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Major US airlines including Delta Air Lines (NYSE:DAL), US Airways (NYSE:LCC) and United Continental (NYSE:UAL) announced air fare hikes ranging from $6 to $10 per round trip recently. Their move was matched with a similar hike by their low cost carriers like Southwest Airlines (NYSE:LUV) and JetBlue Airways (NYSE:JBLU) eliminating the possibilities for any roll back of the prices. The fare hike has been implemented on some US routes and only applies to last-minute tickets, mostly booked by corporate travelers. In addition, United Continental’s CEO yesterday pledged that it would stick to capacity discipline and maintain or cut capacity next year, a move in line with Southwest’s recent statements. Airline stocks broadly rallied on the news yesterday.

We take a closer look to understand the triggers behind the move encompassing the major players of the US airline industry. We have a $26.25 price estimate for United Continental, which is around 35% above the market price.

Limited Price Hikes

Airlines have suggested that the air fare hike will be applied only for the last minute purchases which are typically made by corporate travelers. The advance-purchase fares bought by most leisure travelers will remain unaffected. The corporate travel segment represents the premium customer segment for airlines that often looks at the quality of service as a more important parameter. They tend to be less affected by any ticket price increases as compared to a leisure traveler who is looking for a value buy when making ticket purchases. An increase in premium-class tickets also has a better chance of sticking as a permanent increase.

Business travel demand is generally positively correlated to international trade and business confidence. As per IATA data, the rate of growth of that trade has declined from high single-digits in 2H2010 to mid-single digits during 2011 so far. Business confidence on the other hand has also been declining over the last several months. Both these factors are expected to limit ability of airlines to benefit from premium fare-hikes going forward.

Premium passengers and world trade growth: Jan-2006 to Jun-2011

Premium Travel and Business Confidence: Jan-2006 to Jun-2011

Fare hikes to help mitigate the increasing pressure on margins due to high fuel prices

The fuel prices have been on the uphill since last December and have adversely affected industry’s profitability, already depressed on account of natural calamities and the slow pace of economic growth this year. The easing of fuel prices during the year could not provide much respite to the airlines as the fuel prices were still about 45% higher than the previous year. According to IATA estimates, fuel expenses are expected to increase by $10 billion to $176 billion this year. Airlines therefore considered the fare hike for the premium segment which could help mitigate the fall in margins on account of high fuel costs to a certain extent without impacting the demand from the economy travelers.

Disclosure: No positions

Source: Airlines Raise Prices, Pledge Capacity Discipline As Airline Stocks Take Flight