Southwest Airlines Company (LUV) — Q4 2020 Earnings Call Transcript

Thank you, Chad and I appreciate everyone joining us for our call today. In just a moment, we will share our prepared remarks and then open it up for Q&A. First, you will hear a comprehensive update from our Chairman of the Board and CEO, Gary Kelly; Chief Operating Officer, Mike Van de Ven; our President, Tom Nealon; and Executive Vice President and CFO, Tammy Romo. A few reminders. We will make forward-looking statements today which are based on our current expectations of future performance and our actual results could differ substantially from these expectations. And we also had several special items in our fourth quarter results which we excluded from our trends for non-GAAP purposes and we will reference those non-GAAP results in our remarks. And we have more information in our press release this morning regarding forward-looking statements, non-GAAP reconciliations to GAAP results, and other important risk factors. You can find our release and other helpful resources on our Investor Relations website. So, let's get started and I will turn it over to Gary.

Thank you, Ryan and good morning everybody and thanks for joining us for our fourth quarter 2020 call. We closed out the year as expected with no surprises. And even Southwest is not immune to COVID-19 and we recognized our first annual loss since 1972. It was significant, with non-GAAP losses coming in at $3.5 billion. But having said that, we were and remain very well-prepared to weather this continuing storm and it is especially important that we want to emerge on top in the airline industry. We have the strongest liquidity. We have $14.3 billion including $13.3 billion in cash and equivalents, $12 billion in unencumbered assets, and that doesn't include our frequent flyer program. We have the strongest balance sheet, and pre-pandemic debt to total capital was a company record low at 24%. We have investment-grade credit ratings, and we have cash well in excess of our outstanding debt. Third, we have the best business model. We have an unprecedented run of 47 years of profitability built on low costs and low fares coupled with great service. And that has resulted in unprecedented job security for an airline, going on 50 years without a furlough, without a pay cut, and the only major airline to avoid all of that during this pandemic. And I am very proud of that. We have the best operation, as evidenced by the Wall Street Journal's annual ranking of airline performances; Southwest ranked number one. Finally, we have the best customer service, which I base on numerous brand surveys and my expectation that once again we will be at the top of the industry in terms of the United States DOT Customer Satisfaction Index of Fewest Customer Complaints. Now, no one can deny that is a powerhouse combination of attributes for any company. I mention these things not to brag, but to put things in perspective. Yes, these are bad times and we had our first loss since our startup year. But we have a lot to be grateful for and every reason to be hopeful that this too shall pass, and when it does we will be ready. Speaking of being ready, we want to be prepared for a surge in traffic and revenues. We have to achieve breakeven before seeing beyond that, prosperity. So, there's a balancing act here, balancing a desire to conserve cash and minimize our losses, which requires that we operate at a reduced schedule as compared to the need and the ability to generate more traffic by offering more flights. Getting that balance is key, and we're intensely focused on that. We have the talent, experience, and tools needed to execute effectively. Once we get past this January, February winter doldrum, we'll see what happens and respond accordingly. We have excellent updates prepared this morning from Mike Van de Ven, our COO; Tom Nealon, our President; and Tammy Romo, our CFO. However, I don't want to steal any of their thunder except to say one more thing. I am especially grateful for our people, their resolve, resilience, civility, and love. They are heroes, and I know that everyone in this room could join me in saying how proud we are of them and we all just want to thank them profusely. Some of these heroes are sitting here with me. Mike, I want to congratulate you on a magnificent operational performance. So why don't you kick us off this morning, Mr. Mike Van de Ven, COO.

Well, thanks, Gary, and I would be happy to. As Gary was mentioning in terms of our operation, the fourth quarter was exceptional. We built significant momentum throughout the quarter. The MAX was approved to return to service, and we received much-needed government support which allowed us to pivot away from time-consuming discussions about furloughs and concessions. We were able to grow our city portfolio and the vaccines rollout began. Beneath all of those things, Southwest produced our best quarterly operational performance in our history. As Gary mentioned, I too am very proud and grateful to our people. There's tremendous activity associated with all those items I just mentioned. In addition to those, our people still go to work every day and deal with day-to-day issues of a pandemic environment yet they never lose their focus on our customers, our company, or each other. For the fourth quarter, our on-time performance of 93% was industry-leading and the best in our history. We finished the year at 86%, the best since 2003. Our baggage handling was equally impressive with just over two bags per 1,000 being damaged or mishandled—about a 99.8% accuracy rate. Again, the best in our history and in the top tier of the industry. That reliability coupled with our hospitality produced Net Promoter Scores in the mid-70s for the fourth quarter and for the year. We do expect to lead the industry once more with the lowest DOT customer complaint ratio when those are published. To cap it off, we finished 2020 with the best overall operational performance of any U.S. airline as measured by the Wall Street Journal's Middle Seat Scorecard. Our fleet has been a particular focus lately. We now have a combination of additional aircraft available to us from the MAX return to service as well as a lower demand environment from the pandemic. This gives our tech ops department several options to optimize our maintenance costs. The MAX is more reliable, has a lower fuel burn, is quieter, and is less expensive to maintain. It is a key component of our future. We received seven leased MAX from Boeing in December, bringing our MAX fleet to 41 aircraft by year-end. We identified 20 of our older 737-700s and accelerated their retirement at year-end, reducing our fleet to 718 aircraft going into 2021. As we do start this new year, we are initiating operations in eight new locations by June 6. There’s quite a bit of coordination and facility build-out staffing equipage and security-related actions that go into opening up a new location. Eight between now and early June is another all-time Southwest record. We are in a very reactive environment regarding COVID restrictions. There are new international requirements with testing and attestation protocols and evolving domestic requirements. It does take a special team to deliver record-breaking operating results and I'm really proud to be a part of it. With that, Tom, I'll turn it over to you.

