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Investment Overview for United Continental Holdings (NYSE:UAL)
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Below are key drivers of UAL that present opportunities for upside or downside to the current Trefis price estimate.
United US
- United's US Passenger Yield: United's US passenger yield has increased from $0.11 in 2009 to $0.14 in 2012. We expect it to increase to $0.17 by the end of the Trefis forecast period. As fuel prices increase the carriers' passenger fares shall rise as well. This shall lead to to an increase in passenger yield. If however, the rise in fuel prices leads to a more than anticipated rise in passenger fares so that yield reaches $0.19 by the end of the Trefis forecast period, then there could be a potential upside of approximately 5% to the ${trefisprice}.
On the other hand, if due to competitive pressure, United is not able to increase fares as much and US passenger yield rises to only $0.16 by the end of the Trefis forecast period, then there could be a potential downside of approximately 4% to the ${trefisprice}.
United International
- United's International Passenger Yield: United's international passenger yield increased from $0.11 in 2009 to $0.15 in 2012 as a result of the airlines passing high fuel prices to passengers. We expect this figure to increase to $0.17 by the end of the Trefis forecast period. If however, this rises to only $0.16 then there could be a potential downside of approximately 5% to the ${trefisprice}. On the other hand, if it increases to $0.19 by the end of the Trefis forecast period then there could be a potential upside of approximately 5% to the ${trefisprice}.
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United Continental Holdings (NYSE:UAL) (together with its consolidated subsidiaries,"UAL" ) is an airline holding company, incorporated in Delaware with headquarters in Chicago, Illinois. Its principal, wholly-owned subsidiaries are United Air Lines, Inc. (together with its consolidated subsidiaries, "United") and, effective October 1, 2010, is Continental Airlines, Inc. (together with its consolidated subsidiaries, "Continental"). United Continental Holdings is the successor of UAL Corporation, which agreed to change its name to United Continental Holdings in May 2010, when a merger agreement was reached between UAL Corporation, Continental, and JT Merger Sub, a wholly-owned subsidiary of UAL corporation.
United and Continental transport people and cargo through their mainline operations, which utilize full-sized jet aircraft's, and regional operations, which utilize smaller aircraft that are operated under contract by United Express, Continental Express and Continental Connection carriers.
With key global air rights in the U.S., Pacific region, Europe, Middle East, Africa, and Latin America, UAL has one of the world's most comprehensive global route network. UAL, through United and Continental and their regional carriers, operates over 5,600 flights a day to more than 370 U.S. domestic and international destinations from the company's hubs at Newark Liberty International Airport (“Newark Liberty”), Chicago O’Hare International Airport (“Chicago O’Hare”), Denver International Airport (“Denver”), George Bush Intercontinental Airport (“Houston Bush”), Hopkins International Airport (“Cleveland Hopkins”), Los Angeles International Airport (“LAX”), A.B. Won Pat International Airport (“Guam”), San Francisco International Airport (“SFO”) and Washington Dulles International Airport (“Washington Dulles”). United and Continental are both members of Star Alliance, the world's largest airline network.
On March 1, 2012, FORTUNE magazine rated United Airlines the most admired airline on its annual airline-industry list of the World's Most Admired Companies. In addition, the magazine ranked United No. 1 for global competitiveness and long-term investment among 12 global carriers.
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The Fees and Cargo segment is the most valuable to the company because of following reasons.
Higher operating margin than core passenger travel business
UAL earned over 45% operating margins on its Fee and Cargo business in 2011 and only 12-13% margin on its core passenger operations. Marketing initiatives that contribute to an increase in Other Business revenue such as baggage handling, sale of mileage credits, Continental FareLock have zero or minimal direct costs associated with them. These programs offer additional revenue for the firm without any significant costs associated with them.
Significant revenue growth potential as a result of the synergies from the merger
UAL expects to generate significantly more revenue synergies in 2012, enabled by the conversion to a single passenger service system. A single passenger service system presents the opportunity to optimize the combined network and would enable United to harmonize the ancillary product portfolio of the two airlines and roll out new products.
