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Vaughn Cordle's  Instablog

Vaughn Cordle, CFA serves as an airline analyst and consultant to various institutional investors, investment banks, and money managment firms in the U.S. and around the world. He analyzes industry trends using the core competencies of strategy, finance, and airline economics. Mr. Cordle has... More
My business:
AirlineForecasts, LCC
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airlineforecasts.com
  • JAL and Open Skies Between Japan & U.S. - Key Issues and Implications
    JAL and Open Skies Between Japan and U.S. - Key Issues and Implications
    • The US-Japan deal under negotiations is being designed so that it will only come into effect after the Japanese receive ATI with their US partners
    • ATI with the Japanese carriers is seen as parallel to AA-BA (Despite delay AA-BA approval is widely expected)
    • While the economic benefits of a JAL DL deal are more valuable,there is a political concern about informing AA of a switch.
    • On the other hand there is no reluctance to express disappointment with BA and the fact that LHR is not a good connecting market for Europe.AF-KLM is a better European partner because of geography.
    • Without a Japanese partner, DL’s Japanese routes are not doing well DL’s Japanese routes are collateral for their recent credit line. As a result DL couldn't shift the service if they wanted to.
    • Of particular interest is the DOT requirement for ATIs to have a Metal Neutral JV.
    With regard to the US portion of this information there are the following political elements that affect the equations:
    • Open Skies with the Japanese is a product of ANA and UA’s efforts in Japan
    • This administration is a product of the Chicago political machine. The DOT Secretary and the General counsel are historically connected to Chicago politics. AA and UA are Chicago hubbed carriers who are keenly familiar with Chicago politics and are important elements of Chicago economics and commerce.
    • It is widely viewed here that JAL is not as important as ANA to the new Japanese government
    • Until DL is able to persuade JAL to become a partner, it is using its political clout to oppose open skies with Japan
    • JAL’s need for restructuring complicates its ability to seek government support in open sky negotiations. Japanese culture suggests that JAL’s CEO will have to resign as soon as a restructuring is achieved with the government.
    Tags: UAUA, LCC, CAL, AMR, DAL, British AIr, AirFrance/ KLM, Open Skies, Pacific Airlines Anti trust, airline joint ventures
    Nov 13 03:01 pm | Link | Comment!
  • JAL and the High Stake Game with AMR and DAL
    AMR's reply to Virgin highlights WHY they are so desperate to hang onto JAL.  If JAL goes with DL/AF, the new grouping, when combine with UAL/ANA/CAL, will control 60% of the US-Japan market, which leaves oneworld with just 6%.
     
    Given the change in seat market share – based on AMR's numbers and our own work – this suggests that JAL benefits more with a DAL/AF matchup. Of course, the benefits must be weighed against switching costs, which include management in addition to financial costs.
     
    Reuters reported today that Japan Airlines President Haruka Nishimatsu said that it looks more natural to stay with the oneworld airline alliance at the moment rather than defect to a rival group. Of course, Nishimatsu's statement makes perfect sense; however, it also helps in negotiating with DAL/AF, which could make a hefty equity investment.
     
    AMR is smart to partner with TPG, but I'm not convinced that TPG will choose to risk too much equity given what Japan-US open skies will likely do to fares and earnings.  The only way to save JAL is to reduce underfunded pension plans (over USD $3 billion) and the cost of debt. Without a labor cost reduction, the company is a big, black sinkhole that will destroy any equity investment.
     
    Reports suggest that the retirees are willing t accept some level of cuts. Therefore, the government will either have to force the issue and make changes to current funding requirements or subsidize payments to ease the JAL's financial burden.
     
    It's an open question whether or not the government will go far enough with the restructuring of JAL, and it's tough to value an equity stake without knowing the details of the restructuring, especially as it relates to pension funding. For this reason, TPG will likely not make a commitment until the restructuring is complete, which should occur within 60 days, or so the press reports say.
     
    In terms of a Delta or AMR equity stake in JAL, it must first make financial sense, and the financial case cannot be made without knowing what the labor and debt costs will be in the future. Hence, the need to know how deep the restructuring goes before a proper valuation of JAL can be made. AF/KLM and other SkyTeam members also have a strong incentive in bringing JAL into the Skyteam network. The financial and network benefits cannot not be ignored, especially if JAL equity can be bought at an attractive price.
     
