United Airlines (NYSE:UAL) has come a long way from the start of 2013 when it was focused on cutting its losses through improved operating performance. Through many months in 2012, the carrier struggled to achieve healthy on-time arrival rates due to issues arising from its integration of Continental. In 2013, United not only improved upon its poor on-time arrival rates seen in 2012 to win back passengers, but also cut its losses on support from the stable demand environment for flights and lower fuel prices. In the nine months ended September 30, 2013, the carrier posted a profit of $431 million, compared to a loss of $103 million in the same period last year.  During this period, United also benefited from its capacity discipline which helped prop up its occupancy rates (percentage of seats occupied by revenue paying passengers in a flight) to lift its profits.
Looking ahead, in 2014, we expect United to continue to grow its profits driven by cost cuts and capacity expansion.
We currently have a stock price estimate of $36.60 for United, marginally below its current market price.
Cost Cuts Will Tame Growth In United’s Non-Fuel Costs In 2014
Though United has improved its operating performance and profits steadily through 2013, its cost performance still lags behind those of its peers. For instance 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.   In our opinion, this high growth in United’s non-fuel unit costs is primarily due to the absence of cost-controlling measures unlike Delta, which initiated multiple cost reduction measures in 2012.
Going forward, this is set to change as United too recently initiated measures to reduce its costs. The carrier targets to lift its employee productivity in 2014 in part by asking customers to tag their own bags and swipe their own passes before boarding. It also intends to implement lean practices to save on maintenance costs, and attract greater bookings through united.com to save on distribution costs. United estimates that through these measures it will achieve around $1 billion in annual cost savings by 2017. In 2014, the carrier anticipates these measures to slash growth in its non-fuel costs per seat for a mile of flights to 1-2% annually, from over 6% year-over-year growth likely in 2013.   This sharp decline in United’s non-fuel cost growth will work to expand its margins and profits in 2014.
Capacity Expansion Will Likely Lift United’s Passenger Traffic & Top Line In 2014
Next year, United also intends to grow its top line through increases in flying capacity. At a recent investor meet, the carrier announced that in 2014 it will raise its flying capacity by 1-2%, from 2013.  This is in sharp contrast to the carrier’s conservative capacity stance over the past few years during which it steadily reduced its flying capacity. In our opinion, these steady capacity cutbacks played a major role in lifting United’s profits from the losses incurred during the financial crisis. Capacity cutbacks reduced the number of empty seats on the carrier’s flights at a higher rate as demand improved as a result of the economic recovery from the financial crisis. Fewer empty seats meant lower losses. Having achieved healthy margins and occupancy rates, United’s return to a growth oriented capacity stance was only a matter of time. In 2014, we figure this additional capacity will enable United to carry more passengers given the stable demand environment and lift its revenues.
At the same time, going by previous airline integration experiences, the new American Airlines will likely slash its flying capacity in 2014. Such capacity reductions take place as consolidation of two independent flight networks, those of American and US Airways in this case, inevitably leads to reduction in frequency of flights on some routes and cancellation of flights on less profitable routes. This will provide some downside to the overall flying capacity of the airline industry allowing United to expand its flying capacity to fill this gap. Separately, we anticipate this growth in United’s capacity to help stem the decline in its market share.
All in all, United looks set to expand its margins and profits in 2014 on improved bottom line performance driven by cost cuts and top line growth driven by capacity expansion.Notes:
- United’s 2013 Q3 10-Q, October 24 2013, www.unitedcontinentalholdings.com [↩] [↩]
- United’s 2013 Q3 earnings form 8-K, October 24 2013, www.unitedcontinentalholdings.com [↩]
- Delta’s 2013 Q3 earnings form 8-K, October 22 2013, www.delta.com [↩]
- United’s 2013 investor day presentation form 8-K, November 19 2013, www.unitedcontinentalholdings.com [↩] [↩]