Following the merger, the two airlines are also integrating their loyalty programs. In 2011, UAL announced that MileagePlus will be the loyalty program for the company beginning in 2012. Moving to a single loyalty program will be a significant milestone in the integration of the two airlines. Continental’s loyalty program formally ended in the first quarter of 2012. UAL continues to roll out new ways for customers to earn and redeem miles by expanding the number of business partners that participate in the MileagePlus loyalty network. In its Amadeus 2011 Yearbook of Ancillary Revenues, IdeaWorks estimates that United Continental generated approximately $3 billion in 2010, purely from miles sold through its third party card “partners.”
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Oil prices significantly impact UAL's bottom line
Fuel expenses represent one of the largest single costs faced by airliners and account for over 30% of the costs for airlines.
Based on projected fuel consumption in 2012, a one dollar change in the price of a barrel of crude oil would change UAL’s annual fuel expense by approximately $95 million. Information collected from Transtats indicate that fuel costs rose by approximately 29.7% for airlines over all in 2011 from the 2010 levels, and according to recent data compiled by IATA’s Jet Fuel Price monitor, there will be an increase of approximately $32 billion in the overall 2012 fuel bill for the airline sector.
Focus on keeping prices competitive in the airline industry prevents UAL from immediately passing on price increases to its customers, so UAL's expenses are heavily impacted by fuel prices and their volatility.
Weak macroeconomic conditions
The main challenge the global airline industry faces during 2012 and beyond is the state of the global economy. Europe’s sovereign debt crisis has created enormous uncertainty and is expected to impact the overall profitability of the sector. Tony Tyler, IATA’s director general believes that a failure on the part of governments to resolve Europe’s issues could lead to a loss of $8 billion in 2012 for the airline industry. As a result IATA has already downgraded its 2012 outlook for profitability to $3.5 billion from $4.9 billion that was expected a few months ago.
According to IATA’s latest forecasts; North America carriers are expected to earn about $1.7 billion; Asia Pacific carriers around $2.1 billion; African airlines are expected to lose $100 million and European airlines are projected to take a loss of $600 million due to economic uncertainty and higher passenger taxes.
Cautious capacity stance
Due to rising fuel expenses and weak economic conditions, several airlines have been forced to cut back on routes. Capacity cuts that have occurred in developed markets in 2011 are expected to persist in 2012. On the other hand growth in capacity has been robust in international markets. According to TranStats, the total available seat miles (ASM) have increased in international markets from approximately 524 million miles during the first ten months of 2010 to 560 million miles during the same period in 2011.
Legacy carriers including Delta Airline and United Continental curtailed capacity on domestic routes, while expanding modestly in international markets. Their overall system capacity remained almost flat. For 2012, the carriers are planning for flat to a slight decline in capacity. Delta will follow the strategy of reduced flying in markets that cannot generate adequate returns in a high fuel environment and is planning for 2012 capacity to be down 2% to 3% y-o-y. United Continental expects full year 2012 consolidated capacity to be essentially flat versus 2011.
Growth in ancillary revenues
With profitability declining for the overall airline sector, many of the carriers are figuring out ways to improve income by increasing ancillary forms of revenues. Baggage fees have been one of the main drivers of profitability for many airlines. Airlines are adding various new features to help boost revenues such as WiFi, in-flight entertainment, and improvements in lounge facilities.
According to a recent Amadeus/IdeaWorks study, North American airlines collectively produce the largest stream of ancillary revenues compared to other regions, with an estimated $15 billion in revenue in 2011. This represents a 70% jump over 2010 levels, with the majority of the increase attributable to stronger merchandising efforts by the carriers as well as addition of more à la carte services for sale.
The study also revealed that around 50% of ancillary revenues for the U.S. airlines is generated by the sale of frequent flier miles, notably those linked to co-branded credit card activity.
Trefis Forecast Rationale for International Fuel Expenses % of International Passenger Revenues
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Other costs of UAL represent the direct expenses incurred except costs associated with jet fuel. It consists of salaries, wages, benefits, maintenance materials and repairs, aircraft rentals and interest costs associated with pension, post retirement benefits and operating capitalized leases.
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${forecast} increased from 29.6% in 2009 to 40.4% in 2012. Tensions in the middle east and growing demand for oil from emerging economies drove oil prices from their lows of the financial crisis of 2008-09.
Going forward we anticipate ${forecast} to continue to increase over the Trefis forecast period on higher fuel prices.
