How Does United Continental Plan To Optimize Its Network Potential?

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To bring United back to its past glory days, CEO Oscar Munoz has laid down a comprehensive path to improve its long-term earnings growth 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. Through this series of articles, we discuss some of these initiatives undertaken by the carrier, and their effect on United’s earnings growth.

In this article we discuss United’s plan to optimize its network, by shifting the focus back to domestic routes.

Re-Focus On Domestic Routes

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Historically, for United, international routes proved to be more profitable than its peers in the aviation market. As can be seen in the following table, 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.

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The reversal likely stems from the uncertainty in Europe, and the slowdown being witnessed in many developing economies around the world, resulting in yield pressures in the Atlantic and Pacific.

However, going forward, United hopes to align its interests such that a majority of the incremental growth comes from domestic routes. This strategy will be helped by the fact that the carrier has hubs in the five largest markets (by traffic) in the U.S.

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Strategy For Atlantic Routes

Over the last few years, United’s share of the New York market has fallen 4 percentage points to 26%, despite having a major hub in Newark (EWR) which connects to New York. The company attributes this decline to rolling departures and the arrivals system it uses, as opposed to grouped departure and arrivals used by other airlines, which allows for more traffic connectivity. To give some perspective, in a grouping or banking system, several flights depart and arrive in a short period of time, resulting in short connection time for passengers. However, the system leads to higher costs by increasing the resources needed to handle the influx of passengers, and causing congestion or delays, and thus, inconveniencing customers. Comparatively, rolling departures are spread over the day and are consequently less expensive, but may cause the airline to lose out on connecting passengers by making connection times longer. Going forward, we can expect United, to re-bank its Newark hub, as it tries to make the airline the number one choice for passengers flying to Atlantic cities.

Chicago O’Hare (ORD), fourth largest market by traffic, is one of the United hubs for flights to the Atlantic and Pacific. As of the present, the region remains under-served with connectivity across only a few areas around the Chicago area. Although, here, the flights are banked together, the banking is less as compared to peers. The company expects to make this hub more universally directional, while increasing the level of grouping to serve more customers.
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Presence In Latin America

United Continental was one of the few U.S.-based carriers which decided to not take advantage of the restoration of ties between America and Mexico/Cuba. The strategy was to wait and watch how travelers react to the opening up of borders. However, not being a first-mover could have consequences for United. As the latest quarterly results of various airlines show, demand for travel to Latin American cities led to a recession in headwinds in unit revenues in the region. This, in turn, arrested the fall being seen in the metric for many quarters now. Given that the smaller carriers, such as Alaska and JetBlue, have established a relatively strong foothold in the area by introducing flights to numerous cities in both Mexico and Cuba, it may prove difficult for United to establish its Houston (IAH) facility as a gateway to Latin American cities.

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Strategy In Pacific

In contrast to its strategy in Latin America, United currently holds the largest amount of capacity of any airline between the U.S. and China. The carrier already has presence in the major business centers of the country, such as Beijing, Tai Pei, Hong Kong, and Shanghai. With its bases covered in the most prominent Chinese cities, United expanded its services in some of the more popular second-tier cities, namely, Chengdu, Xian, and Hangzhou. All the secondary cities had their services focused out of the San Francisco airport (SFO). United Continental hopes to continue growing aggressively in China to maintain its leading position, by expanding further into the country. Consequently, it has also partnered with a local carrier, Air China, in the country.

Legacy Carrier’s Existing Presence in China 

(as measured by seat capacity)

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Talking about some of its other domestic hubs, such as Los Angeles (LAX), Denver (DEN), and Washington Dulles (IAD), the company is on the path to improve the network from these areas. While Denver is the most profitable hub for United, with lowest cost per passenger, the relatively larger markets of LAX and IAD remain under-served. United hopes its initiatives across the aforementioned markets become accretive to earnings beginning in financial year 2017. The expected improvement in earnings from these initiatives is as follows:
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Have more questions about United Continental (NYSE:UAL)? See the links below:

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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