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How a Lawsuit can Change the Future of two low-cost Airliners

November 28, 2013 | About:
Patricio Kehoe

patokehoe

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The U.S. airliner industry made headlines recently, following the settlement the Department of Justice reached on its lawsuit merger of American Airlines and US Airways. This latest development is bound to benefit the industry as a whole, as lower competition and higher fares, will consolidate the financial health of companies such as JetBlue Airways Corporation (JBLU) and Southwest Airlines Co (LUV). One of the key factors will be the slots and landing gates US Airways and American Airlines have to give up in seven different airports. In addition, the Department of Justice is seeking to allow low-cost carriers to purchase a significant number of these slots.

How JetBlue can benefit from the deal [/b]JetBlue is a rather new airliner, and thus its fleet is much younger than that of other U.S. airline companies. As it hasn’t had to worry too much about maintenance costs, it has been seeking to expand continuously, only to find itself in front of a major obstacle. The gate constraints have not allowed JetBlue to expand to cities such as New York, Chicago, Los Angeles, or Miami, at the desired pace.

As 52 slot pairs become available at Washington Reagan National Airport, for example, the airliner will be able to launch additional flights from Washington. This will allow for entry into high traffic routes, such as Washington-Miami, Washington Chicago, or Washington-Dallas. The increase in revenue should be significant, adding to the already high passenger traffic JetBlue is experiencing.

The increment in the firm’s flying capacity will surely add to its market share, as the carrier will also gain from its connecting Boston and Caribbean destinations. JetBlue is already achieving 10% annual revenue growth rates, due to higher passenger fares in a stable demand environment. Management is keen on achieving long-term growth, and should not face much trouble sustaining it, as JetBlue is the only airliner in the industry which isn’t unionized. Cost structures can thus be managed with greater flexibility, making it easier to maintain its low cost network.

While the stock is currently trading at 23.7 times its trailing earnings, the hefty price premium of approximately 67% relative to industry peers is meaningful. Yet with such great expansion possibilities, investors have already been picking up this stock consistently. Hotchkis and Wiley Capital Management is one such JetBlue bull, with the hedge fund holding more than 9.3 million shares. I too feel bullish regarding the stock’s future.

[b]

Southwest receives an additional bump
[/b]Southwest has become one of the most profitable, low-cost, regional operators in the U.S., by focusing on domestic flights, point-to-point, and low fare services. With shares already up by more than 47% this year, the company’s expansion strategies are paying off. In 2010, the airliner purchased 36 slots at Newark Liberty International Airport, initiating non-stop flights to 6 destinations, which resulted in a 10 percent drop in air fares.

The latest ruling by the Department of Justice, will surely result in Southwest looking to gain a share of the newly available slots. LaGuardia will be of particular interest, as the airliner could build on its large presence at Newark International. Average fares could thus be lowered even further, allowing the low-cost airliner to exert pricing pressure on legacy carriers.

In addition to the favorable settlement, Southwest is bound to profit from the optimization of its combined networks. New national services will now also reach various new locations, which were yet unexplored, such as Branson, Mo., Charlotte, N.C., Flint, Mich., Rochester, N.Y., Portland, Maine, Wichita, Kan., and Grand Rapids, Mich. The acquisition of AirTran follows the same directive, as expansion and entry into new markets seems to be one of the pillars of the growing airliner.

Financially, the low-cost airliner is very solid, with decent free cash flow levels and revenue on the rise. Future projections for revenue and EBITDA growth are compelling, as the firm is set to profit heavily from its new network of destinations and reduced air fares. Hence, it comes as little surprise that investors are bullish regarding this stock, and are willing to pay the 51% price premium relative to industry peers’ average. Jim Simons, James Barrow, and the boys at Diamond Hill Capital, are all optimistic regarding the company, and have bought large amounts of shares of common stock as of late. I took feel bullish, especially as growth opportunities are clear, and growth projections solid, for the years to come.

[b]Both firms benefit from the settlement
[/b]Clearly the newly available slots at New York, Washington, Boston, Chicago, Los Angeles, Miami, and Dallas, will greatly benefit low-cost carriers such as JetBlue and Southwest. As the largest business centers in the country become operational options for the airliners, price synergies and reduction in air fares are expected. And, despite the price premium one would have to pay for stock of either of these firms, their growth expectations make an investment reasonable. I for one am slightly more bullish regarding Southwest, as it is poised to benefit the most from the settlement due to its size.

[b]Disclosure: Patricio Kehoe holds no position in any stocks mentioned


About the author:

patokehoe
A fundamental analyst at Lone Tree Analytics

Rating: 3.7/5 (3 votes)

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