United Continental (UAL) | Room to Fly

We talk about the airline sector from time to time here at The Options Edge. We have taken a shine to the industry as it has moved from a fragmented industry with a large number of players, some large and some small to one that looks more like an oligopoly. The ease with which entrepreneurs could enter or exit with business in years past was one of its major Achilles heals of the industry. Just as the industry would become profitable, someone would start a new, low-cost carrier. These new entrants would drive down prices for customers, which was great for them, but this drove down industry profitability, which was bad for investors. It was also bad for the stability of the industry. The airline industry is capital-intensive and companies use a lot of debt to buy or lease aircraft. If one is managing a company to add value over the long-term, a prudent financial manager would pay down debt during the good times so they would have the financial strength to manage through economic downturns. But the entrance of low-cost carriers made this difficult to impossible. These folks did not do themselves a lot of good either. As soon as a recession came along, these capital light competitors would fall by the wayside. With these folks out-of-the-way, the industry would recover and profits would return. Such was the typical business cycle. But with consolidation, this cycle is far more muted.

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