United Seeks To Improve Results Through Cost Control And Ancillary Growth Initiatives

by Trefis Team
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UAL
United Continental Holdings
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    Quick Take
  • United aims to cut its costs by $2 billion annually through higher fuel efficiency and employee productivity, among other measures.
  • The carrier also targets to grow its ancillary revenues by $700 million in an attempt to at least double its pre-tax earnings over the next four years.
  • Banking on increased cash flow through these measures, United expects to begin returning capital to shareholders by 2015.
  • In our view, this plan which addresses United’s critical issues including its sharply rising non-fuel costs will help it post better results in the coming years.

United Airlines (NYSE:UAL) on Tuesday, November 19, laid out a plan to reduce its costs by $2 billion annually, grow its earnings by two to four times over the next four years and begin returning capital to shareholders by 2015. [1] This is a much needed step from the carrier whose results in recent quarters have been disappointing. Last quarter, even though United posted higher profits, its results remained below expectations due to sharply rising non-fuel costs and unimpressive revenue growth. With this plan, the carrier aims to lift its growth and make its business more investable. The launch of this plan also reflects that United is largely through with its integration of Continental and ready to focus on improving its performance. Following the announcement of this plan, United’s stock rose by over 3% through the end of the day’s trade. We currently have a stock price estimate of $36.60 for United, marginally below its current market price.

See our complete analysis of United here


Structural Cost Controlling Measures Will Curb Sharply Rising Costs

United’s costs especially non-fuel costs have been rising rapidly. In the previous quarter, the carrier’s non-fuel costs per seat for a mile of flight rose by 6% annually, compared to the 1% growth seen in Delta’s case. [2] [3] Its $2 billion annual cost reduction plan is aimed at controlling this sharp growth in its costs. Of the total targeted cost reduction, the carrier aims to achieve roughly $1 billion through non-fuel heads such as employee salaries, maintenance, sourcing and distribution. [4] United aims to lift employee productivity in part by asking customers to tag their own checked bags and to swipe their own passes before boarding planes. The carrier also intends to implement lean practices to save on maintenance costs, and attract greater bookings through united.com to save on distribution costs.

The remaining $1 billion in cost reduction is expected to come from increased fuel efficiency. United believes that its ongoing replacement of older, less efficient aircraft’s with new, more efficient ones will lift its fuel efficiency significantly. Additionally, the carrier plans to support these gains by installing curved extensions, called winglets, on its aircraft that help reduce fuel burn.

Apart from focusing on the bottom line, United also aims to improve its top line performance through growth in ancillary revenues, which consist of extra baggage fees, ticket change fees, revenue from access to on board WiFi, as well as other sources. The carrier aims to grow its ancillary revenues by $700 million to over $3.5 billion by 2017 by providing fliers with more new options and optimizing pricing. [1] For example, the carrier will link pricing with demand and accordingly seat upgrades will be more expensive on Friday night or Saturday morning flights compared to mid-week flights.

In our view, these cost reduction measures as well as the focus on growing ancillary revenues will help address United’s sharply growing non-fuel costs and low top line growth. However, we are yet to see specific measures aimed at lifting the carrier’s unit revenues – amount taken from passengers per seat for a mile of flight. Nonetheless, United deems these measures sufficient to at least double its pre-tax earnings by 2017.

Capital Return To United’s Shareholders Likely To Start By 2015

Additionally, in our opinion, increased cash flow from these measures, will likely enable United to start returning capital to shareholders in the foreseeable future. In doing so, United will become the fourth major carrier after Southwest (NYSE:LUV), Delta (NYSE:DAL) and Alaska (NYSE:ALK) to begin returning capital to shareholders through dividends and share buybacks in the aftermath of the financial crisis. Currently, Southwest, Delta and Alaska are paying dividends at a yield of around 1%. Though this falls short of the dividend yield that investors are getting from some other sectors, it still points to the improved financial state of the U.S. airline industry. United currently anticipates to start returning capital to shareholders by 2015.

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Notes:
  1. United Airlines outlines path for increasing long term shareholder value, November 19 2013, www.unitedcontinentalholdings.com [] []
  2. United’s 2013 Q3 earnings form 8-K, October 24 2013, www.unitedcontinentalholdings.com []
  3. Delta’s 2013 Q3 earnings form 8-K, October 22 2013, www.delta.com []
  4. United’s 2013 investor day presentation form 8-K, November 19 2013, www.unitedcontinentalholdings.com []
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