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Banking industry

Airlines Face Uncertain Future Amid Mergers and Industry Decline

Strategic Insights

— 1 min read

The airline industry has faced numerous challenges in recent years, including overcapacity and cyclicality, leading many fund managers to view it as a sub-economic market. However, the recent merger talks between United Airlines and Continental Airlines may signal a change in fortunes for the industry. The potential synergies from such a merger, combined with the consolidation of other carriers, could lead to improved returns for investors.

Key Takeaways:

  • The airline industry has experienced a 2 percent margin and a 4 percent lease-adjusted post-tax return on invested capital (ROIC) in 2006, with global industry operating profits reaching $10 billion.
  • Despite a $124 billion increase in industry revenues since 2003, 90 percent of this boost has been consumed by higher costs, mainly fuel.
  • The top three carriers' revenue market shares would rise from 52 percent to 73 percent if both US deals occurred, with potential synergies from cutting capacity and costs being significant, if high-risk.
  • US Airways estimates that a Delta combination would yield annual benefits equivalent to 6 percent of combined sales within two years.
  • A United and Continental deal achieving this level of synergy would result in $3.4 billion benefits, taking US 2006 ROIC from 4 percent to 6 percent.
  • Carriers in Asia are now close to the cost of capital, while those in Europe are nowhere near it, making industry-wide consolidation more challenging.
  • The "open skies" agreement, which could facilitate full business integration, remains a distant prospect.
  • Fund managers should remain cautious, given the economic and aircraft order cycles are near peaks.

Statistics:

  • Global industry operating profits: $10 billion (2006)
  • Industry revenue increase since 2003: $124 billion
  • Percentage of revenue increase consumed by higher costs: 90%
  • US Airways - estimated annual benefits from a Delta combination: 6% of combined sales
  • Potential synergy benefits from a United and Continental deal: $3.4 billion
  • United Airlines and Continental Airlines - combined revenue market share: 73%
  • Current ROIC in US (2006): 4%
  • Potential ROIC in US (2006) with synergy benefits: 6%

Sources:

  • International Air Transport Association
  • US Airways
  • Ryanair
  • Macquarie Bank
  • Flight magazine (not explicitly mentioned, but details confirmed in the original text)

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