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JetBlue Airways Corporation (JBLU), Southwest Airlines Co. (LUV): Who Will Win the Domestic Airline Battle?

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An uncertain economic environment has considerably shrunk the US commercial air carriers market. Although the industry experienced an increase in traffic over the past three years, it has failed to achieve its pre-crisis levels in terms of passengers and available seat miles. High fuel costs and competition within the domestic market have forced airline operators to improve their utilization of available capacity in order to enhance profitability. Fewer flights with more available seat miles and passengers has led to the load factor in the industry reaching a record breaking level of more than 83%.

JetBlue Airways Corporation (NASDAQ:JBLU)

Domestic air travel has seen consolidation in recent years as high competition and costs made operations for some air line operators unfeasible. Within the domestic market, Alaska Air Group, Inc. (NYSE:ALK), Southwest Airlines Co. (NYSE:LUV) and JetBlue Airways Corporation (NASDAQ:JBLU) are some of the largest within the industry and each have shown attractive growth in revenues and net margins.

These companies have traditionally been marked as low cost carriers using the point-to-point network as opposed to the hub-and-spoke network used by the legacy carriers and have given tough competition to the legacy carriers in the US market. The low fares provided by these airlines have helped these companies generally perform better than the legacy carriers in terms of revenue growth and margins during the recent past through the dire environment. These airlines have positioned themselves strongly over the past few years and it is expected that these airlines will remain strong competitors to the legacy carriers and will dominate the domestic market in the future.

Achieving growth in difficult times

Southwest Airlines Co. (NYSE:LUV), the biggest amongst the three in terms of total revenue, experienced an increase in revenue (at a Compound Annual Growth Rate (CAGR) of 11.62%) from $9.86 billion in 2007 to $17.09 billion in 2012. The increase can be attributed to higher passenger yields, a gradual increase in fares, and the acquisition of AirTran in mid 2011.

The company’s operating margins have reduced significantly over the years, dropping from 8% in 2007 to 3.6% in 2012. This decrease in 2011 and 2012 can be attributed to costs incurred in the AirTran acquisition, higher fuel costs and a large quantity of losses recognized on hedging instruments used for fuel costs. I strongly believe that the company will be able to show an improvement in its margins in the future, but its revenue growth will be considerably slower than what it achieved in the recent years.

Alaska Air Group, Inc. (NYSE:ALK) has experienced the slowest revenue growth at a CAGR of 5.84%. However the company showed a massive improvement in operating margins over the years, increasing from -4.7% in 2007 to 11.4% in 2012. The increase in the revenue is attributable to higher fares, increasing revenue passenger miles (RPMs) and the increasing efficiency of the company’s operations.

The company has experienced the largest growth in RPMs at a CAGR of 7.2% as compared to 3.4% and 2.8% for Southwest Airlines Co. (NYSE:LUV) and JetBlue Airways Corporation (NASDAQ:JBLU), respectively. The company has been able to improve efficiency by improving cost structures and increasing the utilization of its capacity. The company has been able to reduce its number of flights over the past decade while it has improved its load factor from 76.4% in 2007 to 86.58% in 2012. It is expected that the company will continue to experience a similar growth in revenue in the future as it adds new routes and increase its fares further. In the future, increasing competition will limit the company’s ability to raise fares.

Out of the peers, JetBlue Airways Corporation (NASDAQ:JBLU) is the only company that experienced attractive revenue growth combined with an improvement in its operating margin. The company’s revenue grew at a CAGR of more than 11.8% over the past 5 years and its operating margin increased by 160 basis points, to 7.5% in 2012.

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