Airlines are All-In on Premium Seating

0:01Tyler Crowe:Airlines are going all premium. Motley Fool Hidden Gems Investing starts now.

0:09Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Matt Frankel and Lou Whiteman. So today we're going to test a little bit of what we call our baloney meters, whether or not what is going on in financial news media actually makes sense or not. And then we'll also, of course, hit the mailbag as we always do. But But we want us to start today on the premiumification, if that is a word, if not, I just made it up, of airlines. The reason that we're bringing this up today is that one of the lead stories in the Wall Street Journal was on Alaska Airlines basically really upping their game in terms of their first class cap.

0:48Tyler Crowe:And as we started discussing this in our channel to prep this morning, Lou also sent a picture over of a United flight where their new cabin configuration was like more than 50 % first class. And it does seem to be that this is where a lot of the airlines want to go is this, we are pretty much a first class flyer. And then, you know, maybe we'll toss in four or five economy seats while we're at it. And this is, at least to me, it seems like a clear change in the way that airlines want to do their business. So guys, what is the business case for doing this? Because first class means fewer people.

1:29Lou Whiteman:Fewer people, but hopefully more revenue, right? As usual in this industry, everyone's following Delta's playbook. And that is basically how this industry has worked since about 2008, when Delta went bankrupt. Ironically, they followed them there too. But back in 2024, the Delta Investor Day, they said they are done treating upgrades as perks. They see them as revenue opportunities. And fast forward two years, today, more than three quarters of Delta tickets have at least one upsell. That could be, you know, just baggage or it could be economy plus or whatever. So, yeah, all of the full service airlines are rejiggering their cabins.

2:06Lou Whiteman:They're trying to give you more premium seats to sell. Basically, every time they try this and they say, can we sell this many? And the answer is more. And so that's what you're seeing. Remember, an airline has massive fixed costs per flight. That plane costs X amount, whether it is one person on it or 280 people on it. Any incremental revenue helps there. You know, once you decide you're going to fly the plane, an extra 10 bucks is just revenue on the top. It's not just the premium guys. Southwest is doing their own version of it by charging for seats and charging for bags. Now, even Bill Franke, the father of the modern discounter, says Frontier, which is an ultra discounter right now, even Frontier can learn from it.

2:50Lou Whiteman:So this is the way everyone's going. Yeah, I mean, you mentioned Frontier, that the discounters are hanging on for dear life right now. I mean, what happened with Spirit? Even JetBlue, that's usually considered more of a discount-friendly airline, is leaning into its premium product a little bit more. This does change the business model quite a bit. It kind of starts shifting the airline model to a commoditized business, to a real product ladder, especially for leisure travelers, which historically have not been what you see in first class. Lou mentioned Delta. Delta already has three different tiers of tickets for both of its cabins.

3:25And it's not just that they're trying to directly sell first class to travelers like me. It's after you buy a ticket, they'll use dynamic pricing to offer you an upsell. and even a little bit more incremental revenue on that, like Lou said, would help. I mean, there have been times when I've upgraded for not very much money. Delta's premium cabin, not only are three-fourths of Delta tickets now coming with at least one upsell, but the premium cabin now out-earns the rest of the plane. Historically, that has not been the case. It's really a smart business decision and I'm surprised it took airlines so long to figure out you don't give away what people are willing to pay for.

4:08But Delta figured it out. Now everyone else is following suit.

4:11Tyler Crowe:I can see the strategy to it. But here's the thing that I keep coming back to it, too, is, you know, this is an extremely and notoriously cyclical industry. I mean, as you just said, we had bankruptcies during the great financial crisis and a lot of them during COVID during 2020 were practically brought to their knees as well. And so like on the it's so over, we're so back scale, this really screams we're so back. And while I can see the incremental revenue gains, yeah, that makes sense in good times. But as we see with these cyclical industries, during the downtimes, capacity does matter. You still need to put butts in seats.

4:51Tyler Crowe:And it would seem to me that this is a riskier move for a cyclical industry that when the times get hard and they're trying to fill seats, this doesn't seem like it would be as good of a way to do it.

