United Continental 2Q Preview: Pricing Pressure Will Likely Drive Down Revenues

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United Airlines Holdings

United Continental Holdings (NYSE:UAL) is expected to release its second quarter results on Thursday, 23rd July 2015((United To Announce Second Quarter Results)), along with its smaller competitors Southwest Airlines (NYSE: LUV) and Alaska Air Group (NYSE:ALK). Unlike the last quarter, United increased its system capacity higher than its guidance for the quarter, despite the growing concerns of an oversupply of seats in the domestic market. As expected, this weighed heavily on the airline’s passenger unit revenues, and is likely to pull down its quarterly revenues. However, we expect United to deliver strong 2Q earnings driven by lower fuel prices. Here’s a quick look at the key trends that are likely to impact United’s second quarter earnings.

We currently have a price estimate of $69 per share for United. We will be updating our valuation model for the airline after the earning release.

See Our Complete Analysis For United Continental Holdings Here

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Lower Unit Revenue To Drag Down Revenues

In spite of facing a sell-off of its stock due to fear of an excess supply of seats in the domestic market, United grew its system capacity by 2.3%((United Announces June Traffic Results, 9th July 2015, www.unitedcontinentalholdings.com)) during the June quarter. This capacity expansion was driven by domestic capacity growth of 4.7%, partially offset by a reduction in its Latin American market.

2 month price movement

Source: Google Finance

While the capacity addition resulted in a 1.3% rise in United’s passenger traffic, it pulled down the airline’s load factor (number of passenger flown per flight) by 80 basis points to 86.3% during the latest quarter. In addition, these capacity expansions, coupled with the rising competition in the domestic market, led to a pricing pressure for the airline in its domestic markets. As a result, United expects its passenger unit revenue (measured by passenger revenue per available seat miles) to fall 5.25%-5.75%((United Investor Update, 9th July 2015, www.unitedcontinentalholdings.com)) during the June quarter, in line with the airline’s latest guidance. Thus, we expect this sharp fall in unit revenues to cause a decline in the airline’s second quarter revenues. The market expects United to report consolidated revenue of $9.93 billion, almost 4% lower compared to last year, in line with the company’s guidance.

Hedging Losses Will Reduce The Fuel Cost Savings

As the global crude oil prices continue to be remain weak during the June quarter, the Chicago-based airline’s fuel price is expected to average $1.98 per gallon((United Investor Update, 9th July 2015, www.unitedcontinentalholdings.com)). However, the airline expects its cash-settled hedging losses to amount to $0.19 per gallon, reducing the fuel cost savings for the quarter. Consequently, the airline has revised its operating margin guidance from 12-14% to 12-13%((United Investor Update, 9th July 2015, www.unitedcontinentalholdings.com)) for the second quarter. Despite this, we expect the airline to deliver a notable decline in its fuel expenses that will result in a significant earnings growth. The analyst forecast is for a profit of $3.31 per share, a more than 40% increase over the last year’s profit.

In a nutshell, despite facing pricing pressure in the domestic markets, we expect United to deliver a strong second quarter on the back of lower fuel costs.

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