UAL & Airlines: Out of Catalysts

  • Big Catalyst Gone:  With the merger news now out, airline investors may need to wait some time for the merger to close and route integration to start.  Courts and regulators will no doubt make the wait abnormally long and we suspect many investors will lack the patience.  Further consolidation may face increased antitrust scrutiny, so this is likely the last consolidation catalyst.  

 

  • We Expect Consolidation to Fail:  We do not expect consolidation at post-AMR/LCC levels to support industry pricing.  There are many more consolidated industries that struggle. We have previously noted Accuride, which went bankrupt with >50% market share in truck wheels and Canadian airlines, but there are many others.  General Motors had a ~40% market share in the 1980s, but was eventually done in by significant legacy liabilities, low cost competition, expensive/inflexible unionized labor and product quality issues, among other factors.  Sound like anyone we know?  Consolidation is neither necessary nor sufficient for a healthy industry structure.

 

  • Low Barriers to Entry:  Even if consolidation does support pricing, those high prices may attract new low cost carriers to the market.  Low barriers to entry and high prices do not mix in the long run.  The current airline valuations are only attractive if the group were to remain profitable in the long-term, as equity valuations are heavily determined by post 2015 results/terminal values.  Betting on a temporary pop in airline profitability from consolidation is more speculation than investment, in our view, and we note that the last six months have shown the opposite - weak pricing and margin declines.