5:05Lou Whiteman:Am I looking at this wrong? Well, one thing to consider here, and coming out of deregulation in the 70s, this was an industry that was about empire building. Everybody wanted to have the prettiest map. Everybody wanted to be the largest capacity. And that age is over. At least it's on the decline. Right now, the focus is on profitability, not who has the most routes and who has the most passenger flown. I can tell you their answer to this is, and we've already seen Delton United talk about it after the holiday season. If demand falls, take capacity out of the sky. Don't change to your cabin configuration.

5:39Lou Whiteman:Look, the nice thing about automated pricing is that you can cut all of your fares by 20, 30,$50, whatever you need to, and still try and upsell that$5 for a better seat. So I think you will see them take capacity out of the sky if the cycle turns. And I think, you know, they will try to manage the cost side, but still just try to upsell as many people as they can at whatever price they can. The fact that they're using a dynamically priced model to upsell as much as directly sell their premium seats, to me, it means that their revenue in a recession wouldn't exactly fall back to what you would normally see in a recession, like, you know, the 2008 recession in airlines.

6:19But I mean, on one hand, premium is usually the more cyclical part of airline revenue. You know, economy revenue tends to not do well, but it tends to hold up better during tough times than premium revenue. But in previous recessions, more of premium cabin revenue came from business travelers than leisure travelers. And that's not necessarily the case today. So, you know, the dynamic pricing helps. There are a lot of ultra premium products, you know, they're not eligible as free perks anymore in a lot of cases. is if demand really collapses, and I mean, in addition to what Lou said, take some supply out of the sky, airlines can go back to that free upgrade model.

7:00They have that optionality and use it as more of a catalyst for their credit card relationships, which that was a saving grace for a lot of airlines during the most recent recession and during the COVID pandemic, especially, when they didn't have a lot of capacity in the sky. So leaning into those type of relationships and giving away what people are no longer willing to pay for is always an option on the table.

7:21Tyler Crowe:So you guys have made the case, but look, airlines have not necessarily been the best investment over the long period of time for myriads of reasons. So with this specific strategy change that we're seeing, does it really make airlines a worthwhile investment for everyday investors?

7:37Lou Whiteman:For most people, no. I will say this. I think that the whole industry is much better run. There's fewer carriers. Consolidation, now four airlines have 80 % of domestic market. The odds of a bankruptcy among the major airlines, the non-French airlines, is lower, so there's less downside risk. But for a buy-and-hold investor, no. I think, if anything, you play the cycles here, or you just buy AirCap. Yeah, I mean, it makes the major airlines less fragile, not necessarily less volatile in tough times. I mean, the discount competition like Spirit went away is less than it used to be. The way loyalty programs have worked has shifted.

8:16It's devalued them for a lot of travelers, but it's shifted them toward monetized parts of the business rather than just a free perks model. At the end of the day, these are still airlines and should be treated as such. The reasons that Warren Buffett abruptly got out of the airlines after the COVID pandemic still apply today. But it's a smart move by the airlines to lean into premium and to not give away what people are willing to pay even a little bit of money for.

8:41Tyler Crowe:Yeah, the Berkshire Hathaway purchase and then subsequent sell was very much indicative of the airlines where it's like just when you think things are getting good, something comes around the corner and really upsends the industry. So hopefully that won't happen again, but history might suggest otherwise. Coming up to the break, we're going to play a quick game of do you buy this new story?

9:28Lou Whiteman:We'll see you next time. You trade brilliantly. Learn more at schwab.com slash trading. Get a concise daily market preview from Charles Schwab, including stock updates, U.S. and global economic news, monetary policy decisions, and key results and statistics that may impact your trading. Schwab Market Update is an original podcast from Charles Schwab. Join host Keith Lansford for this information-packed daily market preview delivered in 10 minutes or less. Listen today at schwab.com slash market update podcast or wherever you get your podcasts. That's schwab.com slash market update podcast.

