Last week, Southwest Airlines (NYSE:LUV) broke ground on a new five-gate international terminal at Houston's Hobby Airport. Southwest already serves more domestic passengers than any other airline, but near-international markets like Latin America and the Caribbean represent a big potential growth opportunity for the company.
The Houston terminal is a big part of Southwest's international expansion plans. Houston is the fifth-largest U.S. metropolitan area, so it has plenty of local traffic, and it is well located to serve as a Latin American gateway. Moreover, it is already one of Southwest's biggest focus cities, with 156 peak-day departures (a figure that is sure to grow after the new terminal opens in late 2015).
The biggest loser is sure to be United Continental (NASDAQ:UAL). United has dominated the Houston air travel market for a long time, offering more than 600 daily departures from the city's larger Bush Intercontinental Airport. The new terminal at Hobby Airport will allow Southwest to compete with United on even more routes from a smaller, more customer-friendly airport, pressuring United's margins in Houston.
Ugly fight over expansion
United's fear of the planned Southwest expansion resulted in an unusually strong lobbying battle between the two last year. United argued that expanding Hobby Airport would siphon passengers away from its hub at Bush Intercontinental Airport.
As a result, United threatened to cut capacity in Houston if the city permitted Southwest to start international flights at Hobby Airport. United began implementing those cuts last fall, after the city sided with Southwest.
While Houston has lost service to some small cities due to United's cutbacks, the upside is cheaper fares on nonstop flights to Latin America and the Caribbean in the future. This is good news for anybody looking to travel from Houston to a popular international vacation destination.
Southwest is likely to focus on routes to cities with plenty of leisure traffic, such as Mexico City, Cancun, Guadalajara, Puerto Vallarta, and San Jose, Costa Rica. Many of those routes have no competition today, because United has such a dominant position at Bush Intercontinental Airport.
United's Houston operation has historically been one of the most profitable airline hubs in the country, which is a sure sign of a high-fare environment. Southwest will look to stimulate demand with lower fares as it begins international service in Houston. In order to maintain its market share, United will undoubtedly drop fares as well -- as it has done when challenged at other key hubs like Newark. This will provide consumer benefits that will most likely outweigh the costs from United's downsizing.
New thorn in United's side
Southwest Airlines has been a recurring thorn in the side of United Continental over the last 10 years, as it has expanded in numerous of United's hub markets, including Denver, Chicago, Newark, and now Houston. This increasing competition from Southwest has taken a toll on United's bottom line.
United's main strategy in recent years for competing against airlines with lower cost structures has centered on maintaining a dominant position at hubs in key markets. Southwest is gradually chipping away at this lead on multiple fronts.
So far, United's attempts to retrench have not allowed it to reclaim its historical revenue premium. In fact, United recently announced that Q3 unit revenue will miss the company's original guidance. With Southwest starting international service, United will have to worry about competition on even more routes, putting additional pressure on its pricing power.
Adam Levine-Weinberg is short shares of United Continental Holdings. 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.