How Will United Continental’s Cost Savings Initiatives Add To Earnings Growth?

As a part of its five-year plan, United Continental (NYSE:UAL) CEO Oscar Munoz has laid down a comprehensive path to improve the carrier’s long-term earnings through a number of strategic initiatives, aimed at commercial enhancements, and improving cost, and operational efficiency. The new strategy is expected to generate $4.8 billion incremental earnings by 2020 for United. In earlier articles we have discussed United’s plan to optimize its network potential, by shifting the focus back to domestic routes (adding $1.45 billion to the company’s earnings by 2020), re-fleeting and upgauging initiatives to be undertaken to promote efficiency, benefits to be accrued from segmentation and fee bundling, and promoting operational efficiency.

Having already talked about some of the initiatives the company plans to undertake in order to promote operational efficiency, here we talk about other cost saving initiatives.

Despite weakness in its top line, United Continental managed to reign in its fuel and non-fuel expenses. Over the past year, the company has consistently shown improvement in its consolidated unit costs, primarily due to the positive impact of plummeting oil prices on fuel costs. The non-fuel costs incurred on salary, aircraft rent, and other general expenses also remained subdued. However, going forward, the company expects its costs, including fuel, to increase slightly owing to the recently ratified labor deals and rising crude oil prices.

The biggest contributor towards increasing costs at United are the newly ratified labor contracts. Following are the terms of the newly ratified contracts:

In FY 2015, wage expense incurred by United was $9.7 billion. As a result of the new contracts, the wages are expected to increase to $10.5 billion in 2016, and to $11.2 billion in 2017. On a positive note, most of these contracts become amenable again only in 2021 (pilot contract in 2019). Consequently, post 2017, the company expects unit costs, excluding fuel to increase at a conservative rate of 1% y-o-y.

1 excludes fuel, profit sharing, third-party expenses, special charges, the impact of certain primarily non-cash impairment, severance and other similar accounting charges. 

In order to offset the affect of rising wages and fuel costs, the company needs to be even more fiscally prudent than before. As a result, it has set a goal for itself to grow expenses at a pace slower than capacity, resulting in improved margins.

• Reviewing the fleet plan

United has aggressively spent on its fleet, to leverage the additional cash flows against falling fuel costs. However, this was unwise, given the company’s inability to efficiently use the existing capacity, as indicated by the deterioration in the load factor.

In order to be more disciplined, the company is reviewing its fleet plan. It hopes to convert four 737-700s to four 737-800s, to be delivered in the second half of 2017, while deferring the delivery of a remaining 61 aircraft and converting them to 737-MAX with no specified delivery date. These changes will allow United to take advantage of the superior fuel efficiency of the MAX aircraft, while also reducing capital expenditures by approximately $1.6 billion through 2018.

It is also modifying the capacity purchase agreement it entered to lease 24 Embraer. Under the new terms, it will be purchasing these aircraft and leasing them to third party carriers. The company said that the new agreement will result in a benefit of $100 million more than compared to the earlier lease arrangements.

• Upgauging

As of 2015, the number of seats per departure stood at 105. The company, with the help of its upgauging initiatives, hopes to increase this number to 119 in 2020. As a part of its upgauging initiative, United will be installing slimline seats, which although less comfortable, are effective in driving down unit costs. Consequently, in addition to an increment to earnings, we can expect to see some improvement in the company’s margins.

Accretion To Earnings

United expects its cost savings initiatives to become accretive to earnings in 2016 itself. The expected improvement in earnings from these initiatives is as follows:

Have more questions about United Continental (NYSE:UAL)? See the links below:

• How Will United Continental Benefit From Segmentation And Fee Bundling?
• How Does United Continental Plan To Optimize Its Network Potential?How Will United Continental’s Re-fleeting Initiatives Contribute To Its Earnings?
• United Continental Q3’16 Earnings Review: Unit Revenues Remain Under The Pump
• United Continental Q3’16 Earnings Preview: Capacity Cuts To Partially Offset The Decline In PRASM
• How Did United Continental Perform Operationally In September?
• What Is United Continental’s New Fleet Plan?
• Is China The New Growth Market For United Continental?
• How Did United Continental Perform Operationally In August?
• Why Are Airline Manufacturers Witnessing A Slowdown In Commercial Orders?
• How Is United Continental Driving Cost Efficiency?
• What Has Led To A 15% Fall In United’s Stock Price Since The Beginning Of The Year?
• Is A Turnaround In The Cards For United Continental?
• How Will United’s Equity Value Be Impacted If The Crude Oil Prices Rebound To $100 Per Barrel By 2018?
• How Will United’s Equity Value Be Impacted If The Crude Oil Prices Average At $50 Per Barrel In 2018?

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for United Continental

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