"Southwest labor costs expected to hold down growth, experts predict"

Tuesday, August 17, 2004 

Southwest labor costs expected to hold down growth, experts predict
By Eric Torbenson
The Dallas (TX) Morning News


DALLAS - Southwest Airlines Co.'s soaring labor costs may hobble its
growth, according to two research reports released Tuesday.

Rising employee costs, combined with stiffer competition and the threat
of sustained high oil prices, could make Southwest look more like a
traditional carrier than the low-cost leader, the reports said.

The trend could keep the Dallas-based carrier's stock price grounded,
Jamie Baker of J.P. Morgan Chase said in his report.

Its labor costs per seat mile flown are now about equal to those of
Continental Airlines Inc.

"Our thesis is that Southwest is entering a period of gradually
declining forward valuation," he said. 

Higher labor costs, negotiated over the past five years in separate
labor agreements, could reduce Southwest's cost advantage over rivals,
Unisys R2A Transportation Management Consultants said in the other
report.

Southwest has negotiated a rich new contract for its flight attendants,
some of whom will see their pay double over the life of the four-year
deal. Pilots are due a 14 percent wage hike next month.

Southwest continues to maintain a cost advantage over traditional
carriers such as American Airlines Inc., the firm said, but mostly
because of very low nonemployee costs.

Continental's nonemployee costs are 84 percent higher than Southwest's,
giving the discounter a big advantage.

Southwest executives weren't available to comment on the reports Tuesday
because of a daylong meeting, said spokesman Ed Stewart.

But the airline's new chief executive, Gary Kelly, has acknowledged that
Southwest faces cost problems.

In the second quarter, Southwest missed its own cost target of 7.5 cents
per seat mile flown _ a measure of what it pays to put a seat in the air
one mile. The figure drifted above 8 cents in the quarter.

"We're looking forward to the third quarter where we think we'll be well
below 8 cents per available seat mile," Kelly said in a conference call
on July 15, the day he was named chief executive officer. 

Keeping costs under control is his top focus in the new job, said Kelly,
Southwest's former chief financial officer. 

Accelerated growth in the second half could help spread increased costs
over more seat miles, he said.

Both research reports said trends at Southwest are alarming.

Labor costs are about to exceed nonemployee costs, a situation that only
struggling Delta Air Lines Inc. now faces.

Baker said Southwest's aggressive fuel hedge positions start to expire
next year, exposing the carrier to the high cost of jet fuel that's
crushing competitors.

Southwest has prepurchased about 80 percent of its fuel needs using
hedges at prices equivalent to $24 a barrel. Spot crude closed at $46.75
a barrel Tuesday.

Also, competitors are adding capacity and implementing aggressive
pricing, instead of avoiding head-to-head battles against Southwest,
Baker said.

Traditional network carriers are seeing "meaningful" improvements in
revenue results, as measured by fares paid per seat mile flown, for the
first time since 1997, he said.

Airline researcher Unisys R2A's report emphasized that Southwest's
efficient operations help offset the rise in labor costs.

The report said, "it is much too early to conclude that Southwest has
lost its competitive edge vis-a-vis the legacy carriers" but that
"Southwest holds no dispensation from the laws of economics."

Other analysts, such as Ray Neidl of Blaylock & Partners, are much more
optimistic about the prospects for Southwest's business and its stock
price.

The carrier is continuing to expand and could announce before year-end
that it's launching service to a new city.

"I think people are going to see that Southwest's turned the corner,"
Neidl said in a recent interview.

Shares in Southwest closed Tuesday at $14.47, down 3 cents.


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