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Sell Airline Stocks In Wake of the DoJ Lawsuit

If you have profits in the sector, now's the time to take them

   

Airline stocks have been on a tear this year thanks to lower fuel prices, greater operational efficiency and continued strong passenger demand. Now, though, last week’s Justice Department anti-trust lawsuit to block the merger of US Airways (LCC) and American Airlines (AAMRQ) threatens to clip U.S. carriers’ wings.

Back in June, International Air Transport Association economists noted the industry’s improving financial performance, saying:

“The improvement is most clearly seen in North America, where margins have been improving since 2011 despite continued high jet fuel prices and sluggish economic growth. Consolidation, on domestic markets through mergers and on the North Atlantic through joint ventures, has more than offset difficult market conditions”.

See, there are significant benefits to a more consolidated airline industry, including economies of scale, a reduction in capacity, greater access to routes and greater control over pricing. In fact, the U.S. airline industry that was hammered by the 9/11 attacks and the Great Recession successfully turned to mega-mergers to gain such advantages.

US Airways, which last took a trip down the aisle in 2005 when it merged with America West, has been waiting with great anticipation for what CEO Doug Parker characterized as the last major airline merger. Until last week, that was supposed to be executed with US Airways acquiring American out of bankruptcy.

There was every expectation that the US Air-American merger would pass regulatory muster. After all, Delta (DAL) and Northwest completed their merger at the end of 2009. In 2010, United (UAL) and Continental merged, and Southwest (LUV) also announced its acquisition of AirTran that year.

But now that US Air’s best-laid plans have gone awry, let’s take a look at just went wrong … and what broader implications could that have on airline stocks near-term.

What Went Wrong

The DoJ appears to be applying a stricter standard than it did to even United-Continental, which created the world’s largest airline, it begs the question, “What’s changed?” While we’ll know the full story once the parties start filing court briefs in the coming weeks, we can find a few hints in AT&T’s (T) failed attempt to acquire Deutsche Telekom’s T-Mobile for $39 billion back in 2011.

The Obama administration never warmed to that deal, rebuffing T’s offer to create thousands of new jobs and invest $8 billion to bring broadband wireless service to rural areas. Instead, DoJ filed suit to block the deal in August 2011, and by Thanksgiving, seven state attorneys general had signed on. AT&T promptly withdrew its merger application with the FCC.

It’s hard for a win that big not to go to your head — remember the litigation landslide that followed the U.S. v Microsoft (MSFT) settlement in 2001? Interestingly, U.S. District Judge Colleen Kollar-Kotelly, who presided over MSFT’s antitrust battle with DoJ, has been tapped to oversee the US Air-American case.

What’s Next

If US Air and American can’t gain economies of scale through consolidation, the logical response would be to throw capacity planning out the window. When airlines can’t price for services, they have only two ways to boost profit: cut costs or sell more seats.

That could mark a return to the crazy, post-deregulation fare wars that characterized the 1980s when carriers hemorrhaged cash, labor relations plummeted and in a few notable cases, safety was compromised since cost-cutting measures affected maintenance procedures and personnel.

Commercial aviation has changed a lot since 1978, but it’s prudent to remember what happened to investors in names like Pan Am, Eastern, TWA and Braniff when fare wars hit their zenith. And while consumers would love a return to cut-throat airline competitio, that scenario isn’t so good for shareholder interests.

While IATA revised its profit forecast upwards recently, even that new number only represents a miserly 1.8% margin on the industry’s $700 billion in annual revenues. That can be devoured by a pennies-per-gallon rise in jet fuel prices. So airlines will have to continue to find ways to pare back labor costs — particularly pensions and benefits– and such a move will have unintended, and unwelcome, consequences for airlines’ union employees.

The Bottom Line

The DoJ’s move to block the US Air-American merger is a shot across the entire airline industry’s bow because it suggests government litigators and regulators may become more aggressive in trying to police other airline activities — like fares and fees — under the auspices of consumer protections.

For airline investors who have seen their shares gain 50% or more over the past year, now is a good time to take profits.

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


Article printed from InvestorPlace Media, http://investorplace.com/2013/08/sell-ariline-stocks-in-wake-of-the-doj-lawsuit/.

©2014 InvestorPlace Media, LLC

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