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Airline Merger Offers Opportunity

November 24, 2013 | About:
Gordon Pape

Gordon Pape

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Contributing editor Glenn Rogers is here this week with his views on the one of the biggest airline mergers in U.S. history and what it means for investors. Glenn is a successful businessman and entrepreneur who has worked in both Canada and the U.S. over his career. He and his family now live in southern California. Here is his report.

Glenn Rogers writes:

If you're like me you've seen a long, sad decline in the quality of the air travel experience over the last decade or so since the airlines were deregulated in the U.S. True, for a time prices did come down since there was a rush of cheap air carriers in the space. That caused many mainstream carriers to reduce their prices - and their services - to compete with the low-cost offerings.

During this era things we had taken for granted such as meals, pillows, blankets, free luggage check-in, etc. were steadily chipped away until we have gotten to the point where we have to pay extra for virtually everything. As this was going, on the airlines still lost gobs of money as they added more seats than the market could handle.

After years of this nonsense they began to figure out that they couldn't outspend each other and gradually began to merge in search of efficiencies and route dominance.

Personally, have always avoided investing in airlines. They never seem to have any financial discipline, they require lots of capital, and were subject to the whims of union contracts and jet fuel prices. Airlines are one of the few sectors where Warren Buffett lost money and he swore he never would invest in one again. I felt the same way, but never say never because I'm about to recommend investing in airlines again.

Part of the reason is that I still believe in the travel industry in general over the next few years for reasons I've mentioned in previous columns. The Internet-related travel stocks we recommended have done extremely well and are now fully priced but I think there is room to grow in some of the still recovering airline stocks.

The result of all the reduction in services and the accompanying increase in fees, combined with a number of huge mergers, has made the space interesting again. This past week the U.S. Department of Justice agreed to let the $17 billion (figures in U.S. dollars) merger of US Airways Group (LCC) with American Airlines (AAMRQ) go forward with very few concessions. Few analysts, including myself, believed they would get off so easily. But now that the terms of the deal have been set, it creates a very interesting opportunity to take advantage of the heavy travel period we are entering which, happily for the airlines, coincides with a recent steady drop in jet fuel prices.

This merger will create the world's second largest airline (next to Delta). It enters into a market that has fewer competitors than at any time in the past 10 years. US Airways shareholders will get 20% of the new company's equity while American Airlines creditors and shareholders will receive the remainder. US Airways management will for the most part run the company with Doug Parker, the highly respected US Airways CEO, taking over the combined business. Although US Airways management will run the show, the merged company will retain the American Airlines name.

The merged American will have to give up a number of landing slots in Washington and at New York's LaGuardia Airport, along with reducing some exposure in Boston, Chicago, and Dallas. But it will still have 57% of the flights in and out of Dulles Airport in Washington and only 12 fewer flights from the normal 175 daily departures at LaGuardia. The company also expects to have over $1 billion in annual savings from the synergies it expects to benefit from post merger. There are other companies that will benefit from this merger, including Southwest Airlines (LUV) and JetBlue Airways Corp. (JBLU), which will be able to acquire a number of the gates that US Airways/American will have to let go.

Compared to the other large airlines, US Airways, which closed on Friday at $24.27, is quite cheap. The shares are trading at a discount to Delta Airlines (DAL) which has a price-earnings multiple of 9 versus 6.6 (2014 estimated earnings) for the new American Airlines. If American just tracks to Delta Airlines multiples against its earnings forecast we could see the stock increase significantly over the next year and a half, perhaps to as much as $32 or better in 2015.

Certainly there could be some churn in the stock as the American Airlines and US Airways stakeholders decide how much they will continue to hold versus sell over the next few months but I would view every dip as a buying opportunity. The only thing that would significantly change my opinion is if jet fuel spikes to over three dollars a gallon for an extended period of time.

You don't have to like airlines to like the investment opportunity that presents itself now. However, you need to understand a few complexities. US Airways stock continues to trade actively on the NYSE. However, American, which is technically still in bankruptcy, only trades as AMR Corp. on the U.S. over-the-counter market under the symbol AAMRQ. It closed on Friday at $12.06.

When the merger is completed and American emerges from bankruptcy protection, shares in the combined airline will be listed on Nasdaq under the symbol AAL. We don't have an exact timetable for that but the whole process should be concluded some time in December.

For now, I advise buying US Airways on the New York Exchange. I expect the two stocks to track one another closely until the merger is complete. US Air closed on Friday at $24.27. I think the stock has the potential to reach $32 within 18 months.

Action now: Buy US Airways Corp. (LCC) at the current price.

About the author:

Gordon Pape
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