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3 Airlines Trying to Boost Your Portfolio's Returns

By Callum Turcan - Sep 27, 2013 at 6:02PM

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The airline industry is trying to change its reputation as a bad industry for investing by employing a few different strategies

Airlines have been viewed as bad long-term investments and the brunt of stock market jokes for a long time. It took a while, but the industry is starting to wake up and notice that it needs to boost revenue and cut costs in order to stay consistently profitable. If you can't be consistently profitable then you will scare away potential investors. Here are three airlines changing the industry.

The fine print
You should always read the fine print before assuming something is the "cheapest." Spirit Airlines (SAVE 0.53%) charges the lowest fares in the airline industry, and makes it up by placing fees on everything. You get nothing special on your flight, and little comfort, in return for flying cheaply.

Spirit has been raising revenue while lowering the cost of its tickets. In 2008, Spirit made an average of $18.61 in fees per traveler, which quickly climbed to $51.39 by 2012. This has enabled Spirit to lower airfare costs by 20% since 2008 while seeing revenue per customer rise 12% in that same period.

This distinctive business model makes Spirit Airlines worth taking a look at. It's helped the company turn a profit for each of the past nine consecutive quarters, while competitors like Delta Air Lines (DAL 2.35%) and Southwest Airlines (LUV 0.79%) were profitable in eight. Spirit's business model allows it to undercut the competition -- and raise prices if oil prices skyrocket.

Spirit has deployed roughly 70 "hidden" fees after you buy your cheap bare-bones ticket. That is why 41% of its revenue is from fees, a percentage that easily tops the industry. The average ticket price for Spirit is $75, yet that almost doubles when you add in the $51.39 in fees Spirit charges each traveler on average.

The cost of checking in carry-on bags ranges from $35 to $100. If you want bottled water, that is $3. If the airline prints out your boarding pass, that is a $10 fee. There is also no longer a toll-free customer service number, and you can pay an extra $199 to sit near the front. As I said before, Spirit has a fee on every type of service.

Spirit's business model enables it to easily raise prices covertly and to undercut the industry while making more money per traveler. Due to this business model I would recommend looking into Spirit as it keeps raising the average revenue made from travelers.

Polar opposite
On the opposite side of the spectrum there is Southwest Airlines, which is well known for not wanting to charge hidden fees. Southwest makes up for it by trying to be very efficient. One way it does so is by using only one type of airplane, the Boeing 737. 

In using just one plane, Southwest can buy just one set of parts to replace broken ones. It also doesn't have to worry about having numerous, different crews to fix different planes. This cuts down on training and maintenance costs. It is far easier logistically to have to know about only one model than it is to memorize the specs for dozens.

Southwest bought out AirTran in 2011, and with the acquisition it acquired 88 717s. Instead of operating those planes, Southwest is leasing them out to Delta, giving Southwest a new revenue stream and letting it stay true to its motto.

Southwest bought AirTran for $1.4 billion to help it expand into new markets on the East Coast. Southwest also expanded into Mexico and the Caribbean because AirTran serviced those markets before the buyout. Not only is the buyout enabling Southwest to expand, but it also is going to save Southwest $400 million in 2013 through synergies, according to Trefis.

AirTran will push up Southwest's revenue by allowing it to access new markets and lease its planes. It is also pushing up its profit margins due to cost savings. All of that will travel straight down to the bottom line, making Southwest worth a look.

Never been done before
One thing that hasn't been done before is the merging of a refinery and an airline. Delta has decided to try and control its fuel costs, which make up about 40% of an airlines costs, by buying a refinery in Pennsylvania.

Trefis sees that refinery saving Delta $300 million on fuel costs in 2013, which will significantly push up its margins, considering that it made just under $2.2 billion in operating income for 2012. The refinery will pay out dividends to Delta and its shareholders for years, as each year the savings will get bigger if oil prices increase. If oil prices go down, then even though the refinery won't be saving it as much money, lower prices will significantly boost its margins.

What the refinery is doing is reducing to zero the spread between the cost to refine jet fuel and the cost at which refineries sell jet fuel. This refinery is a great idea as voracious demand for crude in emerging markets will keep prices elevated indefinitely. Taking steps on your own to control costs is a crucial way to boost profits. 

Final thoughts
All three of these companies are shaking up the airline business model to boost income, either through hidden fees, synergies through acquisitions, or owning a refinery to control fuel costs. Spirit deserves a close look from potential airline investors, especially because of the revenue growth coming from all the hidden fees. Soon Spirit will be making just as much in fees as it does from ticket prices. Spirit hasn't raised ticket prices over the past few years, enabling it to easily add in an increase if oil prices go significantly higher.

Callum Turcan has no position in any stocks mentioned. 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.

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Stocks Mentioned

Southwest Airlines Co. Stock Quote
Southwest Airlines Co.
$39.12 (0.79%) $0.30
Delta Air Lines, Inc. Stock Quote
Delta Air Lines, Inc.
$33.72 (2.35%) $0.78
Spirit Airlines, Inc. Stock Quote
Spirit Airlines, Inc.
$24.63 (0.53%) $0.13

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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