The Prudential report has tables & charts that I'm not going to try to reproduce, but here are the route discussions.....
AWA Has Provided Some Guidance On East-West Cutbacks…
In merger announcement presentations, AWA talked openly about the need for change in the Pittsburgh (PIT), Charlotte (CLT) and Philadelphia (PHL) to West Coast markets. AWA has an existing set of flights connecting PIT and PHL to PHX and LAS, with numerous beyond connections to all of California and the Northwest. AWA indicated that capacity would be cut approximately in half in these markets. Total seats offered will approximate the number of local passengers in each market. Connecting customers who are traveling from competitive points beyond on the UAIRQ system will be accommodated, but capacity will not be built into the system for these typically low-yielding customers.
As shown in Figure 4, these planned reductions should remove about 24 transcon roundtrips from the existing UAIRQ system and eliminate the need for about 21 aircraft. Given the substantial losses UAIRQ is suffering in these markets, and because the beauty of cutting flights in overlapping markets is intuitively easy to relate to employees, vendors, and investors, this is an easy first decision for AWA management. Although the company did not provide details as to current losses by market, we have reviewed certain traffic and revenue data available from the Department of Transportation for the first full quarter after the arrival of LUV in Philadelphia, related to the East-West routes. It is clear from this review that in most markets, over 50% of the revenue is derived from passengers originating beyond PIT, PHL, or CLT. Although exact data has not been provided, it is easy to see how the East-West routes could be losing $50+ million per year, on a fully allocated basis. Cutting 50% of the flights will clearly shrink the losses, but one must remember that cutting the flights will only cut the variable costs.
Reducing the nonstop historic UAIRQ flights, routing the higher yielding of the connecting travelers over existing AWA flights through LAS and PHX, and not carrying the lowest yielding traffic is clearly a good idea. We expect that the full 50% cuts in East-West flying will reduce losses by a net of $20 – 30 million per year.
…But The East-West Cuts Account For Only 1/3 The Aircraft Returns And Solve Just A Fraction Of UAIRQ’s Problems
Given the announced savings target of $150 to $200 million from route restructuring, and with 60 total aircraft to be returned, there have to be more and larger savings expected from elsewhere in the system.
UAIRQ’s Biggest Route Problem Is LUV’s Invasion Of PHL And PIT
Southwest Airlines began serving PHL, UAIRQ’s largest hub, in May of 2004. From data available for markets entered by LUV in its first full quarter in PHL, it is clear that LUV’s arrival has been a major factor in the current UAIRQ difficulties. As Figure 5 indicates, in each of the early markets, the average ticket collected drops from 18% to as much as 83%.
Southwest has indicated that PHL has been their best and quickest startup in 30+ years of operations. With that, it is easy to assume they are likely planning on ultimately building PHL into an operation comparable to their existing largest operations—approximately 200 flights a day to 20+ non-stop destinations. LUV started PIT service in May 2005 and immediately began serving Florida, Chicago, and Philadelphia. Given the population pool in the Pittsburgh metro area, we assume PIT will eventually grow to about 125 flights per day, also to 20+ destinations.
UAIRQ’s Anti-LUV Strategy Has Not Worked – And, Arguably, Has Been Making Things Worse…
Since Southwest’s first announcement that it was planning service to PHL, US Airways has taken a “We can’t let them run us out of Philly like they did in Baltimore†approach to competing with LUV. In general, this seems to have meant that whenever LUV added a flight or two in a market, UAIRQ would counter by adding as many flights, or even more. It often seemed like UAIRQ was trying to offer so much added capacity, at prices equivalent to some of LUV’s lowest promotional fares, that there would be no need for anyone to try LUV, thus starving LUV for traffic, with the hope that LUV would give up and leave town. This obviously has not worked nor has anyone else ever found that approach to work since LUV first started flying from Dallas to Houston in the early 1970s.
…As They Have Been Adding Capacity In Markets Where 100% Full Airplanes Still Lose Money
Figure 7 provides specifics as to the problems with UAIRQ’s methods of competing with LUV. In this figure, we have drawn what we estimate is the total cost curve for UAIRQ and have plotted several data points reflecting the average fares collected in the markets where LUV and UAIRQ compete. The fact that the average fare is below the cost line in these markets means that UAIRQ’s Break Even Load Factor (BELF) is over 100%. UAIRQ has been adding flights into markets and then discounting seats to the point where it needed to sell over 100% of the seats just to break even. As illustrated in the table below, relying on traffic to points north of PHL is not the solution either. Fares continue at roughly these levels today. We thus see cutbacks to Florida against LCCs AirTran and LUV as one obvious place where AWA will likely change UAIRQ’s direction.
AWA Has Prospered Along Side LUV In Its Hubs…
The AWA/UAIRQ combination may seem particularly attractive to the AWA team, but not to other airlines and traditional airline investors. AWA’s view of the PHL hub, in comparison to AWA’s home PHX hub, quite likely looks extremely inviting, given that the PHL metro area has two-times the population of PHX and that UAIRQ serves 99 cities nonstop from PHL that LUV does not serve from any destination.
…By Seeking Coexistence Not Dominance
As Figure 8 illustrates, AWA’s largest PHX markets include several not served by LUV. In addition, several of LUV’s biggest markets are not among AWA’s Top Ten. Importantly, in markets where both AWA and LUV operate, AWA typically schedules fewer flights in the markets than LUV, reflecting AWA’s efforts to tailor capacity to match the needs of those customers not drawn to LUV. This is in stark contrast to the competitive posture of US Airways in its efforts against Southwest.
AWA’s Approach To PHL And PIT Should Go A Long Way Toward The Forecast Route Synergies
Although not mentioned in the early announcements regarding how UAIRQ and AWA will integrate operations, we believe AWA will focus its efforts on reducing North-South capacity. It is not surprising to us that AWA did not mention the North-South capacity specifically. Both current and previous management at UAIRQ repeatedly emphasized the need to compete with LUV in a manner that keeps LUV from taking over PHL. Accordingly, UAIRQ’s employees would surely take any discussion of wholesale pullbacks against LUV as a sign of defeat. However, given AWA’s history and expressed methods of dealing with LUV, we can’t imagine the combined company taking any other course.
After One Year, LUV Serves 8 Of The Top 10 Nonstop PHL Markets
Per Southwest, the PHL opening has been the fastest and best new city opening in their history. They have indicated that their ability to grow in PHL has been limited only by the availability of airport gates. This is often the case for new airlines entering an airport. However, city and airport authorities almost always find a way to accommodate a low-fare carrier. As such, we think the current slowing of growth in PHL by Southwest is only a temporary issue. There is no reason to believe PHL will be anything other than one of LUV’s largest hubs. Figure 8 above shows the relative service levels of UAIRQ and LUV in the largest PHL markets.
UAIRQ Serves 99 Other Nonstop PHL Markets And That Should Support A Smaller Yet Profitable AWA/UAIRQ Hub
In spite of the fact that LUV serves most of the larger cities, there is clearly a way to maintain a meaningfully profitable hub in PHL. As is the case in PHX, where AWA serves 67 cities that are not served by Southwest, given the PHL markets not likely to be served by LUV and the much denser population pools in the Eastern half of the country, we are optimistic that the predicted route synergies will be easily achievable.
Bob McAdoo
(816) 531-2182
robert_mcadoo@prusec.com
Prudential Equity Group, LLC One New York Plaza 15th Floor New York, NY 10292
Jim