Okay, very good, Mike. Thank you. Well, good morning, everybody. I also really want to start by thanking all our frontline employees. What a year, what a result and I am really proud of what we've accomplished with the team. I have always made a point of recognizing our commercial teams, network planning, revenue management, and marketing folks. What they're doing is incredible. But I also want to recognize a few teams; our technology teams, finance teams, strategy teams, and many others. They have done incredible work over the past year. I want to provide a quick recap of our fourth quarter revenue performance and cover our near-term trends and guidance for the first quarter. Our fourth quarter operating revenue was down 65% year-over-year, which is a modest sequential improvement compared with the 68% decline in the third quarter. Fourth-quarter passengers declined 64% year-over-year and our average fares were down 14%, which was a favorable comp to fares being down 20% in the third quarter. We did see some pockets of sequential yield in premium which was encouraging. Our fourth quarter load factor was 54%, up from 45% in the third quarter, primarily driven by a boost in December's load factor which reached 60%. November showed a slowing of revenue trends coinciding with the presidential elections and the rise of COVID cases. December had many of the same challenges with continued COVID surges, but leisure demand for December holiday travel outperformed expectations. We saw an operating revenue decline of 67% year-over-year for December with a load factor of 60%. We estimate operating income penalties relating to maintaining distancing protocols, which did affect performance. Additionally, we've seen business demand remain weak and expect it to continue to be down significantly this year. For January, we expect operating revenues to decrease 65% to 70% with a load factor of 50% to 55%. For February, a similar revenue performance is expected due to the absence of business travel. Although bookings are slowly improving, they remain below historical levels. We are continuing to evaluate our longer-term fleet needs and are currently in talks with Boeing regarding our orders beyond 2021. Our new markets, including Bush Intercontinental, Chicago O'Hare, and Miami, are seeing strong early responses. We are optimistic about the long-term outlook and we expect to strengthen these new stations. With that, I will turn it over to you, Tammy.

Thank you, Tom, and hello everyone. I'll round out today's comments with an overview of our cost performance, fleet, liquidity, and cash burn before we open it up for Q&A. I would be remiss if I did not acknowledge our wonderful team of Southwest warriors for their incredible efforts over the past year as we all dealt with the unimaginable impacts of this pandemic. The effects of the pandemic resulted in our first annual loss since 1972, ending our streak of 47 consecutive years of profitability, a record unmatched in aviation history. Our 2020 net loss was $3.1 billion. Excluding special items, our annual net loss was $3.5 billion or a $6.22 loss per diluted share. While our bottom line results were disheartening, we made great progress last year in reacting to the pandemic and cutting costs, reducing capacity, and significantly bolstering our liquidity. For the fourth quarter, our overall cost performance was strong as we continued to meticulously manage spending. Excluding special items, our operating cost decreased 37% year-over-year to $3.2 billion, although it increased 7% year-over-year on a unit basis. We expect first quarter fuel price to be in the $1.60 to $1.70 per gallon range. Our 2020 cash spending reduced by approximately $8 billion compared with original plans. Based on our current cost trends and capacity plans for the first quarter 2021, we expect operating expenses to decrease in the range of 15% to 20% year-over-year. The timing of the necessary rebound in travel demand to achieve cash-burn breakeven remains unpredictable. However, I am immensely proud of how our team is managing through it all, and we remain focused on maintaining our financial strength and substantial liquidity. We expect a slight uptick in bookings beyond February but are cautious in our projections. We will continue our momentum from 2020 in terms of cost control and efficiency improvements. With that, Chad, we are ready to take analyst questions.

Hey. Good afternoon. Tammy, this might be for you. As we get back to a bit more of a sustained demand recovery, what are your targets for liquidity levels, debt, CapEx? As you think about the priorities for cash as we get to more of a stable path to a recovery?

Yes. Hey, Savi, how are you? I'll start with liquidity, because, obviously, as we manage through this pandemic, I think that's goal number one. Our goal there is to maintain sufficient liquidity. I would emphasize a target for now of at least $10 billion, and we can go down from there post-pandemic as we return to profitability and repay debt. It's important we maintain a strong balance sheet and manage our debt effectively. As we set our targets here post-pandemic, we'll want to consider that a large portion of our working capital comes from advance ticket purchases, which may not serve as a definite source of liquidity in a crisis. We'll continue managing cash wisely and investing in important projects for our future.

