America's Newest Airline Is Almost Ready for Takeoff

Since 2008, numerous competitors have disappeared from the U.S. airline industry either through bankruptcy and liquidation or through mergers. This has left four carriers -- American Airlines (NASDAQ: AAL  ) , Delta Air Lines (NYSE: DAL  ) , United Continental (NYSE: UAL  ) , and Southwest Airlines (NYSE: LUV  ) -- with an 85% share of the U.S. air travel market. No new commercial airlines have formed since 2007 to restore the competitive balance -- until now.

The United-Continental merger was one step in the recent consolidation of the airline industry. Photo: The Motley Fool

On Friday, a new low-cost carrier, PEOPLExpress, officially announced its entry to the U.S. airline landscape. Tickets have already gone on sale for its inaugural routes, and the carrier plans to offer its first flights by the end of this month. This could mark the beginning of a renaissance for competition in the airline industry.

The death of competition
The oil price spike of 2007-2008 and the Great Recession of 2008-2009 dealt a one-two punch to the U.S. airline industry. Many airlines ran into liquidity crises, and several were forced to shut down, including ATA, Aloha Airlines, Skybus, and Midwest Airlines.

Meanwhile, many of the remaining airlines sought out merger partners to cut costs and eliminate competitors. In April, 2008, Delta Air Lines and Northwest Airlines agreed to merge. In 2010, United Airlines and Continental Airlines merged and Southwest Airlines purchased its smaller discount rival, AirTran.

Southwest's purchase of AirTran removed a top low-cost carrier from the landscape. Photo: The Motley Fool

As a result of all this upheaval, there are dramatically fewer airlines operating in the U.S. today than there were in 2007. This has led to much better profit margins for the airline industry -- but higher fares and fewer choices for passengers (not to mention less legroom).

A new carrier takes off
In this context, the launch of any new airline is a momentous occasion. Several airline start-ups have been in the works for the last few years, but it has been tough to raise enough capital and gain the necessary regulatory approvals to start service. Earlier this year, I highlighted PEOPLExpress as the airline start-up most likely to get off the ground in 2014.

Last week's announcement makes PEOPLExpress the first new U.S. commercial airline to take flight since Virgin America started service in 2007. For now, the major airlines (American, Delta, United, and Southwest) have no reason to worry. The initial schedule for PEOPLExpress covers just four daily round-trips from its base at Newport News/Williamsburg International Airport.

PEOPLExpress will start with four daily round trips. Photo: People Express

Those initial four flights will include twice-daily service to New York (via Newark Airport), along with daily service to Boston and Pittsburgh. Later this summer, PEOPLExpress will add daily flights to West Palm Beach and Atlanta, as well as three times weekly service to New Orleans and St. Petersburg, Fla.

Turning the tide?
While the launch of PEOPLExpress will not have an immediate impact on the competitive environment, the growth of smaller carriers more broadly will gradually improve competition in the airline industry over the next five to 10 years.

Today, American, Delta, United Continental, and Southwest all profit from the dearth of serious competitors. These four mega-carriers have tacitly coordinated to grow very slowly, if at all, even though U.S. air travel demand is quite strong today. This has caused U.S. airline industry profit margins to soar toward record highs.

But smaller carriers have been growing much more rapidly. For example, Virgin America built up a fleet of more than 50 Airbus planes in just over five years. The expansion of smaller carriers and the founding of new airlines may start to fill in some of the gaps left by cutbacks from the majors.

Indeed, there are plenty of enticing expansion opportunities for new carriers due to the focus on capacity discipline at American, Delta, United, and Southwest. If the majors continue to hold capacity roughly flat but smaller airlines grow rapidly, the airline industry will start to lose its current "oligopoly" character. That will mean more choices and better fare options for travelers.

Foolish bottom line
PEOPLExpress is the first new U.S. commercial airline to take flight since the Great Recession. Its launch shows that entrepreneurs are starting to see opportunities in the airline industry once again, after a period of many years when red ink was the norm.

It may also be the first sign of relief from high fares for U.S. air travelers. As smaller carriers enter the market and grow, the airline industry will gradually become more fragmented. This additional competition will limit airlines' ability to push through additional price and fee increases.

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Read/Post Comments (21) | Recommend This Article (16)

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 June 02, 2014, at 2:43 PM, Casimm wrote:

    I used to fly by " People Express " in the eighties. It was dirt cheap at the time. It's been gone since 87, not too many would remember it now.

  • Report this Comment On June 02, 2014, at 2:44 PM, Inspectigator wrote:

    Capacity control is now due to a pilot shortage - the smaller airlines can't find enough pilots, are cutting flights and parking airplanes because of it. Major airlines are able to attract and hire pilots from the regionals not because of good starting pay ($22k/yr), but because they offer the chance at higher pay on bigger equipment later in life. PeopleX cannot offer much career opportunity, so they are either going to have to pay a lot, or hire pilots who cannot get hired elsewhere, which is tough to find these days.

