A Major Airline's Potential $1 Billion Mistake

The reason for the Southwest Airlines debacle... 15,000 flights canceled... In pursuit of high margins... A potential $1 billion mistake... The cost of embarrassment... Doc's tips for seeing your New Year's resolutions through...

Thanks for (almost) nothing, Southwest...

We don't discuss specific companies frequently in the Digest. Our editors and analysts mostly do that in their various paid publications. But every so often, it is called for. This is one of those times...

I (Corey McLaughlin) am among those caught up in the widely reported failures of Southwest Airlines (LUV) over the holiday season. Don't worry, I'm not going on a travel-nightmare rant for today's Digest.

Instead, I'm focusing on the business concepts involved in this story. But first, some background...

If you fly in and out of Baltimore, our home base, there's a good chance you'll be on a Southwest flight. It has long been a major hub for the airline. I've flown with Southwest many times without issue... and other times with issue.

This time, my family's jaunt to Florida for the holidays included round-trip travel on Southwest.

Frankly, our experience in the debacle wasn't all that bad. It certainly wasn't as bad as the woman who missed her own wedding and is down around $70,000 associated with the ceremony and reservations at a resort in Belize.

My wife and our children simply got "stuck" in Florida for several extra days, and those days were the warmest of our entire trip. But that's about it. So thank you for that, Southwest. Other family, on the other hand, never made it, and their luggage went to Atlanta for some reason.

I've read estimates that perhaps 1 million boarding-pass buyers were directly impacted by Southwest's downright logistical ineptitude following the recent winter storm. The airline cancelled more than 15,000 flights from December 22 to 29.

The images of luggage sitting in major airports unattended were head-scratching. The stories of missed flights, frustrated travelers, and embarrassed pilots and flight attendants sleeping in airports or booking their own hotels in the middle of night were just as concerning. And as we learned, they were avoidable in some ways and inevitable in others...

In all, it was a travel nightmare-turned-reality for many.

But the root of the problem wasn't really the weather...

Other airlines held up much better over the same span of time when Southwest canceled roughly 3,000 flights for three straight days last week. Other carriers canceled maybe a few hundred at most.

The real problem – revealed not by the company but by Southwest's pilots union – was that Southwest's flight crew scheduling system can reportedly only handle about 300 cancellations at once and needed manual maneuvers to get people in the spots to keep planes flying. That included things like calling staff on the phone... or physically finding staff in airports like the good old days.

Brian Brown, president of Transport Workers Union Local 550, representing Southwest dispatchers and meteorologists, said...

It can't see the best way to fix anything when flights are canceled. It requires a lot more human intervention and human eyesight or brainpower, and can only handle so much.

Combine that Stone Age system with a few thousand flights, and you get a disaster...

How can this be the same business that, on a good day, sends about 4,000 airplanes filled with people 40,000 feet into the air traveling hundreds of miles per hour each day? This is a major player in an industry in which pilots are trained and trusted to deal with all kinds of potential life-and-death variables.

And the company these people work for can't effectively adjust its employees' work schedules over a web-based app or similar technology? Southwest CEO Bob Jordan, 11 months into his role, gave some sorry public-relations-driven excuses as the meltdown unfolded.

But Southwest Airlines Pilots Association Vice President Mike Santoro gave some better detail, saying in a television interview...

What went wrong is that our IT infrastructure for scheduling software is vastly outdated. It can't handle the number of pilots, flight attendants that we have in the system, with our complex route network.

We don't have the normal hub the other major airlines do. We fly a point-to-point network, which can put our crews in the wrong places, without airplanes.

It is frustrating for the pilots, the flight attendants and especially our passengers. We are tired of apologizing for Southwest, the pilots in the airline, our hearts go out to all of the passengers, they really do.

This wasn't a new problem...

The issue of outdated technology has impacted Southwest's operations and customers before, just not at this scale... nor at the time of the year when a lot of people are paying attention to holiday travel.

