Southwest Extends MAX Grounding, Updates Q4 Outlook

Today, Southwest Airlines (LUV) announced that it is removing all Boeing (BA) 737 MAX flights from its flying schedule through April 13. The latest announcement marks the ninth time in the last eight months Southwest Airlines has extended the MAX cancellation period.

In November, the company extended the Boeing 737 MAX cancellation period until March 6, revealing that the MAX grounding would result in 175 daily flight cancellations until then. The airline owns 34 Boeing 737 MAX planes.

With the latest announcement, Southwest Airlines has become the second US carrier after American Airlines (AAL) to extend the MAX grounding period until April. On December 12, American Airlines pushed the grounding of Boeing 737 MAX aircraft until April 6 from March 4. The airline, which has 24 MAX planes, anticipates that the prolonged grounding will cause approximately 140 daily flight cancellations.

Rising uncertainties over Boeing gaining safety approval for its troubled MAX jet prompted carriers to extend their cancelation periods. The last few days’ events have squashed Boeing’s hopes for a 2019 return of the MAX.

Last Wednesday, FAA (Federal Aviation Administrator) administrator Steve Dickson said that the agency would not certify the MAX this year. He stated that Boeing needs to resolve several issues before the MAX returns to service. Considering the latest events, industry experts don’t expect Boeing to receive certification for the MAX before February.

Based on the uncertainty over regulatory approval, Boeing has decided to halt the production of the 737 MAX, beginning in January 2020. Boeing currently builds 42 MAX planes every month and has approximately 400 MAX aircraft in storage.

Concurrent with extending the MAX grounding period, Southwest Airlines updated its guidance for the fourth quarter. In an investor update on December 17, the airline said it saw strong demand and passenger yield throughout the fourth quarter. Therefore, it reiterated its Q4 unit revenue growth guidance despite the impact of the 737 MAX grounding.

Southwest Airlines still expects its unit revenue to increase by 0%–2%, and its unit costs, excluding fuel and profit-sharing, to rise by 4%–6%. The company foresees lower oil prices reducing its fuel expenses in the fourth quarter. The airline predicts fuel costs per gallon to fall slightly YoY (year-over-year), to 2.05–$2.15 from $2.25.

Additionally, Southwest Airlines reaffirmed its overall operating unit cost guidance for 2019, expecting an increase of 8% YoY. The increase is expected due the removal of the 737 MAX, the company’s most fuel-efficient jet.

Southwest Airlines is facing thousands of flight cancellations every month due to the global flying ban on Boeing MAX aircraft. In an investor update, the airline said the flight cancellations would impact its overall seating capacity in the fourth quarter. It now projects its total seating capacity decline to be at the upper end of its previous 0.5%–1% forecast.

Moreover, the carrier still expects the removal of its most fuel-efficient jets to impact its fuel efficiency, and forecasts its fuel efficiency falling 1%–2% in the fourth quarter. Southwest Airlines does not expect any material financial impact in the fourth quarter from its recent agreement with Boeing. On December 12, the airline announced reaching a confidential settlement with Boeing regarding damages caused by the MAX grounding.

In the last two quarters, Southwest has lost a $385 million in revenue due to the MAX grounding. During its third-quarter release, the company forecast losing another $50 million in the fourth quarter. The ongoing MAX crisis is also impacting Southwest Airlines’ expansion plans, particularly across the Hawaiian Islands region.

Analysts have mixed expectations for Southwest Airlines’ fourth-quarter financial results. Whereas their Q4 forecasts suggest a marginal YoY increase in revenue, they suggest a YoY decline in earnings. On average, analysts expect the airline’s Q4 revenue to inch up by 0.4% YoY to $5.73 billion, but its EPS to fall 2% to $1.15. They anticipate its pre-tax profit falling 4% YoY to $784.6 million, and its margin contracting by 60 basis points to 13.7%.

Despite their dismal earnings forecast, of the 20 analysts covering Southwest Airlines, 35% are bullish, 55% suggest holding the stock, and 10% have a bearish view. Their target price of $60.11 implies a 10.6% upside over the next year.

Southwest Airlines stock was battered by the MAX aircraft grounding and labor issues in this year’s first half. However, the stock has managed to rebound in the second half despite near-term headwinds. The airline’s top and bottom lines have improved for two consecutive quarters despite its challenges.

The stock has emerged as one of the top performers in the airline industry. With a year-to-date return of 18.2%, the stock has outperformed most major peers. United Airlines (UAL) and Alaska Air Group (ALK) stocks are up 7.3% and 14.8%, respectively. American Airlines stock has lost 11.7% of its value this year.