KLM Continues to Push Forward

Sep. 5.06 | About: Air France (AKH)

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Behind Easing of Airline Rules, KLM's 20-Year Urge to Merge

  • Summary: In the 1980's KLM (AKH) introduced European travelers to the hub-and-spoke system, enabling travelers to connect to more international flights in its system. Its next feat was to expand the international hub-and-spoke to the U.S., by buying 19% of Northwest Airlines (NWACQ) in 1989. The rest of the industry followed suit, which resulted in the creation of Star Alliance, onworld and SkyTeam (which includes KLM). KLM's next step was to structure a unique merger with Air France, where Air France acquired KLM, but the two airlines keep their own management and identities (plus 2 hubs - Paris and Amsterdam). So far, the result has been a 10% increase in overall traffic, a 20% increase in hub traffic, and a 69% increase in operating profit. Yet even with the increased operating profit, the company's operating profit margin is about 5%, which is lower than rivals'. With the successful integration of the two airlines complete, their next step is to increase their operating margin by cutting costs.
  • Comment on related stocks/ETFs: While shares of legacy carriers have recovered, they are still risky investments. Discount carriers have fared better, especially those with business models that enable them to compete with automobile travel. Keep in mind what Warren Buffet said in a 2002 interview:

    If a capitalist had been present at Kittyhawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money... the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You've got huge fixed costs, you've got strong labor unions and you've got commodity pricing. That is not a great recipe for success.