AirTran: Don't Discount This Discounter

The upstart airline may be in the shadow of JetBlue and Southwest, but it's gaining altitude

AirTran Airways CEO Joseph B. Leonard has every reason to gloat. When he took over the Orlando-based discount carrier five years ago, it was on its deathbed, with just $10 million in cash to keep it running. Leonard pushed AirTran into the ranks of upstart low-cost airlines by chopping costs and focusing on lucrative short-haul flights to underserved markets. Then, when the terrorist attacks of September 11, 2001, sent a shudder through the U.S. airline industry, Leonard kicked in the afterburners. AirTran stole market share from big carriers by pushing into 13 new cities, adding 43 routes, and inking a huge order for 100 fuel-efficient 737s.

So why is the 61-year-old former Northwest Airlines executive planning to throttle back? With AirTran's network beefed up to include huge markets such as Los Angeles and Dallas, Leonard believes that it's time to consolidate gains and gather strength before his company's next challenge: bumping heads with its low-cost rivals, including a possible confrontation with Southwest Airlines Co. (LUV ) on that company's home turf.

Leonard's strategy is to take 2004 to fill in the dots on its now-sprawling route map, while keeping low-fare pressure on his larger, wounded rivals, which have already cut capacity by about 12% since September 11. One reason most other carriers have trouble keeping pace with AirTran is its low labor costs, a result of its highly flexible labor force. When Zakiya Cheris, for example, a newly hired crew member in Philadelphia, moves from counter to conveyor belt to runway at the airport -- she can switch jobs two or three times a week -- she is helping the company keep a lid on its labor costs. Indeed, those costs were only 26% of revenues in the first quarter, the lowest figure in the industry and key to AirTran's success.

But the airline's expansion has also exposed it to more competition: Delta Air Lines Inc. (DAL ), which, like AirTran, has its biggest hub in Atlanta, could soon file for Chapter 11 and emerge a more formidable competitor with sharply lower labor costs. And in Dallas, American Airlines Inc. has responded to AirTran's intrusion and will beef up flights this summer by at least 15% on routes where the two compete, such as those to Atlanta and Baltimore, according to Lehman Brothers analyst Gary L. Chase. Meanwhile, AirTran will face increased competition from JetBlue Airways Corp. (JBLU ) in the lucrative Northeast-to-Florida corridor. Says Leonard, sketching out his strategy on tiny sheets of paper at AirTran's headquarters near Orlando International Airport: "We still run scared every day."


But AirTran is well equipped for this next stage of the airline battle. While legacy carriers such as Delta and US Airways Group Inc. (UAIR ) struggle with high costs and bloated labor forces, doing the most jobs with the fewest bodies is a mantra at AirTran, a unit of AirTran Holdings Inc. (AAI ) AirTran earned $100 million on revenues of nearly $1 billion in 2003. Most analysts expect profits to come in strong again this year, even as rising fuel costs dampen earnings for all carriers. The result: Wall Street is waking up to the fact that AirTran, whose shares have risen about 75% in the past year, is quietly becoming a low-cost juggernaut like JetBlue and Southwest. "They are the hidden gem of the airline industry," says Vaughn Cordle, chief analyst at Airlineforecasts LLC, an investment research firm in Washington.

Leonard and his lieutenants play it close to the vest when it comes to detailing the carrier's next big push, which will come in late 2005. But they hint that it is likely to include several major new cities, and could involve Phoenix and other points now served by Southwest. Analysts believe that when that discount battle comes, AirTran's unique route structure will give it an advantage by driving traffic to its flights. By flying point-to-point, between New York City and Akron, for instance, AirTran can mine new customers in smaller markets. But with a hub-and-spoke system, it can also take those Akronites directly into its Atlanta hub and on to other points. That differentiates AirTran from Southwest, which flies point-to-point routes between some big and many smaller cities, or JetBlue, which mainly flies long-haul flights from major markets like New York and Los Angeles. It is "a model of the future," says Alan P. Sbarra, vice-president at airline consultants Unisys R2A TMC in Oakland, Calif.

AirTran's new fleet should drive down costs even further. AirTran's cost per available seat mile is now 6.42 cents, second only to JetBlue. And each new 737 should lower the cost per available seat mile to 12.4% below that of the less efficient 717s, according to Lehman Brothers' Chase. "The growth parameters at AirTran are are as good as, if not better than, Jet- Blue," says Thomas P. Norton, a portfolio manager at John Hancock Advisors LLC in Boston, which holds 1.2 million shares.

AirTran's biggest competitor, Delta, could cut its labor costs sharply if it enters bankruptcy, as management has threatened. At the same time, Delta is still adding capacity on some competitive routes such as Atlanta to Los Angeles. That pressure has already forced AirTran to reduce prices by as much as $25 one-way on some Atlanta routes, according to J.P. Morgan Chase & Co. analyst Jamie Baker. More ominous, if Delta does suffer the ignominy of Chapter 11 and shrinks radically, it would open up the Atlanta market. Southwest could even decide to take the low-cost battle straight to AirTran on its home turf, says an industry consultant.

Still, Leonard's biggest challenge now is to fill in his own system. Consider that seven years ago, AirTran had three flights daily to Akron. Today it has 11. When flights between Akron and New York City began last year, AirTran had studied the market carefully: Those flights were profitable from Day One. But now it doesn't have seven years to get its new markets right. With cities such as Los Angeles and Las Vegas going active this summer, eight new 737s arriving this year, and 13 more in 2005, AirTran must ensure that the right planes are on the right routes with competitively priced seats -- or risk botching its cost structure.

Leonard is in good shape financially to meet these challenges. AirTran raised $270 million in equity and convertible debt last year, and boasts a balance sheet with about $348 million in cash. And it's willing to spend on upgrades: To attract more leisure travelers, for instance, AirTran is outfitting every plane with no-extra-charge service from XM Satellite Radio Inc. Passengers, no doubt, will enjoy the tunes. But to AirTran's managers, the sweetest sound will be the whoosh of jets filled with passengers who used to fly Southwest and JetBlue.

By Brian Grow in Orlando

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