In April, United Continental Holdings Inc (NYSE:UAL) increased the infamous change fee by $50 from $150 to $200, a move quickly matched by US Airways Group, Inc. (NYSE:LCC). By early May, American Airlines and Delta Air Lines, Inc. (NYSE:DAL) had joined the change fee party and bumped their fees by $50 as well.
Why would airlines think they can get away with this move almost universally detested by passengers? Well, it’s a lesson in oligopoly and the limited choice that accompanies it. Both investors and travelers have seen the names Northwest Airlines and Continental Airlines largely disappear from view. Unlike what has happened so often in the airline industry, these carriers did not disappear because of a bankruptcy. Quite the contrary: they were merged with Delta Air Lines and United Airlines, respectively, in two mergers that have helped to strengthen the hand of airlines.
Three big players
First and foremost, airlines are businesses. They do not exist to fulfill a public good or provide you with extra legroom or a bag of peanuts. And like any other for-profit business, a reduction in competition is a boost to the bottom line. Over the last several years, we have seen the number of U.S. based major carriers reduced to four and soon to be three.
| Year of merger | Acquiring airline | Acquired airline | New company |
| 2008 | Delta Air Lines | Northwest Airlines | Delta Air Lines |
| 2010 | United Airlines | Continental Airlines | United Continental Holdings Inc (NYSE:UAL) |
| 2013* | US Airways Group, Inc. (NYSE:LCC) | American Airlines | American Airlines |
*merger still pending regulatory approval
Note: The acquiring airline listed is the acquiring airline as far as the exchange of shares goes in the corporate sense of a merger. In all three situations, the acquiring airline kept some parts of the acquired airline intact.
As we have seen this reduction in carriers we have also seen capacity cuts, fare increases, fee increases, and economies of scale which are expected to benefit these mega-carriers over the coming years. Due to the relatively short period of time since the latest wave of mergers began, it is difficult to measure the long-term effects of airline integration on airline earnings. What has been seen so far is large integration expenses, especially in focus at United Continental Holdings Inc (NYSE:UAL). However, the majority of these expenses are one-time occurrences and will not affect future earnings.
The closest we can get to seeing how a merged airline will operate is Delta Air Lines which completed its merger long enough ago that nearly all of the integration has been completed. Delta has been able to consolidate existing hubs and shrink others seen in the shrinking of the Cincinnati operations and the enlargement of Delta operations out of former some former Northwest hubs. Delta has been able to record a steady increase in earnings since the 2008 merger but it is not clear how much of this increase was from the merger and how much was from generally improving economic conditions.
However, the largest benefits for airlines could not be realized simply by the Delta-Northwest merger. As it was a case of one airline merging with another, it only reduced the number of large-scale competitors by one. A stronger airline oligopoly will only be able to show its potential once United Continental is fully integrated and the US Airways Group, Inc. (NYSE:LCC) American merger is completed. Since reductions in competition and capacity will not be fully realized in the time frame current earnings estimates cover, the estimates listed below reflect the effects of the Delta and United mergers on the industry without taking into account the benefits of the US Airways Group, Inc. (NYSE:LCC) merger.
Airline EPS 2011-14
| Airline | 2011 | 2012 | est. 2013 | est. 2014 |
| Delta Air Lines | $1.01 | $1.19 | $2.57 | $2.72 |
| United Continental | $2.26 | ($2.18) | $3.37 | $4.84 |
| US Airways | $0.44 | $3.28 | $2.99 | $3.14 |
Source: 4-traders.com
There will likely be major integration expenses at US Airways over at least the next couple years so this airline’s earnings estimates should be taken with a grain of salt. But for Delta and United Continental Holdings Inc (NYSE:UAL), the future appears much brighter as the airlines will have greater control in shaping it how they want, whether through additional capacity cuts, fare increases, or even more fee increases.
Airline oligopoly
One of the most profitable lines of business is an unregulated monopoly. Close behind is a deregulated oligopoly. As the largest American carriers have merged, there is an opportunity for the mega-carriers to realize the benefits of reduced competition by further implementing many of the changes already taking place. Coupled with greater economies of scale, airline earnings should rise not only justifying a higher share price based on earnings but also strengthening the airlines financially. In the end, as airline consumers, we will probably lose in the form of less choice and higher prices, but as airline shareholders, we will probably win through higher stock prices and financially stronger airlines.
Alexander MacLennan owns shares of Delta Air Lines. The Motley Fool has no position in any of the stocks mentioned.
The article When Consumers’ Losses Are Shareholders’ Gains originally appeared on Fool.com.
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