As U.S. Market Nears Ceiling, Southwest Goes Abroad for Growth

  • Daily departures to Caribbean, Latin America start next week
  • It gets `trickier' to leave your comfort zone, analyst warns

New Terminal at Hobby Airport. Source: Southwest Airlines

Since its start in 1971, Southwest Airlines Co. has stuck to its knitting, emphasizing discounts, short U.S.-only flights and cattle-call boarding. The strategy worked: It’s been profitable for 42 straight years.

So why mess with success?

Starting Oct. 15, Southwest will embark on a major expansion in flying abroad, with daily nonstop departures to six cities in Latin America and the Caribbean from a new concourse in Houston’s William P. Hobby Airport. A second international terminal will open in 2017 in Fort Lauderdale, Florida.

Design of Southwest’s New Fort Lauderdale Concourse

Source: Fort Lauderdale Airport

After all but exhausting the list of U.S. cities that it wants to serve, Southwest says going beyond the nation’s borders is now crucial. While most analysts and investors agree on the need for fresh revenue sources, the airline’s gambit may mean higher costs, stiffer competition and complex foreign operations.

“Something that works domestically may not work as well internationally,” said Logan Purk, an Edward D. Jones & Co. analyst. “It just gets trickier as they start leaving their comfort zone and start stepping in other people’s territory.” 

‘Risk and Reward’

Southwest understands the challenge of international routes, said Andrew Watterson, vice president for network planning and performance. But non-U.S. destinations are Southwest’s only option to expand its network, he said. Sales growth of 5 percent this year, the average of analysts’ estimates compiled by Bloomberg, would be barely half the 9 percent gain of 2012.

“We like to have a range of risk and reward in our portfolio, and international serves that purpose,” Watterson said. “We’re happy to go toe-to-toe with any competitors on these destinations.”

The Dallas-based airline has grown from four aircraft shuttling among three Texas cities to now flying more domestic customers than any other U.S. airline. It now has almost 700 jets and is the fourth-biggest U.S. carrier in terms of passenger traffic.

Southwest first tiptoed into international markets in 2011 by buying AirTran Airways, which flew to seven cities in Mexico and the Caribbean. Southwest added two more Mexican cities under the AirTran brand before finally absorbing that airline in 2014.

Reservation System

The latest moves reflect grander ambitions.

Southwest oversaw construction of the $156 million five-gate concourse in Houston, and is doing the same for the Fort Lauderdale terminal, which will cost as much as $295 million. The airline also started an international reservation system this year -- “not something you do lightly,” Watterson said -- and began adding destinations, including San Jose, Costa Rica, and Belize City, Belize. Liberia, Costa Rica, will join the network in November.

Design of New International Terminal at Hobby Airport

Source: Southwest Airlines

By the end of 2015, Southwest will fly to 12 destinations in eight countries in the Caribbean and Latin America from 12 cities in the U.S. mainland. More is coming. It has identified another 50 possible markets -- almost all outside the U.S. -- that can be reached by the longer range of its Boeing Co. 737-800s.

Investor Interest

The new routes may make the airline more attractive to investors who have shunned it in the past because of its limited network, said Robert S. Bacarella, co-founder of Monetta Financial Services Inc., which holds Southwest shares.

“That would mean a higher multiple, with expansion more than just domestically,” he said. “This is almost moving them up to the next tier.”

Southwest missed the start of the industry stock rally that began in 2010, trailing the Bloomberg U.S. Airlines Index that year and again in 2011 and 2012. Then it beat that gauge in 2013 and almost doubled in 2014, when the shares were the No. 2 performer on the Standard & Poor’s 500 Index.

Cowen & Co. analyst Helane Becker has predicted Southwest may reach 200 daily international departures over the next five to eight years, or 20 percent of its passenger capacity. Southwest has a more modest goal, projecting that international flights will remain minor for the rest of the decade, Watterson said. Last year, foreign operations contributed just 1.2 percent of Southwest’s $18.6 billion in operating revenue.

Competitive Challenges

“Flying internationally comes with a different set of challenges,” said Julie Yates, an analyst at Credit Suisse Group AG. “Many times these airports are smaller, don’t have as advanced infrastructure and are a little bit more congested. Their view is that they are going at this in a very slow way to make sure to manage the risk.”

Southwest will face plenty of competition in the Caribbean and Latin America. Fort Lauderdale is the largest international gateway for ultra low-cost Spirit Airlines Inc., with Houston’s George P. Bush Intercontinental ranking second. 

JetBlue Airways Corp. plans to increase daily departures from Fort Lauderdale to 100 from as many as 65 now, and two-thirds of those flights will be to international markets. United Continental Holdings Inc. also flies south from its hub at Houston’s Bush airport.

Consumers could see “very attractive” introductory fares, particularly as Spirit adds three destinations from Houston Bush that overlap with Southwest’s Hobby service, Yates said.

Treading Carefully

In keeping with Southwest’s reputation for sweat-the-small-stuff planning -- it once removed three peanuts from each snack pack to save $300,000 a year -- the airline is treading carefully outside the U.S.

It’s initially requiring tickets for the international flights to be purchased on its website, meaning sales will be denominated in dollars to avoid currency devaluation. It’s also establishing the routes in domestic cities where it already has a large customer base.

“We’re on our home turf even if we’re flying outside the U.S. on these routes,” Watterson said.

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