Travel problems, generally speaking, are as old as bipedalism – and so is the reason thousands of flights were canceled in a week's time... The root of the massive cancellations was Southwest's underinvestment in technology in pursuit of high margins. As we'll show, that backfired...

Herb Greenberg, a longtime financial journalist and editor at our corporate affiliate Empire Financial Research, wrote about this earlier this week...

The easiest thing to do to keep costs low and margins high – especially for public companies eager to meet or beat quarterly expectations – is for managements to defer tech upgrades in hopes that they'll get from here to there before things break.

Like they did at Southwest.

It has been happening for years and will continue – especially if earnings come under increased pressure, as many pundits expect.

While the Southwest episode impacted a lot of people and made for simple headlines, it's not an isolated incident in cause and effect...

Herb cited a recent column from Michael Hiltzik in the Los Angeles Times, which raised the question about "why American companies generally get caught so often with their pants down when operating conditions materialize on the edge of – or outside – normal expectations." As Hiltzik said...

The short answer is their underinvestment in preparation and planning. For decades, Big Business has been squandering its resources on handouts to shareholders instead of spending on workers and infrastructure. There's not enough give in the system, so when crisis comes, it doesn't bend, but breaks.

Herb then shared that a 2020 study by Boston Consulting Group showed that under the cover of COVID-19, 54% of nearly 700 companies surveyed said that they had delayed upgrading existing hardware, and 44% had delayed feature add-ons or upgrades to existing software...

Analysts at investment-research firm Kailash Concepts showed how Southwest screwed up...

In a series of tweets, they noted that the airline's gross profit for the 12 months ending September 30, 2022 was $5.9 billion, a roughly 54% year-over-year increase. That looked good, but they wanted more.

In Southwest's recent third-quarter earnings report, CEO Bob Jordan said...

As we finalize our plan for next year, we remain laser-focused on our goals to grow full year 2023 profits and margins, excluding special items, year-over-year, and to generate healthy returns on invested capital for our Shareholders.

But Kailash wasn't satisfied...

Perhaps it would have served Jordan well to have a laser focus on ensuring that their systems were working adequately to ensure the airline could meet the needs of their customers. You know, the people whose spending is actually delivering those profits to shareholders...

Look, we're not against corporate profits – quite the opposite. But when a company has record profits and fails to invest in the required infrastructure to serve their customers and employees, it HURTS the bottom line. Worse, it hurts people.

Corporate executives need to stop making internal PowerPoints and congratulating themselves and start looking at how they will reinvest so they can sustainably deliver profits to shareholders in the long term.

It's one thing to generate gobs of free cash flow, but the very best businesses reinvest it in a way that benefits shareholders and grows the business. You can see that exact approach in Hershey (HSY) selling a lot of chocolate and using profits to buy other brands, like Pirate Brands (makers of the Pirate's Booty snack) – thereby generating more profits.

Conversely, hurting people is a great way to lose them as customers. Plus, as the Kailash firm astutely suggested, Southwest is taking a big hit to its bottom line anyway due to poor infrastructure. Ultimately, its share price will likely take a hit...

A potential $1 billion loss...

Tom Nekouei, another top Southwest Airlines pilots union official, told news service Reuters today that based on union estimates, the airline faces a potential $1 billion loss in revenue because of the debacle.

Some Wall Street analysts are estimating all the cancellations could cut 9% off Southwest's fourth-quarter profits. Shares of LUV are already down around 15% from previous highs near the end of 2022.

That's the opposite of what the company was hoping for... It owes folks refunds, and people are mad.

Southwest hasn't divulged how many refunds it has processed. However, as a gesture of goodwill, it is awarding customers 25,000 Rapid Rewards points it values at more than $300...

And we said earlier, this has happened before – just not over the holiday season at this scale. Nekouei said the same issues led to a major meltdown at Southwest after a thunderstorm in Florida in October 2021 that cost the company $75 million.

