United Airlines Misses the Mark ... Again

On Thursday afternoon, United Continental (NYSE: UAL  ) issued an investor update in which the company cut its Q3 unit revenue guidance. United now expects unit revenue to increase by 2.5% to 3.5% for the quarter. The midpoint of United's new guidance is a full percentage point below the original 3%-5% range provided in July.

United recently reported weak unit revenue trends. (Photo: United Airlines.)

I've been very bearish about United's prospects for this whole year, so I'm not very surprised by the company's continuing underperformance. United's cost structure is uncompetitive compared with its peers, such as Delta Air Lines (NYSE: DAL  ) .

Meanwhile, its service quality lags Delta's: On TripAdvisor, only 38% of reviewers would recommend United, whereas 57% would recommend Delta. Higher costs and inferior service are a recipe for long-term financial problems. United investors would probably be better off putting their money elsewhere.

Revenue hits a snag
United blamed two factors for its weaker-than-expected Q3 unit revenue. Part of the reduction is due to lower yields on trans-Atlantic interline tickets (tickets that include flight segments on two different airlines). In addition, higher competitive capacity in China hurt transpacific unit revenue for September.

United has already reported unit revenue gains of 3.5%-4.5% in each of July and August, so the new guidance suggests that September unit revenue growth could be quite weak -- perhaps 1%. This is troubling, because September is probably a better indicator for fall season supply demand trends than July and August, which represent the summer peak season. As a result, United's Q4 unit revenue could also miss investor expectations.

Slow march of estimates
United investors have plenty of experience with reducing their expectations. Back in August, I highlighted the extent to which earnings estimates for United Continental have plummeted over time. In mid-2012, analysts on average expected United to earn more than $6 per share in 2013. Those estimates have since been cut in half!

For Q3 specifically, I noted in my earlier article that EPS estimates had fallen from $2.24 to $2.03 during July. Based on United's new guidance -- which should be fairly accurate, coming less than a week before the end of the quarter -- the final EPS figure is likely to be even lower, perhaps $1.80.

Lagging margins
United's weak earnings performance over the past two years sets it apart from the rest of the airline industry. United suffers from higher costs than its rivals, which it traditionally offset with a strong revenue premium. However, this revenue premium fell away in 2012, and it may never return, leading to permanent earnings underperformance.

For example, in the first half of 2013, Delta reported a 6.9% adjusted operating margin (this excludes restructuring costs). The comparable figure for United was 3.5%. Furthermore, Delta projected an operating margin of 11%-13% for Q3, whereas United's guidance implies an operating margin of roughly 8%-8.5%. United thus appears to be making no progress on closing its 300- to 400-basis-point margin gap with Delta.

No improvement on the horizon
United investors' best hope is that the entire airline industry continues to outperform the market, because United shows no sign of catching up to its rivals. This fall, Delta is beginning a major fleet restructuring program that will remove hundreds of inefficient 50-seat regional jets and older Boeing (NYSE: BA  ) 757 and 767 aircraft, replacing them with newer aircraft that are much cheaper to operate.

While United is also looking to become less reliant on 50-seat regional jets, its domestic fleet restructuring efforts are well behind Delta's. As a result, United's cost disadvantage is likely to become even worse over the next two years, putting further pressure on the company's margins.

United's perennial margin underperformance makes it an overly risky investment. The company can muddle along when times are good for the industry; today it is solidly profitable despite having much lower margins than Delta and US Airways (NYSE: LCC  ) . However, if industry conditions worsen, United will probably be one of the first airlines to run into financial trouble.

Weak margins make United an unsuitable investment for most individuals. But that doesn't mean you need to avoid the entire airline industry! The Motley Fool's new special airline report highlights two airlines with enviable profit margins. Click here to learn how these two airlines are leading a revolution in the industry, and discover whether they can keep delivering big gains for shareholders. Your copy is free today!


Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 28, 2013, at 12:44 PM, Tyeward wrote:

    It might be a really good idea to expand on joint ventures considerably with other star partners so that United can speed up the retirement of some of their gas guzzlers. The 747-400´s in their fleet would be a really good idea to get rid of as fast as possible. Getting the 767-200´s out the fleet wouldn´t be a bad idea either. United also has quite a bit of redundancy on some routes that really aren´t key market routes out of their hubs. Might be a good idea to reduce the frequencies on those routes and put those planes that you take off of high frequency routes that are redundant and place them within the network where they would be of better use. They really don´t need to cut jobs. They need to look at their network again and some of the equippment they use. Looking at their cabin configuration wouldn´t hurt either. If you have too much premium product but are not pulling in the numbers to justify having that much, shrink it or just get rid of it on some routes. Something to think about.

  • Report this Comment On September 29, 2013, at 10:42 AM, TMFGemHunter wrote:

    Thanks for the comment.

    It's not so simple to get rid of the 747s. United doesn't have any other aircraft even close to that size; the 747 has about 40% more seating capacity than United's 777s. While the trip cost is much higher for a 747, I would guess the unit cost is actually a little lower. Also, nobody's looking to buy used 747s these days, so if United retires them, it would have to write off the remaining value on the 747s, which would be quite significant. I think United will be happy to see the 747 gone in 10 years, but it's not practical to get rid of it now. I think the 767-200s are already retired.

    I agree that United is not generating much of a revenue premium from all of the premium seats in the fleet. Airline execs always talk about upgrades as high-margin revenue, but there are huge hidden costs from all the seats you had to remove to make more space up front.

    Adam

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