Delta Eyes Virgin’s Heathrow Gates

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Singapore Airlines has been looking to sell its 49% stake in Richard Branson’s flagship carrier Virgin Atlantic, and Delta (NYSE: DAL) is one of the companies that are looking to buy that share. Mr. Branson will be keeping his controlling stake. He also wants to increase his operations on the U.S – U.K route, and by partnering with Delta he can achieve this objective. Although Delta has operations all around the world, it has very little presence at the one airport that matters –  London Heathrow. The slots at this primary Trans-Atlantic destination, where British Airways is the number one operator with 39% of the total passengers (2010 data), are rarely available as it operates at full capacity.

Both Singapore Airlines and Virgin Atlantic have been under pressure over the past couple of years. SIA has been facing increasing competition in the Asia Pacific market; particularly from low cost carriers such as Malaysia’s AirAsia and the Indonesian carrier LionAir’s Malindo Airways.  Rising fuel costs and a stagflationary depression in Europe has rendered obsolete SingAir’s luxury-business travel model. The company now wants to focus on its core market. Meanwhile, Virgin Atlantic posted a $104 million loss in the last fiscal year for the same reasons SingAir is struggling.

The deal could give Delta considerable access to the lucrative London Heathrow airport as Virgin Atlantic is the second biggest carrier there – with 5.4% of total passengers – at one of the busiest international airport. Delta is also in discussions with Air France – KLM and the two might join forces to close the Virgin Atlantic deal.  The companies would be eyeing the coveted London - New York route that attracts business travelers from around the world. Delta is far behind its rivals on this route. United Continental (NYSE: UAL) already has significant operations there, while American (NASDAQOTH: AAMRQ) has partnered with British Airways whereby both airliners share passengers and profits.

On the other hand, Delta has a strong presence at John F. Kennedy Airport, which attracts most of the London flights, where it is spending $1.2 billion to revamp its facilities. In addition, the company is also spending $160 million at LaGuardia airport. Delta clearly wants to become the market leader at New York, and that is not possible until it has considerable operations at Heathrow.  

Unlike its bankrupt rival AMR Corp, the parent of American Airlines, or the integration problems associated with the merger of United and Continental Airlines, Delta has operated the closest to sustainably. According to September’s data, Delta’s on-time arrival rate (89.7%) was far higher than that of United Airlines (82%) while American’s performance was abysmal at 58%. 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong><span>Delta</span></strong></p> </td> <td> <p><strong><span>United</span></strong></p> </td> <td> <p><strong><span>AMR</span></strong></p> </td> </tr> <tr> <td> <p>Stock YTD</p> </td> <td> <p>16.71%</p> </td> <td> <p>9.23%</p> </td> <td> <p>27.20%</p> </td> </tr> <tr> <td> <p>Beta</p> </td> <td> <p>0.6</p> </td> <td> <p>0.71</p> </td> <td> <p>1.52</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>5.78</p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>1.68</p> </td> <td> <p>-0.8</p> </td> <td> <p>-9.64</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>ROA</p> </td> <td> <p>4.56%</p> </td> <td> <p>2.73%</p> </td> <td> <p>1.04%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>243.27%</p> </td> <td> <p>-11.65%</p> </td> <td> <p>N/A</p> </td> </tr> </tbody> </table>

American Airline’s stock has been up 27.2% this year, but the organization is bankrupt and is being tossed hither and yon by M&A rumors. The company’s future remains unknown as rumors have flown regarding a takeover by US Airways, as well as the senior management’s desire to ride out the bankruptcy without a merger, as there is always the possibility of a new round of government support around the corner for airlines in the U.S.  Delta has performed admirably, outperforming the SPDR S&P 500 ETF, up 10.7%, since the beginning of the year.

If Delta is able to pull off this acquisition of SIA’s stake in Virgin Atlantic and the situation in Europe ever stabilizes, it will be in a good position to benefit from greater RPM’s that the London-NY route implies.  But, even trading at a multiple of 5.8, the fundamentals for the airline industry outside of SE Asia -- where growing passenger volume, geography, and short distances between major cities make it the ideal region for growing air travel over the next 20 years – are at best mixed.

According to the latest from the IATA, air cargo growth through 2016 will be the lowest in Europe and N.A. (2.2% – 2.4%) while MENA will rise the most, nearly 6%.  Individually, countries like Vietnam will see rapid growth in air cargo (7.4%).  The U.S. FAA is projecting, however, a near doubling of RPM’s for domestic travel in the U.S. over the next 20 years.    The U.S. shale gas boom should serve to create a comparative advantage over the rest of the world as the Brent / WTI spread continues to hang above $20 per barrel.   But, low overall GDP growth from a fiscal and monetary situation that continues to deteriorate works against any relative fuel cost savings as the U.S. Dollar will weaken versus most of the world over the next decade.


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