By Rajesh Kumar Singh

CHICAGO (Reuters)

Southwest Airlines on Thursday unveiled several initiatives to shore up sagging profits, including partnerships, vacation packages for customers, and aircraft sale-leasebacks, but activist investor Elliott Management shrugged off the plan.

Stock Market Reaction

Southwest shares rose 5.4% after the announcement but are only up about 4% year to date, a gain that is far shy of 29% for Delta Air and 43% for United Airlines (O:UAL). Elliott reiterated its demand for CEO Bob Jordan’s ouster. The hedge fund also said it remained determined to request a special shareholder meeting for the leadership overhaul.

Elliott’s Criticism

Elliott said the airline’s plan was “filled with long-dated promises of better performance” and called for “credible leadership”. It accused Jordan of “playing with shareholders’ money.”

“Another promise of a better tomorrow from the same people who have created the problems we face today,” it said in a statement.

Company Response

While the airline has offered the hedge fund some concessions, it has ruled out any leadership change.

During the company’s first public investor meeting since 2022 in Dallas, Jordan stated that Southwest does not want a proxy fight with Elliott, but the activist investor has shown “little or no interest” in collaborating.

Jordan called the changes announced on Thursday, “the most transformational plan we have ever had.”

New Initiatives

The initiatives aim to attract premium travelers by switching to assigned and extra-legroom seats and starting overnight flights while maintaining the bags fly free policy. Southwest stated these measures would contribute about $4 billion in incremental earnings before interest and taxes (EBIT) by 2027. The airline expects to produce a 10% operating margin, 15% return on invested capital, and over $1 billion in free cash flow in three years.

Analyst Opinions

Airline analyst Savanthi Syth from Raymond James commented that while the 2027 targets are encouraging, the airline must deliver.

Financial Forecast

On Thursday, Southwest also increased its third-quarter revenue forecast and announced a $2.5 billion share buyback program. The low-cost carrier has struggled for new high-margin revenue streams as costs have climbed. The company’s operating margin significantly fell to 0.2% in the first half of this year from more than 13% in 2019, while passenger volumes lag behind pre-pandemic levels, and shares have decreased by about 40% in the past three years.

Southwest has downgraded its outlook at least eight times in the past 20 months, despite a booming travel demand. Analysts expect profits in 2024 to fall by around 83% from the previous year. This trend has raised questions about the airline’s business model. Jordan acknowledged the need for the company to evolve and transform, stating, “Our model is not broken but it is in need of continued calibration and enhancement.”

Operational Changes

Before COVID-19 restrictions, Southwest enjoyed a record 47 consecutive years of profitability. However, aircraft delivery delays from Boeing (NYSE:BA) and changing travel patterns post-pandemic have strained earnings. To mitigate operational risks, Southwest plans to slow annual capacity growth to between 1% and 2% from 2025 to 2027 and minimize hiring.

This strategy aims to reduce aircraft needs and create opportunities to monetize the value of its Boeing 737 fleet. The airline is contemplating selling its planes to leasing companies.

The shortage of new aircraft has turned sale-and-leaseback transactions into profitable ventures for some airlines. Southwest has nearly 700 new Boeing aircraft on order through 2031.

Future Partnerships

The company announced it will partner with Icelandair in early 2025 to enhance transatlantic connectivity and plans to add at least one additional partner carrier next year. Southwest will also begin selling vacation packages to customers.

Additionally, Southwest appointed Robert Fornaro, former chief executive of AirTran and Spirit Airlines (NYSE:SAVE), to its board.