Monday, October 26, 2020

Southwest's New Cities and Rambling Thoughts on Earnings

Last week, my post analyzed Southwest's evolving network design which helps support many of the new cities. While I prognosticated more cities would likely come online, I did not expect COS, JAN, nor SAV. Nor did I expect new cities so soon. Rather, I expected new summer seasonal only cities, not new structural cities. 

For these new cities, Southwest announced they would join the network in the "first half 2021". If I were a betting man, I would expect these cities' schedules to be released for operation in March but most likely in April. While March is currently published, the schedule is absolute rubbish. Currently, the schedules published in January and beyond show a full block hour recovery. Note, I am using block hours as I believe it to be a better measurement of aircraft utilization.

We know this schedule is simply not going to fly. Between the VSP and potential furloughs, there is no way Southwest can operate a 2019 nor 2020 flight level in the first quarter. Additionally, demand nor revenue have recovered to levels that would support the amount of capacity either. Yes, TSA passenger screening rates are looking better recently, but we still have heard little conversation regarding forward-looking fourth-quarter revenues. 

During the earnings call, Tom Nealon talked about how Southwest was revising schedules: 

"We continue to adjust our flight schedules in 30, 60, 90-day increments. At this point, we are in a very, very clean rhythm to do so effectively and efficiently. We are getting pretty good at this."

This flashes the chainsaws are about to come out for January and beyond. It is difficult to know exactly how these changes to be executed, but options range from significant overhauls to a clean sheet republish. Either option would allow for the new cities, including ORD and IAH, to be slide into the schedule.

If March is not your bet for COS, JAN, and SAV, you would have in good company to suspect April as well. According to the Southwest website, the schedule for April 12 thru June 5 is expected to publish on December 20. Additionally, Gary's comments state there will be a second-quarter launch for some of the new cities. 

"Number three, we have announced nine new destinations to be added over the next three quarters. I'm happy to have these opportunities. I'm happy to play offense." 

With MIA, PSP, HDN, and MJT launching in 4Q2020, and it could be assumed IAH and ORD launch sometime in the first quarter, it is easy to suspect COS, JAN, and SAV start in 2Q2021, which would round out the last of the three quarters in Gary's statement. 

So, what should we expect COS, JAN, and SAV to look like? At a high level, I would expect the cities to be around a PSP flight level. I am not, however, going into the sausage-making of which markets which I would recommend. The airports have great consultants or professional staff working the analysis. I don't need to be giving free consulting services. And, let's be honest, SWA has already determined the initial capacity sets anyway. 

To me, one of the biggest wildcards for each of these small cities will be how competitors react. The legacies should continue their standard legacy service. I would not expect any competitive reactions in the COVID world, nor would I expect them to drop service. With no LCC/ULCC service, JAN should see above-average growth compared to its peers. 

SAV, on the other hand, is an Allegiant destination city. This typically means crews and aircraft are based there for the operation. With this investment level, Allegiant has to maintain a minimal level of service at the city overall to keep crews and aircraft productive. While we could see SWA overlap in a few cities, Allegiant has competed with SWA in the past and could reasonably be expected to brush off any direct competition. 

Then we have my old airport, COS. Hopefully, with the SWA announcement, the locals can now quit talking about the glory days of WestPac. However, I do have concerns with competitive responses in COS. The only ULCC operating in the market is Frontier, and I wonder if there is a potential that F9 might pack up and leave. 

I have been able to determine one Frontier has a single strategy to date: make money. If a route or city is not at the profitability Frontier wants, expect them to leave. Depending on both WN and F9's routes into the city, we could see a significant overlap. This could cause Frontier to take their ball and go home. The carrier is not known to be loyal to any city or route. I don't mean this from a negative perspective. The airline's job is to produce returns for its investors, and competitive overlaps into smaller cities may not allow this. 

On the flip side, Frontier has had an extensive product offering in COS since its relaunch in 2016. During June 2018, COS was Frontier's 12th largest city. However, Frontier has dialed their investments in the city back, even pre-COVID. Currently, the only two routes operating in the COVID schedule are LAS and PHX, two of Southwest's largest stations. If Frontier were to leave, this would mute the city's positive passenger growth. 

Let's come back to Southwest's other new cities, IAH and ORD. While the city schedules are not yet published, that didn't prevent SWA leaders from discussing them on the earnings call. The discussion around IAH was pretty bland, so I continue to believe we could see MIA level of service around 12 flights, maybe a notch higher. This would be large enough to continue to spread underutilized ground ops employees out. 

