Southwest Airlines Co. (NYSE:LUV) Morgan Stanley 11th Annual Laguna Conference September 14, 2023 11:45 AM ET

Company Participants

Bob Jordan - President & CEO

Unidentified Analyst

Great. Let's keep the airlines content going and next up we have Southwest Airlines CEO, Bob Jordan. Bob, thanks so much for being here at Laguna.

Bob Jordan

Thank you for having me.

Question-and-Answer Session

Q - Unidentified Analyst

Absolutely. So it's been an interesting few weeks in the airline industry. But first, let's start with Southwest. Obviously, you came into the year with a fairly challenging end to last year and kind of with -- maybe a little bit of show-me story on the operating side, and I think you have shown people that kind of you've taken the steps to kind of improve the operating resilience of the network. So maybe talk about what 2023, the journey has been like for you guys?

Bob Jordan

You bet, on the operating side, yeah, we had a rough December, obviously, the last two weeks, and there's no way around that and not trying to hide from that. I think we were very transparent about what went wrong. It was a weather event, but then we just struggled to recover post the weather event. A lot written about technology was not technology, but technology to some extent, wasn't helpful. So it just -- we just can't do that again. So we have been very, very focused on our robust plan to ensure that, that doesn't happen. So big investments in winter operations, preparations. So de-icing trucks, and more de-icing capacity. We've got a new weather -- set of weather technology that helps us better understand on-airport exactly what the weather is and how much de-icing hold over time we have that go on and on, but a lot of preparation, buying a lot of de-icing trucks and staffing. So I feel very, very prepared for this winter and all that will be in place by October.

Second, the -- we brought the group that designs the network planning together with the group that operates the network, network operations control. So they're under one group, and you just get a better feedback loop, and it really puts the design execution together and it's going to really help the playbooks that we develop to deal with the regular operations. And it's paying off. I mean our completion factor this year is running at 99% -- so it's really a really strong operations year, a lot better understanding of early indication mornings when things begin to go off till we've invested in crew scheduling, staffing, we've invested in technology, even though it wasn't technology, we've invested in technology, the ability to contract and deal with our crews.

Last, one of the big things that's coming here in the next month that I'm very excited about is a new piece of technology that will work to solve -- when we have irregular operations, it will work to solve the -- repairing the movement of the aircraft with the movement and preparing the movement of the crews. So one thing that happens today happened with us in December is you repair the flow of the aircraft then that's done, and then you take that and you repair the flow of the crews. And a lot of times, those two solutions fight against each other. But we've got a new set of technology coming in here in about a month that will solve them together. And I'm just very optimistic about what that will do for the operation.

Unidentified Analyst

Got it. Just to follow up on that. You obviously had a much more reliable July 4 weekend than many of your peers did. Labor Day looks like it went off without a hitch. So you are confident that going into holiday season like you're well prepared?

Bob Jordan

I am. I think the -- we performed two things, very well during high holiday travel, as you described. But then we have had operational days that were a struggle and what we saw before was that you would have a very tough day, like the NOTAM day where the -- there was a ground stop because of some of the issues or a hurricane that drives a very high level of cancellations. We had our own -- there was a network switch issue that caused a ground stop. What we saw is that, in addition to that issue, you would see a hangover in terms of the next day and maybe two days. It would take a long time to work your way out. What we're seeing now with all the changes that we put in place is that you may have a tough day like this NOTAM issue from the FAA, it does not hang over to the next day. I think back there, I think we had one of the best operating days in the industry following that NOTAM Day. So, no, I have a lot of confidence that we're going to operate well this winter.

Unidentified Analyst

Got it. So let's shift gears, talk about the demand environment. Obviously, there was a -- it was an interesting day yesterday.

Bob Jordan

I'm glad I'm presenting today.

Unidentified Analyst

That's great timing. Very, very [appreciative] (ph) of you. But what are you seeing out there? Obviously, we've heard from many airlines presenting so far that September has been fine. The summer was pretty good. Obviously, there are a couple of other ULCCs have been saying that there's been a fairly dramatic drop off in traffic in the last few weeks, what are you guys seeing?

