Friday, February 3, 2017

United Continental Wants to Grow in Los Angeles, but It's Not a Good Idea

United Continental could set off a costly market share battle as it tries to grow again at Los Angeles International Airport.

Four years ago, United Continental was the largest airline in the world -- and the largest in Los Angeles. Since then, it has fallen to third place on both counts, behind top rivals American Airlines and Delta Air Lines.

After a management shakeup that began in late 2015 and a subsequent strategic review, United Continental has decided to double down at Los Angeles International Airport (also known as LAX, based on its identifier code). However, based on the vicious competitive environment there, growing in Los Angeles is likely to turn into a costly mistake.

Los Angeles is a brutal market

Many of the biggest U.S. airports are dominated by just one or two airlines. However, LAX is a key exception to that general rule.

American Airlines is now the biggest airline at LAX, thanks to its 2013 merger with U.S. Airways. Even so, its market share lingers just below 20%. Three other airlines also have more than 10% market share at LAX: Delta Air Lines with 16.4%, United Continental with 14.8%, and Southwest Airlines with 11.6%.

Looking ahead, a fifth major competitor is rising: Alaska Air. Alaska recently completed its acquisition of Virgin America. While those two carriers each had less than 5% of the market, together they had about 8.5% market share in 2016, with further growth planned in 2017.

It's not especially surprising that the five largest airlines are all jockeying for position at LAX. Los Angeles is a huge market with lots of corporate and leisure travel demand. However, the stiff competition is likely to put pressure on airlines' profit margins -- particularly for higher-cost carriers.

United wants a bigger piece of Los Angeles

On an investor call in mid-2016, United Continental noted that it was the leading carrier in all of its hub markets except for two: Los Angeles and Washington, D.C. That fact, combined with various statements that United was working to refine the mission for each of its hubs, led some analysts to speculate that United Airlines could drop its LAX hub.

This seemed like a very reasonable idea. Unlike American and Delta, United operates a larger hub and international gateway less than 350 miles away, in San Francisco. As a result, there's less of a strategic rationale for needing a hub in Los Angeles.

Lending further credence to this idea, United had already started cutting back in Los Angeles in 2014. At that time, it leased four of its gates to American Airlines, helping its biggest rival surpass it in terms of market share at LAX.

Nevertheless, at its investor day later in 2016, management stated that United is working to get more gates at LAX and to make it easier for customers to connect to other Star Alliance carriers there. Company president Scott Kirby recently confirmed to United's pilots that the airline wants to "claim most or all of a future terminal," according to Bloomberg. Clearly, United has decided to grow at LAX rather than shrink further.

Other airlines want to grow, too

United Continental isn't the only airline looking to grow in Los Angeles. Alaska Air (and merger partner Virgin America) have already been growing there. Virgin America began flying from Los Angeles to Hawaii last year. Alaska Air launched a nonstop flight to Cuba last month and hopes to start flying to Mexico City later this year. More routes could be on the table as the merger integration process continues.

Meanwhile, Southwest Airlines has made Los Angeles its most recent international gateway. For example, in December, it began operating five daily roundtrips to Mexico, spread across three popular beach destinations.

Most importantly of all, Delta Air Lines seems intent on continuing its recent growth in Los Angeles. Later this year, Delta will be switching terminals at LAX in a move that will give it 22 gates, up from 16 previously. This will mark the beginning of a seven-year, $1.9 billion terminal modernization project that could ultimately allow Delta to control up to 27 gates.

Thus, the airline battle in Los Angeles is about to heat up even more. And whereas United essentially donated share to American and Delta through its cutbacks in recent years, it is likely to face a stiff competitive response as it tries to regain market share. Thus, growth at LAX could represent a persistent margin headwind for United in the coming years.

United Airlines is proud of the fact that it has hubs in all of the top five U.S. travel markets. Yet Delta is the most profitable of the legacy carriers despite having hubs in just two of those five metro areas. It isn't necessary to be big everywhere to succeed in the U.S. airline industry. United would probably be better off solidifying its dominance in the more promising San Francisco market than chasing market share in Los Angeles.

(Adam Levine-Weinberg - The Motley Fool)

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