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Southwest to Accelerate Second-Hand Jet Inspection

Anirudha Bhagat - Author

Nov. 13 2019, Updated 9:29 a.m. ET

On Monday, Southwest Airlines (LUV) said that it will accelerate inspections of 38 remaining second-hand jets. The company bought the jets earlier from foreign carriers. The announcement came after the FAA threatened to ground the aircraft unless the company completes the inspection.

Southwest Airlines assured the FAA that it will complete the inspections by January 31, according to the Wall Street Journal. Earlier, the company was given time to complete the inspections before July 1, 2020.

The inspections relate to 88 second-hand Boeing (BA) 737 aircraft that Southwest Airlines acquired during 2013–2017 from 16 different carriers. According to the Wall Street Journal report, the FAA thinks that several used planes might not meet mandatory safety standards.

In 2018, the FAA ordered Southwest Airlines to physically check every plane after a safety inspector found discrepancies in a repair and maintenance record book. The airline had a two-year timeline to complete the inspections, which ends on July 1, 2020.

However, Southwest Airlines has only completed the inspections on 41 jets. Meanwhile, another nine planes are undergoing assessments. The FAA has thrashed Southwest Airlines for its slow pace to evaluate the planes’ airworthiness.

Southwest blamed missing repair and maintenance history reports for the delay in its inspection process. The company has a hard time translating “63,000 repair documents in 15 languages,” according to the Wall Street Journal report.

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Inspections add troubles amid MAX crisis

The latest grounding threat might enhance Southwest Airlines’ problems. The company is already suffering from the Boeing 737 MAX grounding. Notably, the Boeing 737 MAX has faced a global flying ban since mid-March following two deadly accidents within five months.

Southwest Airlines, which owns 34 MAX jets, has faced more than 35,000 flight cancelations. Overall, the cancelations have a severe impact on the company’s financials. The grounding has reduced Southwest’s total revenues by $385 million in the last two quarters. The company expects that ongoing troubles with the MAX grounding could impact its fiscal 2019 revenues by $435 million.

Due to the MAX grounding, Southwest Airlines faces huge seating capacity losses, which leads to increased operating expenses. In the third quarter, the company’s overall seating capacity fell 2.9% YoY. As a result, the company’s total unit cost rose 4% YoY to 12.24 cents in the third quarter.

Therefore, grounding another 38 planes would result in substantial financial losses for Southwest Airlines. Also, removing more planes from the company’s fleets would also impact its expansion plans, particularly across the Hawaiian Islands.

Previously, Southwest Airlines planned to use 737 MAX planes across the Hawaiian Island route. However, the global flying ban delayed the company’s expansion plans. Southwest Airlines wants to use its older 737 planes to expand in the region. If the FAA grounded another 38 jets, Southwest Airlines would have a hard time expanding its operations in the area.

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Southwest Airlines’ stock performance

Southwest Airlines stock, which was hit by labor dispute and Boeing MAX issues, has managed to rebound. Currently, the stock is the top performer in the airline industry with a YTD (year-to-date) return of 24.5%.

Its YTD return also outpaces the gains of broader market indexes as well as the iShares Transportation Average ETF (IYT). The S&P 500 and the Dow Jones indexes are up 23.3% and 18.7%, respectively, YTD. The IYT ETF, which has allocated 20% of its funds in the passenger airline, has gained 19.2%.

On the contrary, Southwest Airlines’ top peers have failed to keep pace with the broader market. Delta Air Lines (DAL) and United Airlines (UAL) stocks have soared 14.7% and 10.7%, respectively. Another peer, American Airlines (AAL) has lost 8% of its market value in the year so far.

Analysts don’t see much upside potential in Southwest Airlines stock in the near term. Several analysts are cautious about the stock. At the beginning of 2019, nearly 67% of the analysts were bullish about Southwest Airlines stock. However, the proportion has fallen to 38%. The stock’s average target price has fallen 3.6% to $60.26. The current target price reflects a 4% upside potential over the next year.


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