"We're going to have a great schedule out of there. Houston, the City of Houston and the airport system are very supportive of Southwest, and they're a delight to work with. So, we’ve got the real estate access. I would contrast that -- so again, it’s a great opportunity. If it’s a leisure oriented world for a while, there’ll be plenty of leisure customers that we'll be able to take to and from and through Houston Intercontinental." - Gary Kelly 

Gary's comments on the earnings call clarify O'Hare was an opportunistic COVID move.

"O'Hare is different in the sense that we're going to continue to grow back to the Houston example out of Houston Hobby. We'll continue to invest and grow, not right now because of the pandemic, but this will pass. Chicago is very different. We are not able to continue to grow, once the pandemic has passed at Midway. And I'm sure you're familiar with the constraints there. So, I just can't fathom that it's a good strategy for our Company to sit here and say for the next generation we cannot grow in Chicago. So you can kind of go through the mental list of what the options are.

And I can assure you that trying to expand Midway is not an option. It is just literally not a feasible option. Certainly, it's nothing that could happen in a short period of time, and it would cost a bloody fortune. So that leaves O'Hare. And O'Hare was real estate restricted, and now it's not. And so, we're there. And I'm very much looking forward to that opportunity. Like Houston, it will also offer access to a section of the metro area that we probably don't serve very well in the north. But I think we'll likely have a similar route system to begin to plug into our strengths, and I think we'll do very well there and it will complement Midway very well.

And then, finally, I guess, yes, they're not leisure destinations per se, but there are plenty of consumers that we're getting on our airplanes all over our system. And again, I think pretty much explains why the timing is what it is with O'Hare. If we don't move now, we risk never getting in there. So, we're moving now."

There are a few things that I take from the above quote. First, Gary says, "we'll likely have a similar route system to begin to plug into our strengths." This gives us a general tip where we might see SWA go. Predictably, we could see the same banked cities that we have seen other new cities plugged into. 

But given the amount of time spent on O'Hare, the conversation regarding limitations at MDW, and the limited real estate in ORD, something feels different here. It is entirely possible that we see an MIA flight level approach, and I am just reading too much here. But, if you are completely constrained in your main airport and may not have the opportunity to grow in your new secondary, you might try to shoot high and regret later. Worst case scenario, you reduce flights and return underutilized space and gates.  

Finally, I think the question still needs to be asked, is there more coming? Ultimately, I still see the case to onboard a few more cities. The likelihood of new structure cities such as SAV, COS, and JAN is less likely for right now. There's always a balancing act of accessing new revenue vs. a decaying rate of return. I believe it is more likely we see the introduction of summer seasonal cities similar to the winter seasonal cities of MJT and HDN. 

"At this point, with COVID, we're actually in an aircraft surplus position, and now we're able to put idle aircraft and our people to work, while at the same time strengthening existing markets in our network that are already very, very strong, markets like South Florida, California, Denver, Chicago and Houston. These are markets where we have a significant presence, and these are cornerstones of our network, and these additions only make them stronger still." - Tom Nealon

I could easily be convinced that Southwest will continue to find itself in an aircraft surplus position even with all new announcements. If the upcoming schedules show no more than 60% of 2019's block hour, I would argue there could be an opportunity to deploy additional aircraft if the revenue environment is there. That seems to be a big if. However, more new cities, especially seasonal summer cities, could play a part in generating much-needed cash for the network. 

I would be remiss if I didn't at least touch on furloughs. Potential furloughs could limit the carrier's growth as well. If an additional 10%+ of employees are furloughed to reduce cost, 2021's deployable block hours will be reduced. As of right now, I think the unions are playing hardball, hoping that either the company backs down or additional federal aid comes thru. At this point, I don't see either happening. If furloughs are executed, expect SWA to accelerate aircraft retirements to get maintenance, insurance, and ownership costs down. We could then see an even more prolonged recovery for the carrier. 

On a more positive note, right now is an interesting time to be a network planner. Multiple years of master plans have been thrown out the window. Today, planners are trying to find what little money is on the table. This allows guard rails of the past to be broken. But don't think SWA is the only carrier with unpredictability up their sleeve right now. In the coming weeks, we will likely see other carriers start playing their cards as well. It is not long before peak-March demand (albeit at a lower demand level than normal) will start hitting the 90-120 day window where many carriers are planning their capacity.  

Keep an eye on the hybrid and ULCC carriers. Specifically, I would not be surprised to see JetBlue or Spirit start announcing larger network adjustments as soon as this week. Remember, it is earnings week for these two. 

Nothing takes the wind out of bad earnings like a new shiny object.  


Note: All quotes from the earnings call came from Seeking Alpha.

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