Much to the chagrin of United Continental (NYSE:UAL), Southwest (NYSE:LUV) received approvals from the Houston’s City Council to add overseas flights through Houston Hobby Airport (HOU). As a part of the deal, Southwest will infuse $100 million to fund the launch of five new gates, customs facility, relocation of ticket counters, fuel system expansion and improved security checkpoints to manage higher passenger volumes.
The long term benefits from this investment will come in the form of preferential scheduling rights and rent free access to four of the five new gates as well as customs facility. United Continental had been retaliating to this proposal since inception because of its strong foothold in Houston’s existing hub, George Bush Intercontinental Airport (IAH). As an immediate response to this event, United declared its intentions to axe 1,300 jobs from IAH.
Southwest served only the domestic markets until the acquisition of AirTran in 2010, which offered international services to destinations like Mexico and Caribbean. In December 2011, Southwest received route authority approval from the U.S. Department of Transportation (DOT) for AirTran to operate international flights to new destinations in Mexico beginning in May 2012. The HOU opportunity will open new gateways for the carrier to explore growth opportunities in international markets including Mexico, the Caribbean and cities in Central and South America. Further, venturing into international segment adds a new product-line to tap overseas markets which will add to the carrier’s valuation.
United Continental will bear the brunt as growth focus shifts from IAH, one of its major hub, to HOU. In addition to threat of cannibalization of its services at IAH, the HOU project would also affect future growth prospects at the Bush Intercontinental Airport.
After receiving a nod from Houston’s Mayor recently, the proposition for secondary international facility at HOU was acknowledged by council members with 16/17 votes in favor of the proposal. As the terminal becomes fully operational to serve international markets by 2015, Southwest would leverage rent free access to gates thereby keeping a cap on the landing fee and other rentals. However, other carriers would be liable for rent to access these gates.
For 2011, landing fee and other rentals was reported at $959 million which accounts for 6.4% of the total operating expenses. This competitive cost advantage would complement Southwest’s core competencies of operating under low cost structures. For the longer term, it would also enable the carrier to attain a better control over pricing. However, the carrier’s bottom-line would get impacted in the near term due to investments in HOU international facility until it becomes operational.
We have a Trefis price estimate of $12.54 for Southwest, which implies ~40% upside to the stock’s current market price.