Why Convenient US Airways Flights Will Disappear After the American Airlines Merger Is Complete

Last week, Fool contributor Jay Jenkins flew non-stop from Rio de Janeiro, Brazil, to Charlotte, N.C., on US Airways (NYSE: LCC  )  The flight was barely half full. The flight attendant said it's always only about half full.

The other two flights that night leaving Rio for the U.S. were heading to Dallas and New York, two of the largest hubs in the country. Those flights were at capacity.

As a result of conditions set by the Justice Department, the Charlotte hub and other smaller connecting airports used by US Airways will continue flying these routes for the new entity formed upon completion of the merger of US Airways and American Airlines, owned by AMR (UNKNOWN: AAR.DL2  ) . 

The new American will have to immediately give up space at major airports to lost-cost carriers such as Southwest (NYSE: LUV  ) and JetBlue (NASDAQ: JBLU  ) . But in a bit of karmically appropriate irony, the airline will be delayed before fully implementing the full synergies between the old American and US Airways by shuttering these money-losing flights to secondary hubs.

What kind of efficiencies are we talking about?
As investors, before we can really understand what kind of efficiency gains we can expect to see from this merger, we must first break down the basics of airline economics.

At the highest level, airlines are highly capital intensive, meaning they require expensive and specialized equipment and facilities to operate. This is obvious, one supposes, for any airline customer who has boarded a massive 767 or larger plane. Second, airlines are hugely labor intensive, with a tradition of strong unionization across the industry.

Third, it's expensive to operate an airline -- maintaining the planes, fuel costs, labor expense (ground crews, flight crews, customer service, back office, and the list goes on) -- and don't forget that the free ginger ale on your last flight had to be paid for, along with the microwaved chicken dinner.

Lots of capital -- financial and human -- plus high operating costs translate to tight profit margins. And with tight margins come the need to maximize the profitability of each flight, as well as streamlining operations behind the scenes.

The budget carriers like Southwest and JetBlue are very forward with their methods for attacking this problem. They alter seat configurations to maximize the number of possible passengers on each flight. They cut the frills of flying (bye-bye, chicken dinner), and they operate with smaller, more fuel-efficient aircraft. 

Further, they keep the operation of the airline more straightforward than their bigger competitors. Typically the budget operators focus on a smaller network of routes they know to be profitable and don't venture too far from their niche. You won't be seeing a JetBlue or Southwest direct connection to Shanghai anytime soon.

And it's in this vein that the new American hopes to find new efficiency and hopefully profitability. To simplify the process, here is a theoretical example.

Assume that there is a constant level of demand for flights from Rio de Janeiro to the United States -- every week the same number of travelers desire to leave Brazil for the States. Currently there are competing flights from the major carriers, some heading to major hubs such as Dallas or New York, and others to secondary hubs such as the ones the Justice Department is requiring the new American to continue operating. All together, the total number of available seats far exceeds the number of passengers demanding the flight.

In three years, after the conditions of the merger expire, the new American will be able to eliminate the redundancy in this route. They simply stop operating the connection from Rio to Charlotte, and funnel those passengers through Dallas or New York. Sounds simple, right? It is, but it's also critical.

According to Airlines.org, one fundamental way to view airline profitability is called BELF -- the breakeven load factor. This calculation takes into account both the fixed and variable expenses of operating the flight as well as the average price paid per ticketed passenger on the flight. The BELF is the percentage of the seats that must be sold for the flight to break even. For most airlines, the BELF is somewhere around 80%, and most flights end up within just one or two passengers of this breakeven.

Just one or two passengers per flight can dictate overall profitability! On Jay's flight last week, which was hardly 50% full, it's a safe wager that U.S. Air lost money. 

In the following video, Jay highlights his experience on the Boeing 767 from Rio to Charlotte and discusses his views on the future efficiencies possible for the new American Airlines; despite the delay, the new American could find clear skies for shareholders over the long term simply because the potential efficiency gains are so great in such a thin margin business.

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Read/Post Comments (8) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 04, 2013, at 11:26 PM, Factsmanfacts wrote:

    Jay, would ask you to do a bit more research on Charlotte, it's airport, and it's capacity. It is hardly a secondary airport. In 2010, it was the 6th busiest airport in the world, based on traffic movements. And in 2012 Charlotte was the 23rd busiest airport in the world by passenger traffic. Charlotte Douglas International is the busiest airport in the United States without nonstop service to Asia. It is a MAJOR hub for us airways, and will be for American post merger. Charlotte growth rate has been nothing short of exceptional and the city and it's airport continue to grow. Hen pecking concern flights to select locations does paint an accurate picture of Charlotte, it's market, or it's hub status. Charlotte is a high growth market and not just in air service. The airport continues to expand adding a new 5th runway for its capacity needs, plus numerous additional expenditures to meet demand. Charlotte is and will continue be a major player in air service.

