More Passengers in Fewer Seats Means Profit for Southwest Airlines

Earnings season is underway, and so far, two out of three airlines have posted actual profits, including Southwest (LUV). No, the world isn't ending, but rather, earnings have been front-loaded with two strong performers. While Continental's (CAL) profit is impressive, it's Southwest's that I've been most interested to see. There has been a lot of criticism of Southwest in the last couple years about its revenue strategy, but it now looks like the airline is starting to see things kick into overdrive.

In the fourth quarter, Southwest made a profit whether you include special items or not. Including special items, Southwest made $116 million. Excluding special items, the airline made $74 million. That was above analyst expectations, and it's certainly good news for the airline. How did they pull it off? Well, there were a few things that really kicked their earnings up.

As I've been noting over the last couple months, Southwest's load factors have skyrocketed. The airline has moved airplanes around, cutting frequencies in existing markets and opening up new ones, all without growing. In fact, they shrunk by nearly 8 percent. Yet the changes enabled them to fill so many more seats that their load factor increased by nearly 10 points as compared to the same quarter in the prior year. That means that even with fewer seats, they boarded nearly 6 percent more passengers. That's a tremendous change and it clearly had a major, positive impact on the airline's revenue picture.

Where did all these passengers come from? There was some concern that these extra people were all coming on those really low, really aggressive sales that Southwest posted last year. Looking at their revenue performance, it appears that's what they needed. But it wasn't just from low fares.

Much of it was certainly from changing routes around, but there is more to it than that. They're drawing more passengers away from other airlines. They believe that they're seeing an additional 1 percent market share. In a world of razor thin margins, that's a big deal. If this Bags Fly Free campaign really is bringing passengers their way, the legacy carriers are going to have to start reconsidering.

That's exactly what Southwest CEO Gary Kelly hopes they don't do. In the earnings call, Gary said this about bag fees:

We are not going to be charging for bags. I hope they charge $100 per bag. That would be terrific. We will have 100% load factors. It would be great.

So is it all sunshine and rainbows for Southwest? Not quite. While revenue initiatives seem to be kicking into gear, the cost monster is creeping up behind them. Unit costs excluding fuel in the fourth quarter were up more than 8 percent. They expect 2010 to be 5 percent higher than 2009 and the first quarter to be up more than that over the first quarter of 2009. That's not good, but it's what happens when you stop growing. Southwest says it will be focusing in on this during 2010. We'll have to keep watching.

But for now, the revenue story is carrying the day. That's a nice profit they pushed out for the fourth quarter.