Delta Does the Discount Dance

Defying the recent law of airline business gravity, Delta Air Lines (NYSE: DAL  ) has launched a test program to lower ticket prices on several of its routes. This was mildly surprising to passengers used to the seemingly endless fare hikes and new surcharges typical of the industry. Although we won't see $100 LAX-JFK round trips from Delta anytime soon, this could represent a push in an interesting new direction for the carrier. And just maybe it'll put more passengers in seats and lift company revenue.

The low-cost experiment
Delta has a little bit of wiggle room at the moment. It posted nice metrics in March, with passenger revenue climbing 13%. This rate was higher than the company expected. Load capacity (airline-speak for "occupancy") also moved noticeably upward from March 2011, improving to 84% from 80%.

So the company can experiment here and there with fare cuts. At the moment, these test "basic economy" tickets can be had only on routes originating from Detroit to four cities in Florida. Detroiters flying down to the Sunshine State won't get rich from the savings: The flights are only about $10-$15 cheaper than regular fares. They also carry some heavy restrictions, like the inability to reserve a seat or modify the ticket at all.

Regardless, it's a shift in the right direction as far as passengers are concerned. Industry players are painfully aware that their customers hate the ever-rising ticket prices of recent years. They also know that these people feel nickel-and-dimed by fees for services they once got for free (baggage, meals, snacks, etc.).

The high cost of low fares
Discounting is a tricky activity for airlines, particularly given current conditions. As any car owner knows, the price of automobile gas is spiking and the situation is no different for aviation fuel. 2011 saw a big jump in aviation gasoline costs. Compared to the previous year, Delta paid nearly 30% more for fuel. It did relatively well in that respect; United Continental (NYSE: UAL  ) and US Airways (NYSE: LCC  ) saw notably higher rises, at 38% and 36.5%, respectively.

But at least those guys don't compete exclusively on low fares. For a habitual discounter like Southwest (NYSE: LUV  ) , higher costs take a deeper bite. That company has veered between bottom-line profit and loss over the past few quarters, and eked out a wafer-thin net margin of 1.1% for fiscal 2011. Discount-shy Delta and United posted margins that were around double that level.

Don't expect a pile of cheap tickets
Travelers are always sniffing around for airfare bargains. So it's probable that Delta's experiment will succeed. This will spur the airline to offer, albeit very carefully, sporadic discounts on its other routes. This should boost the load rate and bring in a bit more revenue on the back of increased volume.

Don't expect it to fly away with such offerings, though. It's hard enough to make money in this business, and that law of ticket price gravity can't be violated too flagrantly if an airline wants to net a decent profit and please its shareholders.

The most pleasant news for those airline shareholders would be a drop in fuel prices, but they continue to climb and affect the dynamics of many industries. For investors looking to take advantage of high oil prices, perhaps the energy market provides some interesting opportunities. Start your research in this hot sector by reading our recent report "3 Stocks for $100 Oil."

Fool contributor Eric Volkman likes to fly but owns none of the stocks mentioned in the story above. Motley Fool newsletter services have recommended buying shares of Southwest Airlines. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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