Morningstar | Rising Fuel Costs Challenge Southwest's 3Q Results; Lowering Our FVE. See Updated Analyst Note from 26 Oct 2018
We lowered our fair value estimate for no-moat Southwest to $59 from $62 after the carrier reported third-quarter results with costs per available seat mile 3% higher than the year-ago period, due mostly to fuel costs rising 16%. We raised our expectations for Southwest's fuel costs in 2018 and now expect the low-budget carrier to pay close to $4.6 billion, 13% higher than full-year 2017. Revenue per seat mile improved only marginally, and as a result, margins slipped 200 basis points year over year and 300 basis points sequentially. Following the post-earnings sell-off, shares slid into 4-star territory under our revised fair value estimate.In the high oil-price environment, Southwest has employed tactics like raising fees for early-bird check-in to jump-start revenue per available seat mile, or RASM,  growth , but high exposure to leisure travelers, who are price-sensitive, has curbed this effort. Without deep ties to affluent travelers, Southwest's RASM growth has sputtered compared with legacy carriers. In our previous model, we assumed RASM would increase over 2017, but with management’s latest guidance featuring RASM growth of 2% at most in the fourth quarter, we now expect flattish revenue per seat mile for the full year.
Management’s fresh guidance for 2019 includes elevated fuel prices, between $2.35 and $2.40 for jet fuel, similar to the third quarter. American also projects that costs per available seat mile excluding fuel and special items, or CASM-ex, will increase at least 3% next year. We still assume oil will retreat towards our $60 Brent midcycle price through 2022, but we also assume fuel expense stays above $4 billion next year. As expected, Southwest’s investments in fleet enhancement and new revenue opportunities are weighing on margins. During the quarter, maintenance and labor costs each grew about 7% on a year-over-year basis. After considering management’s guidance, we lowered operating margin expectations for 2018 to 13.8% from 14.7%.
Southwest Airlines operates Southwest Airlines, a passenger airline that provides scheduled air transportation in the United States and near-international markets. The company has Boeing 737 aircraft in its fleet and serves destinations in various states, the District of Columbia, the Commonwealth of Puerto Rico, and other near-international countries such as Mexico, Jamaica, The Bahamas, Aruba, Dominican Republic, Costa Rica, Belize, Cuba, the Cayman Islands, and Turks and Caicos. The company principally provides point-to-point service, which allows for direct nonstop routing. The company also provides a suite of digital platforms to support Customers' needs prior to and during the course of their travel.
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