United Continental Coverage Launch – $28 Price Estimate
United Continental (NYSE:UAL) was formed after the merger of United Air Lines and Continental Airlines. The merger agreement was reached in May 2010, but it wasn’t until October 2010 that the two airlines started reporting the results together. With key global air rights in the U.S, Europe, Middle East, Africa, Latin American and the Pacific, United Continental (UAL) has the world’s most comprehensive global route network. UAL competes with Delta Air Lines (NYSE:DAL), Southwest Airlines (NYSE:LUV), American Airlines (NYSE:AMR), and U.S. Airways (NYSE:LCC).
Our price estimate for United Continental stands at $27.89, which is roughly 20% ahead of market price.
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Launch of Coverage on United Continental ; $27.89 Price Estimate
We’ve broken down our analysis of United Continental into four main business segments:
2. United Continental International
Airline Industry at a Glance
Commercial aviation helps generate more than $730 billion in economic activity and supports almost 11 million U.S. jobs. As the U.S. and world economies continue recovering from the recent economic downturn, the aviation sector will make a strong contribution towards revitalizing the job market. The U.S. airlines industry suffered a major setback in 2008 due to the recession that reduced both business and leisure air travel.
Since then, the U.S. economy has slowly recovered leading to an increase in demand for air travel in 2010 and consequently higher average fares. Traffic demand is highly correlated with economic growth and consumer spending accounts for nearly 70% of economic activity in the U.S. Based on expectations for the an economic recovery in the coming years, we believe this will lead to strong demand for airline travel.
Impact of Merger and Competition on Market Share
Over the past year, United Airlines has lost U.S. market share to low-cost airlines such as Southwest Airlines and JetBlue. Prior to the merger, United Airlines’ U.S. market share deceased form 11% in 2007 to 10% in 2009. Southwest Airlines pioneered the low-cost model which enabled it to offer fares that were significantly lower than those charged by traditional network airlines such as Delta Air Lines, US Airways, American Airways, and United Continental. UAL’s U.S market share increased from 10% in 2009 to nearly 12% in 2010 due to the merger.
UAL expects the merger to deliver $1.0 billion to $1.2 billion in net annual synergies by 2013, including between $800 million and $900 million of incremental annual revenues. The increase in revenue, will largely come from expanded customer options resulting from the greater scope and scale of the network as well as fleet optimization. We expect UAL’s U.S. market share to increase from just under 12% in 2010 to nearly 16% in 2011 and stay at that point thereafter as the increase in market share due to expanded customers options will be offset by decrease in market share due to competition from low-cost airlines
Domestic Passenger yield (passenger revenue per revenue passenger mile) for UAL has decreased slightly in recent years due to competition from low-cost airlines and poor domestic economic conditions. UAL and other traditional network airlines rely upon the hub-and-spoke system, which concentrates most of an airline’s operations at a limited number of central hubs and serves most other destinations in the system by providing one stop or connecting flights through a hub. Southwest Airlines, JetBlue Airlines and other low cost airlines use a point-to-point system, which allows for more direct flights.
Upgrading to Offer Premium Services
United offers first and business class seating on transcontinental flights and United Economy Plus. United’s aircrafts offer international premium travel experience featuring 180-degree, lie-flat beds in FirstBusiness class. Certain aircrafts have been refitted with new premium seats, entertainment systems and other product enhancements. United has completed these upgrades on all of its 21 Boeing 767-300ER aircrafts, all of its 24 Boeing 747 aircrafts and 8 of its 46 Boeing 777 aircrafts. It expects to complete the remaining aircraft updates by 2013.
Continental offers flat-bed seats on FirstBusiness class on its Boeing 777 aircrafts and 31 of its 41 Boeing 757-200 aircrafts with approximately 6.5 feet of sleeping space, laptop power and 15.4-inch video monitors. It expects to complete the remaining Boeing 757-200 aircraft updates by summer of 2011. It is also installing DirecTV satellite programming on its entire fleet with more than 100 channels of live television and previously recorded programming. It has completed the installation of DirecTV on the majority of its Boeing 737 Next-Generation aircrafts and expects to complete the installation on its Boeing 757-300 aircrafts during 2011.