Southwest Is the Most Efficient Airline, But Cost Advantage Narrows

by: Valuentum

In the commodified airline industry, the lowest-cost provider often dictates the price for any given route. And as outlined in "Why Airline Stocks Are Not Long-Term Investments," real pricing growth continues to elude this troubled industry. As a result, efficient and low-cost operations are paramount to success, and in many cases, essential for long-term survival.

The primary metric used to gauge the cost structure of an airline is cost per available seat mile (CASM) -- or the cost to fly one seat one mile, whether it's occupied or not. Unfortunately, comparing one airline's consolidated CASM with that of another offers little insight into which airline is truly more cost efficient, as some carriers sport regional operations and others vastly different route structures and fleets.

To really compare the cost structures between airlines, one has to look at mainline CASM adjusted for stage length (the average distance flown per aircraft departure). Adjusting for stage length corrects for the inherent differences in fleet sizes and route structures, while assessing an airline's mainline operations strips out data from regional affiliates, which remain absent from the low-cost group. Traditionally, the industry has assessed this metric on a non-fuel basis, but given that fuel prices are a huge portion of an airline's cost structure, let's take a look at how the all-in, stage-length adjusted mainline CASM compares across a subset of carriers in the industry.

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Based on first-quarter data, Southwest's (NYSE:LUV) all-in, stage-length adjusted CASM is still nearly 30% lower than even the most efficient of the network carriers -- U.S. Airways (LCC). However, the cost gap is certainly narrowing, as the same comparison in 2008 revealed greater than a 70% cost differential. Though results on a quarterly basis can vary considerably, Alaska (NYSE:ALK) managed to edge out JetBlue (NASDAQ:JBLU) as the second-most efficient carrier within this subset of industry participants. American (NASDAQ:AMR) ("Is AMR's Equity Practically Worthless?") and United Continental (NYSE:UAL) have retained their respective positions as the least-efficient airlines (based on this metric), boasting all-in, stage-length adjusted mainline CASMs that are more than 50% higher than that of Southwest.

The overall cost gap between discount airlines and legacy, network carriers has shrunk to the lowest levels in three years (particularly as Southwest's attractive fuel hedges have rolled off), but low-cost carriers still have a big advantage over their larger rivals, something that will certainly come in handy during the next downturn.

Disclosure: I am short AMR.