Midway Faces High Costs, Stiff Competition

Its base at Raleigh-Durham has become a hot spot, thanks to Southwest and US Airways.
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Interesting things are afoot at

Midway Airlines

(MDWY)

.

The company, based in Raleigh-Durham, has tried to establish itself as a higher-end niche player generating relatively high yields from business passengers. But it is also incurring relatively high costs in the process.

Last quarter, we questioned whether Midway could withstand the impending arrival of

Southwest Airlines

(LUV) - Get Report

at Raleigh-Durham and the rapid expansion of

US Airways

'

(U) - Get Report

MetroJet operation into the airport.

The problem we saw then was simple: costs. If the airline suddenly faced fare pressures as a result of Raleigh-Durham becoming the hot new place, then the higher-end niche concept created by CEO Robert Ferguson could start to struggle.

We think this is exactly what is happening.

Even before the fare wars get underway, Midway faces cost pressure from its pilots. Sources close to the company say the airline has been hit with significant pilot training costs this year; apparently there has been more attrition then planned.

It seems a fair number of Midway pilots have jumped ship and moved over to US Airways, which is hiring new pilots at a pretty hefty rate. Not surprising, as two pilots we talked to mentioned the fact that rumors have been running rampant for months about a possible Midway deal with

AMR

(AMR)

unit

American Airlines

. The pilots' believe they would be better off with a major airline, where they see potential for more money and advancement, instead of waiting to see what will happen with Midway later.

While this problem has quieted down somewhat, in the past month there has been a significant jump in Midway's weekend flight cancellations, primarily, it seems, as a result of crew shortages. So, we are looking at some lost revenue as well.

This is not to say that the airline is not cognizant of the cost issue. We understand that CEO Ferguson has said that costs at the airline have to be lowered from about 12 cents cents a mile to about nine cents a mile. Southwest, by comparison, has costs of about seven cents per mile. (US Airways has costs of about 12 cents a mile, but that's an issue for another day.)

Still, we have a few problems with this Ferguson's effort. One, all airline CEOs should have learned a lesson from the Ron Allen experiment in how

not

to manage an airline when he was the CEO at

Delta Air Lines

(DAL) - Get Report

. Namely, that merely announcing that an airline is going to "cut costs" to some pre-determined figure -- and making that the be-all-end-all objective -- is not a real smart thing to do. Especially in this case, where Midway has established itself as a high-end niche player, not a low-fare airline. By suddenly saying that the focus of the airline is to "cut costs," Ferguson runs the risk of destroying the concept that the airline has worked to establish.

It would be the same as if

Midwest Express

(MEH)

suddenly stopped baking chocolate chip cookies onboard for its passengers, and told them they would now be boarded cattle-car style like Southwest, in an effort to "cut costs." Just doesn't work.

Of course, the motivation behind the edict is not hard to find. Ferguson's efforts come at the same time pressure on fares out of Raleigh-Durham continue to mount, as we had foreseen earlier in the year.

And, because of this rising fare pressure, the airline was set to announce a new round of "low-fare initiatives" this week.

This is not a good sign for an airline that has previously positioned itself as a high-end niche player. You can have higher costs than average, if you have higher revenue per available seat mile and higher yields to offset those costs. But the equation does not work when you have high costs and low fares.

In addition, Midway is also competing with two airlines that are flying 737 aircraft. Midway flies regional jets, which are much more expensive to operate on a cost-per-mile basis. So, the airline is at a disadvantage here also.

We don't like these warning signs. And, the full impact of both MetroJet's expansion and Southwest's arrival will really not kick in until this fall.

Midway's stock has underperformed so far this year, although it has bounced up from time to time as talk of a possible AMR deal surfaces. Year to date, the stock was down 9% through the close on Friday. By comparison, Southwest was up 55%, and US Airways was up 2%. Midway closed Tuesday down 3/8, or 3.45%, at 10 1/2.

US Airways/AMR Update

In a followup to the talks between American and US Airways, last week US Airways' CEO Rakish Gangwal became the first official of either airline to talk about the fact that the two airlines are indeed discussing an "arrangement," as he put it.

At a meeting of the MEC for the airline's pilots union, we understand that Gangwal emphasized that the deal between the two airlines would not involve a "selling" of US Airways, which confirms what we had heard from other sources. In fact, the scenario being played out now (if US Airways can get comfortable with AMR's stock price) would see an equity investment by US Airways into AMR.

United Moves to Increase its Cash Stash

And speaking of cash,

United Airlines

(UAL) - Get Report

announced yesterday that it is going to sell approximately 17.5 million shares of common stock

equal to approximately $900 million based on current market values of

Galileo International

(GLC)

, in a secondary offering that Galileo intends to file with the SEC.

This will certainly increase the airline's liquidity. In fact, it will roughly double it. And what will the airline do with all that cash? It will give the company a much-needed cushion for potential acquisitions under consideration.

Holly Hegeman, based in Dallas, pilots the Wing Tips and Traveling With Wings columns for TheStreet.com. At time of publication, Hegeman was long Southwest Airlines, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. You can usually find Hegeman, publisher of PlaneBusiness Banter, buzzing around her airline industry Web site at

www.planebusiness.com. While she cannot provide investment advice or recommendations, she welcomes your feedback at

hhegeman@planebusiness.com.