Southwest’s Lead From COVID Has Dissipated, And Now They Face The Consequences
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Summary:
- Southwest Airlines maintained more routes during COVID-19, leveraging domestic travel focus and expanding to new vacation destinations, unlike competitors who cut routes significantly.
- Post-pandemic, Southwest faced challenges including a system failure, outdated IT infrastructure, and rising prices, losing its low-cost advantage to competitors like Frontier and Spirit.
- Elliott Management’s 11% stake led to proposed changes like assigned seating and premium options, but these are not innovative and may not ensure growth.
- Southwest remains far from pre-pandemic recovery, with competitors like United and Delta showing more significant growth, raising doubts about the effectiveness of Elliott’s proposed changes.
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How did we get here?
Once considered a highly innovative company, Southwest (NYSE:LUV) has shown signs of struggling to compete against rival airlines. Additionally, due to rising prices, Southwest can no longer be considered the ‘go to’ budget airline for budget-concerned consumers. This article is meant to display that Southwest’s strategies implemented during COVID have led to the situation it is in now. I believe the changes recently suggested by Elliott Management may be too little too late.
Atypical Strategy During COVID-19 Lockdowns
During the peak of the COVID-19 pandemic, Southwest Airlines was the least aggressive in cutting back its flights compared to other competitors in the industry. The main explanation is Southwest’s unique focus on domestic travel compared to international travel. While their competitors had to reduce their routes offered by 60-65%, Southwest maintained more than 70% of the total routes during the peak of the COIVD-19 Pandemic.
This gave them a chance to outcompete the other airlines in the industry. CEO Gary Kelly took the opportunity and expanded their routes to many vacation destinations that were not previously offered. At the same time, the other three main airlines [Delta (DAL), United (UAL), and American (AAL)] aimed to maintain their hub-and-spoke system. The CEO of Delta Air Lines, Edward Bastian, aimed to preserve Delta’s financial liquidity and ensure they were well positioned for recovery.
Southwest’s seat reductions from 2019 to 2020 decreased by 32.6%. This was significantly lower than the other three major airlines (Delta 44.2%, American Airlines 41.5%, United 54.4%). Southwest had many other expansionary policies during COVID-19 compared to other airlines, such as using larger airplanes than their competitors. In addition, in March 2021, Southwest reached a deal with Boeing for 100 new 737 MAX 7’s.
More Trouble For Southwest
After the lockdowns caused by the pandemic ceased, trouble began for Southwest Airlines. Their vision of capitalizing on their competitive advantage started slipping. They could not account for a complete system failure in December 2022, which canceled over 15,000 flights mainly due to outdated IT infrastructure and only made worse by their point-to-point flight strategy.
Additionally, their entire fleet is Boeing-manufactured planes, so orders for planes were delayed after Boeing experienced a malfunction in a door plug. This caused Southwest to announce they would cut 2,000 jobs in April 2024. However, they also reported first-quarter losses of $231 million, which was more than the previous year, even though Southwest reported an increase in revenue by 10.9% in that same time frame. Southwest Airlines also announced they would cut specific flight destinations, which continued up until September of this year.
Q2 Quantitative Analysis
Southwest has had an acceptable Q2 performance this year. Revenue for the quarter stands at $7.4 billion (4.5% year-over-year). In addition, its liquidity is $11 billion, with an outstanding debt of over $8 billion. However, revenue per available seat mile (RASM) decreased 3.8% year-over-year. This could be attributed to increased competition in the industry. Southwest explained this decrease by stating, “industry-wide domestic capacity growth [is] outpacing demand.” In my view, this answer is lackluster, considering they generated an advantage throughout the recent pandemic and could not maintain it. Cost per available seated mile is projected to increase 11%-13% in the third quarter, and year-over-year expected to increase 7%-8%. This displays a rise in costs, which could hurt the profitability of Southwest.
I will now compare Southwest’s results to United Airlines’ results and attempt to account for the size differences of the respective companies reasonably. United’s operating revenue was $15 billion (5.7% year-over-year). The company’s liquidity was $18.2 billion, with an outstanding debt of $26.6 billion. Revenue per available seat mile decreased 2.4% year-over-year. Cost per available seated mile decreased 4.8% compared to the second quarter of 2023. Notably, premium revenues grew 8.5%, and basic economy revenues grew 38% compared to the same quarter last year. CEO Scott Kirby said the following about the aforementioned metrics, “The revenue diversity advantages that we’ve built with our premium customers, Basic Economy customers, and domestic road warriors, on top of the world’s best loyalty program and leading customer service, have propelled our margins to near the top of the industry,”
Where Southwest Is Today
Southwest’s situation has only become more complicated because of its rising prices compared to its competitors. Southwest has always aimed to be a low-cost airline. However, smaller competitors such as Frontier and Spirit Airlines have come in at significantly cheaper prices in recent years.
From a consumer’s perspective, they see an airline that has become more expensive than the competition and cannot compete with Delta, United, or American in terms of quality. This has lost some of their customer base, and their staple free bag policy can be a selling point to some. However, this also leaves significant questions on how much possible revenue they are leaving on the table.
After Elliott Management announced their 11% stake in Southwest Airlines, they criticized how Bob Jordan was running Southwest Airlines. They also outlined a plan for the company that included: Assigned seating, premium seating, boarding changes, and the introduction of red-eye flights. On July 3rd, of this year, the company adopted a poison pill policy to attempt to stave off the ‘hostile takeover.’
These proposed changes are projected to take three years. However, the majority of their competitors have most if not all of these changes already established in their company. To make things more challenging, Elliott is also calling for the replacement of the board of directors at Southwest Airlines. This marks clear instability within the company itself, and could lead to a further departure from the company’s values.
The questions remain, how long will this entire process take, and what will be the outcome?
If Elliott Management succeeds, the airline will still have a long road to recovery, and during that time, its main competitors will likely capture some of their market share. I believe that Southwest’s changes are not innovative to the industry, so there is speculation on how effective they will be for the company’s growth.
Conclusion
Southwest Airlines is still far from recovery since the pre-pandemic era. The company has also not reached its peak achieved in 2015. The only other airline that shares this commonality is American Airlines. United and Delta Air Lines both show much more significant signs of growth than Southwest.
Elliott’s proposed changes aim to modernize Southwest and offer more luxury seating to consumers. However, United and Delta already cater to this style of flight. Once Elliott’s proposed changes can be implemented in Southwest, it’s uncertain how much they will actually affect the growth of the company in the long term.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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