Southwest Airlines
(
LUV
) together with subsidiary AirTran Airways has finally received
approval from the Federal Aviation Administration (
FAA
) for a Single Operating Certificate (SOC), allowing both the
carriers to operate as a single entity. Thus far, Southwest and
AirTran were operating as separate entities despite their merger in
May 2011. The announcement comes well within the expected timeline
for approval (the first quarter of this year).
The FAA approval on SOC represents a milestone in integrating
operations of both the airlines, which would result in meaningful
synergies. Southwest expects it to facilitate the conversion of
AirTran Airways aircraft to the Southwest livery.
The company will not only improve its revenue opportunities but
also gain in terms of expansion into new regions with the
introduction of its services in emerging markets like the Caribbean
and Mexico. Southwest is expected to initiate its services in
Atlanta, the busiest airport in the U.S., this February and debut
in Mexico in May 2012. Effective mid-August, Southwest would cease
operations in six cities served by AirTran and eventually convert
AirTran flights to Southwest in 24 cities, including New York
LaGuardia, Boston Logan, Milwaukee and Baltimore/Washington as well
as many small domestic cities.
Another stumbling block in the integration process is with
respect to the workforces of Southwest and AirTran. Although the
company is facing initial hiccups with the recent rejection by the
mechanics union, thus forestalling the process of implementing a
single contract, it was successful in procuring votes from the
mechanics at AirTran as well as flight attendants of both the
airlines. A single contract would be highly beneficial for
Southwest not only in terms of union dispute prevention, employee
strikes and other labor related disruptions, but also with respect
to synergies through cost curtailments arising from labor disputes
and compensation issues.
In addition, we expect the AirTran merger to be accretive to
Southwest's earnings, once the expected synergies are fully
realized. The transaction is expected to generate net synergies of
more than $400 million by 2013 on full integration. Last year,
Southwest generated $80 million in annual synergies. The company
expects to produce half of the net synergies this year, with
two-thirds realized from revenue and one-third from cost
savings.
However, fuel price volatility continues to be one of the
significant challenges. Though high currently, fuel prices remain
well below the 2008 level of over $140 per barrel. The company's
ability to pass along the increased fuel costs to its customers is
limited by the competitive nature of the airline industry.
Southwest Airlines faces competition from other low-cost carriers
like
JetBlue Airways
(
JBLU
) as well as major airlines like
Delta Air Lines
(
DAL
) and
United Continental Holdings
(
UAL
) that cut fares in order to attract customers. Thus, even a small
change in fuel prices can significantly affect profitability.
We expect crude oil and jet fuel prices to remain largely stable
this year, but forecasting this key variable with any level of
accuracy has always been challenging. Difficulties will increase as
the company has already announced a suspension in its expansion
plans owing to escalating operating costs.
We currently maintain our long-term Neutral recommendation on
the stock supported by a Zacks #3 Rank (Hold).
DELTA AIR LINES (
DAL
): Free Stock Analysis Report
JETBLUE AIRWAYS (
JBLU
): Free Stock Analysis Report
SOUTHWEST AIR (
LUV
): Free Stock Analysis Report
UNITED CONT HLD (
UAL
): Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment
Research