The company has achieved high growth in revenues primarily as a result of increasing capacity, raising the average fare charged and the improvement in load factor. A better utilization of capacity and the increasing ancillary revenues has caused the company’s operating margin to increase from 5.9% in 2007 to 7.5% in 2012.
As the company further increases capacity by introducing more routes and as the company increases the availability of its ancillary services; I expect the company’s revenues as well as margins to improve in the future.
A promising future
The Federal Aviation Administration (FAA) predicts that commercial aviation will remain flat in 2013, with little or no growth in capacity. As economic growth remains slow, the airline operators are keen on keeping load factors at a higher level in order to keep high efficiency in terms of costs and profitability. This is one of the reasons why FAA estimates that the growth in the commercial airline is likely to be slow over the next 20 years.
It is also estimated that slow economic growth will tend to keep the growth in air traffic suppressed over the forecast period. The FAA also estimates an increase in load factors and air fares which will drive higher margins for the commercial aircraft operators. These are positive signs for all the companies under review as I expect them to enhance their revenues and margins by increasing capacity as well as improving utilization.
Another source of revenue growth and margin improvement is the increase in the ancillary revenues, which are non-ticket related revenues including sources such as baggage fees, on-board food, frequent flier activities etc. Based on my analysis, I expect JetBlue Airways Corporation (NASDAQ:JBLU) to outperform its peers in terms of ancillary revenue growth as it still has ample space in its aircraft to install its ancillary services, specifically its widely popular Even More and related services, which generated approximately $150 million in revenues. Within this category, I would expect Southwest Airlines Co. (NYSE:LUV) to closely follow JetBlue Airways Corporation (NASDAQ:JBLU) as its extensive network and high traffic will allow the company to grow its revenues greatly by only a slight increase in per unit charges.
The takeaway
Based on the analysis and the future outlook, I would select Southwest Airlines as the one with the greatest potential to improve its revenues in the coming years. As per estimates of FAA, over the next two decades the load factor for the overall industry is expected to cross the 85% mark indicating that the companies will be concentrating more on controlling costs. Amongst the peers Southwest is currently operating at the lowest load factor, 80.4% as compared to Alaska Air Group, Inc. (NYSE:ALK)’s 87% and JetBlue Airways Corporation (NASDAQ:JBLU)’s 84.3%, which can be attributed to the acquisition of AirTran. Thus I believe that the company will be able to improve its revenues and margins primarily through improvement in load factors.
In the future, I expect the company to achieve a revenue growth of around 3% to 4% per annum, while its operating margin will slowly increase to 7%. These estimates indicate a high growth potential for the company’s earnings and this is why I will recommend buying southwest to take part in this expected future growth while for the remaining two peers I will give a neutral outlook as I expect these two to perform generally at the pace of the industry.
Hussain Asghar has no position in any stocks mentioned. The Motley Fool recommends Southwest Airlines. Hussain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Who Will Win the Domestic Airline Battle? originally appeared on Fool.com is written by Hussain Asghar.
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