Bob Jordan

Well, we modified our RASM guidance modestly. We basically pulled it in. Really, that was due to a -- just being a little off track with our close-in August demand expectations. I think August is changing as a month for us. This is about the fourth year in a row where August just hasn't been what we expected. I think it's a combination of things like schools are going back much earlier, where typically we saw that shoulder period show up in the third week of August. Last year, it was kind of the second week of August. This year, kind of the first week of August. I think that's a lot of what's going on is that close-in demand was different simply because the travel patterns are different. So sort of put that aside, looking past August, we're seeing very strong leisure demand and strong business demand. We had our best Labor Day performance, revenue performance in our history across those four days. So as you look forward, I mean, obviously, business is trailing leisure in terms of demand. But even on the business side, we're seeing a sequential improvement in business from the second quarter to the third quarter on a year-over-year basis. So things can change. But as far as we can see looking forward bookings, leisure demand looks strong and business demand looks strong.

Unidentified Analyst

This whole close-in comment was something that one of your peers made as well. They're also seeing kind of close-in demand kind of drop off in recent weeks, although the longer-term booking curve looks pretty robust. Is that just a function of like, I think it was a very interesting comment you made about some of the travel patterns are changing with the schools being early and such, but -- is it just a case of that little idiosyncratic adjustment? Or was -- is there some kind of fundamental change in closing behavior coming out of the pandemic that's going to be different going forward?

Bob Jordan

I think for us, especially sort of right now, it's really -- it's an August phenomenon for different reasons. So we're not seeing it spread in other months. Now we have two things going on as well, which is you have business is just not fully restored. I think the last 10 to 15 points or so of business restoration are going to be stubborn. That's not unusual. It happened post 9/11. I wouldn't be surprised. So business obviously drives close-in strength, especially on the fare side. So that may be a piece of it that is not unique to Southwest and that may persist for a while. But even that aside, we're seeing close-in strength. We've also put in a new revenue management system and very, very pleased with the performance of the system. And one of the things that it does, it has a bias to take a close-in -- to see and manage close-in strength. So I think you'll see performance there. We saw it during the testing. So no, but cut to the chase, I think the close-in strength softness, if you want to call it, that issue really is isolated to August. We're just not seeing that forward. Now things can change, but we're not seeing that in September forward.

Unidentified Analyst

Got it. let's follow up on corporate a little bit. We had Delta just before you obviously made your corporate airlines saying that they are seeing the impact of return to work in September, potentially in October as well. Are you guys seeing anything as well? Kind of obviously, it's a shorter season on the leisure side, but corporate does pick up in 3Q. What does the corporate outlook like?

Bob Jordan

We are seeing -- again, we're basically right on our expectations for business travel. We are seeing a modest sequential improvement Q2 to Q3 on a year-over-year basis. Again, you've got a percent of that business. I keep saying sort of 10% to 15% that is going to be stubborn, which is hard -- very hard to predict how fast that comes back. I think the thing that's very helpful to us, too, is we've made a big investment in GDS. And the GDS revenue initiative is bringing market share our way. We have seen market share improvement all along the way. So if you go back to what we said at Investor Day, December of last year, we have seen market share improvement between then and today. So we're -- the GDS investment is definitely picking up business share for Southwest Airlines.

Unidentified Analyst

Got it. Can you give us a little more detail, like, what was your share before? What is your share now? Where do you want to go? What does the part look like -- if you don't want to share a number...

Bob Jordan

We haven't. We really haven't shared the numbers, but...

Unidentified Analyst

But what innings are you in with that ramp?

Bob Jordan

Excuse me?

Unidentified Analyst

What innings are you in with that ramp?

Bob Jordan

I think we still -- if you look at our network, and this is why we did the project, if you look at our network and our opportunities, so what would be the right share for Southwest Airlines, we lagged and we lagged considerably. So the investment in GDS was meant to go after that. I mean we have the network to support business. And we get a lot of business travel, but we do or did lag our share. So I'm very pleased. We're on track with where we thought we would be with the GDS initiative. I'm very pleased with the market share gains. If you think about what inning we're in, I do think that, that initiative has considerable room to continue to run. Similar to that, wasn’t your question, but if you think about the RM system, the revenue management system that we put in place -- we put -- we made the decision, put it in place earlier this year. It really -- it was October -- September, October before it's really managing the whole network. It is very different, it -- the old system sort of worked to fill up a flight. It did not have an understanding of the itineraries. So people on that flight may be going -- they're connecting, they're going on to the places. So the new system really works to manage across all itineraries and it works to manage and build to a maximum revenue number more than load, it's new though. It works in a different way, the history sets are different. So I think we have in '24, we have opportunity to really continue to mature the revenue management system as well and continue to drive benefit from that initiative.

