Analysts Give United Continental Too Much Slack

United Continental (NYSE: UAL  ) -- the world's largest airline, for now -- reported second-quarter earnings late last month. The company earned $521 million before special charges last quarter, equivalent to EPS of $1.35. Officially, that beat the average analyst estimate for EPS of $1.29. However, it's hard to call United's recent results anything other than disappointing.

Yet airline analysts all too often let United off the hook for its underperformance. Over the last year or two, a pattern has emerged where United consistently produces lower profits (or bigger losses) than analysts expected at the beginning of the quarter. However, through a process of gradually lowering expectations through twice-quarterly investor updates, United has managed to keep Wall Street happy and participate in the airline industry's recent rally. However, United's weak financial results will eventually haunt the stock; hype and hopes can only get you so far.

A pattern of weakness
JPMorgan analyst Jamie Baker, who is one of the more bearish United analysts, recently pointed out that United's earnings have declined on a year-over-year basis for nine straight quarters. That makes up nearly all of United Continental's post-merger history. Indeed, if you look at Q2 of 2010 (before the United-Continental merger), the two carriers combined to produce adjusted net income of $746 million -- 43% above last quarter's total.

United's declining earnings trend is likely to reverse in the third quarter, but it will still fall far short of the $896 million United and Continental earned on a combined basis in Q3 2010, the last quarter before the two carriers merged. The average analyst estimate for Q3 profit has dropped from $2.24 to $2.03 in the last 30 days.

Based on United's recent investor update, those estimates are likely to continue falling. Unit costs are projected to rise 3%-3.6%, while the company expects unit revenue to increase 3%-5% for the quarter. This should produce a respectable increase from last year's EPS of $1.35, but not the 50% growth that analysts are currently predicting.

Meanwhile, competitors like US Airways (NYSE: LCC  ) and Delta Air Lines (NYSE: DAL  ) have been reporting record earnings results recently and are expected to continue growing earnings in the second half of 2013 and 2014. Delta has an especially promising road map ahead of it, including a $1 billion structural cost reduction initiative that is offsetting normal cost inflation.

United gets a pass
United's results for the past two years have been mediocre at best, especially in comparison to record earnings at peers like US Airways and Delta. Yet analysts have largely given United a pass, assuming (or hoping) that the company will catch up to competitors "next year". For example, while analysts currently project that United will earn $3.18 this year, the average 2013 EPS estimate was more than $6 in mid-2012.

Bob McAdoo of Imperial Capital recently told Crain's that he "can't think of anything that was particularly bad" in United's Q2 earnings report. By the company's standards, he may be right. United's Q2 profit was just slightly below its profit in the year-ago quarter. Yet Delta managed to grow its Q2 earnings by more than 40% year over year. By that standard, United's earnings look quite weak.

Foolish bottom line
Like many other companies in the airline industry, United Continental has achieved big stock gains in the last year. Just a week ago, the company's stock hit a new multi-year high. However, United's competitors have been backing up their stock gains with record earnings. By contrast, United has experienced declining profitability for nine straight quarters.

Analysts have been surprisingly forgiving of United, despite this prolonged period of weak results. While the company is expected to return to earnings growth this quarter -- finally -- it has a long way to go just to regain its 2010 level of profitability. With United clearly lagging its major competitors, its stock should be performing similarly. Yet United's stock trades at a premium to Delta based on current-year P/E ratio, and in-line with Delta based upon the forward P/E. As a result, analysts and investors should clearly favor Delta in a comparison between the two companies.

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