Secrets of Successful Airlines

The airline industry has a singular talent for draining the pockets of well-intentioned investors. Highly leveraged balance sheets and bankruptcies are the norm. Significant labor costs and unpredictable jet fuel prices wreak havoc on variable costs. Yet some airlines generate solid returns quarter after quarter. Alaska Air Group (NYSE: ALK  ) , Ryanair (NASDAQ: RYAAY  ) , Southwest Airlines (NYSE: LUV  ) , and Copa Holdings (NYSE: CPA  ) each manage to be consistently profitable. Let's examine a few themes they share in common, and zero in on their individual strategic ideas.

1. Go regional
None of the four airlines above tries to compete on a grand international scale, with presence in every metropolitan area that looks enticing on a map. Instead, each confines itself more or less to a geographical theme. Alaska Air, for example, primarily focuses on the West Coast of the U.S., along with Alaska (naturally) and Hawaii, with some coverage in the Midwest and on the East Coast. Ryanair operates as a European carrier, with comprehensive coverage across the continent.

2. Maintain a uniform fleet
Southwest pioneered the practice of buying a single type of aircraft from the same manufacturer, which cuts down on maintenance costs significantly, as less specialization of maintenance is required and a standard extra-parts inventory can be maintained at various airports. Large carriers that choose to service a variety of hubs and both short- and long-haul flights can end up like US Airways, which stocks its fleet with multiple model series from at least three different airline manufacturers.

3. Invest in a fuel-efficient platform
The actual aircraft that makes up a uniform fleet is a significant decision. All four airlines have invested heavily in the fuel-efficient Boeing 737 platform. Variants of the 737 represent nearly all of the these companies' active fleets. The 737 has been in continuous production since 1967, and it has been marked by continuous evolution in fuel efficiency and performance in the short-to-medium-range flight segment. So after choosing to implement a uniform fleet strategy, each of this group has voted the venerable 737 series with their checkbooks and long-term debt capacity.

Beyond these three key points, each airline has a strategic bet fueling its returns:

Alaska Airways
Alaska Airways focuses on return on invested capital, or ROIC, as a key performance metric. ROIC is an excellent metric for an airline to consider, as it counts all invested capital, including debt a company must repay, as the base on which financial returns are earned. ROIC forces a company to understand its returns in the context of its debt. In 2012, the airline achieved an ROIC of 13% .

Alaska Airways also invests in its people. In 2012, Alaska's net income as a percentage of revenues was 6.8%. It could have been 8.6%, but the company paid out $88 million of variable incentive pay to its workforce. By making such a significant discretionary payment, the company is proving the premise that giving its workforce an incentive to work around a "common set of goals" will enhance its earnings and reciprocally reward its people.

Ryanair
Ryanair is well known for its low-cost fares. It supplements these with incremental revenue opportunities, which are known in the industry as "ancillary revenues." But less heralded is Ryanair's rabid attention to cost control. The company enjoys the lowest cost per passenger among European airlines.

Significantly for the long term, the company is locking in a low fixed-cost structure. It has a modern, economical fleet with an estimated average carrier life of just 4.6 years, and that fleet has been financed in the current interest rate environment, so the company has an efficient debt service schedule for the next several years. Even better, a recent purchase of 175 Boeing 737NGs (a transition model to the new 737 "MAX") was transacted at an estimated 50% off the list price of $15.6 billion. The combination of lower fuel prices and lower interest expense will be a formidable competitive advantage in the coming years, especially against major European airlines with older, high-interest financed fleets that compete with Ryanair in the short-haul market.

Southwest
On its most recent earnings call, Southwest's CEO Gary Kelly quantified the impact of famously not charging fliers checked baggage fees: $1 billion. However, Kelly wasn't referring to cost to the airline: He was estimating annual revenue gained by increased market share from customers who perceive baggage fees to be a nickel-and-dime tactic of the big carriers. Southwest employs a counterintuitive ancillary revenue strategy: Its brand presence in customers' minds as a low-cost carrier allows it to conduct non-confrontational upsells, including its "EarlyBird" (early check-in for $12.50) and "Business Select" (business class perks) services. The 2012 Amadeus Ancillary Revenue Report, an annual trade industry survey, ranked Southwest fifth among carriers worldwide in terms of total 2011 ancillary revenue. Incidentally, Ryanair ranked seventh and Alaska Air Group 10th.

Copa Holdings
Panama-based Copa Holdings, also known as Copa Airlines, has been in business for 66 years. Its overarching strategy is to be the best carrier choice for those traveling within Latin America. Copa serves 29 countries in the Americas, which, according to CEO Pedro Heilborn, is "the most complete and convenient network and option for intra-Latin America travel." By keeping a singular focus, the company can stay on point in optimizing its operations. Copa achieved a net profit margin of 14.4% in 2012, among the highest in the regional airline industry. 

See how simple it is? Let's start an airline together.
On second thought, let's both keep our day jobs. But if you were going to get into the air carrier business, you could do worse than follow the template developed by these four airlines. For now, consider investing in one or all of this group, which lies far outside the norm in a struggling industry.

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  • Report this Comment On April 15, 2013, at 11:31 AM, Jpbeme wrote:

    Great article. Amazing how many of the older carriers refuse to make the difficult changes to make themselves relevant again.

    ...btw, it's "Alaska Airlines" not "Alaska Airways".

  • Report this Comment On April 16, 2013, at 9:02 AM, TMFfinosus wrote:

    Thanks for the comment Jpbeme, and for calling my slip-up on Alaska's corporate name. I agree with you on the older carriers; and can only guess that they feel they have too much invested in their business models to make radical change. They don't seem to mind a revolving bankruptcy door however. Go figure.

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