As Reuters reported, the airline has been upgrading its technology in phases, but pilots say it hasn't been enough...

In 2017, [Southwest] replaced its entire reservations system, and four years later it enhanced technology at its maintenance department. Recently, it has made investments in digital scanners to make its baggage handling system more efficient.

But union officials said the pace of investment has been too slow.

"Every meltdown that we've had, it's gotten more severe," Nekouei said. "It's become more frequent now and it takes longer and longer to recover from them."

But maybe none of it will matter...

We were supposed to return to Baltimore last Wednesday. Ultimately, we spent extra time in warm weather. My attentive wife, realizing there was an unusual problem brewing with the cancellations, booked a backup flight that we ended up taking back last Saturday.

And we still flew Southwest.

The takeaway from all of this – being our game here with investment research – is examining the impact this will have on Southwest's future business. The debacle is no doubt a stain on the company's reputation.

But will it impact the business's bottom line for years ahead? It's hard to say. Folks are certainly taking time to consider booking travel on other airlines instead of defaulting to Southwest like normal.

Some people will certainly never fly Southwest again. And if the company doesn't make the right decisions in the future, it will face more trouble, embarrassment, and lost profits...

But ultimately, its low fares might still win out. At many airports, Southwest is often the only regular option for travel. And in major airports like Baltimore's, it is by far the most convenient and consistent carrier to get anywhere in the country.

But until Southwest proves that this kind of thing won't happen again, the company has invited customers to fly with a competitor... and it has nobody to blame but itself.

At the least, this debacle might cost the company $1 billion... and a tremendous amount of embarrassment with a to-be-determined price tag.

Lastly today, some advice about New Year's resolutions...

If you made a New Year's resolution – or simply have a goal you want to attain in your portfolio or elsewhere – it can be hard not to give up or forget about it quickly.

That's why our colleague and Stansberry Research partner Dr. David "Doc" Eifrig recently shared some extremely practical advice. In the December 31 issue of Doc's free Health & Wealth Bulletin (which you can subscribe to here if you don't already receive it), he shared a few ideas on how to actually keep your resolution.

As Doc writes...

The grim reality is that too few of us will keep these resolutions. In fact, by February, about 80% of folks each year fail. Why do we make promises to ourselves that very few of us actually follow through with?

I can't really answer the question any better than Doc did. (If I did, I would have written a book and accomplished a few other things last year.) Here's what he said in his Health & Wealth Bulletin...

The first challenge is 'false-hope syndrome'...

Psychologist C. Peter Herman documented cases of this problem and concluded that the issue lies in setting expectations too high. Our own overconfidence hinders our ability to succeed with "pie in the sky" goals.

Try to set smaller, more measurable goals. For example, simply saying you want to lose weight is too vague. Instead, set a goal to lose a pound a week. Or, instead of just wanting to be healthier, set a goal of cutting your soda intake to just one cup a week. Having more attainable goals helps you feel more successful and less likely to quit.

Experts recommend charting your goals (and successes) in a visual fashion, like making a vision board. If your goal is weight loss, perhaps using a picture of yourself (or someone else) at an ideal weight can be a big motivator. Tape the picture on your fridge to remind yourself to eliminate mindless snacking.

Hold yourself accountable, start small, and help yourself...

Accountability can really help us stay on track. That's why it's helpful to share your goals with family and friends... Some folks even find posting their goals on Facebook or other social media helps them stick to them.

Remember, new habits are difficult to make and take time to become engrained. And time is one of the biggest hurdles to forming new habits. So make sure you start small, and don't rush.

If you start small with something like exercise, it's easier to build longer habits over time. Start with short workouts every day, even just 10 minutes in the morning. After a few months, bump it up to 15 minutes, and so on. I like to go on an early morning walk before my brain knows what's happening. It's a good way to get the blood moving.

It's also a good idea to get some help. Having a buddy to help keep you accountable goes a long way toward success. Ask a friend to join you at the gym or – if your resolution is to spend less money – to keep tabs on your spending levels when you shop together.

