Shares of US Airways (
) and American Airlines (
) have seen substantial appreciation over the past few months due
to merger rumors. Now they've
decided to tie the knot
, how will the tie-up affect both profitability and the route
structure to lucrative emerging markets?
[caption id="attachment_77232" align="alignright" width="300"
caption="American Airlines has lucrative routes to South America"]
Over the past decade, the United States commercial aviation
industry has undergone a sea change. Since 9/11 the cost structure
of legacy carriers hasn't allowed full-service airlines to compete
head-to-head with no-frills, low-cost carriers in most
person-to-person domestic markets. The advent of Southwest Airlines
) as a nationwide carrier saw legacy airlines largely retreat from
point-to-point domestic service while further consolidating
hub-and-spoke operations and catering to corporate clients.
This reality catalyzed two fundamental changes in the U.S.
airline industry: increased focus on higher-yielding international
routes, and further consolidation of legacy carriers. The US
Airways/American Airlines merger is indicative of both trends.
After Delta (
) merged with Northwest, and United (
) with Continental, US Airways and American were the last two at
the dance without a partner. Many market observers figured it was
only a matter of time before these two entities got together as it
became increasingly difficult for legacy carriers to operate
profitably on a nationwide scale. Given American's precarious
financial situation, a merger, and a concomitant reset of onerous
labor deals, seemed like the most logical solution.
While American's overall profitability may have suffered as a
result of an inflated cost structure, the company possesses a
number of prized assets that could have made the company a valuable
commodity to any airline. The company's hubs in cities with major
corporate ties - New York, Los Angeles, Chicago, Dallas, and Miami
- make it well-positioned to win lucrative corporate contracts.
With retail domestic travelers opting for either Southwest or
bargain online fares, these corporate contracts are what allow
operations to remain close to profitability.
Furthermore, and arguably most importantly, American Airlines is
the United States' largest operator to the fast-growing emerging
markets of Latin America.
Recently released DOT statistics
show that American is easily the most profitable operator to Latin
America with yields significantly outpacing those of its
competitors. The company's high brand recognition in Brazil and its
service to six Brazilian destinations make it the leading U.S.
carrier to South America's largest economy. American's sizable
presence in markets like Colombia, Peru, Chile, and Mexico also
means the company has exposure to many fast-growing markets to the
A merger with US Airways could allow American to
optimize its South American network
, with US Airways' Charlotte hub possibly becoming a relief hub for
Miami. For example, lower-yielding connecting traffic from Brazil
to destinations like Boston and Orlando could be routed through
Charlotte, while higher-yielding traffic can be kept on the nonstop
routes to Miami. New aircraft types should also allow for the
merged entity to more accurately allocate seats to various
While the synergies envisaged by the higher-ups in Phoenix and
Dallas will take time to implement, the reduction of redundant hubs
and improved cost structure should see the new carrier see
profitability in the future.
Given the vagaries of the airline industry however, now is
likely not the time to invest in either American or US Airways.
Both stocks have appreciated substantially over the past few
months; as market observers know, mature domestic market carriers
make for terrible long-term investments.
However at some point over the medium-term, concerns over some
event, be it the health of the U.S. economy, rising gas prices, or
an aircraft grounding, will send these stocks substantially lower.
When that happens, this new carrier, with its improved cost
structure, lucrative Latin American routes, and numerous corporate
contracts could make for a very profitable trade.