Unidentified Analyst

Got it. Going back to the macro -- kind of just given that spread between what some airlines are seeing and what others are not seeing, there's some speculation as to whether it is a -- it's something that's impacting one end of the market versus not. Kind of you‘re the strongest airline franchise out there, but you're a low-cost carrier kind of -- or do you think that there might be weakness at the low end of the consumer spectrum which is not showing up at the high end and kind of where do you guys fall on that?

Bob Jordan

Again, we're just not seeing the weakness. And we -- given the size and breadth of our network, we serve everybody. We serve every -- we serve -- we have great fares because we have great costs. And so we serve sort of all of America. And we're not seeing weakness in any pockets. The only place, again, is that you can see in the data that you -- pre-pandemic, we had business travelers that had a certain frequency and they're flying, it’s just their frequency is down from what it was. That last bit of travel is going to take a while. But we do not see -- we just don't see weakness across any of the -- any of that spectrum. We're continuing to see the demand for our product.

Unidentified Analyst

Switching gears, talk about pricing. We -- one of the factors influencing pressure on domestic yields all year has been the fact that jet fuel has been coming down a fair bit. But now it's kind of gone up again. Do you think the industry will be successful in kind of passing on this higher fuel onto the customers?

Bob Jordan

Well, yields have held up. You sort of start there. I'm pleased with yields. The -- again, our second quarter fares were up year-over-year. And despite all the discussion of -- you heard yesterday around weakness, I mean, yields are holding up for us, which I'm very pleased with. There's no doubt that costs are up, whether it's fuel, obviously, you've got labor -- the -- if you go back to pre-pandemic sort of fuel aside and you take labor costs and some other costs and you play them through as if the pandemic never happened, they're not up significantly from what -- where we would be if we had sort of year-to-year increases. What's happened is they're coming on a lump here and you've got fuel on top of that. We have work to do on the efficiency and cost side as well. I'm very pleased with our cost position coming out of the pandemic. We actually stayed stable or improved our relative cost position, both the ULCCs and the legacy, very, very pleased with that. But we've hired a lot of folks. We have -- again, I'm very pleased that we're -- I think we're the first airline to get all the fleet flying again here in September.

But -- that is not optimal. So having the right -- all the folks that we need and having all the aircraft flying doesn't mean that the network is optimized or the efficiency of our people and our procedures and our proficiency is where we want it to be. So we have a lot of work to do there in 2024, really to push on efficiency. But long-winded answer to your question -- there is work -- there is no doubt, especially fuel sticks because costs are up. There is work to do on the revenue side. The -- how you think about pricing, it's not in a vacuum. So some of these things are industry questions but there's no doubt that we have work to do on the revenue side in addition to cost to adapt to the new cost environment.

Unidentified Analyst

Got it. Let us talk about cost. Again, I think this industry tends to lower its CASMx by growing capacity, one way of doing it. I’ll get to capacity in a second. But just X capacity growth, I mean, you said there's a little work to do here in terms of efficiencies. A, do you feel like you have a full handle on inflation and the inflationary items in your cost structure and, B, kind of can you elaborate on some of the things that you can do on the absolute cost side to maybe drive some efficiency in system?

Bob Jordan

I feel like we have a handle on it. One of the things I'm pleased with -- many things I'm pleased with is that we have been fully accrued to market for our labor costs all along the way. So when you've looked at our guidance and on our performance, we have had our best guess of market rates in everything that you've seen. So when you look at our -- at our CASM guide, it's fully loaded. That doesn't mean, as we close out our last two contracts here that there won't be changes, there could be, but it's in the guide. And just a side note there. I'm really proud of our labor and other -- our teams that work on all that because we have 11 contracts, we have closed nine of them in 10 months. I think it's a record for Southwest Airlines. I'm very pleased. I mean nine agreements in 10 months is huge. We have two to go, two big ones with our flight attendants and our pilots but we will get there. But again, we're fully accrued to the extent that we understand where the negotiations are today and where the market is today.

