Recently two airlines, US Airways and American Airlines, merged to form the world's biggest airline company, American Airlines Group (AAL). The newly formed company will serve passenger traffic at 336 destinations in 56 countries by operating more than 6,700 daily flights with a fleet of 1,511 mainline and regional jets. This merger will enable American Airlines to serve both customers traveling for pleasure and those traveling for business more efficiently. It will provide shuttle service to corporate customers, who often travel short distances. Corporate customers are expected to travel three times more often than other travelers, generating a good revenue opportunity for the new airline. With its wide national and international network, American Airlines will be able to tap this corporate traffic and provide strong competition to Delta Air Lines (DAL), which also serves corporate customers with its international and shuttle services.
The merger has strengthened American Airlines' position in the market to compete with these other airline companies and is likely to enable the new company to capture market share. The U.S. airlines' market is dominated by American Airlines, Delta Air Lines, Southwest Airlines (LUV), and United Continental Holdings (UAL), which combined hold around 84% of the U.S. domestic airlines' market.
Synergies from the merger
This merger should generate major financial and operational synergies for American Airlines. Cost-saving opportunities should be around $1 billion in addition to the $1 billion in cost-cutting that the old American Airlines completed before this merger. One cost-savings initiative will be that the company will reduce its flights on the same route. It may also switch the size of aircraft between certain routes that are heavily traveled. American Airlines can also reduce costs by cutting some international flights, particularly Chicago, Dallas, and Los Angeles to London that were previously served by US Airways and American Airlines individually. Further, switching to low-cost, fuel-efficient aircrafts with seating capacity of more than 50 will save an additional $70 million while operating fleets on these routes. American Airlines' switching option will benefit aircraft manufacturers such as Boeing (BA), Airbus, Embraer (ERJ), and Bombardier (OTC:BOMBF).
The cost synergies expected are in-line with the previous merger deals in the industry. United Continental's Continental Airlines' merger in 2010 and Delta Air Lines merger with Northwest Airlines in 2008 generated synergies of more than $1 billion. In forming the world's largest airline company, the merger of US Airways and the former American Airlines may generate higher synergies than what is already expected.
Long term cost-saving by switching to fuel-efficient aircraft
With this merger American Airlines aims to generate long-term cost-saving synergies. The company has planned to replace its old 50-seat regional aircraft scheduled for retirement with 76-seat, more fuel-efficient aircraft. The company recently ordered 90 aircraft worth $3.9 billion, purchasing 30 Bombardier CRJ900 NextGen aircraft and 60 Embraer's E175 aircraft. The first Bombardier aircraft is expected by the second quarter of 2014, while the Embraer aircraft will follow in 2015. American Airlines has an option to buy an additional 40 CJR900s and 90 E175s. This will help both Embraer and Bombardier strengthen their backlogs of regional aircraft. Replacing the old, less-efficient aircraft with these new aircraft will reduce the company's repair and maintenance costs, while switching to fuel-efficient and larger-capacity aircraft will improve economic efficiencies.
United Continental estimates it will save $2 billion by 2017, generating 50% of its savings from a 7% reduction in fuel expenses by switching to more fuel-efficient aircraft such as the Boeing 787 Dreamliner and equipping its existing aircraft with winglets to boost conservation. I expect American Airlines will be on the same path of replacing its old aircraft with new fuel-efficient aircraft, positioning itself to achieve long-term cost-saving targets comfortably.
American Airlines is expected to have higher future growth from this merger as it deepens its footprint in the airline industry. This will enable it to compete with the other airline companies in a wide range of networks. It has conservatively planned its cost-saving initiatives, which look feasible to achieve. Further, American Airlines has a more favorable valuation compared to other airline companies in terms of growth prospects, considering its current and forwards price-to-earnings, or PE, multiple.
Forward PE (2014)
Expected earnings Growth
Delta Air Lines
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The table above shows clearly that American Airlines has a strong growth opportunity. Its switching to more fuel-efficient aircraft to connect a large number of destinations will help it serve both corporate and other customers efficiently, providing an edge over the other airlines.