(LUV) Southwest Airlines Capacity Growth On Hold

The largest U.S. low-cost carrier Southwest Airlines (LUV) plans to keep next year’s capacity relatively flat with the 2011 level. The company might not increase flights even in 2013.

The decision was based on surging fuel prices and economic weakness. Given steep rises in fuel prices, the company is taking cautious steps to counter weaker demand, softness in corporate travel trends and lower bookings due to high unemployment and the recent topsy-turvy in financial markets.

Although Southwest has implemented eight fare increases since last December in response of fuel price inflation, it is now cutting capacity to handle sluggish demand.

Southwest will trim its domestic flights next year but increase international voyages. The purchase of AirTran, earlier this year, boosted its flying capacity by 25%.

The company is expected to introduce services to new and unexplored domestic markets and debut in the Caribbeans and Mexico. Additionally, Southwest gained a valuable market presence in Atlanta, the busiest airport in the U.S., post merger.

Despite the capacity cuts, we expect Southwest to report strong revenue and earnings growth on the back of new reservation system, Rapid Rewards frequent flyer program, larger Boeing Co. (BA) aircraft, and increased ancillary product offerings such as EarlyBird check-in, unaccompanied minor travel and pet fees. Further, the integration of AirTran bodes well for future growth, generating substantial synergies and providing more opportunities to drive revenues and profit upward while streamlining its cost structure.

Fleet rightsizing is the airline industry trend. Major airlines like Delta Air Lines Inc. (DAL), American Airlines, a wholly owned subsidiary of AMR Corporation (AMR) and US Airways (LCC) are reducing their capacity for the next year. Delta Air Lines announced the highest capacity cut of 2–3%.

We are maintaining our long-term Neutral recommendation on Southwest. The stock retains the Zacks #4 Rank (Sell) for the short term.

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