Variants Costly to Southwest

Edward Russell

January 31st, 2022

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 last week. “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!”

Madhu Unnikrishnan

Alaska Plans to Focus on Schedule Depth This Year

Alaska Airlines will add back capacity this year not by flying to new destinations but by focusing on rebuilding the depth of its schedule.

“You’re going to see very, very, very few new markets from Alaska Airlines,” CEO Ben Minicucci said during the company’s fourth-quarter and full-year earnings call last week. Instead, the company will add flights to existing destinations, focusing on its hubs in Portland, Ore., and Seattle. By the second half of the year, Alaska could fly as much as 10 percent more capacity than it did in 2019, partially a function of new aircraft deliveries.

California also is in the carrier’s sights. While the rest of the carrier’s network — particularly its Seattle hub, which now handles more flights than before the pandemic — has performed well, the California network has languished. But Minicucci said demand is returning as travel restrictions in California ease.

The recoveries in the Pacific Northwest and California are almost entirely due to the resurgence of leisure travel. Alaska is unique among U.S. carriers in that three of its largest cities — Portland, San Francisco, and Seattle — rely on technology companies for much of its business traffic. Some of the larger tech companies have not resumed travel, and Alaska’s corporate demand is down between 70-90 percent.

Alaska took delivery of four Boeing 737-9s in the fourth quarter and 11 for the full year. The carrier intends to retire its remaining 27 Airbus A320s, inherited from Virgin America, by the end of next year. The retirements were enabled by the carriers order for 93 Maxes with options for an additional 52.

The carrier had a good quarter, until Omicron and winter weather struck. In a normal year, adverse winter weather affects one hub for a day or two, but late last year, both Portland and Seattle were affected for a week, Chief Financial Officer Shane Tackett said. Combined, weather and booking softness from the Omicron variant wiped $70 million off Alaska’s fourth-quarter results. “This was a tough way to end a year that otherwise had progress worth celebrating,” Minicucci said.

Bookings for January fell off and are 25 percent of 2019 levels, but are showing signs of returning. Alaska expects to report a profit for March, based on current bookings, but a loss for the first quarter overall. Lost bookings to Omicron could cost the carrier up to $160 million in the first quarter, Chief Revenue Officer Andrew Harrison said.

The roll out of 5G wireless networks has affected Alaska’s Horizon Air unit, but has not resulted in the regional dropping any of its destinations. Horizon is working with the FAA to resolve any issues, but Alaska noted that Horizon flights are 10 percent of the company’s total capacity. Flights at Paine Field are expected to resume soon, once 5G interference issues are resolved with the FAA.

Alaska intends to hire up to 3,000 people this year to staff its capacity expansion. The carrier has had to raise wages for entry-level staff, resulting in an additional $7 million in wages in the fourth quarter. But Alaska is confident it can meet its hiring goals despite the tight labor market. The hiring pipeline is full, Minicucci said. “We’ve got to fight for good employees, and that’s always a risk, but it’s a risk everyone has.”

Alaska reported fourth-quarter net income of $18 million, but a loss of $31 million when excluding special items. This compares to a fourth-quarter loss of $478 million last year. For the full year, Alaska reported a loss of $256 million, the bulk of which was incurred in the first half of the year. Revenues of $1.9 billion in the quarter and $6.2 billion for the year were 135 percent and 73 percent higher than in 2020, respectively.

Madhu Unnikrishnan

JetBlue Shows the Costs — and Benefits — of Alliances

JetBlue Airways has big expectations for its controversial northeast alliance with American Airlines. The pact is allows it to grow in a big way in Boston and New York, and — it hopes — tap into American’s deep well of corporate customers for more high-revenue flyers. The annual revenue upside could be worth as much as $100 million to JetBlue.

But those benefits do not come without costs. The New York-based carrier forecasts that nearly all of its unit cost, or CASM, excluding fuel growth in 2022 — forecast at up 1-5 percent compared to 2019 — will come from the implementation of the northeast alliance. And while that may seem negligible compared to the double-digit CASM-ex growth forecast at some other U.S. carriers, it’s not insignificant for JetBlue that has long had a challenge with keeping costs under control.

“Keeping our costs low is foundational to our success,” JetBlue Chief Financial Officer Ursula Hurley said during the airline’s fourth-quarter and full-year results call last week. She added that the 2022 CASM-ex outlook also benefits from two points of structural cost savings that JetBlue achieved during the pandemic.

