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Delta(DAL - Get Report) is the biggest competitor to
US Airways(LCC), which makes it seem all the more illogical that a merger between the two was proposed in 2006.
But does Delta benefit from the potential failure of a merger between US Airways and
American(AAMRQ) that would significantly strengthen the two partners?
Investors don't seem to think so. Since the Justice Department announced on Aug. 13 that it would oppose an all-but-done merger of US Airways and American, Delta stock has fallen 9%. On Tuesday, shares rose 6 cents to close at $19.19.
Some analysts are recommending Delta, based on the widespread belief that it is the best-managed U.S. airline and that it will, in fact, benefit if the merger is not approved. But that hope is balanced against the possibility that Delta could be harmed by a weakened airline industry in which American rapidly adds capacity while also having to slash fares to attract passengers.
JP Morgan analyst Jamie Baker takes the negative view. Following the DOJ's announcement, Baker downgraded Delta from overweight to neutral and reduced his price target to $22 from $25.
"We can't sit idly by without adjusting targets and ratings," Baker wrote. "While near-term earnings are unaffected, in our view, longer-term risk is higher." He said "the broader industry thesis has been compromised (not ruined but comprised)" and the risk of investor flight now exists.
In contrast, Avondale Partners analyst Fred Lowrance said the DOJ lawsuit created "an opportunity for those investors who have been patiently waiting for a pull-back" in airline shares. "We do not expect airline management teams to suddenly throw years of hard work on an obviously successful business transition out the window," he said.
Lowrance said Delta is his top pick, not only because US Airways is a primary competitor but also because he does not assume that standalone American and US Airways will suddenly begin to increase capacity.
"We had always assumed that this merger would make the new American more competitive in places like New York and Charlotte, challenging DAL in Atlanta," Lowrance wrote in a recent report. "Secondly, we believe the knee-jerk assumption that a standalone American or US Airways would suddenly throw capacity discipline out the window and begin growing for market share's sake is completely unfounded."
In fact, in a report issued Monday, Buckingham Research analyst Dan McKenzie noted that over the weekend American trimmed 446,000 seats from its November through January schedule, meaning fourth-quarter capacity will rise just 1.4%. McKenzie said the reductions primarily involve flights from Chicago to LaGuardia, Dallas and Miami. "We're not drawing conclusions from a week's worth of data, but if AMR is ultimately forced to exit Ch. 11 standalone (we assign a 50/50 probability), creditors likely require AMR to rethink growth and capex as a standalone carrier," McKenzie said.
He said American's planned growth is based almost entirely on international flying (Dallas-Seoul, Chicago-Dusseldorf and Miami-London). At this point, he added, American appears "to be one of the more rational actors in the industry." US Airways, meanwhile, has been a leader in the industry's disciplined capacity reduction, starting with the 2005 merger between US Airways and America West.
One big problem for Delta,
United(UAL - Get Report) and American is that the Middle East carriers
Etihad, which have the backing of their governments, are expanding rapidly. They are ratcheting up non-stop service to the U.S., buying new airplanes, often at a
lower cost than what U.S. carriers pay due to government policy, and expanding the range of cities served from their hubs, enabling them to offer bargain fares to more and more international destinations. Over the long term, they are real competitors when U.S. carriers bid for corporate international travel, and Delta and United would not benefit from having a weak sister American offering desperation packages to corporate clients to compete with them.
"As it stands now, if the merger does not go through, American will be two-thirds the size of Delta and United and be forced to compete in an increasingly competitive industry, especially as more international airlines fly to cities in the US," wrote Cowen & Co. analyst Helane Becker in a report on Tuesday.
She said Delta and United "clearly stand to benefit from a smaller American Airlines," and will likely continue to strengthen their hubs in Atlanta and New York for the former and Chicago and Newark for the latter. She has outperform ratings on both.
As for the 2006 merger with Delta, during a press conference after announcing the DOJ's opposition to the US Airways/American merger, Assistant Attorney General Bill Baer was asked about previous airline mergers the DOJ had opposed. In his response, Baer noted: "We were looking seriously at the hostile bid for Delta when that got abandoned [so] it's not the first time."
Given DOJ's opposition to previous airline mergers and now to the American merger, it seems clear that the agency would also have opposed the Delta merger -- especially since it is the only one that actually appeared to be anti-competitive.
Follow @tedreednc-- Written by Ted Reed in Charlotte, N.C.
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