Southwest Airlines held its second quarter earnings call on Thursday. And with the airline completely upending its business model, the quarter is a good opportunity to check in with how things are going.
- They say that copying what all the other underperforming airlines are doing is going great!
- But the bottom seems to be falling out of financial performance. They now expect $600 – $800 million in profit for the year. The previous guidance was $1.7 billion. Southwest says their new initiatives are worth $1.8 billion in earnigns this year – so they grade themselves a success against a counterfactual that they’d be losing money without them. That’s one way to do accounting.
- On the one hand, the second quarter was tough with economic uncertainty derived from tariff talk. And Southwest is uniquely positioned to bear the brunt of that. All airlines have been reporting the weakest demand for domestic coach and that’s pretty much the entire Southwest product.
- Fewer people are flying Southwest. The airline’s load factor has fallen. So has the industry’s, but Southwest started off filling a smaller percentage of its seats than competitors.
- Southwest lacks a premium product, and even with all the airline’s changes the most they even have in the pipeline is extra legroom seats with no option to pay for a blocked middle seat – with poor wifi, no lounges or meals.
In other words, they’re giving up their differentiation and their financials are still suffering. But they’re claiming success. Southwest CEO Bob Jordan did drop a hint about lounges being in their future again, though.
Gutting The Customer Value Proposition
Southwest has reduced the value of Rapid Rewards; started selling tickets on Expedia (the worst place to buy tickets for most); started redeye flying; laid off employees for the first time ever; outsourced and started charging for curbside checked bags; ended bags fly free with new bag fees; started expiring flight credits; implemented basic economy restrictions on the cheapest fares; and started retrofitting planes with extra legroom seats (but no first class, no standard power outlets, no ovens in galleys).
One quarter of the Southwest fleet now has extra legroom seats. >Pro-tip: customers boarding early can sit in these free, until seat assignments go into effect – they’ll sell seats starting July 29 for travel January 27 onward. (Southwest is emailing customers on flights with extra legroom seats to encourage them to buy up to earlier boarding.)
$2 Billion In New Share Buybacks
Their activist investor wanted them to load up their balance sheet with debt and buy back shares. And that is happening, with aircraft financing and now new buybacks.
Shares were down more than 10% on the day and they’re down year-to-date. They announced a new $2 billion share buyback program and shares fell.
- Buybacks don’t usually lead to sustained higher prices
- They don’t increase value per share since the value of the company falls by the amount they spend on shares, even as the number of shares fall
Buybacks are fine. It’s weird to think that the number of outstanding shares should ever go up. They can be a tax-efficient way to return capital to shareholders. But they don’t make a company more valuable – there can be a brief boost to price while the buybacks are actually happening (and perhaps some executives time their 10b5 pre-scheduled sales around them).
They can, however, be better for the world. If other companies have better opportunity for productive investment, freeing up the capital for investors to place elsewhere means more growth.
Southwest no longer hedges fuel. They sold off their remaining hedges (which were in the money!) for $40 million. That’s consistent with selling planes, mortgaging planes, and using the proceeds to buy back shares.
They’re also “shifting from a cash target to a liquidity target,” taking on greater revolving credit in order to meet liquidity needs. That way they can extract more cash from the balance sheet.
Basic Economy Scared Customers Away
When Southwest rolled out basic economy, they “experienced a temporary decline in bookings” which they attribute to reduced conversion of flight searches on their website (people saw the basic economy offering and didn’t buy). They’ve changed how they’re marketing the product during booking and things have stabilized, and they ran promotions to fill the seats they failed to sell earlier.
They describe an “impact to second quarter 2025 year-over-year RASM of nearly 0.5 point” and that’s from just one month of the quarter selling basic economy (and charging for checked bags on new ticket sales). They suggested they fixed the problem, but they “expect an impact to third quarter 2025 year-over-year RASM of approximately 1 point.” So it’s ongoing, even if they would have sold some third quarter travel in the two weeks this was supposedly going on.
Checked Bag Fees Aren’t As Profitable As Southwest Claims
So far checked bag revenue is higher than they expected. But they don’t share how much lower their base fares are to compensate. They’ve seen “a modest increase in gate check bags as expected, but have experienced no negative impact to the operation.” They’re using AI to tell them how many bags to confiscate from customers at the gate for each flight, so that it’s not being done at the last minute.
Southwest estimates that “checked bag fees will result in more than $350 million of EBIT for the full year 2025, which compares favorably to our initial estimates and has a run rate of approximately $1 billion of EBIT had it been in place for the full year.”
Checked bag fees are not all profit! Generally fares fall, and fees make up a portion of that. It’s what we’ve seen overall in the industry with fares and fees combined declining on an inflation-adjusted basis.
