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Echoing a similar message as Delta Air Lines (DAL) and United Airlines (UAL), which reported Q3 earnings on October 10 and October 15, respectively, Southwest Airlines (LUV) credited industry-wide capacity moderation and improving travel demand for its better-than-expected Q3 results. The upside quarterly results are only half the story for LUV, though. After four contentious months in which activist investment firm Elliott Investment Management engaged in a proxy fight with LUV and called for the dismissal of CEO Bob Jordan and Chairman Gary Kelly, both sides came to a formal agreement.

As part of the settlement, Mr. Jordan will retain his CEO position, but Mr. Gary will depart from the Board of Directors. Additionally, Elliott's influence will increase considerably as six of its recommendations for the Board of Directors were approved, including David Cush, the former CEO of Virgin America, and Pierre Breber, the former CEO of Chevron (CVX).

The agreement removes an overhang and uncertainty, and it also should help to accelerate LUV's turnaround efforts. However, shares of LUV are still flying sharply lower despite the positive news.

• We believe the weakness is partly attributable to the fact that the stock had already rallied by 30% since early August. In the wake of UAL's strong results last week, investors were anticipating a solid report from LUV. The company's guidance, though, may also been causing an issue.
• While LUV's Q4 RASM guidance of +3.5-5.5% looks good, reflecting healthy holiday-season demand, the company's cost guidance is disappointing. Specifically, LUV anticipates Q4 CASM-X to increase in the range of 11-13%, driven by ongoing cost pressures, especially related to new labor contracts. Furthermore, an expected 4% reduction in capacity will also pressure CASM-X. 
• In Q3, CASM-X came in at +11.6%. For the sake of comparison, UAL reported that CASM-ex increased by 6.5% in Q3, while DAL reported a 5.7% increase in non-fuel CASM. One of Elliott's gripes against LUV has been that the airline wasn't operating efficiently, so we anticipate that further actions to control costs will be on the horizon.
• Removing unprofitable flights and reducing capacity is another lever LUV is pulling to improve profitability. On that note, ASMs increased by 2.4% in Q3, but LUV is planning for a 4% cut in capacity in Q4, which should support higher ticket prices.
• Rounding out the busy news morning for LUV, the company also announced a $250 mln accelerated share repurchase program under its $2.5 bln share repurchase authorization. Buying back stock should help to offset the impact on EPS from the higher costs.

Overall, LUV delivered a solid earnings report, but its performance is still lagging that of UAL's and DAL's. There's plenty of room for improvement, especially on the cost side, but with Elliott now on board, we suspect that operational changes will be coming sooner-than-later, potentially providing a boost to LUV's profits.