Jeff Potter, CEO of Frontier Airlines
Potter focused on simple economics. On the revenue side, he noted that the price of an airline ticket, adjusted for inflation, has dropped about 50% in the last 20 years. On the cost side, data from Goldman Sachs
Potter argued that this differential is simply unsustainable. As low-cost players continue to attack markets where traditional airlines are entrenched, the viability of companies with high cost structures will be threatened. "In this industry, strategy is about being the last man standing. A lot of these companies simply don't have the cost structure to survive," he said.
For individual investors who share Potter's view -- as I do -- the key question then becomes where to invest in the sector.
To me, the most attractive stocks are Southwest and Frontier. Southwest is the lowest-cost company and market leader, with a proven track record of success and a market capitalization of almost $11 billion. With a debt-to-equity ratio of 0.3, its balance sheet is rock-solid. But despite the fact that it is trading near 52-week lows, the stock is still not cheap, at a price-to-sales ratio of 1.8 and price-to-book of 2.1.
With revenues of $600 million over the past 12 months, Frontier is only 10% the size of Southwest and investing aggressively in growth. While it has been profitable for the last three quarters, it has yet to demonstrate sustained profitability over the long haul. However, with a price-to-sales ratio of 0.6 and price to book of 1.3, the stock is not only cheaper than Southwest stock, but also than the stocks of JetBlue and AirTran.
Traditional airlines still have significantly more market share than low-cost carriers. But their business model -- which has failed to even cover its cost of capital over the last 20 years -- is no longer viable. The only question in my mind is how long they will be able to hang on.
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Motley Fool Contributor Salim Haji lives in Denver and does not own shares in any of the companies mentioned.