United Continental Is the Brooklyn Dodgers of the Airline Industry

From the late 1930s until the mid-1950s, the Brooklyn Dodgers fielded lots of good teams, but the franchise could never win the World Series. This inspired a common refrain among fans: "Wait 'til next year!" A better competitor -- often the Yankees -- ended the Dodgers' hopes every season until 1955.

In the past year and a half, United Continental (NYSE: UAL  ) has quickly become the Brooklyn Dodgers of the airline industry. The merger of United and Continental was supposed to create a global giant that would command a big revenue premium because of its strength throughout the U.S. and the world.

United Airlines was supposed to be a dominant global carrier by now (Photo: United Airlines)

Instead, United's leaders have adopted the Dodgers' common refrain, "Wait 'til next year." First, United reported a massive drop in profitability during 2012. But executives promised at the beginning of this year that the company would do much better in 2013. Nevertheless, United's performance has continued to lag. On Thursday, management basically threw in the towel for 2013, urging investors to "wait 'til next year" once again.

Weak earnings... again
Last quarter, United's top competitors posted big profit increases. Delta Air Lines (NYSE: DAL  ) grew earnings by 50%, helped by a combination of strong demand, lower fuel prices, and muted cost growth. US Airways (NYSE: LCC  ) reported an even more impressive 90% jump in pre-tax profit. Even the lowly -- and bankrupt -- AMR (UNKNOWN: AAMRQ.DL  ) reported a record Q3 profit of $530 million!

Delta was one of many airlines to report a big profit jump last quarter (Photo: Delta)

Meanwhile, United continued to underperform. The company contented itself with a 13.5% year-over-year increase in adjusted earnings to $590 million. That gave it by far the lowest pre-tax margin among the four network carriers.

United's EPS of $1.51 missed the average analyst estimate of $1.54. But that figure does not do justice to the scale of United's failure. At the beginning of July, analysts thought United would achieve EPS of $2.24 for Q3! Those estimates fell 31% from the beginning of July until today, as United worked to reduce expectations, yet they still overestimated the company's earnings power.

There are a number of factors working against United. Some of them may be fixable, such as inaccurate demand forecasting in the company's revenue management system. However, more broadly, United is facing increased competition from carriers with better cost structures.

For instance, United has been hurt by new competition from Virgin America on routes from Newark to Los Angeles and San Francisco. Delta's growth in the New York and Los Angeles markets (where United also operates hubs) also seems to be cutting into United's unit revenue.

Weak forecast... again
If shareholders hoped that things would improve this fall, they were sorely disappointed. The good news is that non-fuel unit cost growth will slow dramatically, and jet fuel prices have dropped over the past year. As a result, consolidated unit costs will decline year over year in Q4.

But a number of factors -- including a return to capacity growth, the government shutdown, continued competitive pressures, and revenue management mistakes -- will cause a simultaneous decline in unit revenue. While United's profit margin will still improve relative to Q4 2012, when it was badly affected by Hurricane Sandy, the company expects results around breakeven. Once again, that's well below the average estimate for EPS of $0.48.

Next year?
After a disappointing 2012, United entered 2013 with big profit improvement goals. As is its custom, United has fallen well short of those goals. Once again, United's leaders are telling investors to "wait 'til next year." By then, it expects to resolve its revenue management errors and improve its cost structure through initiatives like adding seats to its domestic Airbus fleet.

But there will be undoubtedly be other issues by then. Whether it's an increase in domestic capacity from the rapid introduction of large regional jets and small narrowbodies at Delta and AMR, stronger competition from a merged AMR-US Airways, or something totally unforeseeable, United will face new challenges in 2014.

In short, I am skeptical that United will close the margin gap vis–à–vis competitors within the next few years. Eventually, United may reach its "1955," when it finally makes a breakthrough and reaches the head of the airline pack. But there could be many more years of "waiting 'til next year" until that happens.

Two carriers that are making cash
Investing in inconsistent airlines like United Continental is a surefire way to lose your hard-earned cash. But two airlines are breaking all the rules by keeping costs low and avoiding direct competition -- leading to enviable profits. The Motley Fool's new special report tells you exactly how they do it. Click here to discover whether they can keep delivering big gains for shareholders!


Read/Post Comments (2) | Recommend This Article (1)

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 October 24, 2013, at 8:01 PM, Lindy wrote:

    The main reason United is failing is the CEO Jeff Smisek. As long as he's at the helm the airline will continue to flounder. He has alienated the employees and doesn't have their respect. He also doesn't have a clue how to run an airline. Hopefully his cronies on the board will eventually wake up and send him packing. Until a true visionary like Greg Brenneman or Richard Anderson is tapped to run it, the future will be filled with more excuses.

  • Report this Comment On October 24, 2013, at 10:18 PM, bburr4307 wrote:

    I'm afraid "Lindy" is correct in his post. Smisek was not the guy for the job. He had no idea what he was getting into when he took the helm. He had an excellent, content and productive work force at Continental and has tried to merge them with a group of disgruntled people who have known nothing but "us-against-them" for decades. That is a very tall mountain to climb and leadership is essential to the ascent. Merging was not the way to go to combine these 2 airlines. It would have worked better had Continental just bought United outright and absorbed them into the existing infastructure at Continental. Everyone thought that because the routing structures of the 2 were seemingly compatible, that it would work out and become a real force in the industry, and what it has turned into is similar to a snake oil saleman trying to convince the disbelievers. Someone much stronger than Jeff Smisek will be needed to get this done. Calling Gordon Bethune!!

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2697211, ~/Articles/ArticleHandler.aspx, 8/23/2014 1:42:37 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement