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AAI AT A GLANCE

P/E ► -702   EV/EBITDA ► 14.1 AVG ROA ► 3.5% AVG ROE ► -0.2% AVG Debt to Equity ► 4.20 AVG Current Ratio ► 0.818 AVG Interest Coverage Ratio ► 1.06 AVG

 

 

 

 

 

 

AirTran Holdings (Nasdaq:AAI) is one of America’s largest low-fare passenger airlines. The airline has managed to achieve low operating costs despite relying on a hub-and-spoke system, in which most of its flights originate and terminate at its hub in Atlanta, Georgia. While the number of flights going to and from the hub has decreased to 65% of traffic by the end of 2007 of 90% in 2001, this is still inconsistent with the business models of other low-fare airlines like Southwest, which have found competitive advantages from moving to a point-to-point traffic system^[1]. The point to point system is less expensive due to the fact that it allows for utilization of minor airports that are in close proximity to major cities. Conversely, the hub and spoke system forces legacy airlines to direct their traffic through major airports that have both high landing and rental fees.

Given AirTran's continued reliance on the hub and spoke system, airline management has cited other operational factors as cause for the airline having a cost structure that is among the lowest in the industry. By using only two aircraft types, the Boeing Company (BA) 737 and 717, ^[2], AirTran is able to spend less on training its pilots and its maintenance technicians. Additionally, it has a smaller inventory of spare parts because the parts are interchangeable. AirTran also has one of the youngest fleets, with average age of only 4.5 years. ^[3] In addition to delaying replacement costs, a major problem faced by other airlines, the relative youth of its fleet translates into greater fuel efficiency. AAI is far from immune to rising fuel prices, however, and by the end of FY 2008, fuel costs accounted for 37% of revenue, up from 32.4% in 2004. ^[4] Moreover, AirTran's status as a low fare carrier means that its customers are more sensitive to fare increases than those of other airlines, limiting AAI's ability to pass along increases in operating costs. The company is also more vulnerable to U.S economic downturns than some of its legacy competitors because it lack an international presence.

Business Financials

As of December 2007, AirTran offered 700 daily flights to 55 different destinations in the United States, primarily located on the east coast. Over the past five years, AirTran has diversified its network, increasing operations in business markets like Baltimore/Washington, Chicago-Midway, and Indianapolis.

AirTran officials had planned to add new Boeing 737s to its fleet in an effort to expand its network to other domestic routes. However, after suffering a loss of $34.8 million in the first quarter of 2008 ^[5], the company announced in an earnings call that the continuing increase in fuel prices will force the airline to curtail growth until 2012^[6]. Under the revised arrangement, the Atlanta based carrier will defer delivery of 18 Boeing 737-700s scheduled for 2009-2011, taking them instead in 2013 and 2014. ^[7]. As the graph below suggests, during early 2008, the airline achieved higher revenues per available seat mile (RASM) after reducing overall capacity. It was this relationship that served as motivation for slowing fleet growth.

Air Finance Conference^[8]

As the graph below suggests, AirTran maintains the lowest cost structure in the United States airline industry.

Air Finance Conference^[9]

This financial position has afforded AirTran some freedom to improve the customer experience. While legacy carriers have been forced to reduce their costs through a combination of service reductions including eliminating meals in coach class and charging for even a single piece of carryon luggage, AirTran has managed to offer several service improvements. ^[10]. AirTran has attempted to follow in the steps of JetBlue's personal televisions and improve the flying experience. On each flight, AirTran has incorporated 100 channels of XM radio service as in flight entertainment on both business class and coach. ^[11]. However, these service expansions have come at a cost, specifically a reduction in the cost-structure spread between legacy airlines and AirTran.

Airline operating costs are measured in CASM (Cost / Available Seat Mile). AirTran's operating expenses for the year ended December 31, 2007 increased $320.8 million (17.3 percent) but decreased 1.7 percent on an operating cost per ASM basis (CASM).^[12] The graph below shows that non-fuel unit cost reduction has been a key component of the AirTran business strategy for many years.

