Where U.S. Airlines Are Headed in 2013

by Susan J. Aluise | January 8, 2013 12:15 pm

Where U.S. Airlines Are Headed in 2013

As US Airways’ (NYSE:LCC[1]) ardent courtship of American Airlines’[2] parent AMR (PINK:AAMRQ[3]) moves closer to the altar this week, it’s a good time for investors to take a fresh look at the airline sector’s fortunes in general — and for individual carriers in particular.

All told, 2012 was a pretty good year for the industry. Consider that U.S. airlines had to contend with the highest sustained fuel prices since 2008 — nearly $3 a gallon — but gains in operational efficiency kept most carriers profitable.

Those gains – combined with tighter seat capacity — were aided by the recent merger-mania. Delta Air Lines (NYSE:DAL[4]) merged with Northwest in 2008, while deals combining United (NYSE:UAL[5]) with Continental and Southwest (NYSE:LUV[6]) with AirTran were inked in 2010.

“With GDP growth close to the ‘stall speed’ of 2% and oil at $109.5/barrel, we expected much weaker performance,” said Tony Tyler, director general and CEO of the International Air Transport Association. Historically, when GDP growth has fallen below 2%, airlines have recorded a collective loss. But they’ve adjusted to these difficult conditions by improving efficiency and restructuring. “That is protecting cash flows against weak economic growth and high fuel prices,” Tyler said.

Better news: According to a new survey[7] by Frequent Business Traveler magazine, one-third of business travelers plan to travel more in 2013 than in 2012, and half will travel more than they did two years ago.

Nevertheless, airlines face strong headwinds in 2013. Fuel price volatility will continue, prompting carriers to hike fares and accelerate fleet modernization. As ticket taxes rise, U.S. carriers also are lobbying lawmakers for relief. To offset costs, United Continental kicked off the industry’s first fare hike attempt last Friday, which Delta matched.

Although the IATA predicts that the U.S. will remain the world’s biggest market for airline travel, it’s also becoming very mature. The group forecasts domestic traffic growth of just 2.6% a year through 2016 — and all bets are off if the economy worsens.

Here’s a breakdown on the fortunes of individual airlines for 2013:

US Airways. Its pursuit of a merger with AMR is heading into the stretch. US Air set its sights on acquiring American shortly after the latter’s November 2011 bankruptcy filing, but a recent flurry of activity suggests a merger deal could be cut as early as this week.

If a deal goes through, it’ll be a big win for US Air CEO Doug Parker[8], who courted Delta and United in recent years — both of which left him at the altar.

But investors should plan for a short honeymoon because as with all mergers in complex, heavily regulated industries, the devil is in the details. LCC shares are up 165% over the past year, but I expect them to give back some of those gains as the airlines move forward.

AMR. AMR’s immediate prospects are intertwined with LCC’s. In a letter to AMR employees[9] last Thursday, President and CEO Tom Horton said he expects to bring the company’s evaluation of a merger with US Air to a conclusion “within weeks.”

Late Friday, US Air’s pilots union[10] OK’d an interim labor deal and that would take effect in the event of a merger. American’s pilots union board had approved it on Dec. 31.

I still believe a US Air marriage is the best next step for AMR — but it’s not the only step. A spin-off or sale of American Eagle makes sense.

United Continental. UAL had a tough 2012 as integration problems from the two carriers’ 2010 mega-merger bedeviled operations. Since the combination of reservation systems last March, UAL has been hammered[11] by unexpected computer glitches that delayed or canceled thousands of flights, invoking the wrath of stranded travelers.

On-time performance plummeted, and customer complaints soared. UAL’s third-quarter earnings also took a hit: Profit plummeted to $6 million from $653 million in the same quarter of 2011. Analysts will be watching closely for improvement in both performance and profitability when it next reports earnings on Jan. 24.

Despite recent turbulence, I think UAL will get off the mat in 2013. It’s making progress — just slower than customers and shareholders would like. The airline aim to regain customers’ loyalty with upgraded club lounges, and it started international service with its new Boeing (NYSE:BA[12]) 787 Dreamliners last week. CEO Jeff Smisek is a savvy industry veteran, so I expect better from UAL in the second half of 2013.

