MIAMI — Southwest Airlines announced a record second quarter profit of $465 million, or $0.67 cents per diluted share, on Thursday, nearly doubling its total profits during the same period a year prior. The second quarter represented the fifth straight in which the Dallas-based airline set a new record for profitability.

Total operating revenues rose 7.9% year-over-year (YOY) to $5.01 billion versus the same period in 2013, led exclusively by an 8.5% growth in passenger revenues to $4.75 billion. Freight revenues rose 2.3% YOY to $44 million, and other operating revenues declined 2.3% YOY to $215 million.

Amongst passenger revenue, revenue for the Rapid Rewards frequent flier program rose to $95 million, up 40-50% YOY. Yields rose 6.0% YOY to 16.62 cents, driving a 9.0% increase in passenger revenue per air-seat-mile (PRASM) to 13.94 cents. The strong PRASM growth occurred despite a two percentage point headwind because of increased seat gauge and stage length.

Operating expenses rose just 0.6% YOY to $4.23 billion, driven primarily by an 8.3% rise in labor costs to $1.40 billion on a capacity decrease of 0.4% as measured in available seat miles (ASMs). Southwest’s labor cost per ASM (LCASM) rose 8.7% YOY and remains the single biggest worry about the airline’s long term prospects.

However, falling fuel and maintenance costs, down 4.3% to $1.42 billion and 16% to $236 million respectively, muted the impact of higher labor costs. The decrease in fuel costs reflects a 2.6% drop in per-gallon costs to $3.03 and an increase in fuel efficiency across Southwest’s fleet. Costs per ASM (CASM) rose 1% to 13.94 cents, excluding fuel to 8.25 cents. According to Southwest, its fleet modernization program (getting rid of 717s, adding seats to 737s, and up-gauging to the 737-800) cumulatively drives $500 million in annual cost savings.

For the trailing twelve months, Southwest recorded a pre-tax return on invested capital (ROIC) of 17.1%, ahead of its consistent, long term, 15.0% ROIC target. Operating profit nearly doubled to $775 million, giving Southwest an operating margin of 15.5% versus 9.5% a year prior, and giving Southwest the highest operating margins amongst its network peers (United, Delta, and American). Free cash flow for the quarter came in at $838 million, better than that of either United or American. Thanks to Southwest’s conservative capital allocation plan of deferring aircraft purchases and deliveries, the carrier has been able to de-lever while still generating enough cash to return to shareholders alongside.

But as with any analysis of Southwest, the focus must lie with a massive opportunity on the horizon and a pressing and real challenge. Starting with the most pressing (perhaps the only pressing) issue with Southwest’s financial performance, labor costs continue to rise at a precipitous and alarming rate.

Adjusted for age of workforce, Southwest has the costliest labor force in the industry, and that ignores the ballooning of retirement expense likely to occur when the first huge swath of Southwest pilots undergoes retirement beginning near the end of the decade. Understandably, compensating labor well is a critical element of the Southwest Airlines ethos (and perhaps its only durable element). And despite this author’s tendency to occasionally underrate the impact of corporate culture on financial performance, Southwest’s management certainly seems to view it as a critical investment, at least rhetorically.

But keep in mind that just two to three years ago, CEO Gary Kelly was facing down the very real possibility of having to ask his workforce for savings for the first time in his career before structural changes in the industry and economic recovery staved off the problem. The best analogy for where Southwest’s labor costs are positioned from a financial standpoint is social security.

Namely for years and years with a young workforce and healthy earnings, Southwest promised benefits and continually increased wages, just as Social Security hummed along as an ever expanding fiscal entitlement for decades. But today, the US government is sitting on a fiscal and demographic time bomb that it must avert by reducing benefits or increasing payroll taxes. Similarly, Southwest must eventually face up to its labor cost challenges, even if it continues to put off the problem with a series of revenue generation initiatives for the next few years. In that sense, Southwest has been a little more prudent than the erstwhile US government in that it has acted to broaden its potential revenue base.

Conversely, international operations represent a massive opportunity, one that should leave Southwest’s investors bullish about future top-line growth (though margins will be a challenge). On the quarterly earnings call, Southwest CEO Gary Kelly spoke of a 50-destination opportunity (including Hawaii) for Southwest in terms of international flying. And we’d largely agree.

In Mexico alone, there are perhaps ten destinations that could support Southwest flying, five in Central America, five in Northern South America, fifteen in the Caribbean, ten in Canada, and five in Hawaii. And despite the lower CASM widebodies that Southwest’s network competitors fly on the route, Mr. Kelly is confident of Southwest’s prospects, “But we feel we have a very solid cost advantage with the 737 and in the route network that we’re envisioning too again, North America and the northern part of South America.”

When analyzing Southwest’s financial earnings, the most remarkable element is not its record breaking streak of profitability, but rather its nearly as lengthy record of adaptability. The elephant in the room remains labor costs, but it’s difficult to bet against an airline that has delivered such consistent results.

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