The management at Continental Airlines (CAL) has long expressed its preference to remain independent. Management has often reported that airline mergers are difficult. Still, the announcement of a deal between Delta Airlines (DAL) and Northwest Airlines (NWACQ) seemed to have pushed CAL into a corner, perhaps not.
Over the weekend, the management reported to the board its findings in regard to the "new airline landscape". Management recommended to remain independent and the board voted to follow the recommendation. CAL will ground 15 more of its older and less fuel efficient aircrafts. The company is determined to fly only profitable routes. At the same time, smaller carries are falling like dominoes. Another "business only" carrier filed for bankruptcy this weekend. Each time a competitor falls, the higher the future bounce for the remaining carriers.
Like my Great Grandpa said, the time to get into the chicken business is when others are getting out. He noted that the price of chicken feed would go down at the same time that the price of eggs would go up. Bankrupted carriers lower the amount of fuel being used while eliminating the availability of the deeply discounted alternative seat. The price of the "last seat" is the one that makes a huge difference in the profit or loss of an airline.Perhaps, CAL is only waiting for a better deal or for a bid from United Airlines (UAUA). UAUA has been bleeding heavily since the last big run up in fuel costs. Analysts now estimate that UAUA will lose over $7 per share in 2008. The loss at American Airlines (AMR) is expected to be $5.15 per share. The projected loss of $2.04 at CAL looks great relative to the others. First quarter numbers are even more lopsided, CAL lost 86 cents compared to more than $4 each for the other two. CAL is still producing positive cash flow, the airline is getting stronger while the public reads about losses. My expectation is that the loss will not be nearly so high because ticket prices have already been raised.
As I wrote on Friday, the merger of DAL and NWA is a powerful event because of the very large number of new city pairs. The merger opens the door to 6,000 new combined routes. Assuming these two carriers can smoothly integrate numerous components (which is no easy trick), the new DAL will be a very powerful airline. This result, or even the fear of it, is putting all the more pressure on the weakest of its competitors.
CAL is currently the strongest of the majors in several ways. It has the youngest fleet, the best relations with employees, the most extensive code sharing system and the most advanced computer technology. CAL is going to survive and then prosper. It remains to be seen if it is waiting for a better deal to be had in regard to UAUA or another carrier. My Dad was famous for walking away from a deal if he could not get his terms. It was often the case that there was a lot of movement toward his terms after he walked away.
When the DAL - NWA deal was announced, the CAL share price went down. The market ran from the risk that CAL would pay too much for UAUA and from the fact that oil prices hit another peak about that time. Tomorrow, there very well might be a relief rally in CAL shares. Besides, investors should remember the "mass transit effect" of higher fuel prices. In the short run, high fuel prices hurt airlines, railroads and bus lines. In the long run, the higher the price of fuel, the more sense it makes to load a truck onto a railroad flat car and for travelers to leave their cars parked.
The public has been sold a lot of upside down thinking. The public is constantly told by the media that an increase in interest rates will make bond interest rates go up. The truth is that an increase in the short term interest rate is the same as applying the brakes to the economy and a slower economy will generally lead to higher bond prices and lower long term mortgage rates. The same is true in relation to the value of the US dollar. The public is told that higher short term interest rates will strengthen the dollar but, once again, it is a question of short term or long term.
In the long run, the dollar is strengthened when the economy becomes strong and the economy becomes strong after short rates act as a stimulus. It is easy to get the cart before the horse. A strong economy will result in higher short rates and a higher dollar but it is the strong economy that is pushing the rates up, not the higher rates pushing up the economy. Over the past couple of weeks or so, market based short term interest rates have started to rise as has the US dollar and the price of oil. The indication is that the economy is stronger than most people think. In a strong economy the demand for air travel is going to be strong.
It is very rare for a public company to sell at an almost 50% discount to its cash in the bank when the company is producing positive cash flow quarter after quarter. You can buy CAL today at a tiny fraction of its long term value. My trust in the management has never been higher.