Wednesday, April 09, 2008


The temporary grounding of old airplanes for inspection is a winner in terms of airline consolidation. What Senator will dare to attack the merger of US airlines that have not been able to purchase new airplanes? The safety argument trumps all others.

A regular reader and good friend has made the point that UPS and FDX are essentially in the same business as the airlines. They move packages rather than people. They sale at an average PE of 15 which is almost 3 times the price of CAL. They sale at a price to sales ratio of 1.1 which is more than 7 times the price of CAL. They sale for a price to book of 3 which is 2.3 times the price of CAL. They sale at an average price to cash flow of 18 which is more than 7 times the price of CAL.

What is the difference? Sentiment. Most investors hate airline stocks and most investors have a favorable attitude for air freight stocks.

James Williams, "the energy economist", reports that US oil product consumption has fallen year over year only 5 times. In October of 1973 due to the oil embargo, from 1979 to 1981 due to the Iranian revolution, from 1990 to 1991 because of the invasion of Kuwait by Iraq, in 2001 due to high prices and a US recession, and, in 2006 due to high prices. The first four instances were accompanied by recessions. In 2006 the world wide economy was strong despite the decline in petroleum use. The two ways the world economy can grow while fuel usage declines is for the world to be more efficient in its use or for the world to substitute other sources of energy. Both of these ways are at work. The question remains how long it will take for supplies to overtake demand and to push the price down. The two nuclear power plant contracts let in the state of Georgia yesterday will take 5 years to come on line. The projects that are making a difference today were started 2 to 5 years ago.

According to MasterCharge, the US consumption of gasoline saw its largest ever one week decline in gasoline usage last week. This one time event can be discounted because it is normal for usage to fall the week after Easter. The record that was broken was the week after Easter in April of 2005. The more telling story is that petroleum use is likely to decline by more than 2% year over year in the USA this year. The EIA projects that the level of Saudi spare capacity will jump from 1.75 million barrels per day to 3.5 million barrels by year end. Williams suggests that crude oil prices will fall below $90 per barrel if such an increase in spare capacity develops. The numbers that make me most optimistic are the natural gas numbers. Natural gas production is rising in the US and Canada. The wide spread in cost per btu is encouraging the substitution of natural gas where ever possible.


Today's news reports are that DAL pilots are being offered raises in exchange for support for reduced work restrictions and for their support for the merger. The NWA pilots will not be required to support the merger. They will continue under the same contract they are currently under. Of course, this offer is designed to encourage the NWA pilots to get serious about negotiating a seniority agreement with the DAL pilots. The DAL pilots already make substantially more than the NWA pilots. Should the merger go through without a negotiated agreement with the NWA pilots, the rank and file will surely put a lot of pressure on union leaders to work out the plan that would give them 30% wage increases.

I am quite comfortable estimating that at least 95,000 of the 100,000 AMR passengers who were bumped today are "mad as hell and not gonna take it anymore". The frustration they feel can easily be "transferred" to any who would oppose the upcoming consolidations. Europe will be pushing hard by May for the US to allow more than 25% ownership of US carriers. The natural "fits" include BA and AMR and DAL-NWA and KLM-France. The DAL-NWA deal will set the ball rolling. The NWA golden share in CAL is only worth $100 as soon as NWA accepts the DAL offer.

The odds of mergers is high. The merged carriers should be able to reduce costs and increase revenues. While it will be a tough job to integrate the various systems, the big savings will not be administrative. The key will be the reduction of overlapping routes. More planes will fly full and fewer seats will be discounted. The destructive practice of flying $10 seats to steal market share is over. There will always be low cost carriers offering low priced tickets. The pressure will be on them to make a profit on each ticket sold. The fuel "wasted" on $10 spring break larks will be used by those paying a fair price for a trip of the same distance. Instead of using $250 worth of fuel to capture market share, the $250 worth of fuel will be used to transport a passenger willing to pay $350 for the trip. It all seems very fair to me.