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Southwest Airlines’ Unit Cost Performance Better than Expected

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3Q17 performance

Southwest Airlines’ (LUV) earnings operating income increased 20% year-over-year (or YoY) to $834.0 million. Net profits rose 29.6% YoY to $503 million, which led to 35.5% YoY growth in diluted earnings per share (or EPS) to $0.84.

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New labor contracts and hurricanes

The airline’s unit cost, or cost per available seat mile (or CASM), excluding fuel increased 3.3% YoY to 8.3 cents in the third quarter. Of this, almost 2.0% impact was from the hurricanes.

Labor costs also increased due to the pilot contract renewal that was completed in 4Q16. Despite this, operating expenses were almost flat at -0.02% YoY, as all other costs declined in the quarter.

Fuel costs rose

Crude oil prices have also risen in the third quarter. Southwest Airlines’ fuel costs rose 10.1% YoY to $1.96 per gallon.

Expectations

Southwest Airlines expects CASM ex-fuel to increase 0.0%–1.5% YoY in the fourth quarter of 2017, as the impact of renewed labor contract wanes. Fuel costs are expected to increase to $2.10 per gallon, including a $0.25 cost from Southwest Airlines’ fuel hedging losses.

Southwest Airlines’ hedging losses will also come to an end in 2018, which is expected to provide a good tailwind to the airline’s margins.

Southwest’s peers JetBlue Airways (JBLU), American Airlines (AAL), United Continental (UAL), and Delta Air Lines (DAL) are also faced with similar problems of rising fuel and labor costs.

Investors can gain exposure to Southwest Airlines by investing in the PowerShares Dynamic Large Cap Value Portfolio ETF (PWV), which holds 1.5% of its portfolio in the stock. It also holds 1.5% in Delta Air Lines (DAL).

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