JetBlue’s ambitious northeast alliance expansion also helps keep CASM-ex down. The airline plans to grow capacity by 11-15 percent compared to 2019 this year with most of that occurring in Boston and New York. JetBlue President Joanna Geraghty repeatedly said that the carrier would operate up to 300 departures from the three main New York City airports — JFK, LaGuardia, and Newark — in 2022. That represents an at least 38 percent increase from the up to 217 departures the carrier operated from the airports in 2019, Cirium schedule data show.

“We expect sequential month-on-month improvement leading to a profitable [second quarter] and a very strong summer peak,” said Geraghty. The outlook follows what will be a first quarter dominated by the Omicron variant, which forced the airline to cut planned capacity by five percentage points. JetBlue expects capacity to be down 1 percent to up 2 percent in the first quarter compared to three years ago.

Neither Geraghty nor another JetBlue executive commented on the pending DOJ challenge to its alliance with American. Executives have previously defended the alliance and, in November, American and JetBlue asked a court to dismiss the suit.

The airline will take delivery of 12 new Airbus jets — nine A220-300s and three A321LRs — in 2022 with the LRs used to launch planned Boston-London flights. These deliveries amount to roughly $1 billion in capital expenditures that Hurley said will be paid in cash.

Supporting JetBlue’s growth is the continued return of travelers. While leisure demand remains robust, the airline anticipates the business travel recovery to pick up from the second quarter — or from April. Roughly half of JetBlue’s pre-pandemic corporate business had returned prior to the arrival of Omicron in December, said Geraghty.

On the subject of the U.S. botched 5G wireless roll out, JetBlue CEO Robin Hayes was not as optimistic as some of his competitors. “We can’t assume that we are completely out of the 5G woods yet,” he said. Hayes described the current process as “iterative” and expressed optimism that the U.S. FAA, Federal Communications Commission, airlines, and wireless companies are now communicating about the new technology and working to eliminate any safety risks.

But issues remain despite the work. Some of JetBlue’s Embraer E190 jets are unable to operate in limited visibility conditions at certain airports — including some unnamed major ones — warned Hayes. This will impact a “very low percentage of flights,” he added.

U.S. airlines narrowly averted major disruptions last week when telecom companies agreed to voluntarily delay turning on 5G wireless transmitters near certain airports. Many fear that the technology could interfere with the radio altimeters, which tell pilots a plane’s altitude, on many aircraft. Roughly 90 percent of the U.S. commercial aircraft fleet had been approved for operations near 5G transmitters as of Thursday, according to the FAA. Missing from that list are many regional aircraft, including the Embraer ERJ-145 that is common at both American and United Airlines.

However, as with JetBlue’s E190s, headline approval for 5G operations is not as broad as it may appear. Not every carrier has gone through all of the steps necessary to certify every “approved” aircraft to operate in bad weather near transmitters. And this is already causing cancellations. For example, Alaska cancelled all of its flights into and out of Paine Field near Seattle last week due to 5G interference.

JetBlue lost $129 million on $1.8 billion in revenues in the fourth quarter. Revenues were down 9.7 percent compared to 2019 in-line with its previous guidance. Passenger traffic was down nearly 12 percent on a 5 percent capacity reduction year-over-two-years. CASM-ex was up 16.3 percent versus 2019.

For the full year, the airline lost $263 million including an $833 million benefit from federal coronavirus aid and other one-time items. Revenues were down a quarter year-over-two-years to just over $6 billion.

Looking forward, JetBlue forecasts an 11-16 percent year-over-three-year decline in first quarter revenues on account of the Omicron variant.

Edward Russell

Wizz Stays The Growth Course

Wizz Air is staying the course. That is, it continues with an ambitious expansion program that would see it fly 50 percent more capacity this summer than it did in 2019 with major growth initiatives on-going in “investible markets,” including Italy, the UK, and even Ukraine. Wizz CEO József Váradi, speaking during the airline’s December quarter results call last week, said he is “quite confident” that the airline can achieve its growth ambitions this summer both in terms of aircraft and staffing. That includes adding four aircraft to its London Gatwick base to use 15 slot pairs it acquired from Norwegian Air in December, and doubling the size of its Abu Dhabi base to eight aircraft by October. And even the Omicron variant, which has taken a bite out of January and February demand and produce a loss in March quarter, has done little to dent his optimism for the summer where Wizz already sees “very strong” bookings.

Of course many things could throw a wrench in Wizz’s best laid plans, not least the still wily Covid-19 pandemic. Another concern is the growing risk of an invasion of Ukraine by Russia. This has the potential to disrupt a market that amounted to 6 percent — and growing — of Wizz’s system capacity in the December quarter, according to Cirium schedules. “The market has remained totally intact from our perspective,” said Váradi. He added that Ukraine continues to be a be a strong performer for the carrier but noted that, if needed, Wizz could pull its aircraft and people out of the country within “days.”

