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Southwest Airlines (LUV) Pilots Approve Contract, Stock Up

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Shares of low-cost carrier Southwest Airlines (LUV - Free Report) gained 2.95% on Nov 7, to close the trading session at $41.57. The stock price appreciation was driven by the decision of the company’s pilots to ratify a pay-related contract.

We remind investors that the Dallas-based carrier and the union representing its pilots, Southwest Airlines Pilots' Association (“SWAPA”), had agreed “in principle” to the terms of the contract in August. The ratification of the tentative deal concludes the negotiations which were initiated more than four years ago.

Details of the Deal

Last year, pilots of the low-cost carrier had rejected the tentative labor contract pertaining to their pay raise. Reportedly, issues related to code share agreements and “retro pay” had prompted pilots to turn down the tentative deal last year.

Following the rejection, discussions commenced once again between the two parties in accordance to the rules laid down by the National Mediation Board. The ratification of the contract will result in an immediate 15% percent pay hike for the more the 8,400 pilots covered under the deal. Moreover, the approval of the deal through Aug 2020, will allow a 3% raise to pilots, each in 2017, 2018, 2019 and 2020. The new contract also includes provisions to boost retirement funding and aims to promote job security.

The terms of the new deal are undoubtedly favorable to pilots, as evidenced by the large voter turnout (96.3%). In fact, an overwhelming 84.26% voted in favor of the contract.

Labor-Related Issues Dominate

The low-cost carrier has been plagued by labor-related issues this year with some of its labor groups demanding the removal of its top executives. However, the carrier has been receiving encouraging news on the labor front in recent times.

The pilots’ approval comes close on the heels of flight attendants of the carrier ratifying a pay-related deal which becomes amendable on Nov 1, 2018. The new deal guarantees ratification bonus and annual wage rate increases during its term.

Rising Labor Costs

We expect the carrier’s labor costs to shoot up after the new deals. This can be made out from the carriers’ fourth-quarter guidance for cost per available seat mile (CASM). Southwest Airlines expects CASM – excluding special items and profit sharing – to increase in the band of 4–5% in the final quarter of 2016. This is substantially higher than the 2.6% increase witnessed in the third quarter.

With labor deals in vogue in the aviation space, we note that not only Southwest Airlines but also its peers are seeing a spike in labor costs. The total operating expense of American Airlines Group (AAL - Free Report) rose 5.2% in the third quarter to $9.2 billion, mainly because of the 15.3% increase in salaries and benefits expenses. The recent labor deals inked by the company were the primary factors contributing to the increase in costs. The same factors hurt JetBlue Airways’ (JBLU - Free Report) third-quarter results. Moreover, CASM, excluding special charges, third-party business expenses, fuel and profit sharing, increased 3.4% at United Continental Holdings (UAL - Free Report) in the third quarter, mainly due to the ratified labor deals.

Traffic Update

Apart from news on the labor front, Southwest Airlines revealed traffic data for October. The carrier’s revenue passenger miles or RPMs (a measure of air traffic) improved 5.2% year over year to 10.5 billion. Available seat miles or ASMs (a measure of capacity) also grew 5.4% to 12.2 billion. Another important metric – load factor (percentage of seats filled by passengers) – contracted 20 basis points to 85.7% during the month as capacity expansion outpaced traffic growth.

The low-cost carrier reiterated its operating revenue per ASM (RASM) guidance for fourth-quarter 2016. It continues to expect the metric to fall in the band of 4–5%.

Southwest Airlines currently carries a Zacks Rank #5 (Strong Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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