Southwest 2Q profit up, sales rise 11 percent

Southwest Airlines Co. earned a profit in the second quarter and beat Wall Street expectations by continuing to rely on financial deals that lowered its fuel costs.

Revenue increased by 11 percent, as Southwest raised fares.

But in a nod to high fuel costs and other problems facing the airline industry, growth-oriented Southwest said it might not grow at all next year.

Southwest said Thursday it earned $321 million, or 44 cents per share, up 15 percent from a year ago, when the airline earned $278 million, or 36 cents per share.

Excluding special items, Southwest said it would have earned $121 million, or 16 cents per share. That beat analysts' forecast of 12 cents per share, according to a survey by Thomson Financial.

Shares of Southwest fell 38 cents, or 2.3 percent, to $15.51 in midday trading. Other airline stocks fell more sharply as the price of oil rose early in the day.

Dallas-based Southwest posted its 69th straight profitable quarter while many other airlines lost money, and it is mostly because of fuel hedging - financial transactions that Southwest uses to lock in lower prices for most of its fuel.

The transactions earned $511 million in the quarter, nearly double the company's entire profit.

Despite its string of profitable quarters, Southwest is under pressure to control costs and boost sales as its fuel-hedging contracts expire over the next few years.

"We cannot stand still," Chairman and Chief Executive Gary C. Kelly said. "We must continue to make the necessary adjustments to adapt to higher jet fuel prices and restore our profit margins."

Southwest has raised fares and cut service on less-productive routes while adding flights where it can take advantage of rivals' weakness.

In a concession to high fuel costs, it also scaled back growth plans to 4 percent or less for 2008 - other carriers are slashing U.S. capacity - and Kelly said it might not increase capacity next year.

Revenue in the second quarter rose to $2.87 billion from $2.58 billion a year earlier.

Southwest's streak of profitable quarters going back to early 1991 will be challenged in the fourth quarter. The analysts surveyed by Thomson expect the company to eke out a penny-per-share profit, but Jamie Baker of JPMorgan said a loss is likely because of expensive fuel and the tendency for other costs to rise late in the year.

In recent years, Southwest has poached business from weaker or higher-priced competitors in Denver, Philadelphia, Pittsburgh and Dallas. Knowing Southwest's history, analysts aren't convinced the company will freeze growth next year.

Michael Derchin of FTN Midwest Securities said Southwest is just waiting to see how and where other airlines cut flights after Labor Day.

"They are going to be ranking the opportunities from competitors dropping by the wayside," he said. "Denver wasn't a layup, but United and Frontier are pulling back and now Southwest sees it as a good city."

But, Derchin added, Southwest could sell more tickets even without adding flights because its jets are usually less crowded than those of other airlines.

Dan Ortwerth, an analyst with Edward Jones, said it's impossible to guess what Southwest will do, because no one knows what fuel will cost next year or whether other airlines would resurrect dropped flights if fuel prices ease.

Even with fuel hedging, Southwest was hit by soaring energy costs in the second quarter. It paid an average $2.19 per gallon for jet fuel, but the going price on spot markets last week was nearly $4 per gallon. By comparison, American Airlines, with a much smaller fuel-hedging program, paid an average of $3.17 per gallon in the second quarter.

Southwest has hedged about 80 percent of its third-quarter fuel needs, down from 90 percent a year ago. The coverage falls to 70 percent next year, 40 percent in 2010 and 20 percent in 2011 and 2012 - with steadily rising prices as well.