Wizz took delivery of eight Airbus A321neos and return two Airbus A320s to lessors for a net increase of six aircraft during the December quarter. Following an order for 102 A321neo and A321XLR jets at the Dubai Airshow in November, the airline plans to grow its all-Airbus fleet by 29 aircraft to total of 179 by end-2022, and 325 by end-2026. Váradi, stealing a line from competitor Ryanair Group CEO Michael O’Leary, described the A321neos as a “gamechanger” for Wizz based on its size and capabilities. The A321XLR, for example, has the ability to fly routes previously the domain of widebody aircraft but with narrowbody costs.

Wizz lost €268 million ($302 million) in the December quarter, which was more than €100 million wider than a year earlier. Revenues jumped 173 percent to €408 million year-over-year but were still down nearly 36 percent compared to the December quarter of 2019. On the cost front, Wizz brought in unit costs excluding fuel to up just 18 percent compared to two years earlier; the metric was double its 2019 level during the same quarter in 2020. Váradi said costs will return to historic levels as the airline ramps up flying and fully utilizes its fleet and crews this summer.

Edward Russell

Hawaiian Pushes Back Expected Start of Japan Flights

Hawaiian Airlines has pushed the re-start of its Japan routes back to the second quarter, given the continued travel restrictions in that country, which is crucial to the restoration of the carrier’s international network.

“The road ahead may not be smooth, but the underlying demand for travel for leisure remains profound,” CEO Peter Ingram said during Hawaiian’s fourth-quarter and full-year 2021 earnings call last week. There has been some recovery in the international network: Flights to Sydney and destinations in Polynesia resumed late last year. Still, Hawaiian operated 25 percent of its pre-pandemic international capacity in the fourth quarter.

The domestic network fared much better. Demand soared in the fourth quarter, despite the Omicron variant’s spread. The carrier was profitable in December, Chief Financial Officer Shannon Okinaka said. Routes introduced during the pandemic, including to Austin and Orlando, are performing well. The carrier operated 81 percent of its pre-pandemic domestic capacity in the fourth quarter.

The carrier may add more longer-haul routes like those to Florida and Texas to utilize excess widebody capacity while its international network remains largely idled. Potential new destinations were not disclosed. The near-term outlook remains strong. Hawaii’s vaccination rate is high, and the state is open for travelers. The Omicron variant affected Hawaiian’s business less than the Delta variant did, Ingram said.

Still, Hawaiian plans to operate 10-13 percent less capacity in the first quarter than it did in 2019 and forecasts revenues down 31-35 percent. The two Boeing 787s it expected by the end of this year now will arrive in early 2023, provided Boeing is cleared to deliver the aircraft again. This delay partially will result in full-year capacity to be down 1 percent to up 3 percent than in 2019. This revises previous guidance that capacity would be flat to 4 points higher than in 2019. Hawaiian has extended leases on two Airbus A330s to provide widebody lift until the 787s arrive.

Ingram expects competitive pressure to ease, as rival carriers, both U.S. and international, that added Hawaii flights during the pandemic may restore that lift to pre-pandemic routes. Some of this capacity “may not return,” he said.

Interisland flights have recovered slower. The Omicron variant had more of an effect on interisland flights as Hawaiians put off non-essential travel within the state. The network now is about 75 percent of its pre-pandemic level.

Full-year costs excluding fuel are expected to rise between 3.5-7.5 percent, partially due to a new contract with the International Association of Machinists and also to the increased staffing associated with the resumption of international flights.

Hawaiian reported a fourth-quarter loss of $93 million on revenues of $495 million, up 231 percent for 2020. For the full year, the carrier reported  $145 million in losses on revenues of $1.6 billion.

Madhu Unnikrishnan

Aeromexico OK’d For Bankruptcy Exit

Judge Shelley Chapman of the U.S. Bankruptcy Court for the Southern District of New York approved Aeromexico‘s reorganization plan late on January 28. The approval paves the way for the airline to exit Chapter 11 bankruptcy protection before the end of the first quarter. Her approval followed 11th-hour settlements to objections from the unsecured creditors committee, Invictus Global Management, and the ad hoc group of OpCo Creditors, the last of which came down minutes before the judge issued her decision.

“I wanted this airline out of Chapter 11 … and have the folks in Mexico know that their flagship carrier had safely made its was through Chapter 11,” Chapman said. “We’re all going to keep our fingers crossed that Covid isn’t going to throw us any more curveballs and that people can get back on those planes and go to Mexico and enjoy some sunshine.”

