Southwest is “effectively unhedged” in 2018 and reviewing its hedging positions for 2016 and 2017.
One of the hallmarks of Southwest Airlines’ persistently successful financial performance is that the company is willing and unafraid to rethink assumptions, even long-held ones. Case in point: On pace for its second straight year of record profitability, the airline is questioning its old assumptions about fuel hedging and pre-tax return on invested capital (ROIC) goals.
The Dallas-based carrier has famously deployed fuel hedging on a consistent basis as insurance against spikes in oil pricesand has long cited a 15% ROIC goal as its measurement for financial performance. But with fuel prices remaining low and Southwest’s ROIC surging well past 20%, the airline appears to be backing off of hedging and is no longer using the 15% ROIC target.
Chairman, president and CEO Gary Kelly, speaking to reporters and analysts Thursday to discuss Southwest’s second-quarter net profit of $608 million, explained, “Given the current fuel price environment and the current industry environment, we’re achieving tremendous shareholder value. It renders the 15% [ROIC] target moot. We’re not targeting down to 15%.”
Southwest’s ROIC for the full year 2014 was 21.2% and for the 12 months ended June 30 was 28.2%. “Last year we had a 21% ROIC and our goal this year is to beat that,” Kelly said, adding that the goal next year will be to beat 2015’s ROIC. He conceded, “If fuel prices double between now and next year, it will be an unrealistic goal in the short term.”
But per barrel oil prices dropped below $50 this week and Southwest is now assuming “fuel prices will continue to be moderate for at least the next several quarters,” Kelly said, adding that the “direction of energy prices appears to be a bit clearer. It’s always dangerous to think you know where energy prices will go, but you have to have a view” and Southwest’s current view is that low fuel prices will be sustained.
That outlook is also driving Southwest to become less attached to fuel hedging. The airline currently is “effectively unhedged” in 2018 and reviewing its hedging positions for 2016 and 2017. Southwest has approximately 40% of its fuel consumption hedged for both 2016 and 2017, but that could change. “We’re still working on our 2016 and 2017 hedge books,” CFO Tammy Romo said. “Our bias at this time is toward lower jet fuel prices, so we’re working to balance that as best we can.”
The company expects a net liability of $308 million from fuel hedge contracts in the second half of 2015 and appears to be looking to lower its future liability from hedging. (About 30% of the airline’s fuel consumption is expected to be hedged for the full year, which is wound down from the 40% hedging position for 2015 it held late last year.)
The current market “argues to be less hedged rather than more hedged,” Kelly said.