Charlotte County Florida Weekly

Avoid legacy airline stocks until they can match competition

MONEY & INVESTING



 

Last week, my wife made the comment that it had been a long time since she had seen her sister in Chicago and that our kids missed playing with their cousin. On a whim, we went on Google Flights just to see the cost of a flight to the Windy City. To our surprise, and amazement, we found a round trip ticket around Martin Luther King weekend out of Fort Myers for $75 per ticket. I remember thinking to myself as I purchased the four tickets that there is no way airlines can be making money with these fares. And I guess my intuition was right as the very next day American Airlines was the latest carrier to announce poor revenues with declining earnings. Its stock dropped.

American Airlines was founded in 1930 via the merger of 82 different air carriers. At that time, most airlines made a large portion of profits delivering mail, but American was the first to run a profitable route with just passenger traffic. It was also the first to open an airport lounge for its most valuable passengers, an Admirals club in LaGuardia Airport in New York. It has grown over the subsequent years both through internal expansion and the acquisition of various other

 

A5 airlines such as TWA in 2001 and US Airways in 2013. Today American flies over 50 million passengers annually and has over 9509 planes in its fleet.

2018 was not a banner year for American c Airlines. Its stock price started the year at around $50 a share and ended the year at around $30 per share. This was surprising from a macro environment perspective as the overall economy was strong, business profits were high — which should have resulted – in more high margin business – travel — and fuel prices were relatively low. However, the main problem is that revenue per seat is not growing despite this favorable environment.

The reason for this lack of revenue growth is mostly attributed to two factors. First is overcapacity by the three remaining“legacy” carriers — American, Delta and United. These airlines have been upgrading their fleets to newer, larger aircraft to save fuel and operating costs. However, this also means that there is a greater supply of seats across the industry, making it harder to raise ticket prices. And last year United announced that it wanted to increase capacity by 4 percent to 6 percent per year even further through 2020.

The second reason that airlines are having difficulties raising fares is the increased competition from ultra-low-cost airlines like Spirit, Frontier and Allegiant. These airlines offer no-frills fares at rock bottom prices. These airlines have been expanding rapidly while keeping their costs low and have enjoyed tremendous success. In fact, the best performing airline stock in 2018 was an ultra-low-cost carrier, Spirit airlines. Because of the growth of these airlines, they have challenged the legacy airlines on many routes and have driven ticket prices down to these destinations.

Given this lack of ability to raise ticket prices, it should be no surprise that American Airlines revenue and stock price are both slumping. However, the airlines are trying to be creative in an effort to increase revenues in this competitive environment. For example, some legacy airlines are rolling out new special economy seat fares at low prices that are more comparable to ultra-low-cost fares where the passenger must pay for everything from seat assignments to carry-on bags to snacks. The airlines hope these tickets will fill seats while bringing in revenues from these ancillary fees.

Finally, investors are always leery of investing in airlines heading into a potential recession. Historically, airlines have followed a similar pattern corresponding with an economic cycle. During an expansion, the airlines will dramatically increase capacity to fill demand by purchasing new planes, limiting income growth. Then in the resulting economic downturn, the airlines will slash fares in an attempt to fill planes resulting in massive losses. Often even this is not enough, and the airline will file for Chapter 11 bankruptcy, wiping out shareholders. Then the cycle will start again. This has happened so many times that Warren Buffet in 2007 said this about airline stocks: “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”

While I am not that bearish on airline stocks, I would be very hesitant to purchase American Airlines or any legacy airline stock until they can prove they can compete with ultra-low-cost carriers and raise ticket prices. ¦

Leave a Reply

Your email address will not be published. Required fields are marked *