And with Southwest now selling 5% of its tickets on Expedia, they need their pricing to be competitive with United, American and Delta. Previously they bundled checked bags and frequently charged more than the lowest fare offered by competitors. That’s the whole idea behind Southwest’s basic economy is to match lowest fares but charge extra for everything.
What checked bag fees do is (1) price discriminate and (2) tax arbitrage.
- Some people want to check bags and others don’t. Those who do pay more. But it’s your most price sensitive vacation travelers and families that tend to check bags and whom you’re trying to charge extra.
- What’s huge, though, is that fees aren’t subject to the 7.5% excise tax on domestic airfare. Moving $1 billion out of fare and into fees saves the airline $75 million in taxes. It shouldn’t be this way – the tax code shouldn’t treat base fare and fees differently – but it does. Congress is subsizing the very fees travelers hate.
A year ago Southwest was saying they’d generate $1.5 billion on checked bag fees and still lose money charging for bags because it would cost them $1.8 billion in revenue from lost sales. So they can say how pleasantly surprised they are by $1 billion in revenue, but it sounds like underperformance and fails to account for the lost sales that Southwest said would be much greater.
Southwest was floundering. They had gotten bloated and they’ve been slow-moving. And the pandemic accelerated a shift in customer preferences away from their basic product and limited route network. That critique was fair. But they were the most financially successful airline in history, most consistently profitable, and that was because they were fundamentally different than the copy cat industry of underperformers.
There’s a reason that Warren Buffet used to say the quickest way to become a millionaire was to start out with a billion dollars and invest in an airline. That was true most everywhere except Southwest. Southwest’s investors aren’t being rewarded for this performative effort. Elliott Management doesn’t seem to be getting rewarded for it, either. And it’s just sad to watch.
@Gary: “– research doesn’t support any lasting benefit to share price from buybacks”
Not to chatGPT….
chatGPT:
Academic & Empirical Evidence
Moderate positive correlation: Studies generally find that buybacks lead to modest long-term outperformance, especially when:
Done when shares are undervalued.
Funded by free cash flow (not debt).
Part of a broader capital discipline strategy.
@George Romey:
“Ultimately the question is will bag fees more than make up for possibly lower load factors and fares. Bag fees are near 100% profit and exempt from taxes”
Wrong.
“In general, there’s too many coach seats chasing too few customers”
Wrong
“… BE fares are total money losers.”
Wrong.
Think about a job at Lehman Bros.
L3,
you as a consumer might want to believe the industry needs as much or more seats than it has now but it is definitional if more than half of the industry is not financially viable that there are too many seats at current costs.
Delta led the industry in raising labor rates post covid and it is not a surprise that they are doing well while many other airlines are not. United is doing as well as it is because it isn’t paying industry average fares for many workgroups. When they are paying the same wage rates as AA, DL and WN, then we can compare their profits.
AA is right that they finally paid the bills with labor and it is costing them; WN also moved fairly quickly to increase its labor costs before revenue challenges returned.
Glad to learn that all the special needs passengers will be getting extra room seats. Probably won’t be more than 50 or 75 wheelchairs and hangers-on for a typical flight between now and January
@Tim Dunn: “Definitional if more than half of the industry is not financially viable that there are too many seats at current costs”.
That is not analysis, it is a statement of the status quo. The analysis is that there are too many restrictions to entry. Eliminating them makes costs endogenous.
Elliott Management doesn’t make their money running an airline. Elliott Management makes their money selling an airline, either whole or in pieces.
So what’s the game here?
I opened an AA card and booked my first non southwest flight in at least 12 years for our family vacation. If I’m going to be paying more (which I actually didn’t) I might as well fly on a nicer airline where I can choose Airbus instead of boeing.
@Denver Refugee — Games are being played here, for sure. Entities like Elliott Management often ‘gut, extract, leave.’ I doubt their plans truly involve these ‘pipe dreams’ like a new First Class (@Mike Hunt) or wide-bodies to Europe (@Tim Dunn), because both of those concepts take real time and major investment to implement. No, instead, these finance bros are just gonna lay off a bunch of hard-working folks, and charge consumers more for less. That’s what ‘lean’ means in reality; it’s usually not a pleasant process or outcome. This has ‘vulture capitalist’ written all over it.
As far as how the ‘end’ could look, it might be a Northwest-style merger or the Pan Am-style sale of assets. There’s also the Norwegian-style break-ofd, where that airline practically sold its 787s to itself (with a new name, ‘Norse’), then kept its 737s for short-haul intra-Europe flights under the original brand. The only problem with that analogy is that Southwest has no wide-bodies to sell. Psh.
