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Patricio Kehoe
Patricio Kehoe
Articles (164) 

These U.S. Airlines Have a Promising Future

October 07, 2013 | About:

Airlines have always had a hard time staying in business, be it due to rising costs, strong competition, or economic cycles. Yet United Continental Holdings Inc. (NYSE:UAL) and Southwest Airlines Co. (NYSE:LUV) are two companies that have been in the air for decades. As of late, rising fuel costs, salary increases and recession-weary passengers have presented themselves as challenges that both airlines seem to be overcoming.

Catering to the Wealthy

Operating nearly 5,500 daily flights for over 375 domestic and international destinations, United Continental Holdings is the largest U.S. airline. Following its $3 billion merger with Continental, the firm increased sales to approximately $37 billion annually, and currently employs around 88,000 workers. Despite the Continental merger, the company is facing rising fuel costs and strong competition.

In order to make ends meet, add-on charges are seen as a possible strategy to increase revenue. By generating ancillary revenues, through the sale of frequent flier miles, or the introduction of baggage fees, United has been able to balance its finances. Baggage fees alone could generate around $1 billion in high-margin revenue for the airline.

By focusing on customers who are willing to pay more for luxuries such as additional legroom and early boarding, the firm already has improved revenues. Additional services, such as flat-bed seats and personal on-demand entertainment systems, cater to premium customers, who are willing to pay higher fares for a better flying experience, have meat with an underserved market. In light of this strategy, the acquisition of a large portion of shares by George Soros of Soros Fund Management makes perfect sense.

Inflation has not worked in the airline’s favor, because volatile fuel prices and wage disputes have given way to rising costs in an industry with very small margins. Despite demonstrating a weak financial position, United is expanding its international route network and fleet. Airbus is set to deliver 35 new jets as part of the redesigning of the firm’s fleet structure. Although the firm is facing some troubles ahead, I believe the add-on charges, along with focusing on premium paying customer, will balance the equation. Like George Soros, I too feel optimistic about this stock’s future.

Focusing on Leisure

Following the acquisition of AirTran, Southwest Airlines now operates a fleet of approximately 700 Boeing aircraft. With its point-to-point network, the firm specializes in short-haul routes, offering flights to 97 destinations. Based primarily in the U.S., the company employs around 46,000 workers and generates $17 billion of annual revenue. Unlike United, Southwest’s focus lies in stimulating leisure passenger demand through cheap fare offerings.

By making use of point-to-point routes, the airline has been able to reduce flight delays. In addition, Southwest makes use of second-tier airports with lower landing fees, in order to minimize costs. Through its low cost structure, the company can offer consumers low fares while generating profits, making it the envy of this bankruptcy-ridden industry.

Through its acquisition of AirTran the firm gained access to 37 new markets, including the Hartsfield-Jackson Atlanta International Airport, the world’s busiest airport by passenger traffic. Additionally, the merger is expected to produce $500 million in revenue synergies, helping Southwest keep a lid on fares. This is important since leisure travellers are very price sensitive and customers are still coping with a recovering economy. The company faces further pressure from its unionized workforce as they push for higher salaries.

Looking to the future, Southwest expanded to New York (La Guardia) and Boston (Logan) airports and is now seeking to acquire larger aircraft for international destinations. The growth possibilities are evident, and James Barrow of Barrow, Hanley, Mewhinney & Strauss has noticed them. He recently purchased a large amount of shares, indicating his confidence in the firm’s future. George Soros seems to agree with him, as he recently bought in to Southwest. The company’s growing revenue and strong financial position, along with its growth prospects, make me feel bullish regarding this stock.

Cheap Fares for a Recovering Economy

Both airlines seem to be on the right path, with growth opportunities and sound business strategies. However, Southwest shares have almost reached 2008 levels and are expected to continue growing, assuring shareholders value increments. By concentrating on the recovering domestic market, I believe Southwest has a slight advantage over the pricier United. Additionally, the domestic airline’s financial position is stronger, thanks to comparable better cash to debt ratio, free cash flow and rising revenue. Hence, although I feel bullish about both stocks, Southwest seems to be the wiser investment option.

Disclosure: Pablo Erbar holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 4.2/5 (6 votes)


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