Southwest Receives SOC Approval - Analyst Blog

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Southwest Airlines ( LUV ) together with subsidiary AirTran Airways has finally received approval from the Federal Aviation Administration ( FAA ) for a Single Operating Certificate (SOC), allowing both the carriers to operate as a single entity. Thus far, Southwest and AirTran were operating as separate entities despite their merger in May 2011. The announcement comes well within the expected timeline for approval (the first quarter of this year).

The FAA approval on SOC represents a milestone in integrating operations of both the airlines, which would result in meaningful synergies. Southwest expects it to facilitate the conversion of AirTran Airways aircraft to the Southwest livery.

The company will not only improve its revenue opportunities but also gain in terms of expansion into new regions with the introduction of its services in emerging markets like the Caribbean and Mexico. Southwest is expected to initiate its services in Atlanta, the busiest airport in the U.S., this February and debut in Mexico in May 2012. Effective mid-August, Southwest would cease operations in six cities served by AirTran and eventually convert AirTran flights to Southwest in 24 cities, including New York LaGuardia, Boston Logan, Milwaukee and Baltimore/Washington as well as many small domestic cities.

Another stumbling block in the integration process is with respect to the workforces of Southwest and AirTran. Although the company is facing initial hiccups with the recent rejection by the mechanics union, thus forestalling the process of implementing a single contract, it was successful in procuring votes from the mechanics at AirTran as well as flight attendants of both the airlines. A single contract would be highly beneficial for Southwest not only in terms of union dispute prevention, employee strikes and other labor related disruptions, but also with respect to synergies through cost curtailments arising from labor disputes and compensation issues.

In addition, we expect the AirTran merger to be accretive to Southwest's earnings, once the expected synergies are fully realized. The transaction is expected to generate net synergies of more than $400 million by 2013 on full integration. Last year, Southwest generated $80 million in annual synergies. The company expects to produce half of the net synergies this year, with two-thirds realized from revenue and one-third from cost savings.

However, fuel price volatility continues to be one of the significant challenges. Though high currently, fuel prices remain well below the 2008 level of over $140 per barrel. The company's ability to pass along the increased fuel costs to its customers is limited by the competitive nature of the airline industry. Southwest Airlines faces competition from other low-cost carriers like JetBlue Airways ( JBLU ) as well as major airlines like Delta Air Lines ( DAL ) and United Continental Holdings ( UAL ) that cut fares in order to attract customers. Thus, even a small change in fuel prices can significantly affect profitability.

We expect crude oil and jet fuel prices to remain largely stable this year, but forecasting this key variable with any level of accuracy has always been challenging. Difficulties will increase as the company has already announced a suspension in its expansion plans owing to escalating operating costs.

We currently maintain our long-term Neutral recommendation on the stock supported by a Zacks #3 Rank (Hold).


 
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Stocks

Referenced Stocks: DAL , FAA , JBLU , LUV , UAL

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