The Department Of Justice's Accommodative Stance Should Benefit The Industry
Since the 2010 merger of UAL Corporation and Continental Airlines to form United Continental Holdings (NYSE:UAL), the outlook has been increasingly positive for the airline industry. Historically, investors have been discouraged from investing in airlines due to numerous issues including regulation, volatile fuel costs and the cyclical nature of the business. However, the latest push for industry consolidation will likely provide tremendous upside for the industry. While consumers may be hurt by fewer choices and higher prices when traveling by air, it is likely beneficial for the long-term sustainability of the US airlines that industry consolidation continues to be permitted. The Department of Justice or DOJ has seemingly taken a new approach to the airline industry as they have allowed the 2010 merger of UAL and Continental and recently announced that they would also permit the merger of AMR Corporation (OTC:AAMRQ), the owner of American Airlines, with US Airways (LCC). Some may grow concerned that the majority of US air traffic will be in the hands of a few major players: the new American Airlines, United Continental, Southwest Airlines (NYSE:LUV) and Delta Air Lines (NYSE:DAL). However, antitrust issues should be less of a concern now as the DOJ has taken a relatively hands-off approach to the airline industry.
Key Benefits Of Consolidation
As the lion's share of US airline capacity is now in the hands of fewer competitors, those aforementioned companies have significant opportunity to provide value for their shareholders in a way that they have historically not been able to do. The recently merged airlines will be able to achieve gains from synergies and increased economies of scale while the likes of Delta and Southwest should benefit from less competition and more pricing power. Additionally, these airlines will have much more bargaining power when purchasing new planes as airplane manufacturers such as Boeing (NYSE:BA) and Airbus, a division of EADS (OTC:OTCPK:EADSF), will have fewer customers with larger needs. This consolidation within the industry will likely lead to higher profits for the merging companies and for the industry in general.
Cautious On Smaller Airlines
While the effects of more concentrated power within the US airline industry are evident for the larger players, the prospects for smaller regional airlines are not so certain. Companies like Hawaiian Airlines (NASDAQ:HA) or Alaska Air (NYSE:ALK) could become the targets of opportunistic M&A by the larger industry leaders or they could face enhanced competition by larger airlines with even more power and competitive assets. It will be interesting to see how the smaller airlines in the US are affected by the DOJ's ongoing and relative hands-off stance for the airline industry. However, in the near and medium term I would be cautious towards the smaller and regional airlines in the US given this uncertainty.
The Department of Justice has made it clear that they are taking a more hands-off approach to consolidation within the airline industry. While this should be very beneficial for the larger airlines in the US, the outlook is not so certain for the smaller players and as such, investors should proceed with caution. Overall this stance by the DOJ is very bullish for the industry long term and could support rather significant profitability over time if this stance is maintained. While the share prices of the large US airlines have appreciated rather significantly in recent months, many trade for reasonable earnings multiples on a forward basis, especially in relation to growth projections.
Disclosure: I am long BA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.