  • Report this Comment On December 05, 2013, at 9:32 AM, Nahbonds wrote:

    Jay, I think one of the other things you are overlooking is how many hubs American has pre-merger close to Charlotte. At this point before this merger closes American has hubs (close to Charlotte) in JFK, Chicago, Dallas, and Miami. The interesting thing is that all these hubs are within 1000 nautical miles of Charlotte and can be easily connected with a regional jet. Seems like a logical way to feed traffic to where you need it, but I may be wrong. While Charlotte does not have nearly as many take off & landings as these other hubs, it may be easier to feed some traffic into Charlotte to relieve congestion at these other hubs.

  • Report this Comment On December 05, 2013, at 10:49 AM, littlemomma wrote:

    What the Flight Attendant failed to mention is that we carry business executives in First Class that could very well pay the cost of the flight. Additionally we also carry freight which brings in a large chunk of money. It amazes me how people can male assumptions about a profession they know nothing about and how it is run. Thank you.

  • Report this Comment On December 05, 2013, at 10:59 AM, rolo1124 wrote:

    That flight has a load factor WAY higher than 50%. He took that flight 1 time and decided that's how it is every day. Likely he flew on a Tuesday or Wednesday.

  • Report this Comment On December 05, 2013, at 12:03 PM, hines495 wrote:

    Amazing how many people can expound on something they know nothing about.! The future of Charlotte as a hub is not going to be based on one US Air Rio o CLT flight.

  • Report this Comment On December 05, 2013, at 12:32 PM, AcuraT wrote:

    One problem with this analysis is that you have to read the decision carefully to understand what is going on. I think Jay misunderstood it as the wording does not indicate that any flights need to be kept in Charlotte. The conditions about maintaining flights only applies to Regan National - where most of the cuts in the new American are coming (over 50 round trips). His flight from Rio to Charlotte will not be covered by this agreement, and as soon as the merger closes, they can eliminate the route. Nice try at analysis, but it seems to me this is misleading.

    I looked at justice.gov for this information, as apparently this news source did as well:

    "In an agreement with the Department of Transportation, the airlines said they would maintain flights from Reagan National to smaller communities that often lose service as carriers focus on their more profitable routes. "

  • Report this Comment On December 05, 2013, at 12:45 PM, Tyeward wrote:

    WOW. LOL CLT is by no means a secondary airport. By aircraft movements alone, CLT is the worlds 6th busiest airport. I think the problem most people are making the choice to see is a danger of sorts for CLT and a fear of it losing it´s status as a hub. That´s just not going to happen. CLT is a hub that is based out of the nations second largest financial center. The other thing about CLT is that it´s pretty cheap to operate out of when you compare it to other rival airports. It´s a good connecting station and it stands to probably gain a little here and there after the network is merged. Now if US is flying out half empty out of Rio, you have to keep in mind that this is US traffic alone and not the traffic of the combined carrier. I am pretty sure that if there is a chance that the new American can shift connecting traffic out of Miami to make more room for O&D between MIA and Rio, you can best believe that the connecting traffic will flow to CLT, and there won´t be a problem anymore with filling the seats to CLT. The combined carrier will need CLT just as much as it will need PHL and PHX (well I don´t really know about PHX all that much, but I do hope they keep it). I guess the bottom line with this is that we will just have to see what happens. When the dust settles, CLT will be just fine.

  • Report this Comment On December 05, 2013, at 10:46 PM, 704GoPanthers wrote:

    This flight is relatively full year round I know because I work here at CLT. It averages over 80% full and this year because of that flights popularity we have also started flying to Sao Paulo GRU daily(Also extremely full flights). The South American routes are some of AA's only profitable flights currently and will continue to grow. Currently the US Air 767-200's average over 25 years old therefore these will flights will transition to newer larger more fuel efficient aircraft(A330, 777, A350, 787). That half full flight you were on was an anomaly, airlines aren't naive enough to leave unprofitable flights for 3+ years. There was a daily CLT to HNL flight on a 767 it was half full on average and they ceased service in less than a year after it's debut.

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