How Does Oil Price Movement Impact United Continental’s Valuation?

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United Airlines Holdings

The downturn in commodity prices that began in mid-2014 led to a turnaround in the fortunes of the US airline industry. Since fuel costs are the single largest operating cost for an airline, the sharp drop in oil prices has augmented the earnings of these airlines over the last few years. The airlines, in turn, have utilized the increased profits to revamp their operating fleet as well as balance sheet to return higher value to their shareholders. However, the rebound in crude oil prices over the last few quarters has resulted in a decline in the profitability of these airline companies. In this note, we show how a change in crude oil prices can impact the profitability as well as valuation of United Continental (NYSE:UAL) using our interactive dashboard.

A Rise In Oil Prices Could Lead To A Surge In UAL’s Fuel Costs

Since fuel costs are the major operating costs of an airline, a marginal change in crude oil prices can significantly impact its operating expenses, and, in turn, its earnings. However, airlines are aware of the volatility in crude oil prices, and consequently, hedge a large portion of their annual fuel consumption at lower oil prices in order to maintain their margins.

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Based on our analysis and company guidance, we believe that a $1 per barrel rise in the crude oil price could result in a 1% increase in United’s fuel cost. For instance, if the oil prices jump $5 per barrel higher than our base case estimate of $65 per barrel, it will cause the airline’s fuel expense to shoot up by 5% (blue bars). This will cause the airline’s net income margin to drop sharply, resulting in lower earnings per share.

Now, if we assume a P/E multiple of 10.3x for United Continental, we arrive at a price estimate of $62 per share, which is roughly 15% lower than our base case price estimate of $73 per share. Thus, we figure that United’s valuation is sensitive to the movement in oil prices.

Do not agree with our forecast? Create your own price forecast for United Continental by changing the base inputs (blue dots) on our interactive platform.

 

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