The Three Cs Of The Airline Industry: Consolidation, Concentration And Crowding

The airline industry has not been able to generate yield gains above inflation over the last decade. While there seem to be opportunities for the industry to drive better pricing, the segment remains competitive, making it difficult to support “a multiyear period of super-inflationary pricing,” Bernstein’s David Vernon said in a report.

Consolidation, Concentration And Crowding

The airline industry’s consolidation at the company level is “a clear positive to the investment case,” Vernon commented. The top four carriers control ~79 percent of domestic capacities.

Although consolidation means there are fewer companies competing for market share, the industry has not been able to generate yields above inflationary rate, with real domestic revenue per passenger mile declining by about 1 percent per annum over the last decade, Vernon added.

“One factor contributing to this outcome is that control over industry capacity at the lane level is actually more fragmented than it was in 2006 [...] The decline in domestic concentration levels is the result of the shift of industry capacity towards more contested markets, the effect of which more than offsets any benefit from a smaller number of carriers,” the analyst pointed out.

Due to capacity additions into crowded markets as well as more carriers serving smaller captive markets, competition has intensified and the number of markets being served by just one or two carriers has declined significantly.

Implications For Investors

Vernon mentioned the important implications for investors as:

• The need to look beyond better market power for sources of pricing power.
• Expectations of the control over industry capacity continuing to fragment.
• Carriers would likely have different levels of control over capacity in the markets they individually serve.

Ratings And Price Targets

• American Airlines Group Inc AAL: Underperform, price target at $31.
• Delta Air Lines, Inc. DAL: Market Perform, price target at $44.
• Southwest Airlines Co LUV: Outperform, price target at $50.
• United Continental Holdings Inc UAL: Market Perform, price target at $59.