Air Finance Conference^[13]

AirTran earned a 1.5 percent increase in passenger unit revenues as measured by passenger revenue per available seat mile (RASM) to 9.69 cents in the year 2007 ^[14].

Operational terminology unique to the airline industry and discussed in the preceding section includes: available seat miles (ASM), revenue per available seat mile (RASM) and cost per available seat mile (CASM). The three metrics are determined as follows:

Key Trends and Forces

More fuel efficient fleet helps company control fuel costs

Fuel is the company’s largest expenditure accounting for 37% of the company’s expense in the year 2007. Like most airlines, AirTran’s balance sheet is largely affected by volatility in the price of oil. Increases in the price of fuel are hard to pass on to consumers due to the competitive nature of the airline industry; however, AirTran does benefit from its new fuel efficient Boeing jets which assist in mitigating the volatility. AirTran has also begun to install winglets on its Boeing 737’s to help improve the fuel efficiency of the planes.

AirTran has relatively high liquidity for an airline company. This liquidity lets AirTran lock in the price of fuel when it is low (airlines with poor balance sheets have had less success hedging fuel because they cannot afford the hedges) and use these hedges to lessen the blow of fuel expenses to the balance sheet.

Air Finance Conference^[15]

AirTran takes advantage of industry consolidation

The airline industry is enduring a period of consolidation after the merger of Northwest Airlines and Delta Airlines. These mergers are a result of the industry attempting to cope with historically high fuel prices. ^[16] AirTran Holdings would actually benefit from the Delta-Northwest merger as it will trim excess domestic capacity, reduce competition in some of the nation’s busiest airports, and let airline companies to keep fares firm. ^[17] In Orlando, one of AirTran’s hubs, Northwest and Delta are the No. 1 and No. 3 airlines for route coverage between the markets that AirTran serves. As Delta and Northwest attempt to cut flights on overlapping routes, AirTran will be able to use its low-cost service to appeal to a new customer base.

The benefits of a merger in the airline industry include the opportunity to cut costs and to pursue a larger route system to better serve customers. By getting rid of duplicate operations and taking advantage of stronger pricing power, AirTran would be able to increase its marketshare and reduce many of its costs. Since 2005, AirTran has been pursuing a merger with Midwest airlines : a mid-sized carrier headquartered in Milwaukee. This merger offered AirTran the opportunity to combine two strong regional networks. On August 12, 2007 AirTran offered over $16.25 per share. In the short term, the merged carriers have the ability to enhance revenue through a broader product offering. However, these mergers are also subject to various regulatory obstacles in addition to difficulties in seeking to successfully integrate the two distinct carrier cultures.

Newer fleet makes it easier for AirTran to comply with government regulation

AirTran can expect stricter regulation in the industry from government agencies after the FAA announced that it will play a larger role in safety inspections. This increase is a direct result of testimonies from FAA inspectors that airlines reported safety problems voluntarily, sometimes without follow-up government safety inspections. ^[18] AirTran has already had to perform intensive work on the hardware of its entire fleet of Boeing 737-700s after a fire destroyed a China Airlines Boeing 737-800 in Japan. ^[19] AirTran was given 10 days to complete the inspections and 24 days to complete the technical services. Both jobs were completed in seven days. ^[20]

Targeted marketing aimed at college students

AirTran has tried to stand out in the airline industry through attempting to target a generally ignored crowd. Although most airline companies attempt to reach business travelers and adult consumers, AirTran is going after the college age crowd in its attempt to foster consumer loyalty. ^[21]. The company has introduced fare specials which alllow college students to fly standby on any flight for $99 or less. It also began airing a new advertising campaign in 2007 aimed specifically at this demographic.

Airtran missing out on international market

Despite the fact that AirTran has 737’s that are capable of reaching South American destinations from its Atlanta hub, the company has thus far decided to focus only on domestic destinations. This does not follow the trend with most airlines in the industry considering the larger margins available from international flights. Delta Air Lines, which has said that more than 40 percent of its flying will be in international traffic by this summer, will start nine new international routes through June 12. ^[22] Other low-cost airlines such as Spirit and JetBlue have already expanded their offering in terms of flights available to the Carribean and Latin America.

