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6 airlines that win if United fails
As United Airlines struggles in Chapter 11 bankruptcy, some investors are betting the airline will be shut down altogether. Here are six airlines positioned to benefit if that scenario plays out.
By Michael Brush
With the shares of the major airlines beaten down to the price of an onboard drink, many investors in the sector are once again looking to Washington, D.C., for redemption.
Theyre hoping intense industry lobbying efforts on Capitol Hill will provide some lift for airline shares by nailing down promises of more federal aid in case a prolonged war with Iraq makes business even worse.
But analysts and investors in a handful of select airlines are quietly hoping politicians will hold the line on handouts. Such restraint could force a major player out of business, or at least make the biggest airlines cut back significantly.
Yes, this scenario could be devastating for the employees of United Airlines parent UAL Corp. (UAL, news, msgs), which is the most likely major carrier to bite the dust. And it wouldnt be too sweet for consumers, who probably would see higher fares and fewer flight options in the long run.
But, there would be beneficiaries -- namely, the air carriers that remain solvent and, of course, the shareholders of those carriers. The A-list of potential winners includes these six stocks: AMR Corp. (AMR, news, msgs) parent of American Airlines, American West (AWA, news, msgs), Northwest Airlines (NWAC, news, msgs), Frontier Airlines (FRNT, news, msgs) and low-cost carriers Southwest Airlines (LUV, news, msgs) and JetBlue Airways (JBLU, news, msgs).
Opportunities for surviving airlines
Heres how the demise of United, which just reported a $382 million loss for January, could benefit survivors.
First, the removal of United -- an industry giant -- would eliminate lots of capacity from a system that has too much. This would help the surviving airlines inch closer to profitability. They could fill up planes more easily. And they might even be able to raise prices for a change, if the economy ever firms up. Admittedly, that would be bad news for consumers. But it would help reverse the enormous flow of red ink that has driven investors to the emergency exits. The sector is expected to lose another $5 billion this year.
Next, the demise of a big airline like United might make unions more amenable to compromise on pay hikes and work rules, bringing costs down for remaining players. Some analysts think thats just whats needed following rounds of healthy pay hikes during the past several years.
Will United really be grounded?
Industry analysts put the odds at about 30% right now that United Airlines will be grounded because it cant navigate its way out of Chapter 11 bankruptcy proceedings. That scenario becomes much less farfetched, however, if just a couple of things go wrong.
The first potential obstacle: Uniteds labor force. You might think unions would be more than happy to give up enough ground to keep the airline alive. Moreover, the workers own a major chunk of the companys shares (though that could change soon, based on a recent IRS ruling that would permit the sale of shares by the company's Employee Stock Ownership Plan). History shows, however, that unions arent averse to forcing an airline to fail; witness the demise of Eastern Airlines more than a decade ago.
Second, the odds of a permanent United grounding rise to 50% or more if a conflict with Iraq drags out, industry analysts say. A long war would cut back on airline revenue because people would fly even less. And it could also drive oil well above $40 per barrel.
That would be particularly bad news for United because it has no hedges in place against a spike in fuel prices. Given Uniteds uncertain prospects, financial institutions fear taking the other side of a fuel hedge.
A prolonged war combined with unbending unions and a lack of help from Washington would be tough on all airlines because of their high fixed costs. But this combination could knock out United forever. Even if it doesnt, the airline may have to seriously cut back to survive.
I would be surprised if United goes away completely, says Clint Oster, an Indiana University professor who has published several books on the sector. I think the real question is how much will they shrink.
Not surprisingly, fund managers betting on Uniteds demise by holding positions in competitors disagree with Oster. The bottom line is you cant lose money forever, and at some point they could run out of gas, says one of them. The chances are a lot higher if there is a war. Under its current reorganization plan, United must be profitable by May. If that starts to look dicey, look for a Chapter 7 filing to wind down United, as early as late next month.
However the situation shakes out, here are the airlines most likely to benefit from any sort of United misfortune:
American Airlines: One of the best ways to figure out who would gain the most is fairly straightforward. Just look for the airlines whose routes overlap the most, says Clint Oster. By this measure, American stands out as a winner, because it goes head-to-head with United in many markets. Both airlines have Chicago hubs. And American also goes up against United in important West Coast markets such as Los Angeles and the San Francisco Bay area. Its the only U.S. airline, aside from United, that flies to Londons Heathrow airport.
