Southwest Airlines CEO Gary Kelly, long more cautious in his outlook than his peers at other U.S. airlines, believes the industry could feel the effects of the Covid-19 pandemic for as long as 10 years as the way people travel evolves in response to the pandemic.
“I would have never bet a year ago that this is where we would be in early 2022,” Kelly said during the company’s fourth-quarter and full-year earning’s call today “I thought we would have this pandemic beat and behind us, but we are far from that.” The effects will be felt for years, he said, throughout all parts of travel ecosystem — airlines, hospitality, tourism — adding that the last year, which started with such optimism, was “humbling.”
But he remains confident the U.S. airline industry is well-positioned to adapt, thanks in large part to government aid during the pandemic. “If you compare the U.S. to other countries, the U.S. has left the commercial airline industry in pretty darn good shape,” he said. “Were it not for the CARES Act, we would be in a very different situation.”
The CARES Act, passed by Congress in March 2020, was a $2.2 trillion economic stimulus bill that, among its measures, included grants and payroll support for the U.S. industry. In total, CARES Act and subsequent federal stimulus packages provided the airline industry with $74 billion, including $54 billion in payroll support.
Kelly, who steps down as CEO on February 1 after 18 years on the job and more than 30 with Southwest, believes domestic leisure travel will be the primary driver of airline industry revenues for the next few years. This is a marked change for an industry that before the pandemic derived much of its profits from more lucrative business travel. “We have to be more heavily dependent on consumer travel than we were before,” Kelly said. Like business travel, international travel will be slower to return. “We will have to be prepared to be more successful domestically over the next couple of years,” he said.
Part of Southwest’s future success will depend on how agile the carrier can be in response to a quickly evolving pandemic. The rise of the Omicron variant late last year hit Southwest hard. The carrier had more than 5,000 employees out with the disease in late December and early January. This was two-and-a-half times more employees out than during the Delta variant surge earlier in 2021. The airline was forced to cancel 3,800 flights in December and early January, or 1,600 due to staffing shortages and 2,200 due to bad weather.
In response, Southwest has raised pay rates and extended incentive pay for employees willing to pick up extra shifts through early February. The staffing surge worked, President Michael Van de Ven said. Southwest’s on-time performance rose from in the 40 percent range in late December to 87 percent last week. Part of this is due to better weather, but part is due to staffing changes and fewer employees calling in sick with Covid-19, he said.
The airline plans to hire 8,000 employees this year and each year through 2025 to fuel planned growth, the restoration of its pre-pandemic network, and to prepare for future surges of the disease. Southwest ended 2021 with 55,000 full-time employees and plans to have around 64,000 by the end of this year.
The tight labor market has presented challenges, incoming CEO Bob Jordan said. In response, Southwest has raised base pay rates, especially for ground staff, and streamlined hiring. The goal is to reduce the time between a potential employee’s interview and hiring from around 30 days to 10 days, and in some cases, Southwest is offering instant job offers during interviews.
This has put pressure on the airline’s costs that, excluding fuel, are expected to rise 20-24 percent in the first quarter, compared with 2019. The additional incentive pay alone is expected to cost the airline $150 million through February.
Hiring 8,000 employees a year could persist for the foreseeable future, Jordan said. Southwest is adding 114 Boeing 737 Max aircraft to its 728-aircraft fleet this year and has orders with Boeing for 406 more, with options on an additional 226. Some of these aircraft will replace older Boeing 737-700s. The carrier has 452 737-700s that it plans to retire over the next 10-15 years.
Southwest has 271 737-7s and 135 -8s on order. It exercised options for 22 -7s due in 2023 in the fourth quarter, and another seven -7s due in 2023 and five -8s due in 2022 in January. During the quarter, Southwest retired eight -700s and returned 10 more to lessors, and it has six of the type in storage. The -700s provide it with schedule flexibility, Chief Financial Officer Tammy Romo said. If demand returns faster than expected, it will keep more of the -700s than planned, and conversely, can retire more if demand is anemic.
The 737-7s are expected to start joining the fleet by the end of the year. Boeing anticipates securing type certificates for the -7s by the end of the first quarter, Van de Ven said, and FAA certification coming soon after. It will take about seven months between that point before the aircraft are in Southwest’s fleet. The -7s could start begin revenue flights early next year, he said.
In addition, Southwest added 14 cities to its route network last year. It is now focused schedule depth. During the pandemic, Southwest, which was known for frequent flights between its major cities, cut back its schedule depth significantly in response to falling passenger demand. This left it poorly prepared in October of last year when bad weather forced the cancellation of thousands of flights and stranded tens of thousands of passengers around the country. This year and next, Southwest plans to use some of its new aircraft to restore schedule depth, rather than on adding new dots to its route map.
The Delta variant cost Southwest about $60 million in lost revenue, while the Omicron variant cost about $30 million. This combined $90 million is less than the $100 million the carrier had anticipated the Covid-19 pandemic to cost it last year. Bookings in January and February are weaker than expected, due to the Omicron variant, and Southwest anticipates a loss in the first quarter. But demand for travel from March onward looks strong, and the carrier expects to be profitable in that month and for the balance of the year. “We’re hearing from our customers that they are optimistic about future travel plans,” Chief Commercial Officer Andrew Watterson said.
Southwest reported a fourth-quarter profit of $68 million, its first quarterly profit excluding special items since the fourth quarter of 2019. For the full year, the carrier reported a loss of $1.3 billion, which excludes $2.7 billion in remaining federal payroll support through the end of September. Fourth-quarter revenues of $5 billion were 151 percent higher than in the same quarter last year. Southwest expects to fly about 94 percent of its 2019 capacity this year, compared with 84 percent for the full year in 2021.
The call marked Kelly’s 134th consecutive earnings call, counting from when he was chief financial officer. Of his final earnings call as CEO, Kelly said, “I’m delighted to say that there were earnings!”