September has always seen sluggish demand for airlines as vacations come to an end and leisure traffic tends to shrink. However, this time around, circumstances were exacerbated by weaker-than-expected growth in the U.S. and Chinese GDP and volatile oil prices that are a key cost component for airline operations. However, airlines have prepared well by consolidating and managing their capacity accordingly. That is probably why the International Air Transport Association (IATA) has raised its global aviation outlook for 2012, and has said that airlines will now earn $4.1 billion rather than $3 billion.
US Airways (LCC) has been no exception in this context. Despite operating in a weak global economy, LCC managed to improve its load factor by 0.8 points in September. The recent dip in oil prices has been favorable for the stock, as LCC does not employ any oil hedging techniques. Its deal with AMR is also another positive aspect of the stock. However, bears believe that debt will be a major hindrance in the company's growth after the merger.
LCC's September's Traffic Report
The market expected Delta Airways (DAL) to report a revenue increase of 1%-3% per available seat miles (RASM) in its September Traffic Report, released on Tuesday. However, DAL only reported a rise of 0.5%, blaming lower demand from walk-up customers and low cancellation rates.
After DAL's episode, bears anticipated that LCC might not be able to meet its estimate of an increase of 1%-2%. The same happened when LCC President Scott Kirby remarked that Consolidated (Mainline and Express) RASM for September was flat on a YoY basis. The Mainline Revenue Passenger Miles rose by 1.8% to 5 billion and Available Seat Miles (ASM) also rose by 0.9% YoY for the same period. The load factor improved by 0.8 points to 84.4%, thus providing evidence for the IATA's claim that airlines are being managed more efficiently according to the changes in demand.
LCC's on-time performance was reported to be 87%, with a satisfactory completion factor of 99.6%.
Before we discuss LCC's merger talks with AMR's subsidiary - American Airlines - it is important to discuss the IATA's outlook for the global airline industry in order to understand its future progression.
As stated before, IATA expects the airline industry to make $1.1 billion more than its initial guidance of $3 billion, announced in June. The IATA also revised its expectations regarding margins. Earlier, the IATA expected that margins would fall from 1.4% to 0.5%, but now it expects margins to fall to 0.6%.
The outlook varies from region to region:
Europe: European airlines are set to make the largest loss on a regional level of $1.2 billion, which is a revised figure from $1.1 billion. The loss has been increased due to the rising Euro debt crisis. Although the ECB and the government have come together to pull the economy out of these difficulties, many political problems are still expected to hinder its success.
Profits for North American airlines were boosted from $1.4 billion to $1.9 billion through tight capacity management. The load factors are also the highest for this region, with an average of 83.2% in the time period January-August.
The profits for Asia Pacific have also been revised upwards. This came as a surprise, as the Chinese economy has hardly shown any signs of a revival. Also, 40% of the global cargo demand comes from this region. With negative forecasts for cargo demand for this year, the IATA expects the expansionary monetary policy in China to bring some growth.
Merger with AMR
The talks of a merger between LCC and AMR have been going on for quite some time. AMR does not have the option to merge with a big airline player like DAL or United Continental Holdings (UAL), as regulators will not allow such a move. However, nothing has been officially finalized so far.
Recently, LCC and American Airlines signed an agreement, according to which both parties would be more careful before any transaction was initiated. The CEO of LCC has been more than willing to proceed with the deal.
However, bears anticipate that the partnership will not be beneficial for LCC in the long run. A major factor behind this claim is the high debt level of LCC. LCC already has a massive debt-to-equity ratio of 877%. The figure is expected to go up after it merges with American Airlines.
Secondly, the recent track record of airlines mergers has not been encouraging. The acquisition of Frontier Airlines by Republic Airways (RJET) has not boded well for RJET's profits and margins. RJET has been trying to sell the subsidiary, but to no avail. Similarly, the merger of United and Continental Airlines to form UAL has not turned out well, with UAL experiencing declining margins since then. Also, DAL has decided to spin-off Comair, its commuter carrier.
However, let us not forget that the acquisition of American Airlines will give LCC access to key Latin American routes that will definitely boost its earnings.
LCC is a story of improving margins. However, this is the only airline that employs no hedging techniques against oil prices. Currently, oil futures are dipping, from which LCC has benefited the most. LCC is up 10% in last few days today, as oil prices fell after crude oil inventory data turned out to be below expectations. However, as the global economy recovers, oil prices are expected to rise as well. The economic recovery will also improve LCC's top line. The LCC and AMR merger talks are still in the air, but no one can tell when such a move is expected to be executed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.