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Southwest's Slow Slide
Friday January 21, 2:34 pm ET
By Bill Mann
One of the investing habits I have is tracking the financial performance for companies over long periods of time. It's relatively easy to see how companies have done over the last two or three years -- you need only to pull the most recent 10-K. Some companies, such as Coca-Cola (NYSE: KO - News), put in financial information that goes back a decade -- which can be tremendously helpful in determining how well the company has deployed its capital for long periods of time. I wish more companies did this.
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I've updated my numbers on Southwest Airlines (NYSE: LUV - News) -- which, to its credit, gives financial information for the last five years in its 10-K -- following its earnings report earlier in the week. For some unknown reason (let's go out on a limb and call it laziness), I hadn't updated its financial information for two years prior. I have to say that I'm somewhat shocked at how some of the financial statistics at Southwest have declined over the longer term.
I'd say that this is a function of oil prices, but this isn't entirely it. Southwest, which has prided itself (rightfully) on its frugal nature, has seen a steady rise in the amount of total revenues that are consumed paying salaries, wages, and benefits. In 1998, salaries accounted for 30.8% of revenues; in 2004, that number was 37.4%, with the amount consumed gradually increasing during that span. If you count on just the most recent 10-K, you might not see the longer-term degradation here, since you get only 2004, 2003, and 2002, when salaries consumed 33.4%.
You can see the impact of this directly on the operating income line. For 2004, operating revenues for Southwest were $554 million, or 8.5% of total sales. In 1998, the company generated operating revenues of $683 million for an operating margin of more than 16%. So while Southwest has generated substantially more revenue in 2004 than in 1998, it generated less operating profit.
The degradation gets even more extreme when you work from the high point of Southwest's operating profitability: 2000. In that year, the company's operating profit was $1.02 billion on revenues of $5.64 billion, a margin of 18%. Yes, 2001 was a dislocative event for the entire airline industry, but Southwest's 2003 and 2004 results were worse than those in 2001.
We could point to salary creep (or head-count creep) as a direct factor, but really all of Southwest has become less efficient from an operating perspective. In 2001, the company's operating expenses consumed 88.6% of revenue, while in 2005 they consume 91.4%. And again, it's not like 2001 was a bellwether year: In 1998, operations consumed only 83.6%.
For shareholders, this trend is worrying. Southwest, along with its discount brethren JetBlue (Nasdaq: JBLU - News) and AirTran (NYSE: AAI - News), have absolutely tortured the legacy airlines with their low-cost structures. But those costs, at Southwest, at least, seem to be creeping higher. Perhaps this is a sign that the best low-hanging-fruit routes have been plucked; perhaps it's a natural outcropping of an aging employee base that demands more money (again, rightfully so). But the long-term trend for Southwest is pretty ominous.
Southwest's Slow Slide
Friday January 21, 2:34 pm ET
By Bill Mann
One of the investing habits I have is tracking the financial performance for companies over long periods of time. It's relatively easy to see how companies have done over the last two or three years -- you need only to pull the most recent 10-K. Some companies, such as Coca-Cola (NYSE: KO - News), put in financial information that goes back a decade -- which can be tremendously helpful in determining how well the company has deployed its capital for long periods of time. I wish more companies did this.
ADVERTISEMENT
I've updated my numbers on Southwest Airlines (NYSE: LUV - News) -- which, to its credit, gives financial information for the last five years in its 10-K -- following its earnings report earlier in the week. For some unknown reason (let's go out on a limb and call it laziness), I hadn't updated its financial information for two years prior. I have to say that I'm somewhat shocked at how some of the financial statistics at Southwest have declined over the longer term.
I'd say that this is a function of oil prices, but this isn't entirely it. Southwest, which has prided itself (rightfully) on its frugal nature, has seen a steady rise in the amount of total revenues that are consumed paying salaries, wages, and benefits. In 1998, salaries accounted for 30.8% of revenues; in 2004, that number was 37.4%, with the amount consumed gradually increasing during that span. If you count on just the most recent 10-K, you might not see the longer-term degradation here, since you get only 2004, 2003, and 2002, when salaries consumed 33.4%.
You can see the impact of this directly on the operating income line. For 2004, operating revenues for Southwest were $554 million, or 8.5% of total sales. In 1998, the company generated operating revenues of $683 million for an operating margin of more than 16%. So while Southwest has generated substantially more revenue in 2004 than in 1998, it generated less operating profit.
The degradation gets even more extreme when you work from the high point of Southwest's operating profitability: 2000. In that year, the company's operating profit was $1.02 billion on revenues of $5.64 billion, a margin of 18%. Yes, 2001 was a dislocative event for the entire airline industry, but Southwest's 2003 and 2004 results were worse than those in 2001.
We could point to salary creep (or head-count creep) as a direct factor, but really all of Southwest has become less efficient from an operating perspective. In 2001, the company's operating expenses consumed 88.6% of revenue, while in 2005 they consume 91.4%. And again, it's not like 2001 was a bellwether year: In 1998, operations consumed only 83.6%.
For shareholders, this trend is worrying. Southwest, along with its discount brethren JetBlue (Nasdaq: JBLU - News) and AirTran (NYSE: AAI - News), have absolutely tortured the legacy airlines with their low-cost structures. But those costs, at Southwest, at least, seem to be creeping higher. Perhaps this is a sign that the best low-hanging-fruit routes have been plucked; perhaps it's a natural outcropping of an aging employee base that demands more money (again, rightfully so). But the long-term trend for Southwest is pretty ominous.