@L3 Typical event studies show 0.5% to 1% pop from repurchase announcements, but the effect goes to zero within 6-12 months (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4074962) and where there had been studies based on data in the 80s and 90s showing long-run alpha from buybacks, that disappeared in the data after 2000 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4074962).. buybacks don’t create shareholder value in themselves. Clearly here in this piece I defend them! They’re tax-efficient return of capital and a company that does this is better and more valuable than one that hoards capital while underpeforming with it!
@Tim Dunn “thank you for posting the LUV chart; we as commenters can’t do that.”
This is the same chart that is in the post itself, which given earlier comments and criticisms jousted at things not said it still seems like you did not fully read 🙂
Gary,
I can read just fine. It is you and your caustic comments about AI while failing to realize that WN is carrying fewer passengers and RPMs than it did last year.
None of which changes that we as commenters cannot embed images.
we can all CHERRYPICK the dates we want to show a stock performance story.
Specific to LUV, the story should not be about when Elliott started buying shares but when WN started rolling out and implementing plans to change its business plan.
WN JUST implemented its baggage policy one month before its last earnings period closed.
If you would get off of your high horse long enough to recognize that some of your readers just might know a thing or do that you don’t, your reader comments sections just might be a more constructive place.
Quite frankly, you have harped on WN for over a year and repeatedly understand or accept that WN’s changes were financially necessary regardless of how much you or anyone else wants to mourn the loss of what WN once did.
@Tim Dunn: “Specific to LUV, the story should not be about when Elliott started buying shares but when WN started rolling out and implementing plans to change its business plan.”
No. I gave you the date. – the date they got control.
@Denver Refusenik: “Elliott Management doesn’t make their money running an airline. Elliott Management makes their money selling an airline, either whole or in pieces.
So what’s the game here?”
The selling price is the NPV — capiche?
@Gary: Buybacks.
First chatGPT, now Claude are supporting my view.
do share buybacks lead to a long-term increase in stock prices?
The research on whether share buybacks lead to long-term stock price increases shows mixed but generally positive results, though the academic consensus isn’t entirely settled.
Evidence Supporting Long-Term Benefits
A seminal paper found that firms who buy back stock subsequently outperform their peers by 12.1% over the next four years. This finding appears robust across different markets – studies of buybacks in 31 non-U.S. markets found that share buybacks are associated with higher shareholder value in the long run, with results holding in most countries.
(PDF) Are Buybacks Good for Long-Term Shareholder Value? Evidence from Buybacks around the World
Research found no compelling evidence of a negative impact from share buybacks on long-term value creation for investors overall.
The Mechanisms
…
L3,
Elliott did not gain control and still does not “have control” They are a major shareholder. Let us know the percentage of each of the large US airlines that are held by a few major players.
Elliott has succeeded at convincing the world of WN’s strategy failures, WN mgmt said they had identified some of those issues themselves (but have never released internal documents to prove it),
you and Gary and anyone else can argue all you want about the past including stock performance.
WN’s story will be defined by whether they can turn things around NOW THAT THEIR TRANSFORMATION ELEMENTS ARE BEING IMPLEMENTED.
if we have quarter after quarter of WN making excuses (like AA has done for a decade), then we can say that WN really has no control of its business.
But if that happens, then AA and WN come into play with other carriers and that is a far bigger story than what happens with UA and B6
Southwest has been the victim of a classic private equity play: Maximize short-term earnings, sell off assets, load the company with debt, then exit (that part is still in the future) Maximum gain for the private equity firm, but usually eventual bankruptcy and dissolution of the actual business. Private equity is rarely ever about actually running a business for the long-term.
All the reasons that led me to fly Southwest have been removed. Now that have to pay for bags and seating changes…..will fly Delta and AA now. Beginning of the end for SW in my opinon.
@Tim Dunn: Elliott did not gain control and still does not “have control”
No. They do, or they would not feature in SWA discussions. .
Elliott features in discussions because they want WN to fear that they COULD take control – which is just as true about labor/mgmt relations and loyalty program participant/mgmt discussions.
We have no idea what WN intended to do but it is preposterous to believe that WN didn’t realize something needed to be done
Should they have recognized that change was needed and implemented earlier? Absolutely.
Southwest has turned long time loyal customers/buyers into shoppers and I am one of them. They took one of the most expedient plane loading practices and threw it in the trash. What I admired most was that they could efficiently get passengers on board in 15 minutes and be ready to roll when other airlines with assigned seats take more than 30 min. This direction of seats and bag fees will be looked at by buyers as the same mistake made with changing Coke and Bud Light.
