The merger of US Airways and American Airlines, which exited bankruptcy today, is probably the last big deal for U.S. carriers in two important ways: It’s the final piece of a consolidation the airline industry has sought for years, and it’s the last large transaction regulators will likely permit. Now the airlines’ performance over the next few years will prove whether such a drastic restructuring has truly fixed the long-ailing industry’s finances.
Analysts say that—barring a huge spike in oil prices, a major terror attack, or global health pandemic—the conditions for a sustained improvement in the industry’s long-term profitability are ripe. The four largest U.S. airlines—American (AAL), United (UAL), Delta (DAL), and Southwest (LUV)—now control roughly 84 percent of domestic traffic. That concentration is expected to aid the airlines’ efforts to price their product above costs and turn a consistent profit. “I think there are some permanent changes to the U.S. industry now that suggest that financial performance in the future should be a lot better than the past 35 years under deregulation,” CRT Capital airline analyst Michael Derchin wrote in an e-mail today.
The industry has been fortified with about $7 billion in new yearly revenue from ancillary items, such as charging for checked bags and assigned seats. Airlines also have learned to master “real time capacity management,” as Derchin puts it, so that they more quickly match supply and demand and keep their planes fuller all year, not just in the summer. That helps keep them from needing to discount seats steeply in slower travel periods.
In addition, the new post-bankruptcy American has several other conditions working in its favor. US Airways’ network was heavily dominated by domestic flying, which will serve as a source of feeder traffic for American’s international network in the Oneworld alliance of global carriers. The new company also has agreements with pilots to allow more flying on larger regional jets, those with more than 50 seats, as rivals do. That will allow the airline to redeploy its full-size jetliners from markets that don’t support the seat capacity. And American’s larger network is likely to win more attention from corporate travel buyers when their airline contracts are up for renewal, Derchin wrote in a Dec. 9 report, rating the airline a Buy. (Shares of the new company were up 5.2 percent at midday.) “Corporate accounts prefer as many options as possible for their frequent fliers and AAL’s enlarged network with [US Airways] is likely to result in a fresh look at doing more business with AAL when contracts are renewed, in our view,” he wrote.
The size of that network is one of the key arguments American and US Airways made in their defense when the Justice Department’s August lawsuit sought to block the merger. Preventing the creation of the new No. 1 airline would have left Delta (DAL) and United (UAL) with a virtual duopoly, the airlines argued, allowing them to siphon the most lucrative travelers into their respective global networks and leaving American and US Airways to wither financially over time.
Now, with the three dominant carriers set to compete aggressively for lucrative business travelers with more expensive services, such as posh first-class cabin service and pricey lie-flat seats, it remains to be seen exactly how cost-sensitive U.S. leisure travelers in the back of the plane will be affected. Some in the industry already are questioning whether coach class could become so pricey at full-service global airlines that more budget-minded fliers will migrate to such cheaper options as JetBlue (JBLU), Spirit (SAVE), and Allegiant (ALGT).
That prospect could be hastened if big airlines begin skewing their traditional frequent-flier programs more toward business travelers, for whom companies pay the usually higher fares. “The airlines have been evolving into a more rational business model which prices more appropriately according to services offered,” Gimme Credit senior analyst Vicki Bryan said in an e-mail.