United’s 2Q Profits Surge As Fuel Prices Remain Depressed

United Continental Holdings (NYSE:UAL) released its second quarter operating performance on Thursday, 23rd July 2015, reporting an adjusted net income of $1.3 billion or $3.31 per share((United Announces Second Quarter Results Press Release, 23rd July 2015, www.unitedcontinentalholdings.com)), matching the analyst earnings expectations. This marked the highest ever quarterly profit delivered by the airline, driven by plummeting fuel costs due to weak global crude oil prices. Defying its earlier stance of maintaining capacity discipline, United grew its capacity during the quarter, pulling down its unit revenues significantly. As a result, the airline experienced a 4% decline in its revenue, slightly missing the market estimate. Going forward, we expect lower fuel costs to continue to drive the airline’s bottom line growth. In this article, we discuss the factors that impacted United’s 2Q results and the airline’s outlook going forward.

Source: Google Finance

Revenue Decline Due To Pricing Pressure

Unlike the previous quarter, United increased its system capacity by 2.3%((United Announces Second Quarter Results, 23rd July 2015, www.unitedcontinentalholdings.com)) during the June quarter driven by capacity growth in Latin America and the domestic market. While this growth resulted in a 1.3% rise in the airline’s passenger traffic, it pulled down the load factor (number of passenger flown per flight) by 1.4% to 86.3% during the latest quarter. Further, these expansions coupled with the rising competition in the domestic market, led to a 5.6% drop in the airline’s passenger revenue per available seat miles, a measure of unit revenue. Consequently, United reported quarterly revenue of $9.91 billion, against the consensus estimate of $9.93 billion.

Lower Fuel Expenses Boost Bottom Line Growth

Due to the weakness in the oil price market, the Chicago-based airline realized an average fuel price of $2.01 per gallon((United Announces Second Quarter Results, 23rd July 2015, www.unitedcontinentalholdings.com)) for the June quarter. However, the effect of these fuel cost savings was dampened by the hedging losses of $0.12 per gallon suffered by the airline. Thus, while United’s fuel cost savings amounted to almost a billion, they could have been much higher without these hedging losses. In addition, the airline’s labor costs went up by 12%, further reducing the impact of the lower fuel costs. Despite this, United managed to deliver an operating profit of approximately $1.5 billion, translating into a margin of 14.6%, beating the higher end of its previous guidance of 12%-14% margins. This enabled the airline to post an adjusted income of $1.3 billion or $3.31 per share, a more than 40% increase over the last year’s profit.

Strengthening Balance Sheet Through Share Buy Back, Reducing Debt, And Meaningful Investments

In an attempt to return value to its shareholders, United authorized a new $3 billion share repurchase program((United’s Investor Update, 23rd July 2015, www.unitedcontinentalholdings.com)) to be completed by the end of 2017. However, this has created an unrest among the flight attendants, who are demanding a share in the company’s profits. Despite the conflict, the airline has announced its new program. Further, the company expects to complete its previous repurchase program of $1 billion in the third quarter, almost two years ahead of schedule. This demonstrates the airline’s confidence in the sustainability of its operations.

In addition, the second largest airline prepaid $800 million in debt, contributed $620 million to its pension plans, and repurchased shares worth $250 million during the quarter((United’s Investor Update, 23rd July 2015, www.unitedcontinentalholdings.com)). The legacy carrier also made important investments to strengthen its operations.  For instance, United invested $100 million to acquire a 5% stake in Azul Brazilian Airlines which will enable it to offer code sharing flights to different destinations in Mexico. The airline also invested $30 million in Fulcrum BioEnergy, an alternative-fuels company. In order to streamline its flights, last month United announced its plans to consolidate its transcontinental flights to the East Coast at its hub at the Newark Liberty Airport from the John F. Kennedy Airport, in the last quarter of the year.

Outlook – Third Quarter and Beyond

Despite the fear of oversupply of seats in the market, United expects to grow its system capacity by 1.25%-2.25% in the third quarter and 1%-1.5% for the full year((United’s Investor Update, 23rd July 2015, www.unitedcontinentalholdings.com)). Since this is expected to create  pricing pressure, the airline projects its unit revenue to fall 5% to 7% in the next quarter. The airline projects its third quarter international unit revenue to drop by 11% due to foreign currency headwinds and lower international surcharges.  Accordingly, United expects to deliver a pre-tax earnings margin (excluding special items) of 13.5%-15.5% during the September quarter.

Source: Deutsche Bank Industrial and Basic Materials Conference

Despite facing pricing pressure, United managed to deliver strong second quarter earnings on the back of lower fuel costs. Going forward, we expect these fuel cost savings to continue to boost the airline’s profits.

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