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Southwest: The 900-Pound Gorilla in the Airline Industry
By Vaughn Cordle, CFA / June 12, 2006
Based on CEO Gary Kelly's own words and company performance, it appears that
Southwest's "the low cost, low fare airline" motto and strategy is still alive and well.
Given the capability of the new generation B737s, and the superior economics of Southwest’s
business model, the company has exceptional growth opportunities. It has the balance
sheet strength and earning power to successfully win the war of attrition, which is well
underway.
Southwest is "connecting the dots" in its route structure, and there are more opportunities for
growth than the current supply of used and new aircraft allow. What's next is that Southwest
continues to dominate the U.S. domestic market and prepare for international flying. It will
use ATA as a stalking horse to move up the learning curve and develop the infrastructure to
handle international flights. I believe that within five years, Southwest will be feeding traffic to
Europe out of Dallas, Washington, and New York with B787s or B777s. Once it has sufficient
ability to handle international flights, it will bring everything in house. After all, it will not want
the ALPA-represented ATA capturing the value of the growth and new routes. ATA's code
share arrangement provides valuable options for Southwest.
Kelly is properly focusing on maximizing share price and growing the airline as fast as
practical. In practical terms, he eventually has to tap other markets and sources of revenue.
In the U.S., it's a zero sum game in terms of industry-wide capacity growth. The haves—and
Southwest is the 900-pound gorilla—will take market share away from the have-nots, which
is just about every old-line network airline. Moreover, small airlines with concentrated hubs,
like Frontier (90 percent of traffic is from Denver), simply cannot compete against a
powerhouse competitor like Southwest, which has very deep pockets and a very large
national network.
Southwest’s growth and success will force other airlines to shrink and consider merging with
other airlines. US Airways and America West had to merge, in large measure, to survive the
Southwest onslaught. We expect more mergers to occur, and Airtran, as an example, should
consider taking over failing Midwest.
Southwest's image as a consumer friendly and happy employee airline is correct. But it can
be said that it is a cutthroat competitor that has no mercy for those foolish enough to stand
and fight. Southwest is the Mike Tyson of the airline industry, when he was in his savage
prime.
We think there is another down leg in capacity reductions yet to come. Given reasonable fuel
cost assumptions and a slowing economy, excess capacity is about 5 percent. However,
lower-cost capacity growth offsets some of the uneconomic capacity contraction. The net
effect is less domestic capacity relative to traffic and GDP growth.
Southwest is actively searching for new and used aircraft, and will quickly fill any capacity gap
opportunity that becomes apparent. As we approach the end of the current cycle and
economic growth decelerates, it will become increasingly apparent who has to "give it up."
Southwest's primary focus is on increasing share price. I believe it is doing the best it can
with what it has, given industry conditions. The success of Southwest’s growth strategy is a
function of competitors' weakness, which is balance sheet over leverage, higher relative
costs, and employee unhappiness.
Bottom line: Southwest is kicking the competitions' butt even as its share price has
underperformed the broader market averages. The poor relative stock performance is why it
is moving away from its "heritage" behavior, which has typically been to compete with
automobile traffic. This is no longer the case.
By Vaughn Cordle, CFA / June 12, 2006
Based on CEO Gary Kelly's own words and company performance, it appears that
Southwest's "the low cost, low fare airline" motto and strategy is still alive and well.
Given the capability of the new generation B737s, and the superior economics of Southwest’s
business model, the company has exceptional growth opportunities. It has the balance
sheet strength and earning power to successfully win the war of attrition, which is well
underway.
Southwest is "connecting the dots" in its route structure, and there are more opportunities for
growth than the current supply of used and new aircraft allow. What's next is that Southwest
continues to dominate the U.S. domestic market and prepare for international flying. It will
use ATA as a stalking horse to move up the learning curve and develop the infrastructure to
handle international flights. I believe that within five years, Southwest will be feeding traffic to
Europe out of Dallas, Washington, and New York with B787s or B777s. Once it has sufficient
ability to handle international flights, it will bring everything in house. After all, it will not want
the ALPA-represented ATA capturing the value of the growth and new routes. ATA's code
share arrangement provides valuable options for Southwest.
Kelly is properly focusing on maximizing share price and growing the airline as fast as
practical. In practical terms, he eventually has to tap other markets and sources of revenue.
In the U.S., it's a zero sum game in terms of industry-wide capacity growth. The haves—and
Southwest is the 900-pound gorilla—will take market share away from the have-nots, which
is just about every old-line network airline. Moreover, small airlines with concentrated hubs,
like Frontier (90 percent of traffic is from Denver), simply cannot compete against a
powerhouse competitor like Southwest, which has very deep pockets and a very large
national network.
Southwest’s growth and success will force other airlines to shrink and consider merging with
other airlines. US Airways and America West had to merge, in large measure, to survive the
Southwest onslaught. We expect more mergers to occur, and Airtran, as an example, should
consider taking over failing Midwest.
Southwest's image as a consumer friendly and happy employee airline is correct. But it can
be said that it is a cutthroat competitor that has no mercy for those foolish enough to stand
and fight. Southwest is the Mike Tyson of the airline industry, when he was in his savage
prime.
We think there is another down leg in capacity reductions yet to come. Given reasonable fuel
cost assumptions and a slowing economy, excess capacity is about 5 percent. However,
lower-cost capacity growth offsets some of the uneconomic capacity contraction. The net
effect is less domestic capacity relative to traffic and GDP growth.
Southwest is actively searching for new and used aircraft, and will quickly fill any capacity gap
opportunity that becomes apparent. As we approach the end of the current cycle and
economic growth decelerates, it will become increasingly apparent who has to "give it up."
Southwest's primary focus is on increasing share price. I believe it is doing the best it can
with what it has, given industry conditions. The success of Southwest’s growth strategy is a
function of competitors' weakness, which is balance sheet over leverage, higher relative
costs, and employee unhappiness.
Bottom line: Southwest is kicking the competitions' butt even as its share price has
underperformed the broader market averages. The poor relative stock performance is why it
is moving away from its "heritage" behavior, which has typically been to compete with
automobile traffic. This is no longer the case.
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