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Leading U.S. low-cost carrier Southwest Airlines Co. (LUV - Analyst Report) reported third quarter 2013 adjusted earnings of 34 cents per share, surpassing the Zacks Consensus Estimate of 32 cents. The results improved from the prior-year quarter adjusted earnings of 13 cents per share on fleet re-designing, optimization of network and less fuel expense.

Quarterly revenues moved up 5.5% year over year to $4,545 million and marginally beat the Zacks Consensus Estimate of $4,525 million. On a year-over-year basis, Passenger and Freight revenues increased 6.1% and 5.1% respectively, while Other revenues dropped 7.0%.

Operating Statistics

Airlines traffic, measured in billions of revenue passenger miles, decreased 0.6% year over year to 27.0 billion in the third quarter. Capacity or available seat miles increased 1.0% to 33.4 billion, while load factor (percentage of seats filled with passengers) dropped 130 basis points year over year to 80.8%. Passenger revenue per available seat mile (PRASM) moved up 1.0% year over year.

Operating Expenses & Operating Income

For the third quarter, non-GAAP operating income was $439 million as compared to $208 million in the prior-year quarter. Total operating expenses, excluding special items, remained flat year over year at $4.1 billion. Fuel price (economic) accounted for $3.06 per gallon, down from $3.16 in the year-ago quarter. Consolidated unit cost or cost per available seat mile (CASM), excluding fuel and special items, increased 2.6% year over year to 8.01 cents.

Liquidity

At the end of the third quarter, Southwest had $3,328 million in cash and short-term investments as compared to $2,970 million at the end of 2012. The company has $1,000 million in unsecured revolving credit facility. Long-term debt (including current portion) was $2,875 million, representing debt-to-capitalization ratio of 29.1%.

In the third quarter, Southwest generated operating cash flow of $428 million and invested $268 million. The airline repurchased 11.5 million shares for approximately $150 million in the reported quarter and paid total dividend of $28 million. As of Sep 30, 2013, return on invested capital (before taxes and excluding special items) was 11%.

Outlook

Fuel price (economic) in the fourth quarter is estimated at $3.05 to $3.10 per gallon, which is same as third quarter 2013.

Another Airline Stock

Delta Air Lines Inc. (DAL - Analyst Report) third-quarter 2013 adjusted earnings of $1.41 surpassed the Zacks Consensus Estimate of $1.34. The results also improved from the year-ago adjusted earnings of $1.23. The company’s performance was buoyed by strong sales and reduced interest expenses.

Our Take

Southwest – which operates with the likes of United Continental Holdings Inc. (UAL - Analyst Report) and JetBlue Airways Corp. (JBLU - Analyst Report) – currently holds a Zacks Rank #3 (Hold rating).

We believe that the company will benefit from the implementation of a number of strategies to increase revenues and reduce costs over the next three years. These include efficiency in operations, introduction of various customer friendly programs, network optimization and capacity management.

Nevertheless, high non-fuel operating costs, a new advertising policy along with intense competition and heavy investments are expected to limit the company’s earnings potential.

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