Could This Industry Shift Bankrupt Every National Airline?
Jan 23rd 2013 9:54PM
Updated Jan 24th 2013 7:00AM
I know what you're thinking: "Bankrupt" and "airlines" are synonymous, and to some extent you're correct. We've witnessed more than 100 bankruptcies in the airline sector since 1990 and all national carriers have declared bankruptcy at least once since 2002 -- US Airways should feel "special" for declaring bankruptcy twice in a three-year period. Even Warren Buffett will generally go out of his way to avoid the sector as it's a high-capital investment with little to no long-term returns.
Yet every few years, the airline sector finds a magical sweet spot where fuel prices cooperate, Americans travel in droves, the economy clogs along at a 2% growth rate or higher, and the sector subsequently soars. But with such short memory spans, investors always seem to forget that the airline sector rarely makes it longer than a decade without a catastrophic event crippling the sector. The terrorist attacks in 2001, the Iraq war in 1991, the market crash of 1987, the dot-com-induced recession beginning in 2001, and the Great Recession of 2007-2009 all dented the sector and pre-empted bankruptcies shortly thereafter to often debt-riddled airlines.
Now, an even bigger shift is under way that threatens to completely bankrupt such non-agile national carriers as Delta Air Lines , United Continental , and US Airways: shrinkage!
Do you want to be a little shot?
No, I'm not having a "Seinfeld" flashback! I mean a dramatic shift is under way in the airline sector where bigger is no longer better. Smaller, more agile regional airlines that focus on anywhere from a few routes to a few dozen routes are slowly chipping away at the traditional customer base of national carriers.
Historically, larger airlines relied on their brand name, the extremely high barrier to entry to get into the business, and their sheer service volume to win over passengers. More recently, larger airlines such as Delta and United Continental have focused their efforts on promotional items such as loyalty reward credit cards to retain customers and encourage travel.
But this isn't going to be nearly enough to stop the onslaught of regional airlines that are chopping down the mighty national carriers like a woodpecker to a tree trunk.
Regional dominance is here
The first area where regional carriers have the nationals beat is price. Regional airlines run on a tight cost structure that's even more dependent on service fees such as baggage and food. This allows these airlines to lure customers in with extraordinarily low fares and collect very high-margin revenue from ancillary fees. Take Spirit Airlines for example. It regularly offers flights for under $100, but its optional service fees for a family of four traveling with four bags and a carry-on would total $275! Ka-ching for Spirit!
Secondly, regional airlines are considerably more nimble than national carriers when it comes to route flexibility. Delta Air Lines, which handles roughly 5,000 flights per day, can't simply shutdown a route because jet fuel prices rise and passenger counts taper off in that region. As a national carrier with multiple U.S. hubs, it has very little flexibility. Allegiant Travel , on the other hand, can alter or cancel its routes very easily if they become unprofitable as it's not bound by the same hub restrictions as Delta or any other national carrier.
Finally, regional airlines often boast significantly better balance sheets, which give these companies greater flexibility when it comes to plane purchases and leasing. Allegiant, for instance, tends to purchase older planes that can require more maintenance over time but are cheaper upfront. Spirit has chosen the route of buying newer planes, which is better from a fuel efficiency standpoint but costlier upfront. The good news for both regionals, however, is that they're both net cash positive. The same can't be said for Delta, United Continental, or US Airways, which boast net debt of $9.9 billion, $5.6 billion, and $2.1 billion, respectively.
Headed for a crash landing
As a whole, the airline sector is still a very big gamble because the returns are minimal at best over the long run. However, in a scene where smaller is increasingly becoming preferred, I'd have to give the edge over the next decade to the regional airlines. Whether the national carriers know it, the torch has been passed to the likes of Spirit, Allegiant, JetBlue, Alaska Air, and Southwest, and if they don't react quickly enough to divest their operations into smaller, more nimble, and competitive components, we could be facing another round of national carrier bankruptcies within a decade.
One big idea
The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in our brand-new free report: "The Motley Fool's Top Stock for 2013." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.
The article Could This Industry Shift Bankrupt Every National Airline? originally appeared on Fool.com.Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. Motley Fool newsletter services have recommended buying shares of Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.