Shares of major airlines stocks like Delta Air Lines DAL, United Continental Holdings UAL, American Airlines Group AAL, Southwest Airlines LUV, JetBlue Airways Corporation JBLU and Virgin America VA took a battering on the first day of July following a report appearing in the Associated Press of a probe by the Department of Justice (DOJ) on the possibility of unlawful co-ordination by some carriers. With airline stocks plummeting on the news, the NYSE ARCA Airline index declined 1.53% to $92.55 on Jul 1.
DOJ Concern
Airline stocks are under the scanner as the government antitrust investigation intends to find out whether carriers illegally coordinated and consequently expanded at a slower pace to limit the availability of seats with the objective of keeping airfares high. The fact that domestic capacity was almost flat in the 2010-2014 period even though the US economy expanded adds weight to the allegations.
Moreover, the average domestic airfare (inflation adjusted) climbed well over 10 percent in the 2009-2014 period. An argument in favor of the airlines is that there has been a decline in domestic airfares in 2015 according to data released by the U.S. Transportation Department.
As part of the probe, the DOJ has asked the carriers to furnish detailed documents pertaining to the communications between them apart from information on their passenger-carrying capacity since Jan 2010. Even though The DOJ has not revealed the identity of the carriers being probed for the alleged collusion, according to a report appearing in the Wall Street Journal carriers like Delta, United Continental, Southwest and American Airlines have confirmed the receipt of written communications from the DOJ asking for the above information.
Are Mergers Responsible?
The antitrust probe also intends to investigate whether the allegations have stemmed from the plethora of mergers which have characterized the airline industry since 2008. Mergers have limited the competition in the space as a result of which big players like Delta, United Continental, Southwest and American Airlines currently control in excess of 80% of the domestic air travel market.
As a result of their excessive clout, the carriers are alleged to have eliminated unproductive routes to control capacity. No wonder, “the Big 4” are part of the DOJ investigations. However, they have stated that they are complying fully with the investigations.
Even though the mergers have received government clearance, we note that the DOJ had initially opposed the merger between American Airlines and US Airways leading to the formation of American Airlines Group. However, the merger was ultimately cleared by the department following some concessions.
Investigation Not a Bolt from the Blue
The ongoing DOJ probe does not come as a surprise as the stage for an investigation had already been set. For example, late last year, Senator Charles Schumer had asked the DOJ and the Department of Transportation (DOT) to investigate as to why air tickets continued to be expensive despite plummeting crude prices. Furthermore, Senator Richard Blumenthal had also called for an enquiry last month.
Mergers have stifled competition in the airline space. Furthermore, low oil prices have resulted in huge profits for the major carriers. Additionally, these companies have further augmented their revenues by means of other charges like bag fees and reservation-change fees.
Low Oil Prices: Huge Boost to Airline Profitability
Lower jet fuel prices have been a boon for the airline industry given the inversely proportional relation between crude prices and aviation stocks. Weak oil prices have resulted in tremendous savings for carriers. For example, Delta has projected savings in excess of $2 billion in 2015 due to low fuel costs. In the same vein, American Airlines Group expects its fuel expense to reduce by over $4 billion in 2015.
In view of such favorable conditions, airfares should have declined substantially to provide relief to fliers. However, the case has not been so, which eventually has prompted the investigations.
Probe Follows Airline Sell-off
Even though conditions look favorable as highlighted above, the airline space has also seen some troubled times lately. The industry saw a major sell-off in May this year due to capacity and pricing worries. The trigger was Southwest Airlines’ announcement that it plans to increase its capacity in the band of 7% to 8% in 2015 as opposed to the earlier projection of a 7% increase.
Southwest’s projection wreaked havoc among investors who feared that the increased capacity expansion would lead to an oversupplied market even as fuel costs remain weak. Investors were naturally concerned that oversupply could result in lower fares and hamper profit. The DOJ probe comes close on the heels such concerns. It is being feared by some market watchers that carriers might be reluctant to trim capacity in the wake of the probe.
Another concern confronting the U.S. airline industry is the ongoing dispute between leading U.S. carriers and their Gulf counterparts. Earlier in the year, Delta, American Airlines and United Continental complained to the Obama administration that the massive subsidies and other benefits enjoyed by the three state-owned carriers – Qatar Airways, Etihad Airways and Emirates – were rather unfair in nature as they denied a level playing field to the American carriers.
Conclusion
Even though news of the probe caused airline stocks to plummet, we do not expect any drastic change to take place in the industry following the results of the investigations. With the major carriers in solid financial health, they would be easily able to withstand any fines that may emanate from the probe.
Moreover, Airlines for America predicts a busy summer for airlines while International Air Transport Association projects higher profitability for 2015. This lends weight to the view that airlines will experience good times going ahead. Nevertheless, we expect investors to remain focused on the outcome of the DOJ probe.
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