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Trefis considered the following factors for its forecast:
${header:supporting}- Limited crude oil production
- Many people believe that the world’s crude oil production is close to maximum levels after which it will start to decrease. A decline in crude oil production will lead to a decline in aviation fuel produced.
- On the other hand, it is expected that aviation demand will continue to rise. Airline traffic is expected to grow by 5% a year to 2026 and fuel demand by 3% during the same period. The aviation industry will have a hard time replacing jet fuel with other sources and thus will serve to keep a floor on prices.
- Weak US Dollar to keep prices elevated
- Jet fuel prices are currently based in US Dollars and represents nearly 33% of the total operating costs for airlines. A weakness in the US Dollar is expected to keep prices elevated.
- Growth in demand in emerging economies
- Growing demand in emerging economies have helped increase aviation fuel prices. According to the World Energy Council (WEC), transport fuel demand in the next forty years is expected to come mainly from developing countries such as China and India, where demand will grow by 200-300%. In contrast, transport fuel demand for the developed countries will drop by up to 20%, mainly due to increased efficiencies. The demand of the developing countries is expected to surpass that of the developed countries by 2025.
- Tensions in the Middle East
- Civil unrest in Egypt and other Middle Eastern countries caused a sharp rise in oil prices and significantly dented profitability across the U.S. airline industry in 2011. According to IATA, the global airline industry’s fuel bill is forecast to total $178 billion in 2011. This is an increase of over $37 billion over 2010 and is four times the 2003 fuel bill of $44 billion.
- As political unrest in the Middle East pushed oil prices up the past year, most U.S. airlines saw their fuel bills jump anywhere between 30% and 50% in 2011 as compared to 2010. A decline in oil output due to threats of further revolts in many oil producing nations of the Middle East could likely disrupt supply which would lead to an increase in crude oil prices and hence jet fuel prices. Most recently, sanctions against Iran over its nuclear program have cut off a major source of oil for many refiners while supplies from several smaller producers, including South Sudan, Yemen and Syria, have also been cut off in the past few months, thereby tightening supplies to some markets.
- UBS increased its brent forecast for 2012 in January by $5 per barrel to $105 for 2012 due to the recent price strength, supply issues and resilient demand. According to UBS, the Arab awakening, non-Opec shortfalls and the Iranian nuclear issue support the supply-side case.
- According to Vitol, the world’s largest independent energy trader, oil prices could surge this year to a record high due to growing geopolitical tensions in the Middle East. Ian Taylor, chief executive of Vitol, said his main scenario envisaged oil prices remaining at around the current levels for the balance of 2012, but warned that it was possible for oil prices to surge to $150.
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- More efficient aircraft
- United is however mitigating the fuel cost pressures by bringing in more efficient fleet. The carrier expects to induct into service 24 new aircraft's this year, comprised on five Boeing 787 Dreamliners and 19 737-900ER aircraft's. The Dreamliner is being viewed as a game changer creating new profitable market opportunities for the carrier, especially on long haul routes, with its excellent operating economics.
- Fuel hedging
- UAL routinely hedges a portion of its future fuel requirement.
- It uses fixed price swaps, purchased call options, collars or other such commonly used financial hedge instruments based on aircraft fuel or closely related commodities like heating oil and crude oil.
- It strives to maintain fuel hedging levels and exposure generally consistent with industry standards so that the company's fuel cost is not disproportionate to the fuel costs of its major competitors.
- UAL arranges to have fuel shipped on major pipelines and stored close to its major hub locations. It ensures the adequate supply of fuel and helps UAL control prices in the short term.
- UAL has hedged approximately 48% of its expected first quarter fuel consumption at an average Gulf Coast jet equivalent of $3.24 per gallon in 2012. It has hedged approximately 32% of the expected fuel consumption for 2012 using a combination of collars, swaps and calls.
- Alternative fuel sources to impact prices
- The aviation industry is actively searching for alternative replacements to conventional jet fuel, for instance through the use of bio fuels. Airlines such as Air New Zealand, Continental Airlines, Alaska Air and Virgin Atlantic have performed successful test flights using bio fuels. The production of bio jet fuels has so far only been for research purposes and is far from use on an industrial scale.
- UAL is taking various actions to reduce its carbon emissions through fleet renewal, aircraft retrofits, and actions that are establishing the foundation for the commercialization of aviation biofuels.
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How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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