Competition

AirTran faces heavy competition from JetBlue, especially considering the announcement that JetBlue will be making Orlando one of its focus cities. This move not only positions JetBlue as a direct challenge to AirTran in one of its focus cities, but also gives JetBlue a gateway for trips to its various international destinations. JetBlue provides the only service from Orlando, Florida to Cancun, Mexico. The airline has also received tentative approval to begin daily nonstop trips to Bogotá Colombia. These international destinations offer much higher margins and pose a threat to AirTran in one of its largest developing markets. ^[23]

Southwest announced in May 2008 that it needs to raise its revenue through higher ticket prices. The company has been forced to add $10 to $30 to its highest fares for the right to choose early on its flights. It has also increased, to 15, the number of fares it might have on any one flight, nearly double the old number, permitting more effective competition against hub-and-spoke carriers that list as many as 26 fares.^[25]

AirTran has a less immediate need for cash, given that it raised $140 million through public offerings of stock and convertible notes. ^[26] This cushion of capital permits the company to deal with its rising fuel costs without having to significantly raise its prices and thus lose its standings with consumers as a cheap alternative to large carriers. In addition to this accumulation of capital, AirTran also has initiated plans to suspend capacity growth in order to move more assertively against rising fuel prices. T

Air Finance Conference^[27]

References

1. ↑ AAI 2007 10K, Item 1, pg. 1
2. ↑ AAI 2007 10K, Item 1, pg. 3
3. ↑ Airsafe.com Average Fleet Age for Selected U.S. Carriers
4. ↑ AAI 2007 10-K pg
5. ↑ Wall Street Journal "AirTran To Defer Deliveries Of 18 Boeing Aircraft" May 31, 2008
6. ↑ NY Times "Memo Pad" Jun. 3, 2008
7. ↑ Aviation Daily "Aircraft Deferral To Limit AirTran" Jun. 2, 2008
8. ↑ New York AirFinance Conference "Managing in a High Cost Energy World" April 2008
9. ↑ New York AirFinance Conference "Managing in a High Cost Energy World" April 2008
10. ↑ Wall Street Journal "THE MIDDLE SEAT: How to Travel Smart This Summer" May 27, 2008
11. ↑ Air Tran Press Release Nov. 19 2007
12. ↑ 2007 AAI 10-K, Item 6 Operating Expense pg. 27
13. ↑ New York AirFinance Conference "Managing in a High Cost Energy World" April 2008
14. ↑ 2007 AAI 10-K, Item 7 Operating Revenues pg.27
15. ↑ New York AirFinance Conference "Managing in a High Cost Energy World" April 2008
16. ↑ CNN Money.com "Atlanta tops in population growth" Apr. 27, 2007
17. ↑ Marketwatch "AirTran could profit from a Northwest-Delta merger" Jan. 29 2008
18. ↑ The Washington Times "FAA to play bigger role in safety inspections" Apr. 19 2008
19. ↑ PrNewswire "AirTran Airways completes Boeing 737 Inspections Early, Airline Completes FAA Safety Review Ahead of Schedule" Sep. 4, 2007
20. ↑ AirTran 10-K Item I Business. pg. 8.
21. ↑ Adweek "Air Tran Caters to College Crowd" Apr. 9 2008
22. ↑ New York Times "Memo Pad" Jun. 3, 2008
23. ↑ Jet Blue Press Release "JetBlue Plans New Focus City At Orlando International Airport" Mar 19, 2008
24. ↑ Reutersretrieved July 7, 2008.
25. ↑ The New York Times "Southwest is Waiting in the Wings" May 6,2008
26. ↑ Wall Street Journal "Airlines Sweat Whether to Merge" May 16, 2008
27. ↑ U.S. Department of Transportation, Bureau of Transportation Statistics