    If I were in the shoes of JAL executives and government officials, I would pit AMR against DAL to get the highest EQUITY investment. Why? Because this reduces the amount of government subsidies and increases the riskiest component of capital to non-Japanese entities, entities that have a significant incentive to control feed into Japan and throughout Asia from gates at Narita and Haneda.
     
    It's a high stakes poker game for UAL, ANA, JAL, AF/KLM, AMR, and DAL. Each has a different hand to play and the stake is a function of JAL's restructuring and whether or not it decides to jump to Skyteam.
     
    Tags: UAUA, DAL, AMR, AF, Open Skies, Pacific Airlines
    Nov 13 11:59 am | Link | Comment!
  • Southwest's Failed War of Attrition Strategy
    - Time for Southwest to Raise Fares & Ancillary Fees

    Airlines have yet to fully understand what higher bag [and other ancillary] fees will do to demand once fully developed.  One has to assume that extra fees will eventually cut into the fare revenue stream.

    Increasing the fees too quickly or by a large amount will result in less traffic and earnings as passengers flock to lower priced competitors.  It is appropriate to de-bundle the services provided by airlines, but high cost airlines will be competitively disadvantaged if the value proposition is less than that of the competition.

    We are making the valuation case that Southwest will have no choice but to follow the herd with increased fees, especially as it relates to charging a fee for the 1st and 2nd bags. In my estimation, the company needs to raise fares by 5 to 8% AND start charging for bags if it is to prop up an over-priced stock.  The downside is that Southwest will have to pull down significantly more than the 6% capacity reduction planned for this year. Of course, it could pay out a special dividend or initiate another stock repurchase plan. By our estimation the company has approximately $1.6 billion in excess equity on the balance sheet.

    Absent an acquisition, management has limited options for both growth and strategies to increase shareholder value, and this must be a primary focus of management. The inability to produce opportunity cost shareholder returns gets to the heart of Southwest's primary problem.

    We calculated earnings from increased baggage fees to be in the $165 - $280 million range, but don't expect the company to change things this year, based on what CEO Kelly is saying. The EarlyBird Check-In for $10 is a smart way to raise revenue and help the consumer.

    Kelly is rightfully worried about Southwest's brand and what higher bag and ancillary fees will do to that brand.  However, the value of the brand component that is related to not charging typically bag and ancillary fees must be measured against the value created by charging higher fees.  I would argue that the [market] value created with higher fees exceeds the brand [market] value component that is lost.  

    Using the mid-point of our conservative estimate results in an increase in share price of ~ $3.6, all else held constant.   In other words, the share price increases 50% if Southwest simply matches other airlines.   FYI, we took into account the [price elasticity of demand] fall off in traffic and revenue if additional fees are charged and adjusted for employee profit sharing and taxes.  So, the question is how much "brand" value is Kelly protecting given the opportunity cost of not raising fees? Is that value worth $2.7 billion ($3.6X 741m)?  Not likely.

    I don't mean to beat up on a management team that can't control most of the forces and factors that buffet airlines and earnings.  However, investor frustration is building because the company has not been able to earn its average cost of capital since 2001, let alone get the stock price moving up.  

    Southwest's war of attrition strategy has been a wealth-destroying proposition for the last 9 years, and has trashed the pricing power of the industry, generally speaking. Perhaps it is time for a new direction - one that involves raising fares to a level that covers capital costs. We believe that investor pressure will continue to build and eventually force management to change course in regards to increasing bag and ancillary fees. Moreover, without the higher revenue from increasing fees and/or fares; it's just a matter of time before the market concludes that Southwest no longer deserves a valuation premium. In other words, the currently over-priced stock will fall.

    None of this provides comfort to the passengers who must endure the hassle of being nickeled and dimed. The alternative is for airlines to charge a fare level that results in a viable business that is worthy of investment.

    When the former Wall Street darling, Southwest - the so-called "low-cost and low-fare" airline - loses money, it's time for management to develop a new strategy.  If the current management team is incapable of improving returns, it risks being replaced by a fresh team with a new strategy, especially as it relates to properly pricing its product.

    No position in Southwest
    Tags: LUV
    Sep 03 08:33 pm | Link | Comment!
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