United Reported Outstanding 3Q Numbers Driven By Plummeting Fuel Costs

As expected, United Continental Holdings (NYSE:UAL) released a strong set of numbers for its September quarter last week on the back of depressed fuel prices ^[1]. However, the airline’s top line suffered due to weakness in unit revenue given the foreign currency tailwinds and stiff competition in the domestic markets. For the next quarter, we expect that the fuel cost savings will continue to boost United’s bottom line, while the airline’s operational performance will depend on the execution skills of the interim Chief Executive Officer (CEO), Brett Hart, who is managing the affairs of the airline in the absence of the permanent CEO, Oscar Munoz. In this article, we briefly discuss the key highlights of the airline’s 3Q earnings release and its outlook going forward.

Source: Google Finance

Declining Unit Revenues Pull Down Revenues

United grew its system capacity by close to 2% during the September quarter, in line with its target for the quarter. The majority of this growth came from the international markets which grew at about 4%, while the domestic capacity remained largely flat during the latest quarter. Despite an increase of 2% in its passenger traffic, the network carrier could not attract passengers commensurate with its capacity expansions, which marginally pulled down its load factor (occupancy rate) for the quarter. In addition, a stronger US dollar and lower surcharges from international markets, along with domestic competition, led to a drastic fall in the airline’s unit revenue. The Chicago-based airline’s unit revenue declined by almost 6% during the third quarter, which led to a drop in its revenues.

Source: United Continental Holdings Form-10Q, 22nd October 2015

Fuel Costs Drive Earnings Growth

United Continental, the world’s second largest airline by traffic, reported third quarter revenue of $10.3 billion, 2.4% lower compared to last year. On the cost side, the airline experienced a significant decline in its fuel costs due to the depressed state of oil prices due to fears of an economic slowdown in China during the quarter. The Chicago-based carrier’s fuel price averaged at $1.97 per gallon, more than $1 per gallon lower than its realized fuel price in the same quarter last year. However, the airline’s fuel costs could have been lower by almost $0.25 per gallon, had the airline refrained from hedging its fuel consumption for the quarter, like its closest competitor American Airlines. Nonetheless, the fuel cost savings of more than a $1 billion boosted the airline’s operating income to $1.9 billion, representing a jump of almost 60% on a year-on-year basis. The legacy carrier generated an adjusted operating margin of 16.6% for the September quarter, which is much higher than its previous guidance of 13.5%-15.5%. This, coupled with the income tax benefit of $3.2 billion, enabled the airline to enjoy a net profit of $4.8 billion on a GAAP basis. On an adjusted basis, United posted earnings of $4.53 per diluted share, almost 65% higher compared to the third quarter of last year.

Source: United Continental Holdings Form-10Q, 22nd October 2015

Guidance

Since United’s CEO Oscar Munoz is on an indefinite medical leave, Brett Hart, the interim CEO, presided over the third quarter earnings call. He highlighted that the airline will focus on customer service, team work, and innovation, while operational safety will continue to be of paramount importance. Given the continued foreign currency pressures, United expects to slow down its international capacity growth, while pacing up its domestic capacity in the last quarter. This means that the airline will grow its total system capacity by 1%-2% during the December quarter, translating into full year capacity growth of 1.4%-1.7%. The airline foresees the unit revenue environment to somewhat improve, and provided a guidance of a 4% to 6% decline for the last quarter. The airline anticipates its fuel cost to average between $1.85 and $1.90 per gallon for the fourth quarter and $2.00 and $2.05 per gallon for the full year 2015. Consequently, the legacy carrier estimates its 4Q pre-tax operating margin to be in the range of 9.5% to 11.5%, as opposed to 5% margin earned in the same quarter last year.

Source: United Continental Holdings Form 8-K, 22nd October 2015

In a nutshell, we believe that while United’s bottom line will continue to benefit from the lower fuel costs over the next few quarters, its long term success will depend on the leadership skills of its top management.

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1. United Announces 3Q Results, 22nd October 2015, www.unitedcontinentalholdings.com [↩]