Can This Airline Keep Its Edge?

The sky is falling as far as the airline industry is concerned. Price cuts have become the order of the day as carriers compete fiercely to achieve higher passenger traffic as well as keep costs low on all fronts.

Southwest Airlines (NYSE: LUV  ) , always a customer favorite, has now pulled out all stops to maintain its edge over others as it places a massive order for Boeing (NYSE: BA  ) aircraft, including a new fuel-efficient version.

A look at the numbers
Southwest will buy 150 fuel-efficient 737 MAX planes and 58 regular 737s for a total of 208 aircraft. The list price on the deal was $19 billion, but Southwest will likely get a sizable discount.

Southwest is flying through a cloud of mixed fortune right now. On one hand, its revenue shot up to $4.05 billion in the third quarter of 2011 from $3.06 billion in the year-ago period. That's an impressive 32.2% increase, powered mainly by Southwest's acquisition of AirTran, another low-cost carrier, as it opened up new markets for the former. In fact, two-thirds of Southwest's passenger revenue growth in the third quarter was on account of AirTran's revenues.

But the bad news is that it has also recorded a net loss of $140 million in the third quarter, which management attributed to unrealized price drops based on fuel hedges.

The Boeing factor
And this is where the Boeing deal assumes massive significance. The 737 MAX aircraft are fitted with a new engine version that lowers fuel-consumption costs by 10% to 11% compared to current single-aisle type aircraft, which would result in lower operating expenses. In recent years, Southwest has witnessed steady erosion of its edge over competitors, since fuel costs have surpassed labor charges as its single-biggest headache. This has prompted the need for newer areas of cost-effectiveness, since nobody wants to repeat a negative-profit scenario.

What others are up to
In fact, some of Southwest's rival carriers have taken drastic steps to reduce the cost burden. For instance, American Airlines' parent AMR filed for bankruptcy to curtail expenses. Only recently has it received approval from concerned authorities to move ahead with a deal to purchase 32 Boeing aircraft.

The Foolish take
Southwest has taken the profitability challenge head-on with the Boeing deal, and the AirTran acquisition is already reaping sizable rewards. I'm not ready to commit one way or the other right now, but I'll add Southwest to my watchlist and monitor the company as it continues to integrate AirTran and work on further cutting costs.

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