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Delta or Southwest, which Airline Company Should You Buy?

April 26, 2014 | About:

For investors who have been investing in the airline industry in the hope of profiting from mergers and acquisitions, the attempt to block the merger between American Airlines and US Airways was indeed a dampener. However, some see this as a possibility of bigger airlines acquiring smaller regional players in the aviation industry.

The aviation industry is poised to become a $3.5 billion industry by 2016 and consolidation is expected in the industry with each operator wanting a bigger share of the pie, and here are two that you should consider.

Southwest to take-off

Southwest Airlines (LUV) is a regional operator that focuses on domestic flights, point-to-point and low fare services. One of the distinguishing features of this company is that it has the distinction of being one of the most profitable low-cost airlines in the world. Shares are up 47% this year on the back of strong performances and solid strategies.

In line with current trends, the airline expects unit revenues to grow in the future, and this might lead to further share price gains. The company is on the right path as far as its strategies of improving efficiencies in operation, introducing various customer-friendly programs, optimization of network, and capacity management are concerned.

Among the customer-friendly programs are the All-New Rapid Rewards Program and supplementary products such as pet fees and EarlyBird check-in. Going forward, it is expected that these initiatives will benefit Southwest over the next three years. However, higher operating costs as a result of maintenance, salary and wages, airport fees and aggressive advertising along with intense competition in the segment are some of the headwinds that would work against Southwest.

To combat further cost increases, Southwest has retired two 737-300 Boeings and added three 737-800 jets to service. The company plans to expand its network by integrating AirTran aircraft and the addition of new domestic and international destinations, all based on its cost-efficient business model.

To cover up for empty seats, Southwest Airlines had implemented a "No Show policy" and "Lost Ticket." Under the no show policy, if a customer fails to change or cancel tickets 10 minutes prior to travel and fails to board the flight, he/she will be termed as a "no show" and no refund will be provided. In case of Lost Ticket, no replacement or refund would be provided and new tickets will have to be purchased at appropriate fare charges.

In addition, Southwest Airlines has increased its share repurchase program from $1 billion to $1.5 billion. In the last quarter, the airline repurchased 18 million shares worth around $251 million. Also, it paid dividends amounting to $28 million. Hence, with a combination of cost-control measures and growth-driving strategies.

Delta is another good bet

Delta Air Lines (DAL) is the second-largest carrier in the U.S. The airline recently launched a daily non-stop service between Seattle and London. It intends to expand its services by launching non-stop seasonal flights to Aspen, Colorado. In addition to daily services from Atlanta, there will also be flights every Saturday, from Minneapolis-St. Paul. This will enable Delta to offer a well-diversified network with its usual high-class customer service. The airline is making constant moves for expanding its business line to cater to the travelers' demands.

In September, the U.S. Department of Transportation (DoT) granted approval to Delta for its joint venture with Virgin Atlantic Airways for routes connecting North America and the U.K. This approval enables Delta to reap the benefit of the lucrative New York-London route and Delta.

According to survey reports, Delta was the market leader in the domestic airlines market (July 2012 - June 2013). It commanded 16.3% of the market share in domestic airlines. Also, Delta has the distinction of being the first and only airline to have daily non-stop service between one of the top global skiing destinations and Southeastern U.S.

This will offer better connectivity between the destinations, making it convenient for travelers. It also acquired a 49% stake in British carrier Virgin Atlantic from Singapore Airlines. Delta has also established its strong hold over the New York-London air route -- one of the busiest itineraries across the globe. The service is slated to begin early next year and should prove accretive to Delta's earnings. Delta has been on a tearing run this year with shares up 112%, and it won't be surprising to see further gains on the back of its strategies. I have short listed both Delta and Southwest for my portfolio along with Philip Morris (NYSE:PM) and Lorillard (LO).

Final words

Both airliners have been following different strategies to grow and should see good growth going forward. At a trailing P/E ratio of 11.8, Delta is cheaper than Southwest, which has a 28.8x multiple. However, I think both these companies will show good growth going forward, which is why I think investors should add it to their portfolios.

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