Helpful. And if I might just have a quick follow-up on the comment on ATL. Just kind of curious about your current sales mix. How much of that is coming from credits versus new cash and how that compares to a more normal environment?

Yes. At the end of 2020, our ATL balance was about $7 billion, with a current liability of $3.8 billion and a non-current liability of $3.3 billion. Approximately $4 billion of that was from our loyalty program, with about $2 billion representing travel credits we've already issued. Our hope is that credit usage will return to something more normal like 5% post-pandemic.

Hi everyone. Good afternoon. Tammy, can you elaborate a little bit on the CapEx plans? You mentioned $5.5 billion out. Can you bracket in the CapEx high and low possibilities for 2022 and 2023? And how does that tie to your fleet count outlook both high and low?

Yes. Our CapEx will return to more normal levels as we return to profitability. I believe historically that's about $2 billion. However, we are still working with Boeing to restructure our order book so I can't provide exact numbers until we have that locked down. Overall, we will want to continue investing in technologies and facilities as our profitability normalizes.

I think it's a fair question. We owe you that bracketing, and we need to re-baseline our capital plan. This will apply both to aircraft and to non-aircraft areas. We've been focused primarily on survival and taking care of our people and customers. What we're looking for is demand to stabilize so we can thoughtfully approach the need for capital investments moving forward.

Yes. Understood. Thank you. Given that, as you think about re-baselining things, how do you think about Hawaii now in light of what's happening with COVID and with the MAX? What does the MAX give you in Hawaii that the NGs don't?

We're enthused about several things as we emerge from this, and Hawaii is certainly one of those. The MAX gives us better cost performance. It has greater range allowing for full payloads, especially in high-wind conditions, which means we can serve routes that the NGs can't handle efficiently. Overall, demand in Hawaii seems strong despite challenges with new strains, and we believe we are well-positioned there.

Hey. Thanks. Good afternoon. Gary, can you talk about your recent leadership role at A4A? How does your involvement potentially change the posture at A4A, and how might priorities change given you're coming from a position of strength?

At A4A, I aim to lead in a fair-handed way to be as productive as possible. This is not just about Southwest's position but rather what is best for the industry as a whole. Our strategic initiatives need to be collective, helping all members of the association. It's a challenging time for all airlines.

I appreciate you sharing that. Just for my follow-up, how much better do you think your CASM profile will be as you emerge from this given the cost savings that you've locked in?

It is speculative at this point, but we have made significant progress on operational efficiency and are well-positioned to improve our cost effectiveness as demand stabilizes. Our objective remains to be more efficient than our past performances as we regain our customer base. However, predicting specific CASM levels is currently not feasible, as it depends on several external factors.

Hi, good afternoon. Gary, this may segue into my question. With your competitors targeting significant cost reductions, what impact do you think this will have on Southwest's cost advantages?

While others may reduce costs, Southwest's advantages will continue. We've historically achieved a strong balance between low fares and customer service, and we remain committed to that. As we stabilize demand, we'll innovate and discover efficiencies that will enhance, not diminish, our competitive edge.

So, Gary, I just want to say it's been a great discussion so far. What is your focus looking ahead? Is it returning to full employment and a full schedule? What about getting back to margins and return on invested capital?

Our primary focus is on stability. We're aiming for the right balance this year between managing demand, minimizing losses and preparing for recovery. Once demand normalizes, we will direct our attention to profitability targets, margin recovery, and strategically managing our operations and capital expenditures. However, it's hard to make firm commitments until we have clearer demand indicators.

Okay. Well that wraps up the analyst portion of our call today. I know we shared a lot of information. Thank you all for the great questions. If you have any others, feel free to give me a call. Thank you all for joining and have a great day.

Well thank you, Chad. I'd like to welcome members of the media to our call today. And I think we can get right to the Q&A portion. So Chad, if you would give them instructions on how to queue up for a question, we'll get started.

Hi, thanks so much. I wanted to see what you're hearing or if you're picking up anything about additional requests for government aid, when the existing PSP expires at the end of March.

At this point, we would like to have a seat at the table regarding further assistance. The government support provided previously was to maintain jobs, and we are committed to doing that moving forward. The industry faces challenges and we need to have open discussions about securing continued support.

Hey everyone, thanks for taking my question. The CDC said this week that it is actively looking at mandating COVID-19 tests for domestic travel. Has it approached Southwest or A4A about this possibility?

Well, it’s not completely clear at this moment. We've been primarily focused on international testing requirements and evaluating how they could affect our operations domestically. If testing becomes mandated, we will be prepared to discuss its implementation and how it may affect passenger flows.

Thank you for that. So now let's switch gears for a moment. You all are filling your planes, and there's considerable chatter about when regular food and drink service will come back. Can you walk me through the thought process there regarding alcohol sales?

We're working through those logistics. There is no fixed timeline yet, but we all want to return service safely, and the timing will depend on the case counts. We expect to have a clearer view soon, and we'd like to bring back those services as soon as it’s reasonable to do so.

Yes, it’s about the health and safety of everyone onboard. While we hope to resume services in the future, we ensure that any decision made puts the safety of our passengers and crew first, maintaining an environment where customers feel comfortable.