A New Era In The Airline Industry

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Anyone who has been investing for a while knows that airlines are a tough business. For decades overcapacity and price competition have been destroying shareholder value. Not even great investors such as Carl Icahn have managed to make money in this industry. Nowadays airlines keep on losing money most of the time, but the economics in the industry are ameliorating fast thanks to the ongoing cut in seat availability (capacity) and a strong consolidation process. The last mega deal to be announced was the one between AMR, the bankrupt parent of American Airlines, and US Airways (NYSE: LCC).

The deal promises to reshape the US airline industry and create the world’s second largest airline by revenues. The deal between these two airline giants is the last step in the the US airline industry consolidation that should be the cornerstone to create the healthy competitive environment airlines have been expecting for decades. Now there will be three $40 billion revenue companies: American, United Continental (NYSE: UAL), and Delta (NYSE: DAL).

All of the above being said, companies are not always easy to merge. The merger between United Airlines and Continental Airlines in 2010 is still causing headaches for investors. Different problems coming from diverse IT systems to unions could make the lives of the management behind a merger pretty far from heaven. Despite the expected bumps ahead for airlines, merging still does make sense.

The merger between Delta and Northwest Airlines in 2008 is a great example of this. The company has been ameliorating its numbers since the all-stock merger took place. Nowadays Delta can show reasonable results to its shareholders, as it has one of the most efficient cost structures in the industry. As an example, in 4Q 2012 Delta could show investors that its passenger revenue per available seat mile, which is the key measure of airlines unit revenues, was up by 4.3%. I bet the new merged company will also finally succeed. American will provide US Airways with a much-need international network, and US Airways shall provide a very efficient East Coast hub. As a matter of fact, the two companies (whose route networks almost don't overlap) plan to keep operating all their present hubs and serving every destination they currently travel to.

The combined company will not only help to reshape the competitive environment, but it will also produce nearly $1 billion in synergies. Of course the merger would not have been possible without the AMR restructuring, which cut costs sharply. Actually, American's costly structure has been the main cause for the company's low gross margins. Let's just take a look at the following: while American made a $107 million operating profit on $24.9 billion revenues for 2012, (although it reported a $1.88 billion net loss after restructuring costs), US Airways reported $637 million net income for 2012 on $13.8 billion revenues. The combined company's margins should resemble more those at US Airways than those at the old American. According to analysts, the new company will generate over $6 billion in operating cash flows, assuming just half the expected synergies, and will carry around $15 billion of net debt.

Those numbers look sustainable and seemingly healthy in an industry that has been destroying value almost from its birth. Maybe now things will be different. US Airway's management deserves a bet. Its stock price went up by 60% in the past year thanks to great management and an easier operating environment. Even though US Airways shareholders will only get 28% of the new company, US Airway's CEO (Doug Parker) shall remain in his seat as chief executive. I would start taking a close look at this industry and place some faith in the new American Airlines, or at least in its new CEO.


martinzaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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