Is The Market Pricing United Fairly?

United Continental (NYSE:UAL) has had a rather eventful 2017. The first half of the year recorded better than expected results, with revenues and earnings consistently beating the consensus estimates. That said, financials in the second half were severely impacted on higher costs associated with adverse weather conditions that forced the airline to cancel more than 8,300 flights through Q3. Further, to add to investor’s woes, the company announced in Q4 that it will be increasing capacity through 2018 in an effort to maintain market share.  This was a major point of concern as strong increases in seat counts coupled with modest jumps in revenue could seriously challenge United at a stage where it faces higher costs, such as fuel.

In Q1 2018, revenues and earnings came in positively, reporting a rather balanced first quarter. At present the company’s stock is trading at around $67, which is in line with our price estimate as well. We have created an interactive dashboard to best explain the reasoning and method behind our valuation.

In general, United earns its revenues from four major sources: Passenger-Mainline, Passenger-Regional, Cargo, and Other. We expect the airline to post modest revenue increases across all divisions, consequently helping the overall top line expand.

One of the biggest points of concern for investors, as mentioned previously, is the management’s decision to increase capacity at a rate of 4-6% in 2018, which is about 50-250 basis points higher than the total capacity increase in 2017. Analysts across the board are worried that this could lead to an oversupply situation that forces key players to further discount (already low) ticket prices in order to compete efficiently. That said, the company has reiterated that it plans to increase capacity in a systematic and efficient way. In this respect, the airline has launched quite a few initiatives around segmentation, loyalty programs, and revenue management that should help boost sales over the coming years. While this is good news, we are yet to see what the overall impact on Passenger sales is going to be.

At Cargo, we expect the segment to post positive sales through the year as things in the overall global economic climate improve. Further, we expect the top line to also benefit from the heavy increase in e-commerce shipments the world over.

Other revenue typically constitutes baggage charges and other ancillary fees that are associated with passenger travel. As mentioned above, capacity cuts are expected to bring down overall ticket prices. While this is expected to hurt overall revenues, Other revenues are expected to increase on increased air travel, in general.

As one can see from the analysis above, United is in for a tough year in 2018. While overall revenues are expected to increase year over year, the rate at which sales grow could be quite constricted. In this respect, we believe there is little room for upside at the moment.