10:06Tyler Crowe:One of the more important skills I would say as an investor, and I think Lou, Matt, you guys would agree with me on this, is after a long time, you build a little bit of a, since this is a family-friendly show, we'll call it the baloney meter, where sometimes when you see news stories, as an investor, sometimes it's hyping up a company or hyping up a major investment or a major announcement. We kind of were poking fun at it a little bit yesterday with NVIDIA's buyback story. But there's a little bit of, as an investor, do you actually believe that what this story says is material to your investment?

10:42Tyler Crowe:And so, there's been quite a few news stories hitting the newsreels recently that, as an investor, might change the way you might go about your investment thesis. So, what I want to do is we're going to do quick hit news stories today. And we're going to play a game of, do you buy this? As in, do you actually believe what management is saying with this? Or is there perhaps like something about this story doesn't sniff quite right. And as an investor, I'm either going to ignore, or perhaps this is just not something I'm going to consider here. So we're going to start for the first one. And this is the claim.

11:15Tyler Crowe:So Aura, the health ring company, I'm sure that there's some very long description of what this is as a business, but you know, Healthring company, it's delaying its IPO. And now, do you buy that there is overwhelming demand for its shares as management claims in this IPO delay?

11:35Lou Whiteman:I do. I mean, there's caveats there. But as you mentioned, our prep meeting, there's a lot of IPOs that have been that have been delayed. So I don't think they're alone here. There's the question of at what price, because I think you can always get an IPO out the door if you don't care about price. But I do think it's a relatively small offering, and when it goes out, it'll be oversubscribed. What happens from there, who knows? But I do think there is more demand than there are shares to be sold. Yeah. As Tyler said, the baloney meter is an important skill for investors to have, but that doesn't mean we have to agree.

12:07So I'm going to say I don't buy it here. I was skeptical about Aura's ability to succeed as an IPO before management decided to delay. Even some recent oversubscribed IPOs have quickly fizzled out. And I wouldn't be shocked if that were the case here. It's a solid product. I don't know how much, you know, how much long-term interest there is, especially. And I'd like to kind of see where it goes after day one before I would even make a decision on that company.

12:35Tyler Crowe:Open debate for the first one. Second one here, we have OpenAI say it's delaying the release of its newest frontier model to the public. Do you buy that this is completely for safety and altruistic reasons?

12:49Lou Whiteman:Thank you for putting the word completely in because that makes it easy. And no, I don't buy it. I mean, for one, I think all of these pre-IPO companies in particular, they are starting to realize that maybe throwing all this cash at the frontier isn't the way to show revenue for your IPO. So I think, look, maybe there's some safety concerns, but this is pretty convenient way to reallocate resources ahead of a potential IPO. Yeah, I mean, I kind of buy it in the sense that I believe it's for safety reasons, but not necessarily that it's not like a self-serving move here. You know, during internal testing, their unreleased agents have gone rogue recently.

13:27There are several reports of that. Releasing a model that actively breaks into government and corporate databases could be a disaster for a company aiming for a trillion dollar IPO next year. So, yes, it's for safety reasons, but it's kind of more to protect themselves.

13:44Tyler Crowe:The Anthropic S1 was released or leaked to the media, but we have not yet seen it, so we didn't want to get too deep into it. But the risk section of that one is sure going to be a fun one. All right. So here's the next story here. Indian steelmaker Mesabi Metallics says it wants to build a$15 billion and 7 to 10 million tons of steel per year plant in the United States. This would have a profound impact on the steel industry, steel producers like Nucor, Steel Dynamics, things like that, maybe even bring down costs for automakers. Do you buy that this will happen by 2030 as claimed?

14:21Lou Whiteman:By 2030 is tight, and I'm not sure I believe that, but I do think that it will get built. For one, they've been trying to do this for decades now, and maybe that's an argument against me, but I do think that there is a will to get this done. And I don't even I don't think a change of control situation in Washington will cut back on the eagerness to hand out tax incentives and to think about reshoring. I think it gets done. The question is what year? I don't buy it. And my reason is because you put the as claimed wording in there. We've seen this movie before. You know, Foxconn was supposed to build a 10 billion dollar plant.