Back to your point about costs, again, I think we have two things to do. We have sort of normal -- three things maybe, normal ringing out efficiency, inefficiencies that just came into the system as we hired rapidly coming out of COVID, we have a lot of folks that are still in training. So that will come down. We have folks who are arguably not all the way proficient yet. And there's just work to do to get back to our so-called [flighting weight, 2019 flighting weight] (ph). We will work on that. There's work to do as we -- we haven't talked much about the huge effort in the first quarter to sort of rerack the network, which is very important -- but a piece of that will be pushing flights into the period of time, not just there's higher demand, but where we have dips in a station, dips in the schedule. So you have all the -- you have people at the gates, the cost there. We just don't have enough flights. So there's work to do on the operating leverage side, especially in our big stations, driving our operating leverage. Now beyond this, and we'll be sharing a lot more as we get into 2024, we have a lot of opportunities as we continue to digitize the customer experience. So there is still a lot of transactions that are handled on the phone. We are a low user -- arguably a low user of bots and chat and those kinds of things.

If you look at our lobbies at the airports, we're bag checking machines bigger because bags fly free on Southwest Airlines. And there's an opportunity to really wring out costs that occur because of that. So as we get into '24, you'll see a lot more from us around how we streamline those experiences, which is good for our customers and our costs, digitize a lot of those experiences. There'll be a lot of use of AI in terms of understanding how we answer customer transactions. So we will be sharing more in the future. But I think we have opportunities with new initiatives to continue to drive out cost as well.

Unidentified Analyst

Just a follow-up on that point. Is that a 12-month initiative? Is that a multiyear initiative? And how long do you think it…

Bob Jordan

It really depends on what you're talking about. And again, I'm not quite ready to share the detail and it varies. Some of these things like lobby redesign are more complex, using Generative AI and things like an understanding of handling a customer transaction, I think there's an opportunity to go a little faster, but we're just not ready to share that.

Unidentified Analyst

Got it. And we look forward to the December…

Bob Jordan

But there will be a lot of push on that, though.

Unidentified Analyst

Absolutely, understood. Let's switch here talk about capacity. I think there's a lot of debate in the industry as to whether domestic capacity should be growing as much as it is, given the current macro environment. Again, you're saying you're not seeing any weakness, which, again, your peers have backed up as well. But it's not exactly a robust macro environment, right? So what's your response to that? Kind of, how do you balance growth versus what the market can handle?

Bob Jordan

Yeah, maybe separate those. Again, I probably said this before, but there's a lot of focus on capacity. But if you go back to 2019 and play forward sort of normal growth, we -- the industry, Southwest Airlines is not off of where we would have been sort of buffer the pandemic. It just sort of went through a down then and an up but it's not like the industry is way ahead. In fact, arguably, the industry is behind where we would have been capacity-wise had the pandemic never occurred. If you look at our own capacity, we're growing 14% to 15% here in 2023, but the majority of that, 10-plus points, is simply due to getting aircraft that were here. We just could not fly them because we didn't have enough pilots and get them off the ground and restoring the network. So that's not really incremental capacity, sort of a choice with deliveries and all that. So that will help efficiency just to move -- get the assets moving. So the majority of the 2023 capacity really is getting the assets up and productive. If you play forward to ‘24, and it's still capacity, but if you play forward to '24, 7 points of '24 capacity is simply the carryforward of '23. So you take what we've done in '23, you roll it forward, it's going to produce a 7.

The incremental capacity above that, sort of the net new will be small. So our desire is to take -- for the 7 that were -- that's carryover really grow into that. That's a lot of the network optimization work, which we can talk about. And then the sort of discretionary net new above that, we're not ready to share the exact number, but it will be a small number. And the other thing, too, I mean, obviously, we have a lot of work here. The network restructure going on in the first quarter that ends in March is significant. It's a recognition of where demand is today post-COVID. And so our business is down, so our short-haul traffic -- our short-haul percent of the network will come down from roughly 41% to about 38%. The ends of the days are -- the deep shoulder flying are tough to fill up. So those will come in 2 to 3 points. And then where you have weaker days, especially Tuesday, Wednesday, the historic -- if you go back to this January, the step down from a Monday to a Tuesday was about 2 points. The step down in 2024 will be about 8 points.

So we're working hard to get capacity to where obviously the demand is, and then just last, sort of nobody knows where -- nobody has pure sight -- line of sight in terms of where we're headed. And we have plans like the network restructure, but we're not slavish to a growth plan. So if we -- I'm very optimistic about the network restructure and we expect that to generate over $500 million in value. But if things change, that's not enough, we'll continue to work and continue to work. But just -- we don't think a Southwest Airlines is slavish to the things that I'm telling you. If we need to adapt, we will adapt.

Unidentified Analyst

Sounds good. Just on that network reorg. It sounds like you're trying to reduce the -- not the seasonality of the business, but just the kind of improved utilization through the week, through shoulder seasons. Is that where we'll see it the most?

