More Airline Consolidation on the Way?

Damon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

News over the past week or so has given us reason to believe that further combinations will soon take place among air carriers. The potential implications of these moves for airline stocks are largely positive, and investors have reacted accordingly. Last week’s reported offer by US Airways Group (NYSE: LCC) to purchase AMR’s American, a company now lingering in bankruptcy, was followed by Delta Air Lines’ (NYSE: DAL) acquisition of a 49% stake in Virgin Atlantic. If you are considering this a buying opportunity in this volatile sector, the actual impact may be limited. But, here are some possible benefits:

New Routes

A merger agreement between US Airways and AMR would stand a decent chance of avoiding regulatory scrutiny because of their lack of overlapping routes. Therefore, the former’s hubs in Dallas, Miami, New York, L.A., and Chicago would now be matched up with the latter’s in Charlotte, Philadelphia, and Phoenix. And so forth. In such a case, revenue benefits are likely to be visible. Without any top-line synergies, the new entity would already be the largest domestic airline, topping United Continental (NYSE: UAL), created through a merger in October, 2010. For references, UAL’s management expects to reach its expected $800 million to $900 million in annual revenue benefits next year, a modest percentage of its total.

As for an hypothetical Delta/Virgin Atlantic combo, DAL is banking on strength in London, where practically all of the potential target’s flights originate or land. Currently, Singapore Airlines owns Virgin Atlantic. Of some note, DAL shares edged up on news of the planned investment.

Efficiency and Fare Hikes

Along with the addition of new city pairings, a merged carrier may choose to cut service on less profitable routes. A good example of this is Delta’s 2008 acquisition of Northwest, after when it substantially reduced its fleet count and lifted the productivity of its assets. Once such integration measures are complete, an airline can realize heightened occupancy rates (load factors) and certainly a higher average airfare.

AMR is already undergoing a Chapter 11 restructuring, though a system overhaul does not appear to be a primary aspect of the plan. It is likely that US Airways’ motivation lies more in increasing its size and scope than finding the most profitable mix of business.

Cost Synergies

Expense pruning is always a consideration among the major airlines, as jet fuel price fluctuations and sometimes inflated labor costs (as with AMR) have historically led the industry to go through periods of severe losses. Cost cuts could be hard to come by from activities including headquarters consolidations. UAL’s anticipated annual cost cuts resulting from its merger are $300 million to $400 million.

Overall, by way of fuller aircraft and better yields (revenue per available seat mile) the industry could head toward more consistent profitability. Another wave of consolidation, albeit not required at this juncture, might help its stability. However, too, in the short term, integration expenses can be a burden on the bottom line to a great extent, and the full effect of mergers is unclear until after several years. All told, the seeming achievement of Delta  / Northwest has spurred others to seek partners if not through merger then through codeshares in efforts to improve earnings performance.

 

 


dctotal has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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