DOJ’s Investigation Will Not Have Long-Term Impact On The US Airlines

At a time when the US airlines have been struggling to convince investors about the sustainability of the industry, an investigation launched by the US Department of Justice (DOJ) to detect any unlawful price collusion among these airlines has only added to their troubles. The four largest US airlines – American Airlines, United Continental Holdings, Delta Air Lines, and Southwest Airlines – have received letters from the DOJ demanding all communications of capacity expansion plans with the shareholders, officials of other airlines, or Wall Street Analysts. Though the news has triggered a panic among the investors, it should not result in any material alterations in the capacity expansion plans or pricing policy of these airlines in the long term. Rather, some may see this as an opportunity to buy airline stocks in expectation of strong second quarter results to be reported later this month.

See our complete analysis for United here

What Made The DOJ Decide To Probe The Airlines?

Based on the data provided by the Bureau of Transportation Statistics (BTS), airline ticket prices have increased 14% over the last five years as opposed to the domestic capacity that has grown at only 6% during the same period. Accordingly, the DOJ fears that the top four US airlines are restricting their capacities to inappropriately control the commercial air fares. Thus, to prevent the air fares from shooting up further and to return the fuel cost savings from lower oil prices to the customers in the form of low air fares, the DOJ has launched this probe. Though the investigation appears to be in the interest of the customers, there are rumors that JetBlue had written to the DOJ in April about the collusion among the larger airlines that has instigated the probe. Irrespective of the trigger, the news of the DOJ investigation pulled down the stock of the four airlines by more than 4% in a single trading day last week.

Are The Air Fares Really That High?

According to the BTS data, the average domestic air fare has increased 2.7% over the last five years on a compound annual growth rate basis (CAGR), while the consolidated domestic capacity of US airlines, measured by available seats miles (ASM) grew only 1.1% over the same period. Based on these numbers, one may be tempted to consider DOJ’s claims to be reasonable. However, it is important to note that the larger airlines were forced to cut down on their capacities during the economic slowdown in 2009-2010 due to weak air travel demand. While the demand improved post 2010, the airlines continued to keep their capacities low in order to meet the demand and supply of air travel. While the ticket prices have increased steadily since 2009, they have not reached the exceptionally high levels of fares that were charged to the customers at the beginning of the decade. Thus, the capacity control adopted by the larger airlines should be considered to be a sensible decision for the industry as opposed to an unlawful coordination.

Source: Bureau of Transportation Statistics (BTS)

Moreover, the rise in air fares post the recession can be viewed is a consequence of the consolidation of the US airline industry. The last decade saw eight US airlines merge into four large airlines controlling almost 80% of the domestic market. Interestingly, the DOJ, which is probing the US airlines for restricting capacity, is the authority that was responsible for the approving these high-profile mergers, which led to the consolidation of the US airline industry. It had approved four of the largest airline mergers over the last decade starting with Delta with Northwest in 2008, United Airlines and Continental Airlines in 2010, Southwest and AirTran in 2011, and finally, American Airlines and US Airways in 2013. Thus, if we assume that the DOJ had been reasonable at the time of approving these mergers, it would be logical to believe that the higher ticket prices are a result of the consolidated industry, rather than collusion among the players.

Finally, over the last two years the tickets prices have been rising at a slower pace than the capacity increase. From the table provided above, we deduce that the average air fares have increased by only half a percent on an average in 2013 and 2014, while the airline capacity has gone up by 1.5% over the same period. This trend has continued to prevail in the first half of 2015, as the airlines have been adding capacity to benefit from the lower jet fuel costs. While the traffic data for the second quarter is yet to be released, based on the data for the two months of the quarter, the DOJ worries over rising air fares seem to be unwarranted.

Are The Airlines Restricting Capacity?

At an analyst conference in late May, Doug Parker, the Chief Executive Officer (CEO) of American Airlines, indicated the airline’s willingness to engage in price competition and expand its capacity as a recourse against its competitors. This statement, coupled with Southwest’s expansion plans at Dallas Love Field, triggered a panic among investors who penalized all the major airline stocks over fear of an oversupply of seats in the market. Thus, the DOJ’s accusations that the top airlines are colluding with one another and restricting capacity to control the air fares are completely contrary to the market’s view.

While the airlines are trying to reassure investor confidence, this has not stopped them from rigorously competing with one another to expand their market share in the key domestic markets such as Dallas, Seattle, and Chicago. For instance, Delta and JetBlue have announced their plans to add new transcontinental flights from New York-JFK after United decided to move its flights on the same routes to Newark. Also, Southwest and Delta have been aggressively battling over the leased gates at the Dallas Love Field airport. Further, it is interesting to note that the consolidated capacity of airlines in the first quarter of this year has been the highest since 2010, when the airlines had to cut down their capacities. Thus, it is fair to say that the airlines have been competitive and rapidly expanding their operations on routes which are profitable and have a strong demand, rather than colluding among themselves.

Source: Bureau of Transportation Statistics (BTS)

Conclusion

To conclude, we believe that the DOJ’s probe on the US airlines does not have merit, as the industry continues to be highly competitive. Hence, the probe will not have much implications for the airlines in the long term. However, it could be a good time to invest in these airlines as we forecast notable second quarter earnings for the industry on the back of weak crude oil prices.

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