Delta. With most of its major competitors in some stage of consolidation or integration, DAL believes this is its year to soar. “We enter 2013 as a stronger airline, ready to continue improving our performance and executing on our key strategic initiatives,” Delta CEO Richard Anderson wrote in his year-end letter to employees.

His global ambitions make sense: The IATA forecasts international routes will grow at a 4.3% annual clip. That’s one reason Anderson paid $360 million last month for a 49% share of Virgin Atlantic[13]. That deal gives DAL greater access to slots at London’s Heathrow and aims to help the carrier better compete against American’s and British Airways’ Oneworld Alliance for profitable business travelers.

Delta made domestic investments, too: It ponied up nearly $75 million in financing to help its regional partner Pinnacle Airlines operate while in Chapter 11. On Friday, it announced that Pinnacle would emerge from bankruptcy as a wholly owned DAL subsidiary.

Delta’s acquisition and conversion of the shuttered Trainer refinery from Phillips 66 (NYSE:PSX[14]) last spring was widely viewed as an innovative approach to controlling skyrocketing fuel prices. But I still have doubts about DAL’s prospects in the oil business — more so since Jon Ruggles[15], the airline’s point man on the deal, left last month.

Southwest. LUV is a perennial favorite among investors because it does a lot of things right. That’s a big reason why the stock hit a new 52-week high on Friday. The airline is fast-tracking its integration with AirTran and has leased 88 Boeing 717s to Delta[16] to preserve its efficiencies in using just a single aircraft type.

Southwest is upgrading its existing Boeing 737 fleet and plans to begin replacing it with the fuel-efficient 737 MAX in 2017. Although LUV CEO Gary Kelly predicts an additional $400 million in revenue and cost savings during 2013, even the best-managed integration deliver a few bumps along the way.

The traditionally fee-averse airline seems to be rethinking that position. Southwest has announced an “increasing reliance” on ancillary fees — including a “no-show” fee — for 2013. That could raise the ire of otherwise happy customers. Southwest shares are also a little rich for my taste right now. I like LUV in the second half of the year.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.

Endnotes:
  1. LCC: http://studio-5.financialcontent.com/investplace/quote?Symbol=LCC
  2. American Airlines’: http://studio-5.financialcontent.com/investplace/quote?Symbol=AmericanAirlines’
  3. AAMRQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAMRQ
  4. DAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DAL
  5. UAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UAL
  6. LUV: http://studio-5.financialcontent.com/investplace/quote?Symbol=LUV
  7. a new survey: http://www.prnewswire.com/news-releases/business-travel-to-increase-in-2013-according-to-survey-of-very-frequent-travelers-185866042.html
  8. US Air CEO Doug Parker: http://investorplace.com/2012/04/us-airways-parker-a-smart-bid-for-american/
  9. letter to AMR employees: http://aviationblog.dallasnews.com/2013/01/heres-the-horton-letter-of-jan-3-2013.html/
  10. US Air’s pilots union: http://www.bizjournals.com/dallas/news/2013/01/04/us-airways-pilot-leaders-clear-path.html?ana=yfcpc.
  11. UAL has been hammered: http://investorplace.com/2012/11/united-continental-struggles-to-ride-out-post-merger-turbulence/
  12. BA: http://studio-5.financialcontent.com/investplace/quote?Symbol=BA
  13. 49% share of Virgin Atlantic: http://dealbook.nytimes.com/2012/12/11/delta-takes-49-stake-in-virgin-atlantic-for-360-million/
  14. PSX: http://studio-5.financialcontent.com/investplace/quote?Symbol=PSX
  15. Jon Ruggles: http://blogs.platts.com/2012/12/22/jon_ruggles/
  16. leased 88 Boeing 717s to Delta: http://blogs.star-telegram.com/sky_talk/2012/12/no-10-southwest-leases-717-fleet-to-delta-air-lines-retrofits-737-700s-gets-first-737-800.html

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