Loading more passengers on these routes would be a big plus for American because of the way airline ticket pricing works, says Stan Pace, an airline-sector expert at Bain & Co. Airlines typically charge more for seats as planes get fuller. A look at how well American would have done last year without United on the scene provides a hint of the potential upside. Analysts at J.P. Morgan estimate that American would have lost $2 per share last year instead of the $13 per share it actually reported after charges.
All this makes American a tempting play on Uniteds troubles.
But theres a big problem: American faces lots of troubles of its own. Debt analysts at J.P. Morgan, who admittedly take a hard-nosed view of corporate financials compared to equity analysts, think theres an 80% chance American itself will be in Chapter 11 bankruptcy proceedings if a war with Iraq lasts longer than two months, or if theres another major terrorist strike. Since the shares of companies in Chapter 11 typically end up being worthless, that makes American a pretty risky play on troubles at United.
America West: A better bet against United: Buy shares of small, more financially sound airlines whose service overlaps United. One good example is America West, which competes with United out of Denver. America West is the least likely to go into Chapter 11, with the most upside, says an analyst at one investment fund that holds shares in the company as a play on weakness at United. America West, headquartered in Phoenix, could earn $2 a share next year if United closes down, which would propel the stock up at least five times, he says. Frontier, which competes against United in Denver, also could benefit.
Northwest Airlines: Northwest shares no hubs with United, but its Detroit and Minneapolis hubs compete against Uniteds Chicago home base for traffic. Northwest also goes up against United in the Pacific. It would benefit there from weakness at United, but other airlines like American or Delta Air Lines (DAL, news, msgs) would probably move in on those routes sooner or later if United disappears.
The discount airlines: Todays low airfares at the major carriers are great for consumers, but they produce major turbulence for discount carriers like Southwest and JetBlue. Cheap fares at major airlines make it harder for these discounters to do what they do best -- steal business by competing on price. So any change that leads to firmer pricing, such as a cutback in capacity at United, would be good for the discount players.
Cutbacks at United could also open up room for the discount airlines to branch out. Uniteds routes on the West Coast are a juicy target. And Southwest would love to expand its presence in the Washington, D.C., market, should United leave slots open at Washington Dulles International Airport. Southwest already serves the nations capital at Baltimore Washington International.
The problem with Southwest stock is that too many airline investors have bought it in a flight to safety. Southwest is one of the safer airlines because its balance sheet is strong, it has much lower costs, and its not exposed to any of the pension-plan shortfalls you find at other major airlines. At $12, the stock trades for 29 times this years estimates -- well above its historic trading range of 15-22 times forward earnings. A better entry point might be in the upper single digits.
Lower labor costs
Another way to try to identify the airline industrys stock climbers is to scout out the ones that would gain the most if labor unions become more conciliatory due to a United shutdown. That would serve as a kind of warning to union workers that they are not going to have their jobs if they follow Uniteds unions down the path of default, says Harold Vogel, a New York-based venture capital manager and author of the book Travel Industry Economics.
American and Continental both have open pilot contracts on the horizon, and the pilots' contract at Northwest can be amended next summer. If these airlines manage to negotiate lower costs, Delta might be left stranded as a high-cost provider because its pilots' contracts arent open for negotiation again until 2005. (Delta, it should be noted, is already approaching labor for concessions.)
The effect on the consumer
While the grounding of United would be good for many of its competitors, consumers would likely get stuck paying more in the long run. It is pretty tough to argue that losing a carrier is in any way good for consumers, says Oster.
True, a shutdown of United might make it easier for other airlines to cut costs if it means they get more cooperation from unions. You would basically be transferring wealth from pilots and flight attendants to consumers, says Bain & Co.s Stan Pace. It might be enough to reverse the trend of sharply rising airline costs that set in during the second half of the 1990s, he thinks.
On the other hand, says Oster, when the economy does turn up again, you still have one less competitor, and it is really hard to see how having fewer competitors is good for consumers in the long run.
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