United Smacked By Integration Costs And Higher Fuel Costs

Trapped in the integration burden, United Continental Holdings (NYSE:UAL) reported massive losses of $286 million this quarter excluding special charges. The losses including special items widened further to $448 million led by integration-related costs. While most of the airlines including Southwest Airlines (NYSE:LUV), Delta Airlines (NYSE:DAL), US Airways (NYSE:LCC) managed to report marginal profits, United Continental has posted the biggest loss by an airline in this quarter.

As a result, the stock sunk by 3.7% before the markets closed for the day. The carrier posted modest revenue growth of 4.9% in this quarter as a result of hiccups in integration of revenue management and booking systems, reduced load factors and marginal increase in capacity. However, the company is confident of generating significant revenue synergies by leveraging the integrated IT systems. The carrier also faced the fuel price headwind with a $557 million increase in fuel costs which constitutes a whopping 80% share of the total rise in operating expenses. These statistics also indicate that the company did a good job in cutting down its non fuel expenses.

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Technology Deployments Affected Revenue Growth

This quarter saw the launch of a single passenger information system starting from March 3. In order to ensure smooth transition, the company operated fewer flights and compromised on the load factor as well. The carrier also faced another IT issue in February when the computer system for forecasting demand ended up selling more than budgeted seats at lower fares. The switching process of IT systems accompanied by technology hiccups directly impacted the revenue figures for this quarter. As the IT systems get settled, United would definitely generate significant benefits from these systems to compensate for this quarter’s revenue loss.

In addition, the company has plans to reduce overall capacity by 0.5-1.5% this year. The existing model assumes flat growth in overall capacity for 2012. Assuming that capacity falls to extreme of 1.5%, the Trefis price estimate falls by 2.5% to $25.81.

Rising Cost Liabilities to Further Impact Bottom-line

United Continental forecasts fuel expense to be $3.44/gallon for Q2 and $3.40/gallon for this year including the impact of hedging. The company has currently hedged 36% of the expected fuel consumption for H2 2012 through various derivative contracts.  In order to upgrade its fleet, United is also expecting to add 15 Boeing 737-900ER aircraft and five 787 Dreamliners. The CapEx guidance for this year stands at a massive $2.35 billion. Adding to these expenses, the integration related costs would further impact the net GAAP income for this year.

Our pre earnings Trefis price estimate of $26.50 is UAL represents a near 20% premium to the market price. We are in the process of revising our estimates for United Continental based on the quarterly results and company guidance.

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