SOUTHWEST AIRLINES CO

SOUTHWEST AIRLINES CO Annual Report: A Deep Dive for Investors

This summary cuts through the jargon, offering a clear, investor-focused look at Southwest Airlines' latest annual report. We highlight key financial performance, strategic initiatives, and potential risks to help you understand the company's position.

Business Overview

Southwest Airlines Co. (NYSE: LUV) operates as a major passenger airline across the United States and nearby international markets. Unlike the traditional hub-and-spoke model, Southwest stands out with its unique point-to-point route structure, delivering high-frequency, low-fare air transportation.

The company primarily flies a single fleet type, the Boeing 737. This standardization boosts operational efficiency in maintenance, training, and scheduling. Southwest also earns recognition for its exceptional customer service, employee-centric culture, and customer-friendly policies, such as no change fees and two free checked bags.

Fiscal Year 2025 Performance Snapshot

Southwest Airlines achieved solid revenue growth in Fiscal Year 2025, reaching $25.71 billion. This marks a 5.8% increase from $24.3 billion in 2024, signaling robust demand for air travel.

However, operating expenses grew faster, climbing 7.0% to $23.0 billion from $21.5 billion in 2024. Consequently, operating profit slightly decreased to $2.71 billion (an operating margin of 10.5%) from $2.8 billion (11.5% operating margin) in 2024.

Despite the dip in operating profit, the company reported a Net Income of $1.9 billion for 2025, compared to $1.95 billion in 2024. Significant share repurchases helped Earnings Per Share (EPS) increase to $3.28 in 2025 from $3.20 in 2024, showcasing how capital allocation strategies can enhance shareholder value.

Revenue Streams: Where the Money Comes From

Passenger revenue remains the primary driver, reaching $24.1 billion in 2025. This represents a consistent increase from $22.8 billion in 2024 and $21.5 billion in 2023. Here's how it breaks down:

• Regular ticket sales: $20.0 billion (77.8% of total revenue), up from $19.0 billion.
• Loyalty program (Rapid Rewards): $3.0 billion (11.7% of total revenue), growing from $2.8 billion, which indicates strong customer retention.
• Ancillary revenue: $1.1 billion (4.3% of total revenue), up from $1.0 billion, reflecting success in offering paid extras like preferred seating.

Beyond passenger fares, cargo and freight revenue grew to $210 million (0.8% of total revenue) from $200 million. Other services contributed $1.4 billion (5.4% of total revenue), including income from co-branded credit card agreements and ground handling services for other airlines.

Geographically, North America generated the vast majority of revenue at $25.0 billion, with Latin America contributing a growing $710 million.

Operating Expenses: Managing the Cost of Flying

Operating expenses totaled $23.0 billion in 2025. Key components include:

• Fuel and oil: This was the largest single expense, reaching $7.0 billion, a 7.7% increase from $6.5 billion in 2024. Southwest actively manages this volatility through fuel hedging contracts. These contracts generated a $100 million gain in 2025, effectively reducing the net fuel cost. Approximately 60% of their projected fuel needs for 2026 are hedged.
• Salaries, wages, and benefits: Approximately $8.0 billion, reflecting the airline's significant workforce, 85% of which is unionized.
• Maintenance: Around $2.5 billion, essential for ensuring fleet safety and reliability.
• Depreciation and amortization: Approximately $1.5 billion, representing the cost of aircraft and other assets spread over their useful life.
• Landing fees and rentals: Around $2.0 billion, paid to airports for using their facilities.

Strategic Initiatives (Management Discussion Highlights)

Southwest actively modernizes its fleet to boost efficiency and enhance the passenger experience. In 2025, the company added 50 new Boeing 737-8 MAX aircraft and began receiving the 737-7 MAX, with 10 delivered and another 20 expected in 2026. These new aircraft are up to 15% more fuel-efficient per seat than older models. Concurrently, Southwest retired 10 Boeing 737-700s and 5 Boeing 737-800s. The total fleet size stands at approximately 780 aircraft, with an average age of 12 years.

Beyond fleet upgrades, strategic priorities include:

• Network Optimization: Adjusting routes and schedules to maximize profitability and meet evolving customer demand.
• Customer Experience: Investing in digital tools and in-flight amenities to enhance passenger satisfaction.
• Operational Reliability: Implementing technology and process improvements to minimize delays and cancellations.

Financial Health and Capital Allocation

Southwest maintains a strong financial position. The company ended 2025 with $5.0 billion in cash and cash equivalents, a slight decrease from $5.5 billion in 2024. Crucially, cash flow from operations remained robust at $3.5 billion in 2025, up from $3.2 billion in 2024, demonstrating strong internal cash generation.

The company actively manages its debt, reducing long-term debt by $500 million to $8.0 billion from $8.5 billion. This results in a healthy debt-to-equity ratio of approximately 0.32, indicating a conservative leverage profile. Southwest also successfully managed the maturity of $1.25 billion in Convertible Senior Notes in 2025. Its current ratio, a measure of short-term liquidity, stands at approximately 1.17.

Retained earnings continued to grow, reaching $20.0 billion, reflecting accumulated profits reinvested in the business. Southwest also returned significant value to shareholders through $2.0 billion in share buyback programs during 2025, with an additional $500 million program initiated in January 2026. The company does not currently pay a regular cash dividend, prioritizing reinvestment and share repurchases.

Key Risks

Investors should be aware of several key risks:

• Fuel Price Volatility: Despite hedging, significant and sustained increases in fuel prices can materially impact profitability.
• Labor Relations: With 85% of employees unionized, labor negotiations are ongoing. Potential disputes or significant wage increases could impact operating costs and operational stability.
• Economic Downturns: Air travel demand is sensitive to economic conditions. A recession could reduce passenger volumes and revenue.
• Intense Competition: The airline industry is highly competitive, requiring continuous investment in pricing, service, and network to maintain market share.
• Operational Disruptions: Weather, air traffic control issues, and IT system failures can lead to costly delays and cancellations.
• Regulatory Changes: Environmental regulations, air safety standards, and consumer protection laws can impose additional costs or operational restrictions.

Future Outlook

For the upcoming year, Southwest's management focuses on maintaining operational excellence, continuing fleet modernization, and disciplined cost management. These efforts aim to improve profitability within a dynamic operating environment. The company also seeks to enhance network efficiency and customer experience to drive sustainable growth.

Competitive Position

Southwest Airlines operates in a highly competitive industry, facing rivals from legacy carriers (e.g., American, Delta, United), ultra-low-cost carriers (e.g., Spirit, Frontier), and other low-cost carriers. Southwest differentiates itself through its:

• Low-Cost Structure: Achieved through its point-to-point network, high aircraft utilization, and single fleet type.
• Customer-Friendly Policies: Including no change fees and two free checked bags, which enhance customer value perception.
• Strong Brand Loyalty: Fostered by its Rapid Rewards program and reputation for customer service.
• Operational Efficiency: Driven by its standardized fleet and efficient ground operations.

The company's competitive strategy centers on offering a compelling value proposition to leisure and business travelers. It achieves this through a combination of competitive fares, reliable service, and a positive customer experience.

Investor Takeaway

Southwest Airlines delivered solid revenue growth in 2025, fueled by strong passenger demand. While rising costs, particularly fuel, pressured operating profit, the company's strategic fleet modernization, effective fuel hedging, and disciplined capital allocation (including significant share buybacks and debt reduction) stand out as positive indicators. Investors should monitor Southwest's ability to manage ongoing cost pressures, especially labor and fuel, and its execution of strategic initiatives to enhance operational efficiency and customer experience in this competitive and volatile industry.