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Southwest may tweak strategy
Smaller planes, in-flight entertainment studied; profit tops forecasts
CDT on Tuesday, October 21, 2003
By ERIC TORBENSON / The Dallas Morning News
Southwest Airlines Co. reported another quarterly profit Monday under its tried-and-true business plan, but the Dallas-based carrier signaled that big strategy changes could be on the horizon.
The company earned $106 million, or 13 cents a share, for July, August and September, its 50th consecutive profitable quarter.
The total was more than double Southwest's third-quarter $50 million profit a year earlier, not counting a government grant, and topped analysts' expectations by a penny a share.
While the profit story remains the same, Southwest executives are considering significant tweaks to the company's longtime business model.
Southwest's often-studied model of using just one family of planes – the Boeing 737 – and offering friendly but rudimentary on-board service has been mimicked but never quite equaled.
The company is now "casually" studying the possibility of adding a smaller plane, said chief financial officer Gary Kelly.
The chief suspect is Embraer's 190 series. JetBlue Airways Corp., a fast-growing New York-based rival of Southwest, ordered the Brazilian-built, 100-seat planes in bulk this year.
"We have looked at and declined on [flying] regional jets several times over the years," Mr. Kelly told analysts Tuesday in a conference call.
But, he added, Southwest could now use smaller planes in its smaller markets. "We're acknowledging that we're looking at it," he said.
Southwest also is studying whether to add in-flight entertainment, which until now has been limited to witty banter from flight attendants. Mr. Kelly wouldn't specify what was being considered, but said the options would appeal to business travelers.
Southwest is operating more long-haul and transcontinental flights that are well-suited to in-flight entertainment. Another motivating factor is competition from JetBlue, which offers in-seat satellite television.
Mr. Kelly knocked down a rumor – floated during an Oct. 6 aviation forecast conference – that Southwest was planning to start assigning seats. It isn't, he said.
But the carrier will continue to grow, Mr. Kelly said. Southwest will get 47 new planes in 2004, including five announced Monday.
By contrast, Southwest's fleet totaled 46 planes in 1983. The fleet currently totals 385 planes.
Southwest also will add one city to its network by year's end and has enough planes to add a second destination.
The carrier hasn't decided what it will do at St. Louis, where American Airlines Inc. is pulling half its capacity Nov. 1.
The issue there isn't passenger demand, but high airport costs, Mr. Kelly said.
Overall, Southwest operations will grow 7 percent next year and 11 percent in 2005, Mr. Kelly said. That pace – after a couple of years of growth near 4 percent – has some analysts warming to Southwest's shares.
"In our view, investors have paid less attention to Southwest than some of its low-fare peers because of the company's adherence to its basic operating principles and its very conservative nature," Gary Chase of Lehman Bros. said Monday in a note to investors.
"We expect that investors will begin to appreciate the relative stability that Southwest offers," he said.
But others, such as Jim Higgins of Credit Suisse First Boston, say Southwest shares are priced too high.
Investors seemed inclined to adopt Mr. Chase's view Monday, when Southwest shares climbed 59 cents to $18.99.
That's not to say Southwest doesn't have big challenges ahead, namely rising labor costs. Southwest's pilots are due for 13.6 percent wage increases next year.
"Southwest's pilots will emerge as industry wage leaders" if Delta Air Lines Inc. and Northwest Airlines Inc. persuade their pilots to accept lower wages in contract renegotiations, Jamie Baker, an analyst with J.P. Morgan Chase, said in a note to investors.
"Therein lies the problem with costs," he said. "If you can't beat 'em, try and grow out of 'em."
Southwest intends to counter the higher wages with productivity improvements.
"We're not going to run our business based on what the competition pays their people," Mr. Kelly said. "Our goal continues to be the low-cost producer."
Southwest will cut one of its larger costs by ending 5 percent commission payments to travel agents Dec. 15. Southwest is the last major carrier to drop the payments, and it expects the move will save it $40 million next year.
Travel agents once booked 53 percent of Southwest's tickets, but now account for 15 percent of sales. More than half of Southwest's customers now book through the Internet, the cheapest way to sell tickets.
The revenue side of Southwest's ledger looks "pretty good" going forward, Mr. Kelly said. Revenue rose nearly 12 percent year over year, and bookings for the upcoming holiday months are solid, he said.
The percentage of passengers paying Southwest's top fares – mostly business travelers – rose to 36 percent from 31 percent in the third quarter of 2002. That healthy increase helped fuel third-quarter earnings, Mr. Kelly said.
Overall, business travel is coming back, although slowly, he added.
Separately Monday, Standard & Poor's Ratings Services said it changed is long-term outlook on Southwest to "stable" from "negative" on the strength of its results.