Investor Insights:

  • The top four airlines in the U.S. have an 87% share of the market.
  • Congress recently tore into their CEOs for their dishonest pricing practices.
  • But in recent years, one of the four has broken ranks with the other three.

You know there’s something wrong with the world when fraud becomes business as usual at one of our country’s biggest corporations.

Fraud, as in: “I paid $87 for something. The seller didn’t deliver, and then claimed that its internal rules made that OK.”

That’s exactly what happened on my trip to Virginia last week to celebrate Thanksgiving with my family.

I’d used frequent flyer miles to book basic economy seats on Delta.

Now, basic economy doesn’t allow you to choose a seat before you board. You’re assigned one at the gate.

But the day before our trip, Delta emailed me, offering preassigned seats for $29 each.

That seemed reasonable. My wife, daughter and I were traveling, so I handed over $87.

When we got to the gate, however, we were assigned random seats elsewhere on the plane.

I was not amused.

I was further unamused when I contacted Delta. They said I was ineligible for a refund. Their “rules of carriage” allow them to change passenger seating at their discretion.

That part I get. But what I don’t get is why they think they can do that and refuse to refund the money I gave them for a service they advertised to me but didn’t deliver.

This sorry tale is a symptom of the growing power of mega corporations in the U.S. economy … a power that allows them to get away with things that would be criminal if you or I did them.

But the backlash against overweening corporate power is growing, as we’ve seen with Google and Facebook.

If our do-nothing Congress ever gets off its collective backside and does something about this, there could be serious implications for some of America’s biggest companies.

Not Too Big to Flail

Atlanta-based Delta Air Lines is a $36 billion company. It’s the second-largest airline in the world by passengers carried and fleet size.

Delta is cheap by stock market standards, however.

Its price-to-earnings ratio is 8, much less than the S&P 500 Index average of 20.3. And its market capitalization of $35.9 billion is substantially less than its enterprise value of $51.9 billion.

Its closest competitor, American Airlines, has an even worse relative valuation — an enterprise value of $41.9 billion but a market capitalization of only $12 billion.

A big gap between enterprise value and market cap usually means investors have doubts about a company’s ability to generate future profits.

The explanation for the market’s low opinion of America’s two biggest airlines has a lot to do with my recent experience.

There are seven major airlines in the United States, but the top four have an 87% share of the market.

The big four — American, Delta, United and Southwest — dominate the most popular U.S. domestic routes. They control gate assignments at the big hubs, such as Atlanta’s Hartsfield-Jackson International Airport.

As I explain in my YouTube series on competition in the U.S. economy, a market structure like this should allow the big four carriers to earn excess profits by raising their prices.

But in recent years, one of the four has broken ranks and competed aggressively on price.

That’s caused big problems for the other three.

Nickel-and-Dimed in the Sky

Southwest Airlines has aggressively marketed prices that undercut those of its competitors.

American, Delta and United have responded by lowering their ticket prices as well.

But to compensate, they’ve created an elaborate structure of additional fees and rules designed to chisel as much money as possible out of unsuspecting passengers.

They now charge for everything from assigned seating (as in my case) to carry-on bags and even cheap disposable headphones.

Heaven forbid you should try to change your itinerary — you’d be looking at a $300 fee.

Their strategy is to appear competitive with Southwest’s fares on travel aggregation websites and search engines — but to claw back lost profits by nickel-and-diming passengers like me.

By contrast, Southwest emphasizes the fact that the price you see is the price you pay.

Mr. Market Knows a Losing Strategy When He Sees 1

Even though it charges low fares and doesn’t resort to outrageous fees, Southwest’s net profit margins are about the same as the other three big U.S. carriers.

That’s because it’s a more efficient company.

Delta, American and United — the so-called legacy carriers who’ve been bailed out repeatedly by Congress over the decades — are bloated by excessive overheads and a corporate culture that refuses to scale them back.

But consumers, Congress and the stock market are losing patience with the bait-and-switch tactics of the legacy carriers.

In recent House Transportation Committee hearings, representatives from both parties tore into their CEOs for their dishonest pricing practices.

That tells me the legacy carriers are facing an uphill battle in coming years. After all, if you can unite the Republicans and the Democrats on something, you’re in big trouble.

So it gives me great pleasure to recommend that, if you’re interested in buying a U.S. airline stock at a great valuation and with great growth potential to boot, buy Southwest Airlines Co. (NYSE: LUV).

And if you’re wondering … yes, I’ll be sending this article to Delta as soon as it’s published.

Kind regards,

Ted Bauman

Editor, The Bauman Letter

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