Expect A Jump In United’s 3Q Earnings On The Back Of Lower Fuel Costs

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United Airlines Holdings

Even after facing several ups and downs in the last three months, we expect United Continental Holdings (NYSE:UAL) to release a strong set of numbers for its September quarter on Thursday, 22nd October 2015 [1]. We anticipate the depressed fuel prices to be the major driver of the airline’s earnings growth, though the third quarter revenues are likely to be weak given the foreign currency tailwinds and competition in the domestic markets. For the next quarter, we presume that fuel cost savings will continue to boost United’s bottom line, while the managerial skills of the interim Chief Executive Officer (CEO), Brett Hart, will play a crucial role in the airline’s performance in the absence of the permanent CEO, Oscar Munoz, who is currently on medical leave following a heart attack [2]. In this note, we take a quick look at the key events that took place in the last quarter and how they would impact the airline’s 3Q results.

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Frequent Changes In The Top Management

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Almost a decade after exiting the bankruptcy proceedings, United finally managed to get a place in the S&P 500 Index in September this year. However, within a few days of trading in the Index, the airline’s President and CEO, Jeff Smisek, along with two other senior officials, stepped down in the wake of a federal investigation questioning their connections with the Port Authority of New York and New Jersey. The news was not well received by the investors, who ended up penalizing the airline’s stock. Although United was quick to find a replacement for the position internally in the form of Oscar Munoz [3], there was still a lot of uncertainty regarding the decision. Now, a month later, when everyone thought that things would start improving for United, the newly appointed CEO has suffered a heart attack. While the severity of his condition is unknown, the airline has appointed an interim CEO, Brett Hart, to take care of the airline’s operation in his absence. Though this is an unfortunate event for the airline, and the people involved, the frequent changes in the top management may not go down well with the investors.  Assuming that the interim CEO will have to remain on board at least for the next quarter, his managerial and execution skills will be vital for the airline’s December quarter performance.

UAL-Oct-Price

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Weak Unit Revenues To Drag Down Revenues

Just like most of the large US airlines, United, too, is having a tough time due to the strengthening of the dollar against other currencies and lower surcharges from international markets. In addition, the airline has been facing stiff competition from smaller domestic players such as Southwest and JetBlue, as well as Gulf carriers. Consequently, the Chicago-based airline expects its unit revenues to be down by 5-7% in the third quarter. Further, the second largest airline (by traffic) is expected to grow its system capacity by close to 2%, which is towards the higher end of its guidance of 1.25-2.25% for the quarter. However, the airline may not be able to attract passengers commensurate with this capacity expansion, which is likely to pull down its load factor (occupancy rate) for the quarter. Thus, we figure that United will see a drop in its top line in the September quarter.

Fuel Cost Savings – Sole Driver Of The Rising Profits

After recovering to more than $60 per barrel in the second quarter, the crude oil prices dropped again sharply to multi-year lows in the third quarter on fears of slower-than-expected growth in the Chinese economy. Consequently, oil prices remained depressed through the quarter, further reducing the fuel prices for most of the airlines. Based on the latest traffic release ((United’s Traffic Results For September, 8th October 2015, www.unitedcontinentalholdings.com)), United expects its fuel prices (including hedging losses) to average around $1.97 per gallon. However, if the airline had adopted a no hedging policy like its closest competitor, American Airlines (NASDAQ:AAL), it could have realized much lower fuel prices which could have further enhanced its margins. Nonetheless, the airline is likely to generate large fuel cost savings due to the slower-than-expected oil price recovery, which will bolster its September quarter earnings. United expects its third quarter pre-tax operating margin (excluding special items) to be in the range of 13.5-15.5%. We forecast the airline’s operating margin to be on the higher end of its guidance.

To sum it up, despite facing operational disturbances, we expect United to report strong third quarter earnings on the back of lower fuel costs. With a challenging outlook for the commodity markets, we predict that fuel cost savings will continue to be the largest driver of the airline’s profits, at least in the next couple of quarters.

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Notes:
  1. United To Announce 3Q Results, 15th October 2015, www.unitedcontinentalholdings.com []
  2. Brett J. Hart Named Acting CEO, 19th October 2015, www.unitedcontinentalholdings.com []
  3. Oscar Munoz Named CEO, 8th September 2015 []