United Continental (NYSE:UAL) will announce its third quarter earnings this Thursday, October 25.  The airline has posted lower than expected earnings growth in the first half of the year. Its revenues increased 3% y-o-y to $18.5 billion, but its operating income declined 64% y-o-y to $304 million in the six months ended June 30, 2012.
This drop has been largely due to a 12.5% rise in fuel costs for the airline in the first half of the year.  In addition, in the second quarter, earnings were impacted from increased competition on Latin international routes that resulted in lower yield for the airline on these routes. Integration costs related to the merger between United and Continental have also impacted earnings in the year so far.
In the third quarter, fuel costs are not expected to rise much as crude oil prices in the third quarter of 2012 were comparable to the crude oil prices in the third quarter of 2011.  However, a decline in passenger traffic due to reduced capacity and intense competition from low cost carriers, particularly Southwest (NYSE:LUV) and JetBlue (NYSE:JBLU) on domestic U.S. and Latin international routes, will impact earnings growth for United in the third quarter.
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We currently have a stock price estimate of $21.72 for the airline, approximately 5% above its current market price.
The decline in capacity is expected to impact earnings in Q3
In the first half of 2012, United was able to cut its capacity without impacting its passenger traffic. Available seat miles (ASM), an indicator of capacity, declined by 0.2% y-o-y while revenues passenger miles (RPM) increased by 0.4% y-o-y in the six months ended June 30, 2012. As a result, the airline improved its yield by 3.4% y-o-y in the same period.  United also plans to reduce its capacity in the range of 0.5% – 1.5% in 2012, on a y-o-y basis to improve yields.
However, according to monthly traffic reports released by the airline, its capacity cuts in the third quarter have impacted its passenger traffic. Available seat miles declined by 2.1%, 0.6% and 1.3% in July, August and September respectively, on a y-o-y basis. As a result, passenger traffic (RPM) declined by 2.8% in July, increased by 0.4% in August and again declined by 2.1% in September, on a y-o-y basis.    This decline in passenger traffic will likely impact passenger revenues for the airline in the third quarter as passenger revenue per available seat mile (PRASM), an indicator of passenger fares, also declined y-o-y in each of the three months of the third quarter.
Integration costs will continue to impact earnings
Integration costs related to the merger between United and Continental have also impacted earnings for the carrier over the past few quarters. In the first half of the year, the carrier incurred $271 million in integration costs,  and we anticipate these costs to continue to impact margins for the airline in the third quarter.
Fuel costs expected to remain stable
Also the September traffic report released by the airline states that the anticipated average fuel cost for the third quarter is $3.19 per gallon.  This compares to $3.13 per gallon it incurred in the third quarter of 2011.  This marginal rise in fuel price coupled with the decline in the amount of fuel consumed owing to lower capacity is not expected to impact margins much.
All in all, United will post a tough third quarter on account of decline in its passenger traffic.Notes:
- United To Hold Live Webcast Of Third-Quarter 2012 Financial Results, October 3 2012, www.unitedcontinentalholdings.com [↩]
- 2012 Q2 10-Q, www.unitedcontinentalholdings.com [↩] [↩] [↩]
- Oil price performance in the last 2 years, www.moneyweek.com [↩]
- United Reports July 2012 Operational Performance, August 8 2012, www.unitedcontinentalholdings.com [↩]
- United Reports August 2012 Operational Performance, September 10 2012, www.unitedcontinentalholdings.com [↩]
- United Reports September 2012 Operational Performance, October 8 2012, www.unitedcontinentalholdings.com [↩] [↩]
- 2011 Q3 10-Q, www.unitedcontinentalholdings.com [↩]