As everybody knows by now, American Airlines and its parent company, AMR, filed for bankruptcy on Tuesday morning. AMR shareholders will certainly be wiped out in the bankruptcy process, but many of American's competitors (and their shareholders) stand to gain. While it was clear that AMR was destined for bankruptcy sooner rather than later (as I wrote here), I was surprised to see it file this early. Management and the board, as well as the unions, had seemed to be in denial about the scope of their problems (see the statement made in early October that bankruptcy was "not a goal or preference"). AMR seemed to be trying to hold out as long as it could. That strategy would have made liquidation much more likely than reorganization. Given the depth of American's competitive disadvantages, no reasonable lender would have offered debtor-in-possession financing. American avoided that problem by self-financing its restructuring with the $4 billion in cash that it still holds. Liquidation would have provided a big shot in the arm to the airline industry by drastically reducing capacity, whereas a reorganization means any benefits will accrue slowly over time.
Some airlines are likely to benefit from AMR's bankruptcy more than others. There are two major reasons why a competitor's reorganization can lead to increased profits. First, there is the likelihood of lower competition. Bankruptcy will allow American to reject aircraft leases (a process that has already begun) so that the company can cut unprofitable capacity. JP Morgan has reiterated its belief that American will ultimately cut 10% of capacity in the near term. American will keep the routes where it has a dominant presence, but will cut back on routes where it faces strong competition (which are likely to be money-losers). For every route that American cuts, its competitors on that route will see significant gains in traffic and passenger yield, because fliers will have fewer options. The second potential catalyst for gains is that bankruptcy in the airline sector has tended to cause consolidation. American Airlines will emerge from bankruptcy as a much leaner company and an attractive merger partner. If another airline can tie the knot with American, it will gain access to American's strong network to Europe and Latin America. With all that in mind, let's see which airlines are poised to gain.
1) United Continental (UAL) is probably the largest beneficiary. It has the most route overlap with AA, meaning that if American cuts capacity (as it is likely to do), United will see less competition. The carriers each have hubs at ORD and LAX, and competing hubs in the New York metro area at Newark (United) and JFK (American). They are also the two leading carriers to Latin America. Competition between the two has had a noticeable impact on pricing. While Thanksgiving and Christmas airfares have shown strong year over year gains nationwide, they have actually declined in Chicago, where United and American compete with each other and with Southwest (which flies from Midway Airport). Ratcheting down this competition will drastically increase United's profit going forward.
2) Southwest (LUV) will also see major benefits from any reduction by American. Southwest is a major player in four of American's five cornerstone hub markets. (Chicago, Dallas, and Los Angeles are all among Southwest's 10 most served destinations, while the airline also has a substantial presence in South Florida at Fort Lauderdale-Hollywood International Airport and Palm Beach International Airport.) Southwest has been very careful with regard to capacity lately in an attempt to boost fares. Lower competition will help immensely on this front. Southwest will continue to increase its load factors, making each flight more profitable.
3) US Airways (LCC) is the third carrier that has a chance to recognize significant gains from American's troubles. US Airways needs a merger partner to ensure its long-term financial health. It is far smaller than the other network airlines, particularly in the more profitable international markets, and has been forced to rely on (not necessarily sustainable) lower labor costs than other legacy airlines to stay profitable. Since the bankruptcy filing, substantial speculation about a possible merger between American and US Airways has begun. The two carriers' route networks are very complementary, and a merger would also make American's small hub at JFK somewhat superfluous, because of US Airways' much larger hub in Philadelphia. This would potentially allow them to sell or trade valuable slots there to Delta or JetBlue, which also have hubs at JFK. On the other hand, if a merger does not pan out, US Airways will see fairly minimal benefits due to the lack of route overlap with American.
Each of these three airlines is a buy candidate (and not just because of AMR's bankruptcy). Delta (DAL) and JetBlue (JBLU) are also strong competitors, but they have less route overlap with American than United or Southwest. While they are also likely to realize some benefits from the bankruptcy, these will probably be less substantial.