Southwest Airlines Screaming About Tax Proposals (And a Bit About Atlas Air)

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By Holly Hegeman
Special to

TheStreet.com

Normally known for his entertaining personality, jovial manner and occasional late-night encounters with the always-elusive

Wild Turkey

, Herb Kelleher, CEO of

Southwest Airlines

(LUV) - Get Report

, is madder than a wet hen these days.

The reason? Proposed changes in the way the federal government taxes the airlines. If the House version of the current tax bill is passed, Kelleher minces no words when he says that the basic short-haul point-to-point model that has served Southwest for 26 years will be toast.

The math is simple. Let's take a carrier such as

American Airlines

(AMR)

or

United Airlines

(UAL) - Get Report

. Their average fare runs around $200. Under the existing tax law, they would pay 10%, or $20, in tax on that ticket. Under the current House proposal, they would pay 7.5% ($15) plus a $2 "head" tax. Total? $17. Benefit to the carrier? 15%.

However, let's look at a low-fare carrier, such as Southwest. Southwest's average fare is around $70. Under the existing law, they would also pay 10%, or $7, in taxes. However, under the proposed change, they would pay $5.25 plus $2. Total? $7.25. Cost to the carrier? 4%.

The higher the fare, the bigger the advantage, or the tax break. The lower the fare, the higher the percentage of tax on each ticket. Long-haul flights are at a distinct advantage to short haul. It's no wonder the major carriers are lobbying

Congress

heavily for the change.

"Pass it along ... just pass the increase along to the passenger. That is what we are being told to do," Kelleher said in a briefing at Southwest headquarters on Monday. "Well, we are a

low-fare

airline. We compete with the automobile." Kelleher expressed concern that passengers would not simply "absorb" such increases. He thinks airfares are about as high as they can go in the current economic cycle.

He then added, "And how long will it be before they raise that $2 head tax to $5? Once the camel's nose is under the tent -- it is too late."

How would Southwest change its current business model? Kelleher predicts that if the change is approved, Southwest would be forced to reduce its short-haul service into new markets and increase its proportion of long-haul flights. In fact, Southwest has already been hedging its bets, with the company showing an increase in average stage length, and a slowdown in new market entries this year over last. In addition, it has slowly been developing a "stealth" transcontinental connecting network -- establishing a number of cities that can serve as midpoint connections for transcontinental flights.

From an airline investor's viewpoint, the numbers tell the story. If the House proposal is adopted, the major airlines stand to gain. There is no question. The low-fare carriers stand to lose. Maybe this is part of the reason that most of the major carriers posted terrific gains on Wednesday.

Needless to say, if you are an airline investor, a bit of

C-Span

watching might be advantageous to your health during the next week or so.

And who knows, you might see Herb on his hands and knees -- which he has already done once this past month -- pleading his case. And, he feels, he is pleading the case for all low-fare airlines, not to mention for the long-term financial health of the industry.

********

Wing Tips Notebook

We were certainly timely with our

comments about

Atlas Air

(ATLS)

two weeks ago. Did we not say the stock had a propensity for being volatile? It lost 35% of its value last week. Company officials issued a press release after everyone had gone home for the holiday weekend announcing that results for the June quarter would be "below current analyst expectations." Those expectations were for earnings in the neighborhood of 50 cents per share, according to

First Call

.

Atlas will write off the money it has sunk into its maintenance hogs --

FedEx

747-200s, which have required above-average maintenance and repair costs to keep them flying.

Morgan Stanley

analyst Jordan Sherman, who lowered his rating on Atlas to neutral from outperform, was quoted as saying: "It seems we're going to have more near-term volatility in earnings that we had assumed, and the volatility is going to last a little longer than expected." The stock has rebounded a bit this week, and closed Wednesday at 23 1/4.

AirTran

(AAIR)

, which has posted a phenomenal 126% gain on the year, and

ValuJet

(VJET) - Get Report

announced plans to "merge" last week. But Yogi, this is far from your average merger. The two carriers will continue to operate under separate

Federal Aviation Administration

certificates! This is not much more than an attempt by ValuJet to re-create itself -- something the carrier should have done months ago -- following the crash in the Everglades last May. And honestly, I think it may be too late. From the perspective of AirTran investors, it doesn't look like much will be gained from this "merger."

The new

Boeing

737-700 is in its final testing cycle phase, and we got to climb aboard one on Monday. The wing of the plane has been completely redesigned; the cockpit uses state-of-the-art liquid crystal 777 technology; and it is projected the plane will shave 6% in annual fuel costs and 15% in annual maintenance costs over the 737-300 model.

Boeing

(BA) - Get Report

has already sold 672 of these babies, so you know they are happy -- as are Boeing investors. Southwest Airlines is the launch customer for this plane.

Holly Hegeman is a Dallas-based weekly contributor to

TheStreet.com

who also publishes the industry newsletter

PlaneBusiness.

Hegeman owns stock in

Southwest Airlines.

She appreciates your feedback at

Hollyberry@aol.com.