  • Report this Comment On June 02, 2014, at 2:46 PM, Gflatt wrote:

    Were is the "Link" to invest?? Or who are the Gutsy, privateers looking to make "HAY" out of the

    from the current pricing structure??

  • Report this Comment On June 02, 2014, at 3:26 PM, vespajet wrote:

    Does anyone remember the short-lived revival of Western Airlines back in 2007? Much like with this revival of PEOPLExpress, the flights were contracted out to a charter carrier (In the case of Western, they used Xtra Airways, which PEOPLExpress tried to acquire last year and the deal fell apart.) and when Western had trouble paying Xtra as well as other vendors. Western ceases operations two and a half weeks after their first flight. I could see this happening with PEOPLExpress as well, although Vision needs this contract as well as they've been hanging by a thread in the last year or so after their failed attempted at scheduled seasonal service out of Ft. Walton Beach.

    I can see why they're planning on adding service to Atlanta since Delta will be the only airline serving the region once Southwest's service to Norfolk ends on Saturday.

  • Report this Comment On June 02, 2014, at 4:36 PM, Curiousone wrote:

    I find it interesting that some comments seem to be negative around airlines having record profits in last couple of years. That industry has extremely narrow profit margins and honestly am glad to see these record profits. These majors are in dire need of fleet renewals which most people never consider the enormous cost involved. I think its interesting that US carriers are finally placing aircraft orders after delaying these for many years because they simply could not in those days of extensive losses due to in reality - overcompetition. Yes, no doubt fares have increased because they were never realistic in those fare war days. Yes, some cities have lost service due to mergers. Personally, when I fly, I prefer an aircraft thats not 30 years old, has a top notch flight crew manning that aircraft. We take that industry extremely for granted. So go ahead and applaud new competition. Nothing wrong with that but would have to consider if the big guys were to fold at some point, will you have a way to get just about anywhere you want with these upstarts? US airlines cannot continue to fly their aging fleets forever and go to the aircraft manufacturers websites to get a glimpse of average prices for new airplanes. A Boeing 777 starting at over $200 million. For one. In addition, carriers are having difficulty finding pilots. At one time most major carriers recruited from military pilot ranks. I liked the fact that the guy/girl sitting up there was probably used to just about anything that could go wrong. Now these people have no real incentive to go to commercial carriers because the pay scales have so drastically dropped compared to what they used to be. So, when you are seated on that 30 year old plane with a graduate of "Bubbas Flying School" manning the controls (yes a bit extreme I know) and something goes wrong with the plane, weather, whatever, are you going to be more concerned about what your ticket costs or who is in control of the plane and what type of plane you are on. This is truly one industry where you get what you pay for.

  • Report this Comment On June 02, 2014, at 4:42 PM, beewatcher wrote:

    Adam,

    You should have exited your short position while you had the chance. What you need to realize is that the paradigm has shifted. The upstarts used to have a huge advantage in labor costs as compared to the incumbents. The largest cost for airlines however has become fuel. This in a sense has made it nearly impossible for an upstart to undercut and still make money. PeopleExpress is using "older" gas guzzling 737-400s. They will command no revenue premium. Virgin America has still not become public since they have essentially lost money for their entire existence. This time it is in fact different. Short at your peril...

  • Report this Comment On June 02, 2014, at 5:13 PM, ganttc wrote:

    Hope they have deep pockets! I wish them well, but I'm glad it's not my money funding the operation.

  • Report this Comment On June 02, 2014, at 5:17 PM, globeflyer wrote:

    Beewatcher and Curiousone are spot-on with their assessments. The airline industry is the most regulated, "de-regulated" one in existence. They can't expand without Govt. approval, must please the FAA before doing almost anything (relative to the financials), and have to act as the "tax-collector" for some of the highest taxes in the marketplace. If passengers knew how much of their ticket price went to taxes, they might just revolt.

  • Report this Comment On June 02, 2014, at 5:32 PM, TMFGemHunter wrote:

    Thanks for the comments everybody.

    On cost structure: PEX hopes to have non-fuel unit costs of $0.06 per available seat mile. It might take a little while to get there due to startup costs, but it seems like a plausible target. Yes, it will be paying more for fuel because it is wet leasing older planes. But Delta (which also has a pretty old fleet on average) has non-fuel unit costs around $0.085 per ASM for mainline operations. Even if PEX is paying a penny more per ASM in fuel, it will still have a double digit unit cost advantage. Legacy carriers have improved their cost structures, but they still have "legacy" costs.

    On pilot availability: PEX planes will have 150 seats. There are still probably close to 1000 regional planes with 50 seats or less in operation today. Who do you think can afford to pay more to pilots? (Hint: each pilot at PEX will be at least 3 times more productive than a regional airline pilot.)

    On airline startups generally: the 10-year period from 2000-2009 was a brutal period to start a new airline. If existing airlines with brand recognition and long-time customer bases could not make money, how could a startup with none of those advantages prosper? (JetBlue was the exception.)

    Today, essentially every commercial airline is solidly profitable. That includes historical laggards: Frontier, United, Virgin America, you name it. You don't need to be best-in-class to make money. Will PEX achieve profitable growth from day 1? Probably not. But I think it has a much better than 50% shot at long-term survival.'

