% in 1Q16. This metric has been quite volatile since the second half of 2016.
LUV plans to continue expanding capacity in 2017, albeit at a slower pace than in 2016. The management’s current capacity growth target is 3.5% YoY. Traffic growth led by the growing global economy will help fill up its seats.
However, competitive pressures will continue to rise, especially since United Continental (UAL) and American Airlines (AAL) have increased their capacity growth targets. United plans to increase its capacity by 2.5% to 3.5% for 2017, while Delta Air Lines (DAL) has maintained its capacity growth target at 0–1%. Spirit Airlines (SAVE) is expected to increase its capacity by 18.5%. Alaska Air plans to grow its capacity for 2017 by 8.5%.
Investors can gain exposure to airline stocks by investing in the iShares Transportation Average ETF (IYT), which invests ~24% of its portfolio in airlines.