Huge bummer all around. I’m already shopping for new airline card to switch to as soon as I deplete the massive amount of miles from my Rapids Rewards Card I use for almost everything.
The income statements of the airlines themselves show flying isn’t really at that profitable, including the US3 that have lucrative premium demand and increasingly are monetizing premium cabins in lieu of free upgrades. L3 apparently didn’t learn basic economics with his Lesbian Dance degree.
Which would mean BE fares will never make money and that’s not the point. The point of BE fares is number one to fill seats that might otherwise go empty and number two increase cash flow because the airline has your money months before it has to deliver the service. But again economics generally wouldn’t be covered in Lesbian Dance.
If Southwest loses an average of ten passengers per flight but obtains bag fees from ten passengers financially it will come out of head as baggage fees are pure profit. There’s a tiny amount of labor and a one cent bag tag and that’s pretty much it. No fuel, no crew, no dispatcher, no airport charges.
@Tim Dunn: Elliott does have control. They are the instigator or approver of every SWA value-changing move.
Ladies and gentlemen: This is the intellectual level of what comes out of George Romey’s mouth.
” L3 apparently didn’t learn basic economics with his Lesbian Dance degree.”
@Jay L Hohensee — Yes. YES. YES!!! Bingo. 100%. Winner, winner chicken dinner. Thank you.
@L3 — @George Romey is just jealous. Besides, he (and others) are probably into at least *watching* that ‘dancing.’ Thanks for fighting the good fight here.
@L3 – you’re not providing citations, but again I point out you can’t look at old data and the question isn’t whether ‘companies that do buybacks outperform those that don’t’ (your study) but whether ‘buybacks are the cause of higher market returns’.
You’d expect companies with lots of free cashflow to outperform those without in many cases, especially in older (pre-2000) data. That’s different than saying the buybacks themselves drive value.
how very sad, JL, that you think companies and people are controlled by anyone.
WN always had the choice to ignore what Elliott wanted.
They didn’t because it was obvious that WN knew their model was broken and was taking steps. Whether they were the same as what WN wanted, we will never know.
and Elliott is not interested in running or even owning an airline. They are interested in making money on their investment and their ability to “win” is as long as WN execs take to get LUV’s share price up as much as Elliott thinks it will go.
@Tim Dunn – on what planet am i failing to realize WN is carrying fewer passengers, that was literally one of the key points made.
You argue they’re shrinking as an airline but I point out they grew capacity.
You have just been making stuff up that fits whatever narrative, even if it has nothing to do with the matter at hand.
@Gary: Run the same query in Claude. The citations are in pop downs. The important thing is that there are good (AKA value maximizing reasons) for mgt. to instigate share buybacks. One is that mgt. can signal true value.
@Tim Dunn: Elliott runs SWA. They are the board. Who on earth do you think can contradict them?
Yesssssss south west sinking. Gooooo board. Keep on going. Wait till the seat charge goes in. By by more loyal customers
Wanna make more money. Hmmmmmmm make more flights through out usa. North Central big hole.
How do I get to north and south dakota. Ohhhhhh fly to Denver and drive 8 – 15 hours. Wait a minute. I can fly United quiet flights
What a thought idio. Oh wait ✋️. Can’t hurt thy feeling. Why not you hurt mine robbing my pocket and screwing open seating
A lot of pain could have been avoided if they didn’t let customers abuse the early boarding system. Those that got group A had to watch approx half the plane board during early boarding. And on flights to Hawaii you didn’t have food for purchase.
@Srini Rao — So ‘jet-bridge Jesus’ is the scapegoat here!
SW will be so much easier to be merged or sold in pieces when it walks and talks like the big three. Except for no F class, that is the new SW as managed by Elliott. Think Project 2025; except it’s the airline industry not the federal government.
The only reason people fly this airline is because it’s CHEAP. Once you remove that the competition will eat you up.
Your terminals are the dirtiest in the airport.
Keep nickel and dimeing your customers and the flights will start to be empty.
Can’t convince me that Elliott hasn’t sold the stock short, through one instrument or another. Possibly hidden aka a corporate shell game. They should be investigated. Hate to see such a successful business model destroyed by a bunch of hack parts peddlers.
Long time frequent SW traveler here. I used to only fly JetBlue until pricing went up. Switched to SW . Sadly, now with all of this nonsense going on with SW , I will be searching other airlines for comparative fares. To fly TPA to JFK or LGA is now a 5 plus hour flight due to no nonstop flights. I would rather pay a little more money and travel for 2 hours than sit in an airport layover for 6 hours. Get it together SW , you are losing your customer base!
@Marie — Cheapest options from TPA-NYC probably Frontier and Spirit. Think under $100/person/way no frills.