    On industry profitability: the industry needs to earn at least its cost of capital to stay in business in the long run. It's already earning well above that level (even United earned a return above its cost of capital last year, and it had a terrible year!). That's a sign that the industry can accommodate growth/incremental investment. I think it's unlikely that the airline industry can sustainably grow margins beyond present-day levels.

    Adam

  • Report this Comment On June 02, 2014, at 5:34 PM, Tyeward wrote:

    I wish them all the best. The location to base themselves out of is very interesting. Since that area is heavy with US Government installations, I would suggest they get hot and heavy with contract negotiations. Lot´s of defense contractors there as well (hint). I see quite a few benefits to being based there, however the downside is that airport really doesn´t have alot of gate space. Norfolk just down the street isn´t all that great either when it comes to gates. Maybe somewhere down the line they can move and occupy one of the abandoned hubs that the big 3 dropped. Never say never. I think that Eastern is going wheels up this year as well out of Miami.

  • Report this Comment On June 02, 2014, at 5:52 PM, ddc wrote:

    worked for NWA, miss the job not management! Out of all of them in my mind, American was the best. Now, Southwest has them all beat! I think they have what it takes to make it, all the majors better tune up their skills, cause Southwest is going to be hard to beat!! And yes I'd love to work for them, the rest are just not good enough anymore.

  • Report this Comment On June 02, 2014, at 8:54 PM, walter17 wrote:

    it was nice when there were a lot of different airlines. now there are limited choices and no competition.

  • Report this Comment On June 02, 2014, at 9:14 PM, GeaugaTruck wrote:

    I drove to PIT from an eastern Cleveland rural suburb to catch a PEOPLEexpress flight to Newark a good number of years ago.

    i bought some stock in the airline after that flight which quickly netted me enough to buy a spanking new Apple IIe, my first computer. ($5,000.00)

    The Apple offered better software than the competitive IBM at the time. Those were the good old days....

  • Report this Comment On June 03, 2014, at 1:41 AM, JMike50 wrote:

    >>Today, essentially every commercial airline is solidly profitable. That includes historical laggards: Frontier, United, Virgin America, you name it.<<

    Hmm, perhaps I am confused. How much money did United make last quarter?

    This "new" PeopleEXPRESS is DOA. Even I know that and I just saved 15% on my car insurance is less than 15 minutes.

  • Report this Comment On June 03, 2014, at 3:08 AM, tonyatn wrote:

    A new airline is like having a new girlfriend. She will take advantage of you for your money.

  • Report this Comment On June 03, 2014, at 5:09 AM, tonyatn wrote:

    Jesus, I wonder what kind of planes they fly, old 757s, heaven forbid, MD80's. Does the pilot make at least minimum wage?

  • Report this Comment On June 03, 2014, at 10:05 AM, TMFGemHunter wrote:

    @JMike50: United lost money last quarter, but the first quarter is a seasonally weak period. To clarify, every airline is solidly profitable on a full-year basis. United earned over $1 billion last year (excluding some special items), and despite losing a ton of money last quarter, it's on pace to earn more than $1 billion again in 2014.

    @tonyatn: They fly 737-400s, which are late 1980s/1990s vintage planes. They are old, but almost every major airline has at least some planes of that age in its fleet.

    Mainline-size airplanes are designed for a lifespan of 25-30 years... or even longer in some cases. There's no reason to believe that a 20-25 year old plane is unsafe.

    And yes, I'm sure the pilots are relatively well compensated, or else they would go find other pilot jobs with higher pay.

    Adam

  • Report this Comment On June 03, 2014, at 10:51 AM, redtape wrote:

    I suspect that by Christmas 2016, you will either not be able to or won't want to buy tickets on this airline.

  • Report this Comment On June 03, 2014, at 11:01 AM, bsleblanc wrote:

    "Much better than 50% shot at long-term survival". Those are some high odds of success for any startup in any industry but off the charts for the airline industry. I like your enthusiasm.

  • Report this Comment On June 03, 2014, at 11:21 AM, Flytheway wrote:

    If the People Express business model offers reasonable low fairs and a reliable product they will survive. They have picked a hub with descent O/D traffic, a dependable aircraft choice to get them thru start up phase until financing is available for a 737max or 320neo, and a facility located in good airspace to avoid ATC delays. Cheap or free parking and hassle free security lines will help too. Once southern cities come on line the operation will flourish with connections because passengers are sick of delays @ PHL, EWR, LGA, etc causing them to miss their connections. As far as pilots go

    regulations, licensing, physicals, & currency set the standard for safety, not pay. As far as equipment I've flown 737s for over 15yrs and there isn't much I know of that is much more reliable or safer. Cheers to PEX!

  • Report this Comment On June 03, 2014, at 6:13 PM, tequilasurfer67 wrote:

    What the article fails to mention is that the airplanes, pilots and flight attendants for the new peoplexpress are outsourced from a charter company called visionair out of las vegas. You get what you pay for!!

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