Before the deregulation of the airline industry in 1978, air travel was typically considered a treat for the well off. Passengers put on their best clothes to fly and were served an extensive meal with real plates and silverware. But over three decades and many bankruptcies later, the airline industry is now one where the everyday person can afford to travel. And some airlines are taking this to the next level, forming a new category of ultra-discount airlines.
The first discounters
When discount carriers are mentioned, people normally think of airlines like Southwest Airlines (NYSE:LUV) and WestJet Airlines (TSX:WJA). Carriers like these have been able to gain a foothold as they serve up an alternative to full-service carriers.
Founded in 1967, Southwest actually existed prior to deregulation but was able to avoid being regulated at the federal level by only flying flights within the state of Texas. After the legacy carriers were allowed to fly where and when they wanted, Southwest expanded out of Texas but took on a discounter business model, choosing to operate point-to-point flights in contrast to the legacy carriers' hub-and-spoke systems.
Nearly three decades after Southwest's founding, Canadian airline WestJet sought to move into the Canadian air market by adopting the Southwest business model and competing with the two dominant carriers, Canadian Airlines and Air Canada. Even with the merger of Canadian and Air Canada a few years later, WestJet was able to expand while the newly merged Air Canada filed for reorganization in 2003.
Based on the airlines' histories, Southwest and WestJet have been remarkably successful. While Southwest has provided nearly four decades of straight profitability and WestJet shares have provided multi-bagger returns since the beginning of the century, all the legacy carriers have filed for bankruptcy wiping out their shareholders (the only exception being AMR, parent company of American Airlines, which did file for bankruptcy but shareholders could realize some value if the airline's merger with US Airways is successful.)
It can be cheaper
Southwest and WestJet have expanded well across their respective markets, with each carrier now on solid financial footing and paying a dividend to shareholders. But Spirit Airlines (NASDAQ:SAVE) has decided to make flying even cheaper.
With less legroom and a plethora of extra fees, Spirit is making a business model of driving down airfare. For the base price, at least. Those extra fees could boost a ticket price back near that of an ordinary discount carrier, especially if one decides to not pay in advance and carry on a bag at the gate for $100.
Like Southwest expanding out of Texas and WestJet growing its Canadian network, Spirit is setting itself up for growth. In May, Sun Sentinel reported Spirit CEO Ben Baldanza noted that consolidation trends in the industry have left Spirit room for expansion, with Baldanza also saying that he is "bullish about the growth of the company and where we can go." Clearly, Spirit does not have any plans to slow down and travelers looking for cheap airfare may be excited to see Spirit come to an airport near them.
More to the story
With shares of Spirit up more than 90% year to date and continued earnings growth expected, Spirit's investors have had one great flight. But as the ultra-discount airline expands, should legacy carriers be worried about Spirit igniting the price wars of the past or have the biggest airlines built themselves enough of a moat to fend of low-priced competition? In part 2 of this series, we will look at whether Spirit poses a major threat to full-service airlines or whether these two types of carriers can co-exist.
Alexander MacLennan owns shares of Air Canada, AMR, Delta Air Lines, and Gol Linhas. He is also long the following options: $22 January 2015 Delta calls, $25 January 2015 Delta calls, $30 January 2015 Delta calls, $17 January 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.