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United Airlines Is Slimming Down to Grow Earnings

By Adam Levine-Weinberg - May 31, 2016 at 3:05PM

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United is dropping a slew of underperforming routes to stabilize its unit revenue performance.

In recent years, United Continental (UAL 2.88%) has lagged behind its major airline peers in terms of profitability. Most of its problems stem from the poorly managed integration of United Airlines and Continental Airlines, which alienated once-loyal customers.

But United's route network has also been a source of problems. First, United operates one of its biggest hubs in Houston, where the weak energy market has hurt demand. Second, United's large global footprint has been a curse in recent years, as supply has grown rapidly, the dollar has strengthened, and demand has been weak in many key international markets. Third, United faces more competition in its hub markets than its rivals.

United Continental faces heavy competition at many of its hubs.

The result is that United has been saddled with many underperforming routes lately. As a result, it expects passenger revenue per available seat mile to plunge 6.5%-8.5% year over year this quarter. However, United is finally getting serious about cutting money-losing flights, which could be a sign that better times are ahead.

United takes a hatchet to energy market flights

During 2015, as the energy market crashed, United chose to maintain most of its flights serving energy industry customers. If the energy market had bounced back quickly, that strategy might have paid off. Instead, it looks like it could be many years before energy companies return to their free-spending ways. This necessitated a change in strategy.

United started by slashing its capacity to the Persian Gulf region. In addition to weak demand, it has also encountered withering competition there from fast-growing Middle Eastern airlines, led by Emirates. Thus, in January, United discontinued its route from Washington D.C. to Kuwait and Bahrain as well as its route from Washington D.C. to Dubai.

It has also started to cut routes within North America that relied heavily on energy demand. Earlier this year, it pulled out of the Elmira, New York market (near the Marcellus shale region). At the end of June, United will drop its flights from Houston to Ontario, California and Montreal and from Edmonton to San Francisco and Chicago.

Finally, United announced last week that it will end its route from Houston to Lagos, Nigeria -- the carrier's only flight to Africa -- at the end of June. The route was never very successful, and the downturn in energy market demand and currency controls in Nigeria exacerbated United's losses to the point that it is finally giving up.

United will discontinue its only route to Africa at the end of June.

Cutting back in weaker hub markets

United isn't limiting its route cuts to energy markets. It is also eliminating some routes in its weaker hub markets. In Cleveland -- which isn't even a true hub anymore -- United continues to downsize by cutting flights to non-hub markets. A month ago, it ended its nonstop Cleveland-St. Louis and Cleveland-Las Vegas routes.

Los Angeles is still officially a United Continental hub, but it too has seen gradual cutbacks due to stiff competition (which is only increasing). Thus, in August, United will stop flying from Los Angeles to New Orleans: a route served by four other competitors.

Focusing on bright spots

United Continental clearly has plenty of underperforming routes that arguably should have been cut earlier. Ending these flights should bolster the company's unit revenue performance, starting as soon as next quarter.

However, some of United's hubs are actually performing quite well. United's management has repeatedly pointed to Denver and San Francisco as markets that are supporting capacity growth.

San Francisco, as the epicenter of the global tech industry and the largest transpacific hub in the U.S., clearly has the most upside potential. In March, United began flying three times a week from San Francisco to Tel Aviv, another key tech industry market. It will use some of the capacity from its canceled Nigeria flights to expand the Tel Aviv route to daily service this fall.

United is also adding new nonstop routes from San Francisco to Singapore; Xi'an, China; Hangzhou, China; and Auckland, New Zealand, this summer. In most of those markets, United will be the only carrier offering nonstop flights to the U.S.

To thrive in the ultracompetitive airline industry, United Continental needs to be nimble. It can't afford to operate unprofitable flights just for prestige -- or even to please a small number of customers. In the past year or so, United has become more proactive about moving capacity to its top-performing markets. This new mind-set could lead to better results going forward.

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