Aeromexico will emerge from Chapter 11 a leaner and more nimble carrier. The carrier cut roughly $1.1 billion in debt and achieved roughly $605 million in annual cost savings through the process. Its plan calls for growth, particularly with new and efficient Boeing 737 Max aircraft that it committed to 41 of from both Boeing and lessors during its restructuring, and leveraging a strengthened position at its key Mexico City hub. The airline also plans to build on its joint venture with Delta Air Lines and partnerships with other SkyTeam Alliance carriers, as well as expand a partnership with Latam Airlines Group in South America.

The airline expects passenger numbers to recover and surpass 2019 levels to roughly 25.8 million this year. And revenues are forecast to recover in 2023 to $4.2 billion, or potentially their “highest level” ever for Aeromexico. It estimates 22 percent lower unit costs excluding fuel helping propel it to more than $1 billion in adjusted earnings before interest, taxes, depreciation, amortization, and restructuring (EBITDAR) in 2023.

Delta, which owned 51 percent of Grupo Aeromexico before its bankruptcy, will retain a 20 percent stake in the reorganized carrier. Apollo Global Management, which led the airline’s debtor-in-possession financing package, will emerge with a 22.4 percent stake and a group of Mexican investors that previously sat on the Aeromexico board will have a 4.1 percent stake. The remaining shareholdings will be split among creditors and new investors.

Edward Russell

In Other News

  • Lufthansa Group and global shipping giant MSC Group have partnered to buy a majority stake in ITA Airways, the successor to Alitalia that launched in October. ITA confirmed last week that it had received an expression of interest from Lufthansa and MSC that it viewed as providing the “best prospects” to the company. Lufthansa and MSC have requested a 90 day exclusivity period for due diligence and finalize the terms of their proposed investment. In October, Lufthansa Group CEO Carsten Spohr said they were interested in a strategic partnership with ITA and called the group “natural home” for the new Italian carrier.
  • Korean Air continued its profitable streak during the pandemic, again drive by its astonishingly strong cargo performance. The carrier reported a full-year operating profit of 1.5 trillion won ($1.2 billion) on revenues of almost 9 trillion won. This was a record annual profit for the carrier. Yes, you read that right. A record. Its previous record annual profit of 1.2 trillion won was in 2010. Thanks to global supply chain woes, cargo brought in 2.2 trillion won in the fourth quarter, or the bulk of the Korean Air’s 2.8 trillion won quarterly revenue. This bested the previous quarterly cargo revenue record, in the third quarter of last year, by 500 billion won. The spread of the Omicron variant could redound to Korean Air’s benefit, the carrier said, if it continues to snarl surface freight transport.
  • Air China, China Eastern Airlines, and China Southern Airlines all warned of deep losses in 2021. Air China forecasts a 14.5-17 billion yuan ($2.3-2.7 billion) loss, China Eastern an 11-13 billion yuan loss, and China Southern an 11.3-12.8 billion yuan during the year. All three carriers cited the continuing Covid-19 pandemic, rapidly changing travel demand, and the near closure of the China’s borders for the losses.
  • EasyJet posted a £213 million ($285 million) pre-tax loss on revenues of £805 million in the December quarter. The results were in line with the discounter’s expectations though it noted weaker demand in December with the onset of the Omicron variant. EasyJet, like competitor Wizz Air, remains bullish for summer 2022 with expectations of strong leisure demand, particularly on holiday and beach routes from the UK. The airline plans to fly near-2019 capacity levels this summer. EasyJet operated 64 percent of 2019 capacity in the December quarter and plans to operate roughly 67 percent of three-years ago in the March quarter.
  • Azul has fired back at Latam Airlines Group‘s claims that its $13 billion takeover proposal was “skeletal and incomplete.” In a U.S. bankruptcy court filing last week, the Brazilian carrier described their offer on November 11 as an “illustrative transaction” with the expectation that Latam would engage with them to discuss details. However, Latam “declined any substantive engagement” with Azul despite the potential transaction having the backing of at least the ad hoc group of creditors and a group of unsecured Chilean bondholders. The same creditors are pushing for an end to Latam’s exclusivity period to file a reorganization plan, which could open the door to a competing Azul takeover proposal being presented to the court.
  • IAG has named a new chief financial officer. Nicholas Cadbury, currently finance chief at hotel and restaurant company Whitbred, will join IAG in March.

Edward Russell & Madhu Unnikrishnan

Edward Russell

January 31st, 2022