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.
The vulture capitalist scum that is Paul Singer and his company have found new carcass to feed on. It isn’t carcass yet but they will peck on it until it becomes. That’s the idea. My last SW flight was in January before I knew Elliot had taken over and now that I know, it will remain my last SW flight. All future flying will be on Delta provided they don’t follow through with their AI / Fetcherr fair gouging, and/or AA. Paul Singer can go F himself.
Please fix typo in my previous post “Vulture Capitalist…”
Fair = fare. Thanks.
I will continue to use Southwest until my points run out. I will check a bag when I travel and will then cancel my Southwest Priority Card as it will not longer be of any value since they have raised the annual fee now by $80.00 to a whopping $229. per year.
I fully agree with @John Smith, the Vulture Capitalist is circling it’s prey, and will soon pick the carcass of any leftovers. I have looked into some of their other predatory destructive conquests. They are truly despicable.
@TG — I critique much of what you do on here all the time. However, the ideals of Wall Street, financial markets and institutions, etc., are not inherently bad. Like, we do not need to ‘blow it all up and start over.’ That’s too extreme.
For this era, the underlying problem is that we’ve de-regulated to the point of generalized corruption. Ironically, #45/47 correctly diagnosed the problem, blaming the elites, but then gave them everything they wanted (tax cuts for the super rich, more de-regulation), while screwing his own base (the folks that actually rely on the existing social safety net programs, Medicaid, etc.) It’s sad to watch, as they may soon realize their healthcare is no longer covered, their homes and food no longer affordable, their jobs automated, shipped overseas, etc.
As for Southwest, yes, it is sad to witness a once ‘great’ company, which differentiated itself with consumer-friendly practices, now just become ‘yet another’ airline with extra fees for everything. As others above have stated, it does feel like a ‘private equity’ takeover, which usually ends poorly for workers and consumers, but is ‘great’ for the ‘get rich quick’ types, who seek to pump n’ dump. Sadly, when the rug is eventually pulled, we’re the ones holding the bag as we’ll have lost a quality competitor in this industry.
My hope remains that we’ll survive this 2nd Gilded Age, and a new Progressive era will follow, but that takes real effort (and there are wealthy, powerful people, and their enablers, who will do everything they can to prevent that from happening, most of us and the climate be damned.)
Why would I fly another copy of AA, Delta, And United with something that has no first class, no lounges, no international destination, small basic 737s, when I can just travel on the big 3. Southwest you got it all wrong and I hope Elliott feels the loss
I already cancelled my credit card and used up most of my points. I will now only fly a southwest if I have no other viable option. Way to destroy customer loyalty by dropping everything that made us your loyal customers in the first place! The schadenfreude watching your suffering due solely to your greed and stupidity will be delectable.
I have been a devout SWA customer for over 20 years. I do not have elite status on any other airline by design. I have flown.them.almost exclusively for all my domestic travel be it personal or business. It is beyond disappointing that SWA drank the Koolaide and joined the other airlines in charging bag fees in the misguided notion that it would boost it’s bottom line. Activist investor interference has shown itself to be the downfall of many companies. Their only interest is making money and lining the board members already bulging pockets. The vultures will be circling the SWA carcass if they continue to go down this unpopular course.
“Everything Wall St touches dies.” That’s why I’m so glad I haven’t been investing my retirement money in stocks. No, wait, I did invest in stocks and, like my parents and grandparents who did the same, my money hasn’t died—it has grown nicely thanks.