American Airlines Group (NASDAQ:AAL) posted tremendous share price gains in the first half of 2014. Investors were rightly excited about the potential synergies from its recent merger with US Airways, as well as other profit improvement initiatives. However, the stock has slumped in the past few months.
Unfortunately for investors, American Airlines could continue to struggle. Most of its merger synergies might be whittled away by rising competition across American Airlines' global route network.
More capacity coming in Dallas
One key headwind confronting American Airlines is the expiration of the Wright Amendment in October. For decades, this piece of legislation has prevented Southwest Airlines from operating long-haul flights at Dallas Love Field, a midsized airport that is closer to downtown Dallas than American's massive hub at Dallas/Fort Worth International Airport.
The end of this flight restriction is encouraging Southwest to grow in Dallas, making it a more serious competitor to American Airlines there.
Today, Southwest operates about 118 peak-day flights to a handful of short-haul destinations from Dallas.
The airline plans to operate up to 153 daily flights from Dallas by January. It will cut back on some short-haul routes it currently flies there while adding flights to major cities including New York, Washington, D.C., Chicago, and Los Angeles.
Even American Airlines' management has admitted that the sudden addition of significant competitive capacity will hurt the company's unit revenue. However, investors will have to wait until next month to get an initial estimate on the extent of the damage.
Transcontinental competition heats up
Another area where American Airlines could face competitive pressure is its transcontinental routes from New York to Los Angeles and San Francisco. American Airlines has been a leader on these routes for decades, and it is the market share leader on flights from New York's John F. Kennedy International Airport to Los Angeles.
American recently doubled down on its transcontinental service by replacing the old Boeing 767s flying that route with specially configured Airbus A321s. These planes have just 102 seats, including 10 in first class and 20 in business class. American also added flights, so it now offers 13 daily round trips for a "shuttle-like" service on the New York-Los Angeles route.
However, competition is rising on the transcontinental routes. In June, Delta Air Lines finally matched American with flat-bed seats on all flights between New York and Los Angeles. In the same month, JetBlue introduced its own highly regarded premium product for that route, which features 16 flat-bed seats.
American Airlines has bet big on the premium market for its transcontinental flights. It is using the same type of plane as JetBlue, yet JetBlue has 159 seats on its "Mint" A321s compared to 102 seats for American's A321Ts. JetBlue's low prices have already forced American to reduce the price tag for some transcontinental flights. As JetBlue ramps up its Mint service over the next few months, this could impact American's profitability.
International competition remains tricky
A third concern for American Airlines investors is the increasingly competitive environment for international flights. First, American Airlines is trying to build up a competitive Asian route network despite having less than ideal hub locations for trans-Pacific flights. Even if this effort eventually succeeds, it will be costly in the short run.
Second, American Airlines' dominant position in Latin America is under attack from a variety of low-cost carriers. Rapid capacity growth has hurt American's unit revenue growth there. (American also benefited last year from a short-lived fluke in Venezuela's exchange rate policy that encouraged Venezuelans to buy pricey airline tickets to the U.S.)
Third, Delta's joint venture with Virgin Atlantic became operational this year, and the two are adding U.S.-U.K. capacity. In doing so, they are assaulting the British Airways-American Airlines joint venture that has recently dominated air travel between the two countries. By early 2015, Delta and Virgin Atlantic will offer 10 daily flights for the key New York-London city pair.
Through the first eight months of 2014, American Airlines increased international capacity by 6%, compared to a hike of just 1.1% on domestic routes. It might be putting its eggs in the wrong basket, as the competitive situation is much more benign for domestic service than for international flights.
Tough times ahead?
Across several of its top hubs and key routes, American Airlines faces an atypical rise in competition this fall and into 2015. Depending on other factors such as economic growth and the price of jet fuel, this rise in competition could fully offset American's merger synergy gains, ending its recent run of rapid earnings growth.
This in turn could cause further pain for investors. Until American Airlines demonstrates that it can maintain profitability in the face of tougher competition, its stock price could stay stuck below $40.
Adam Levine-Weinberg owns shares of JetBlue Airways. The Motley Fool has no position in any of the stocks mentioned. 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.