Bob Jordan

Really, what we're trying to do is say, you've got a -- post-COVID, we have a new demand environment. Demand is just in different places. There's not as much short haul. I think it's because of the lack of business trips or that dip in business trips, the dip from Monday to a Tuesday is much lower for whatever reason, it is more difficult to fill up those late flights. But again, I think it's probably business travel. And so you're just moving capacity out of where it's -- those flights are just tougher to perform and into places where we know we're performing. But a lot of that is the heart of the day. So a lot of this is just matching -- you're restored. You've got everything flying, but not optimal. Now we need to optimize it to what the post-COVID demand environment looks like. The other thing is we -- is we do add incremental capacity, I don't think all capacity is the same. We have tremendous opportunity and performance in cities where you're seeing big GDP and population growth like Denver and Phoenix and Nashville and Austin, and we have the gates and capacity or the ability to add capacity. So you'll see our incremental capacity and then some of this rerack flying in the first quarter going to places where -- we know we have points of strength. We know the demand is there and the macroeconomic backdrop tells you that GDP is growing. People are moving there and there's demand. Nashville is a great example. National is growing like crazy.

Unidentified Analyst

Yeah. Great town. Been there a few times. Any questions in the audience?

Unidentified Analyst

So obviously, this past summer, there was a lot of long-haul international travel. I feel like everyone was traveling abroad and Southwest not having much exposure to that. But just curious were you seeing some sort of impact from that, like some other carriers had mentioned? And do you think that the pendulum between domestic and international kind of normalize back in 2024?

Bob Jordan

Yeah, I can't speak for others. But the COVID sort of changed everything, and we're working our way back to normal here. So you had this huge boom in travel in '21. You had a lot of sort of revenge domestic travel in '22. Now that's happening on -- especially on the far international market basis. So I think logic would just tell you, at some point, it swings back to normal. A lot of those trips in my mind, we've all taken some of these big trips, and you don't do that every couple of months, well, maybe you do, I'm not sure, but you -- so you save for those. So I think you have revenge for international travel thing going on, and you would expect that to come back to normal and ride itself. And our domestic trends will be normal. Our international trends will be normal. Yeah, our exposure, we don't have a lot of exposure -- no exposure to far international, modest exposure to near international, and we saw strength there, but I do expect it to normalize.

Unidentified Analyst

Any other questions? So, Bob, maybe just to wrap us up here, it's been a tough three years for the industry. I'm not going to catch myself saying 2024 is going to be fine because we made that mistake twice now. But is 2024 going to be the year where kind of you guys -- kind of have all the ducks in a row. I mean, obviously, unless there's a big recession, all bets are off, right? But if macro kind of holds stable, is this '24 the year when you can see the true earnings power of Southwest?

Bob Jordan

If you go back through, no one has the crystal ball that tells you exactly what's going to happen. And fuels to an extent are a wildcard here, which is why I'm so pleased that we are 54% hedged in 2024. We feel really good. But if you can sort of run your way across the last couple of years, travel demand comes soaring back and everybody is trapped with -- wow, we're not staffed, ATC is not staffed, we're not staffed. And so you just -- you're just fighting to get enough staff to more efficiently operate the airline. You come into '23, and it's all about keeping those staff, getting enough pilots now to fly our aircraft, getting all the aircraft off the ground and getting the whole fleet to be efficient and restoring the network to pre-pandemic levels. And now as you go into '24, to me, it's all about two things. It's about getting back to running the airline normally because we've got a lot of those things in place. It's about getting back our -- really making progress on our -- back to our pre-pandemic efficiency levels.

We hired -- I feel really good about our staffing -- but now we've got to ring out the excess, so to speak, to get back -- because we're known for that, get back to the efficiency of our people, our aircraft, our gates, all of our assets. It's about getting the network adapted to what the post-COVID travel demand themes look like. And we'll have that done by the end of the first quarter. I feel really good about that. And of course, it's about making progress on our long-term goals. So obviously, we've talked about -- we'll end the year at sort of a normal growth rate, mid-single digits, we will end the year at a normal level of markets in development. We feel good about that. But again, it's about making progress on our returns, our returns on invested capital, our margins and marching our way back to where we have been and will be, which is industry-leading operational performance and industry-leading financial performance.

Unidentified Analyst

Bob, we look forward to the Investor Day in December. Thank you so much for being here.

Bob Jordan

Thank you. Appreciate the time.