15:02That's what President Trump announced at the beginning of his first term. It ended up getting scaled way back to about$672 million. Big difference there. So I think the plant will ultimately happen. But at the scale that's being claimed, maybe not.

15:17Tyler Crowe:It certainly does sound like a few of those soft bank investments that ended up being fractions of what the number they originally spoke. All right. And this is our last one here. And of course, when it comes to the baloney meter, we're going to go with Elon Musk because he always has some very strong statements. And Elon Musk said that SpaceX's orbital compute will beat its 2028 forecast. Do you buy the timeline? I feel like this one's a layup because it's timelines and Elon Musk.

15:45Lou Whiteman:Yeah. And the answer here is not a chance in the world. So we do have our first data center going up in the space. Google's Project Suncatcher is expected to be launched early next month. It is one kilowatt of capacity with a K. Musk, right now the target is one gigawatt by 2028, which would basically be the size of a modern data center in space. We will barely have proof of concept data on the Suncatcher by then. No way we have a fully constructed, full-size data center up in orbit in two years. Yeah, I don't buy it. This seems aggressive even by Elon Musk's standards. And the Tesla Roadster that is being revealed this week was announced 10 years ago.

16:27You know, too many regulatory and engineering hurdles to overcome for that short of a timeline. I mean, even SpaceX's own filings project the start of their deployment at the start as 2028 at the earliest. And SpaceX's president has said even internal testing isn't going to be until the end of 2027. The vision of Orbital Compute itself is very viable, but not that soon.

16:53Tyler Crowe:One thing with all of these news stories that we saw, it all involves very large money. There's a lot of moving parts that are happening here and kind of similar to the Aura IPO. It does seem like more and more people are being more, I wouldn't say skeptical, but certainly giving these bold propositions a little bit more rigor in terms of due diligence. So we will see how this all goes. but I think we're pretty online here with a lot of these timelines and a lot of these numbers seem much more optimistic than what investors should expect. Coming up after the break, we're going to hit the mailbag.

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18:49Tyler Crowe:Axel XL, facing into risk for a future to be imagined. This advertisement doesn't constitute an offer or solicitation, nor a description of any products or services of Axel XL. Today's question comes in from Vignesh, and he says, I've been listening to the Motley Fool podcast for the past year, and I started investing around that time. And my question might be a basic one, but are there growth stocks in the sectors such as consumer staples or agriculture, which are important to our day-to-day living? The need for these sectors are going to exist forever. And why are they not growing as other growth stocks?

19:23Tyler Crowe:I realize I'm missing something, but this has been in my mind for a while and I keep going on a loop. So any general insights on how these sectors work would be really great. Thanks in advance. So I'm going to open this and I'll send it to you guys in a second here. But one thing I want you to keep in mind, Vignesh, is that even though our industry itself can be incredibly resilient, you know, food and agriculture is obviously an important thing that's going to exist forever, doesn't necessarily guarantee the resiliency of a company. Grocery stores go in and out of business all the time. And as far as like consumer discretionary, consumer cycles, Sears, people thought Sears was going to last forever.

19:59Tyler Crowe:And then, I don't know, Eddie Lampert got his hands on it and look where it is now. So, guys, what are your thoughts on the growth of consumer staples in agriculture and where should Vignesh be looking?

20:10Lou Whiteman:So the first question is define growth because there are companies in this sector that will grow better than others. I mean, Costco on the retail side, ADM at times has been a great grower relative to the industry. But if you're talking NVIDIA AI type growth opportunities, no. And part of that is, is resilience kind of the tradeoff with resilience is kind of slow growth. It's yes, it's necessary. But look at the nature of the industry. We are not going to 3x, 5x what we eat and accept it as an economy, probably not 3x, 5x the staples that we buy. We need X amount. We buy X amount. And so that is not a formula for a rapid fire growth sector wide.