You can also tackle self-care activities with some electronic help. Apps like Insight Timer and Headspace offer free meditation guidance, while a good sound machine and alarms can help you improve your sleep schedule.

What are your goals this year, and how do you plan on sticking to them? Let us know at feedback@stansberryresearch.com.

Top 10 Potential Surprises for 2023

I recently joined Dan to run down a list of 10 potential market surprises in the year ahead. And in keeping with Dan's favorite adage of "Prepare, don't predict," we reviewed possible events investors are largely unprepared for, based on current market conditions...

Click here to listen to this episode of the Stansberry Investor Hour right now. And to catch all of the podcasts and videos from the Stansberry Research team, be sure to visit our Stansberry Investor platform anytime.

New 52-week highs (as of 1/4/23): Alamos Gold (AGI).

In today's mailbag, feedback on Tuesday's Digest in which we mentioned that the S&P 500 has been flat since June 2022... and your thoughts on Mike DiBiase's Wednesday Digest... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Hi Corey! Thanks for the reminder that we are probably in a sideways market, with the S&P 500 at June 2022 levels. However, that is only in nominal terms. In real terms, inflation has eaten into, what 7% or 8% of that return, so what month are we at in real terms?

"It is worse than people think, and I think it would be good to remind all of us of that fact until inflation abates. Five years ago I would have called a 7% return 'OK.' Today, that is just standing still (although standing still is certainly preferable to losing money).

"Thanks for all you do and keep up the good work!" – Stansberry Alliance member Alan K.

"Mike, I think you are correct. People have asked in retrospect 'Why the Fed didn't save Lehman'? They could have but did not? Me? I think they needed to get the attention of Bond Kings and Queens.

"Just like this time, but differently, the Bond Royalty is fighting the Fed. I agree with you." – Stansberry Alliance member Bill B.

"Mike, I believe we are on the leading edge of the eye with several months of calm to follow giving consumers a false sense that the worst is over.

"That will lead to an even more drastic result when the inflation and debt crisis merge into a catastrophic impact to the economy, the country and middle and lower class consumers." – Paid-up subscriber Dickie P.

"I think your commentary is literally 'spot on'. There is no doubt in my mind that a serious stock collapse is now due and it needs to be stated in those words. Thank you for such up-to-date predictions as we go woefully into this new year." – Paid-up subscriber Alan S.

"To Mike DiBiase and the Stansberry research team, Thanks for the update on credit opportunities. Investors would appreciate a little more information on where these bonds can be purchased without you having to give away your specific picks.

"From what I understand these bonds are traded on the OTC exchange? Can individuals trade directly or do we need a brokerage involved? Some general 'in's and out's' on how and where these alternative investments are traded be of particular interest to investors new to this alternative investment in the credit market." – Paid-up subscriber Rodger G.

Mike DiBiase comment: You can buy corporate bonds through brokers like Charles Schwab, Fidelity, or E-Trade. Buying bonds can be as easy as a click of the mouse, just like buying a stock. Instead of a short stock ticker symbol, bonds are identified by nine-digit alphanumeric CUSIP symbols.

But sometimes buying bonds does require a little extra work.

That's because bonds aren't traded on central exchanges like stocks. Most transactions happen between brokers and dealers in a decentralized, over-the-counter market. Not every broker will have every bond available to sell you. It depends on the liquidity and availability of the bond.

When you place an order for a bond, your broker has to go out and search for a seller from bond dealers. Some brokers will tell you they don't have the bond available. So you might have to call around to other brokers to buy it. But don't let that discourage you. The extra work is well worth the reward.

In fact, that's part of the opportunity in this corner of the market that is routinely overlooked and not even understood by many everyday investors. You can learn more about it here, including how one subscriber retired early at age 52 by using the strategy.

All the best,

Corey McLaughlin
Baltimore, Maryland
January 5, 2023