Southwest Airlines: Can it Overcome Higher Fuel Costs?

Airlines are expected to see a drop in profit for the first time since 2009, according to the International Air Transport Association, which serves as an intriguing lead-in into Southwest Airlines' earnings report on Thursday.

One of the factors for the drop in profits, according to the report, is that supply continues to outpace demand. Airline companies have tried to cut down on flight capacities, but profit margins continue to be squeezed by the inefficiency.

Airlines have continued to be hit by the economic slowdown as more and more travelers have looked at alternative travel measures to flying. That along with rising fuel costs has made it difficult for companies to squeeze out profits in the competitive industry.

Southwest Airlines is the last of the major airlines to release its earnings report and here is what you need to know:

Factors to Keep an Eye on

One of the key factors is the impact of rising fuel costs on the airline company. On Wednesday competitor Frontier Airlines cited rising costs as a reason it missed earnings expectations. Frontier claimed fuel prices were 44.3 percent higher, which will undoubtedly have some impact on Southwest's numbers.

Southwest is known in the industry for affordable flights-some would say it focuses on quantity over quality-which means the airline carrier needs to have a lot of flights to make a big profit. Higher costs along with a lot of flights could mean a cut in profits.

Another factor is the impact that its purchase of AirTran has on its bottom line. Southwest's $1 billion purchase of AirTran will be reflected for the first time in this quarterly earnings report. The two companies operate in vastly different ways and investors and media alike have wondered how well the two will mesh and work with one another.

What to Expect Short-term

Southwest is expected to beat analyst expectations in revenue and earnings per share behind good summer numbers. Although the economy has affected travel budgets, the company has been able to capitalize on the shrinking market by offering competitive prices in lucrative markets.

Analysts expect the company to post net income of $160 million and $4.1 billion in revenue. Despite the rising fuel costs and speculation that bookings are down, Southwest has seen its market share grown in some key airports and has set itself up to beat expectations. A lot of it will ultimately come down to just how busy it has been this summer though.

What to Expect Long-term

Long-term is where the potential issues arise, especially once the summer bump ends. One of the biggest issues for Southwest, and really all airline companies, is the rising operational costs. As fuel costs continue to rise and rise, it cuts farther and farther into the profitability into the companies. That along with the cannibalistic nature of airline companies trying to offer the cheapest prices possible, the airline industry is perhaps as unstable as it gets.

One of the first things to get cut in times of recession is vacation and flight budgets. Instead of flying first class, persons and companies will downgrade to coach. The trend continues downward to the point that driving or other options are strongly considered instead of flying in order to cut costs.

Some financial personalities, including Jim Cramer, have already begun to speculate that the United States could be seeping back into a recession. While one could certainly make the argument the country never inched too far out of a recession to begin with, more economic hits will damage airline companies such as Southwest.

Short-term the company stands to continue to profit, but with the uncertainty of the world's economic standing, it might be wise to hold off on investing long-term in an airline company.