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Should Investors Take a Ride on US Airways Group, Inc. (LCC)?

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A high degree of leverage, expensive personnel costs, and chronic over-capacity have generally made the airline industry a bad investment choice. However, the industry’s fundamentals have improved somewhat through recent consolidation, including the merger between Delta Air Lines, Inc. (NYSE:DAL) and Northwest in 2008 and Continental’s merger with United in 2010. Now, US Airways Group, Inc. (NYSE:LCC) has made a bid to become the industry leader, with its $11 billion deal to merge with bankrupt American Airlines. So, should investors buy into the combined company?

US Airways Group Inc (LCC)US Airways is itself the product of a merger with America West, after emerging from bankruptcy in 2005. With roots that date back to 1939, the company has transformed itself from a small regional player into a national airline with strong operations in the east coast and central regions of the U.S. It also participates in the global marketplace through partnerships with leading international airlines, including Qantas, British Airways, and Japan Airlines.

US Airways has bounced back from steep financial losses in 2008, with improving profitability and a stock price that has gained roughly 60% over the past 12 months. For FY2012, the company reported increases in revenue and adjusted operating income of 5.9% and 97.6%, respectively, over the prior year. It benefited from a modestly higher load factor for its flights, as well as a 4.4% increase in average passenger revenue per seat mile. In addition, US Airways was able to offset rising personnel costs with savings in its administrative overhead and maintenance categories.

The combined company expects to have a global base of operations that is capable of running 6,700 daily flights to over 330 destinations around the world. Management also estimates at least $1 billion in operating synergies, which are likely to come from combining duplicate facilities and negotiating better aircraft lease and fuel contracts. Plus, the combined company should have a stronger financial profile that would enable it to generate the capital needed to re-invest in its fleet.

Delta’s merger with Northwest provides a good blueprint for US Airways. The 2008 merger created a stronger company that was better positioned to withstand the industry’s volatility. After posting operating losses in 2008 and 2009, Delta’s results have bounced back the past three years, due to rising demand for air travel and greater load factors on its flights. In addition, the company has reduced flights and upgraded its fleet to more fuel-efficient models.

In FY2012, Delta reported increases in revenues and operating income of 4.4% and 10.1%, respectively, compared to the prior year. The company’s operating margin benefited from stable, non-fuel operating costs, as well as strong average pricing for its flights in most regions around the world. Unlike US Airways, though, Delta was not as successful in hedging against rising fuel prices, which led the company to acquire a refinery in Pennsylvania during the period. By eliminating the refinery’s profit margin, Delta hopes to give itself a competitive advantage through direct sourcing of low-cost fuel.

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