United’s Capacity Restraint and Cost Cutbacks Will Enhance Its Margins

UAL: United Airlines Holdings logo
United Airlines Holdings

United Continental Holdings (NYSE:UAL) will release its first quarter operating results before the market opens on Thursday, 23rd April 2015. The airline continues to adopt capacity discipline to prevent an oversupply of seats in the market and maintain the current levels of air fares (Read: Restrained Capacity Addition Is Key To Sustaining Airline Industry Profits). Consequently, the airline’s flying capacity and passenger traffic is expected to remain flat during the first quarter [1]. United, the second largest US airline in terms of traffic, has delivered positive earnings surprises in each of the last four quarters. In the midst of weak oil prices, the market expects the airline to earn a profit of $1.41 per share, as against a loss of $1.33 experienced a year ago.

Our price estimate for United stands at $69 per share, almost 8% ahead of its current market price.

See our complete analysis for United Continental Holdings here

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Currency Fluctuations Could Pull Down The Margins

The recent fluctuations in the currency market are expected to create a dent on United’s unit revenue (amount collected from each passenger per seat for a mile of flight). The airline’s unit revenue for international passengers is expected to drop by 1% due to the strengthening of the US dollar during the March quarter. This will, however, be offset by a 1.5% increase in domestic unit revenue driven by strong air travel demand and capacity discipline by the airline [1]. As a result, the overall unit revenue of United is expected to remain flat during the quarter. According to analyst estimates, United will post consolidated revenue of $8.62 billion, a decline of 1% on a year-on-year basis, due to a fall in the ancillary revenue from its cargo and extra baggage fees business.

On the cost side, the currency fluctuations will likely reduce United’s non-fuel costs by 0.5% during the quarter. The airline forecasts its unit costs (excluding fuel costs and special items) to decline by 1.5% on a year-on-year basis [1], driven by the strong US dollar and cost efficiencies from its Project Quality efficiency program. Based on the preliminary statistics released earlier this month, United expects its fuel price to average $2.12 per gallon, higher than its previous guidance, due to an early termination of second quarter hedges. Overall, the airline estimates its pre-tax margin (excluding special charges) to be 6-7% for the latest quarter.

United’s capital expenditure is expected to be $755-775 million for the first quarter, lower than its previous guidance due to timing of certain non-aircraft projects shifting to later in the year.  The company spent approximately $200 million on the repurchase of shares of common stock during the quarter [1]. However, we do not expect the airline to start distributing dividends due to its high debt obligations.

Going Forward

Large network carriers, including United, have been facing pricing pressure due to the aggressive capacity expansions by low-cost carriers such as Southwest and JetBlue, and smaller carriers like Alaska Air. While the Chicago-based airline continues to restrict its capacity, the recent pullbacks by Delta in its international capacity, may force United to follow suit and announce capacity cutbacks or further limit capacity additions. Though this may help to ease  the pricing pressure in the market, it may negatively impact United’s top-line growth during the year.

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  1. United Announces Traffic Results for March, 9th April 2015, www.unitedcontinentalholdings.com [] [] [] []