Last Thursday, Southwest Airlines (NYSE: LUV) reported a record third-quarter loss of nearly $1.2 billion, as the COVID-19 pandemic continued to weigh heavily on air travel demand. The company also recently warned employees that it will need to furlough some workers in early 2021 unless its labor unions agree to temporary pay cuts -- or the federal government provides additional stimulus funds.
However, while the results were bad by any objective measure, they were better than management -- and many Wall Street analysts -- had initially feared. That's a great sign for shareholders that Southwest Airlines will be able to emerge from the current crisis in a strong position.
Revenue recovery resumes
Like other U.S. airlines, Southwest Airlines saw demand start to improve in a meaningful way during late May and June. Unfortunately, that momentum petered out in July, as a surge in COVID-19 cases in many parts of the country frightened off some would-be travelers.
As a result, at the time of its second-quarter earnings report, Southwest predicted that revenue would plunge 70% to 75% year over year in July and 70% to 80% in August. The company didn't provide formal guidance for September, but management didn't have high expectations for the month, given that leisure travel demand typically slows after Labor Day.
Image source: Southwest Airlines.
Fortunately for the company, the number of new COVID-19 case reports fell significantly between late July and mid-September. This caused demand to start improving again. Ultimately revenue declined 70.6% year over year in July, with sequential improvement in August and September. For the full quarter, revenue declined 68.2% to $1.79 billion: near the high end of analysts' estimates. Southwest's adjusted loss per share of $1.99 was also significantly better than the average analyst estimate of $2.35.
Cash burn starts improving again
This improving revenue trajectory also helped Southwest Airlines slow its cash burn. In the second quarter, average daily core cash burn averaged $23 million, but slowed from $30 million in April to $16 million in June. The company's initial Q3 guidance called for average daily core cash burn to remain in the vicinity of $23 million: in line with its second-quarter average but significantly worse than its June performance.
During the quarter, Southwest improved its cash burn estimates in a pair of investor updates. Ultimately, daily core cash burn averaged just $16 million for the third quarter, including average daily core cash burn of $12 million in September.
The $7 million reduction in average daily core cash burn relative to management's initial forecast implies cash savings of more than $600 million over the course of the quarter. That helped Southwest maintain a best-in-class balance sheet, with $14.6 billion of cash and investments as of Sept. 30, compared to just $12.6 billion of debt and lease liabilities.
Seizing the future
COVID-19 case counts have been rising again in many parts of the U.S. recently. So far, this "second wave" doesn't seem to be undermining air travel demand, although Southwest Airlines' management is keeping a careful eye on booking trends -- especially for the major holiday periods -- in case that changes. Based on current trends, Southwest expects average daily core cash burn to slow to $11 million this quarter.
With cash burn continuing to moderate and tons of cash on the balance sheet, Southwest's management has been able to pivot its focus to seizing future growth opportunities.
For example, Southwest Airlines is continuing its push to gain share with business travelers by making its fares available through several global distribution systems. The company also announced on Thursday that it will begin flying to three additional cities (Colorado Springs, Colorado; Savannah, Georgia; and Jackson, Mississippi) in the first half of 2021. That follows several other recent new service announcements, putting Southwest on track to add nine airports to its route network between now and next June. Management even said it is considering adding a second aircraft type to its fleet in order to better serve smaller markets.
The fact that management is able to work on big strategic initiatives like these rather than focusing most of its efforts on managing day-to-day operations could prove to be a big advantage in the long term. This could pave the way for Southwest Airlines stock to reach new all-time highs as air travel demand recovers over the next few years.
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