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Southwest Airlines swings to Q3 loss on fuel hedging markdowns

Published: 15:59 20 Oct 2011 BST

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Southwest Airlines Co. (NYSE:LUV) said Thursday that it swung to a loss in the third quarter on unsuccesful fuel hedging - the first quarterly loss since the third quarter of 2009. Hedging to lock in an oil price is insurance against a spike in oil prices, but the airline's hedges went the wrong way as crude prices fell by a fifth during the third quarter.

"In accordance with fuel hedge accounting rules, our third quarter GAAP net results included $227 million of unrealized, noncash mark-downs relating to future periods' fuel hedges," said chairman, president and CEO, Gary C. Kelly.

"These special items resulted in a GAAP net loss for the quarter; however, since September 30th, market prices have rebounded, and our future fuel hedge portfolio has gained back over $300 million in fair value.

"Our economic fuel costs per gallon, which excludes this GAAP mark-down, increased approximately 34 percent compared to third quarter last year. This surge in fuel costs caused our quarterly profits to decline despite record revenue results."

Indeed, for the third quarter, the Dallas-based company reported a net loss of $140 million, or 18 cents per share, compared to net income of $205 million, or 27 cents per share, a year ago.

Excluding special items including one-time integration expenses associated with Southwest's May acquisition of fellow discounter AirTran Airways, and hedging markdowns of $227 million, third quarter net income was $122 million, or 15 cents per diluted share, beating analyst estimates by a penny.

The company's total operating revenues for the third quarter, benefiting from the AirTran acquisition, increased 35.1 percent to $4.3 billion, compared to the $3.2 billion Southwest made on its own a year ago.

"Passenger revenues were driven by strong load factors, revenue yields, and unit revenues, which were all third quarter records. Third quarter passenger unit revenues increased approximately six percent, compared to third quarter last year," continued Kelly.

Total third quarter operating expenses were $4.1 billion, compared to $2.8 billion a year earlier, the company said. Excluding special items, unit costs in the quarter increased 10.1 percent from the third quarter 2010, largely due to a 34 percent year-over-year increase in economic fuel costs per gallon to $3.18.

Southwest Airlines said that based on its fourth quarter fuel hedge position and market prices as of earlier this week, economic fuel costs for the current quarter, including fuel taxes, are estimated to be roughly $3.30 per gallon.

Looking ahead, Kelly commented: "Despite the cautious economic outlook, our booking trends remain strong. Importantly, business travel has remained stable since spring. Based on October traffic and booking trends, thus far, we expect solid passenger unit revenue year-over-year growth in the fourth quarter."

 The company said it continues to make progress with the AirTran integration, and expects to be able to connect the networks of both airlines in the first half of 2012. It has a target of achieving net annual pre-tax synergies in excess of $400 million by 2013.

Shares of Southwest were up 2.4 percent on Thursday, trading at $8.92 as of 11:02am EST.

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