Cutting Airline Operational Costs

| About: Southwest Airlines (LUV)
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Summary

Airlines are schedule, and therefore time, driven.

Saving time could improve profitability.

Time savings on the ground seem plausible.

Investment thesis: Southwest Airlines (NYSE: LUV) has a cost advantage over its competitors few people realize.

Airlines are one of the toughest businesses to run. On the one hand, you have regulations that limit flexibility to respond to shocks. On the other hand, you have outside shocks like weather, terrorism, and economic upheavals on a regular basis.

Our research of the US airline industry, looking at the past two years, shows us the typical US flight spends 17% of its travel time taxiing. Take a look at this chart. On the left side is average travel time, and on the right, the same data in percent. The 17% averages out at 23 minutes.

McKinsey reported they estimate the amount of an airline's costs at 45% for "maintenance, ground handling, in-flight services, call centers, and aircraft acquisitions". Airlines for America, the US airline trade group, estimates an airline minute is worth $65. Others estimate an airline minute value to be up to $150.

What we can be sure of is that, given the significance of time, if an airline can save even one minute across its operations, this adds quickly to big money. Take a look at the next table.

This table lists major US airlines on the left, along with their average taxi times, average monthly flights and fleet sizes for 2015 and 2016. The 2015 average taxi time was 23 minutes, and in 2016, it rose to 23.2 minutes. That extra 0.2 minute cost the industry $176M at $65/minute and over $361M at $100/minute.

Each of these airlines has a different operating profile - some have hubs which suffer from crowding and a consequential slowing down of operations. One airline that does not have a hub problem is Southwest Airlines. Take a look at this next chart.

Here we show each of these airlines (2015 is the most recent full year of data) and their top five airports. Notice how Southwest has the lowest percentage of flights using its top five airports - its top five account for under 30% of all flights.

The numbers in each column list the main airport for each airline. So, whereas Midway (MDW) is 7% of Southwest's flights, Virgin America (NASDAQ:VA) has 29% of its flights at San Francisco (SFO).

The bottom line here is that some airlines, like Southwest, are doing much better on taxi time than others. This lower time "wasted" on the ground means more flying time - which is what makes money.

It seems there is an opportunity for the airlines to cut their costs by focusing on methods to reduce ground time. If we use the 2016 average number of monthly flights and offer two price points, $65/minute and $100/minute, we can see what monthly savings could be for each of these airlines.

Is this a feasible goal? Can these airlines try to save one minute (or more) in taxi time?

It is a very complex business and airline managers constantly tweak at the edges of their operations to save time. Common sense says there has to be a way to reduce taxi time from the current 17% of travel time. It may seem mythical - but look at the financial impact. That minute is worth chasing.

In terms of Southwest Airlines, the time saved is worth a lot. Research we did on airlines in Europe show that for a minute saved, an airline sees a 0.43% improvement in margin. The European number is not transferable to the US. But we would suggest that investors take a another look at Southwest Airlines because it is the most efficient in terms of ground time. The share price might not reflect the full value of the advantage the airline has over its competition.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.