Please ensure Javascript is enabled for purposes of website accessibility

Airlines and the Incredible Shrinking Hubs

By Alexander MacLennan – Feb 4, 2014 at 7:01PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Why are so many current and former hubs seeing cuts?

As the airline industry works its way through a decade preceded by bankruptcies across the industry, carriers are eager to begin cutting costs and streamlining networks. Looking through the past several years, it becomes clear where a major component of this will come from: network rightsizing and hub reduction.

Network consolidation
Coming off a record wave of mergers, the airline industry is eager to make full use of its cost-savings potential. When there were many competitors in the industry, airlines often operated near overlapping flights from nearby hubs. Additionally, having a lot of different airlines, each run by their own management team, made controlling total capacity far more difficult.

In 2008, we saw the merger of Delta Air Lines and Northwest Airlines, which created the current Delta Air Lines (DAL 1.77%). Two years later, another airline merger took the crown for the world's largest airline as United Airlines and Continental Airlines joined to form United Continental Holdings (UAL 1.67%).

Fairly soon after the merger, Delta began to reduce its operations at its Cincinnati Northern Kentucky hub, moving many of the flights to the former Northwest hub in Detroit. But not all former Northwest hubs grew after the merger: Memphis lost its hub status in 2013 along with much of its service as Delta found having a second hub so close to its massive Atlanta operations to be uneconomical.

The latest move
United Continental has been working to finish the merger integration process for more than three years now. Through much of this time, synergies were difficult to realize and even those that did get off the ground were often balanced out by one-time integration charges. But with the biggest obstacles out of the way, United Continental is preparing to show investors what it can do by further streamlining operations and avoiding one-time charges.

Like Delta, United Continental came to the realization that, as a merged airline, it had too many hubs. So last week, the airline made the announcement that it would dramatically shrink operations out of the former Continental Airlines hub in Cleveland.

In a letter to Cleveland's workers, United Continental CEO Jeff Smisek, said:

No city has been more supportive of its hub carrier, and no group of employees has been more dedicated to providing great service, but the demand for hub-level connecting flying through Cleveland simply isn't there. Ultimately, we can't create demand, but we do have a responsibility to react to it. We must make the right business decisions, even when those decisions are painful, so we can continue to compete effectively and invest appropriately in our business.

Ultimately, the shrinkage of Cleveland operations is not a big surprise. When United Airlines and Continental Airlines merged in 2010, an agreement with the Ohio Attorney General at the time, Richard Cordray, limited the levels of flight cuts United Continental could implement at the airport in the interest of protecting Cleveland's jobs. But, as time progressed, the airline would be given more room to cut flights if the airport continued to underperform. With the current performance levels at the airport and United Continental now being able to cut more flights, the current actions in Cleveland are not too surprising.

Another settlement
As the airline industry has consolidated, the merger between AMR and US Airways that formed American Airlines Group (AAL 0.56%) came under far more scrutiny than past megamergers. Although the lawsuit by the Department of Justice never went to trial, the settlement agreement obtained many of the things the DOJ and the plaintiff states were looking for.

Among the terms is a requirement for the new airline to use all of its commuter slots at Washington National Airport for service to small and mid-sized non-hub communities for the next five years. During this time, American Airlines Group should be evaluating performance for each route to determine which ones stick around after the five years are up.

Fortunately for the hubs now controlled by American Airlines Group, the hubs all appear to have an economic purpose in the network, increasing their chances of sticking around. The hubs of the old American Airlines all serve high volumes of passenger traffic and are a core part of the network. Former US Airways hubs also look to be a good fit as they are in areas where fees are often lower and their location allows American Airlines to direct flights while avoiding busier airports.

Network reorganization
Like any other for-profit corporation, airlines are designed to make money and therefore eager to cut unprofitable flights and make networks more efficient. Expect airlines to continue using this as a way to cut costs over the next several years; after all, cost cuts are a primary benefit of mergers.

Alexander MacLennan owns shares of American Airlines Group and Delta Air Lines and has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long May 2014 $31 calls on American Airlines Group, and long January 2015 $17 calls on American Airlines Group. 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 has no position in any of the stocks mentioned. 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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Delta Air Lines Stock Quote
Delta Air Lines
DAL
$35.10 (1.77%) $0.61
United Airlines Holdings Stock Quote
United Airlines Holdings
UAL
$44.42 (1.67%) $0.73
American Airlines Group Stock Quote
American Airlines Group
AAL
$14.50 (0.56%) $0.08

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

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
356%
 
S&P 500 Returns
118%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.