by Jonathan Yates
Speculation over the progress of the potential US Airways (LCC) and American Airlines merger continues to increase. Interestingly, what is turning out to be the most valuable asset for American Airlines is its routes to Latin America, not its longtime service to cities across the United States.
Because competition to Latin America is far less intense than that of the American domestic market, these routes-- if managed correctly-- can be quite profitable. As well, these routes are likely to continue to be lucrative over the next decade thanks to positive demographic trends in emerging markets.
"(t)he region…relies heavily on aviation for…transport. Airspace, airport, and ground infrastructure are all struggling to keep pace with growing aviation demand. The anticipated increase in international traffic from the 2014 World Cup and the 2016 Olympics in Brazil highlight the need for investment. The greatest opportunity for growth is within the region. For example, air travel is beginning to overtake bus travel in Mexico and Brazil. In 2011, the number of domestic air travelers in Brazil rose above the number of bus passengers for the first time, as 8.7 million passengers took their first commercial airplane flight. Regional growth has spurred the rise of low-cost carriers such as Viva, Interjet, Azul, and Volaris. As LCCs drive growth and stimulate demand, they are entering partnerships to extend their reach globally."
This phenomenon is being played out in the investment arena too. Bridgewater Associates, the world's largest hedge fund headed by the most successful hedge fund manager in history, Ray Dalio, just made the Brazil ETF (NYSEARCA:EWZ) its largest investment for the second quarter. It follows that US Airways would be interested in the American carrier with the most profitable routes to Brazil and other Latin American countries.
Given the positive demographic trends in emerging markets, carriers with significant exposure to the region could become increasingly attractive. In Latin America, that means American, COPA, (NYSE:CPA) and LATAM (NYSE:LFL).
More urban areas are being developed in emerging market countries and air travel will provide much of the needed transportation. The middle class in emerging markets is expanding, so more will be able to afford air travel. US Airways is obviously hoping to capture this growth through a deal for American Airlines, as this part of the world has eluded US Airways. Without an obvious gateway to Latin America, the airline struggled to gain a foothold in the region. In fact, US Airways only serves one route to South America: Charlotte-Rio de Janeiro.
If US Airways is able to ameliorate American's onerous cost structure in order to take advantage of the bankrupt carrier's position as the dominant carrier on U.S.-Latin America routes, such a merger could ensure future profitability for the Phoenix-based US Airways. However, it's imperative to keep in mind that the airline does not engage in fuel hedging, and so it is highly exposed to the vagaries of the oil market.