Southwest Airlines Co., the most profitable U.S. carrier, is wrestling with a rising fuel bill even after hedging 90 percent of its 2007 needs at below-market rates, Chief Executive Officer Gary Kelly said.
“The biggest struggle that we've had is energy cost,'' Kelly said yesterday in an interview in New York. “We're very well hedged, but even with that our energy prices have gone up every single year.''
Southwest locked in jet fuel at prices pegged to crude oil at $50 a barrel, compared with an average 2007 price of $60.96 on the New York Mercantile Exchange. Still, the Dallas-based airline is paying 15 percent more a gallon than in 2006, and “that's painful,'' Kelly said.
Higher fuel expense is squeezing the world's largest discount carrier as it works to generate more revenue while not losing its ticket-price advantage over other big U.S. airlines. Fuel accounts for a fourth of Southwest's expenses, Kelly said.
A slowing U.S. economy and at least 10 air-fare increases by major airlines in 2006 may be stiffening travelers' resistance to paying more for tickets. The industry has succeeded with only two of seven attempts to raise prices this year.
“We are seeing strong demand, but we're having to discount to earn it,'' Kelly said. “Based on the current trends, I'm not expecting that we're going to see any remarkable change in the revenue outlook for the rest of the year.''
Expenses, Revenue
June and July will be Southwest's peak travel months, Kelly said. He said Southwest is having “a solid year, but not nearly as strong as it was in 2006,'' when the carrier reported net income of $499 million, the most since 2001. Sales totaled $9.1 billion.
With costs up and revenue growth slowing, Southwest may not match last year's 11 percent return on invested capital, he said.
Kelly said Southwest's cost to fly each seat a mile, an industry benchmark, rose 4 percent in the first quarter, while revenue by the same measure increased 1 percent. Overall, the price of jet fuel has tripled in the past four years, contributing to a 20 percent increase in expenses, Kelly said.
“We set our pay rates when fuel was 70 cents'' a gallon, Kelly said. “If we had known then that fuel was going to be $2.10 a gallon would we have done something different with labor rates? Maybe.''
Jet fuel for immediate delivery in New York Harbor has climbed 20 percent this year to $2.12 a gallon.
Fuel hedging has helped Southwest maintain a consecutive quarterly profit streak dating to 1991. Last quarter, benefits from the fuel-hedging program helped Southwest report a 52 percent increase in net income.
$3 Billion
Kelly said Southwest is among the most-hedged U.S. airlines and has saved $3 billion since 2000 by using the tool. He estimated that Southwest will save about $500 million this year because of the advance-purchase contracts.
In 2006, Southwest locked in 85 percent of its fuel needs at prices pegged to crude at about $44 per barrel, Kelly said. “Our hedged prices are quite good, but they've stepped up,'' he said.
Shares of Southwest rose 30 cents to $14.65 at 4:01 p.m. in New York Stock Exchange composite trading. They have declined 5.5 percent in the past year.
The solution to the expense pinch is to boost passenger loads and add more value so that customers will be willing to pay more, Kelly said.
Through April, Southwest's planes flew with 69.1 percent of their seats filled, down 2 percentage points from a year earlier. The industry average on domestic flights — Southwest flies only within the U.S. — was 78.2 percent.
Southwest will add international itineraries in 2009 under a marketing agreement with ATA Airlines that may increase passenger loads, Kelly said. It also is proceeding with a plan to test wireless Internet access on flights next year, which also may boost revenue, he said.
