Why Has United Continental’s Stock Price Risen To $73 Per Share?
The legacy carrier, United Continental’s (NYSE:UAL) stock price has been on an upward trajectory since October 2016. After falling slightly post its third quarter 2016 results, the stock price began ascending. This is primarily attributable to Warren Buffet’s investment in the airline sector at the time and diminishing yield pressure on the U.S. carriers. Furthermore, United’s stock got a major impetus in November, when CEO Oscar Munoz presented at the company’s investor day to lay down a comprehensive path towards future growth. Consequently, since October’16 to date, United’s price has risen over 35%.
In line with the company’s most recent earnings and the path it has laid down for future earnings growth, we have revised our price estimate for United Continental to $73 per share. Below we present some of the key reasons supporting the upward revision of the company’s valuation:
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Re-Focus On Domestic Routes
Historically, for United, international routes proved to be more profitable than its peers in the aviation market. United generated higher revenues from its operations internationally than domestically in the years 2012-2014. This resulted in the company focusing more on international expansion than domestic. The de-emphasis on domestic, led to lower frequencies and less connectivity through the network. However, over the last five years the scenario has reversed again, industry-wide, with domestic routes proving to be more profitable than international. Through 2016, the industry underwent a high pressure period, wherein the airlines saw their unit revenues constantly declining in the international markets (except Latin America). Keeping this in mind, United wants to align its interests such that a majority of the incremental growth comes from domestic routes. The following table lays down the company guidance for capacity, a majority of which is expected to come from domestic routes.
$4.8 Billion In Incremental Earnings By 2020
As mentioned before, CEO Oscar Munoz has laid down a very comprehensive path to improve United’s long-term earnings. Through a number of strategic initiatives, aimed at commercial enhancements, improving cost and operational efficiency, and promoting ancillary services, the management expects to generate $4.8 billion incremental earnings by 2020. The following table discusses the expected increment from the company’s various initiatives:
Cost Reduction Measures In The Face Of Rising Oil Prices
The carrier 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, owing to the newly ratified labor contracts, the company’s costs were seen trending upwards, especially in the 2H’16. In order to control its costs, in the face of rising oil prices, the company has undertaken a number of measures. Firstly, since the newly ratified contracts become amenable again only in 2021 (pilot contract in 2019), the company expects unit costs, excluding fuel, to increase at a conservative rate of 1% y-o-y post 2017. Secondly, United is undertaking upgauging initiatives, such as installing slimline seats and increasing the number of seats in existing aircraft, 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.
Moderating Capital Expenditure
United has aggressively spent on its fleet, to leverage the additional cash flows against falling fuel costs. However, given the company’s inability to efficiently use the existing capacity, as indicated by the deterioration in the load factor, the higher expenditure can be deemed superflous. In order to be more disciplined, going forward, the company has reviewed 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.
Consequently, the lower capital spending will allow the company to focus and invest its capital in high margin projects that will add upside to its stock in the long term.
Addition Of A New Service Class
United, at its investor call, announced the addition of another class of service in addition to its Economy Plus (Premium Economy, as per the above classification). This class of service, called the Basic Economy, is targeted towards the price sensitive customers. The Basic Economy will allow the travelers to only pay for those services that they value. The move can be seen as a way to compete with low cost carriers such as JetBlue and Alaska Airlines. The launch date of Basic Economy is the first quarter of 2017, and will be available for the booking of Q2’17 onward. We expect this to add considerably to the company’s top line and even ancillary revenues.
Have more questions about United Continental (NYSE:UAL)? See the links below:
- United Continental Witnesses Significant Improvement In Q4’16, Outlook For Q1’17 Bleak
- United’s Unit Revenues To Show Improvement in Q4’16, But Higher Costs To Be A Drag On Earnings
- How Will United Continental’s Initiatives To Promote Operational Efficiency Contribute To Its Earnings?
- How Will United Continental’s Cost Savings Initiatives Add To Earnings Growth?
- How Did United Continental Perform Operationally In November?
- 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 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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