Last week, airline giant United Continental (NASDAQ:UAL) made a surprising announcement. CFO Andrew Levy has left the company, and will be replaced (on an interim basis, at least) by long-serving United finance executive Gerry Laderman.
This personnel change came as a complete surprise to most industry analysts. While CEO Oscar Munoz was quick to reaffirm the company's existing financial guidance, Levy's departure may indicate brewing problems at United Airlines.
This isn't normal
On the surface, Andrew Levy's departure from United Continental seemed to be on cordial terms. His boss, Munoz, stated that Levy left the company in better financial position than when he arrived. On his LinkedIn page, Levy simply stated, "As satisfying as this job has been, I am considering several exciting opportunities and will choose one in the coming weeks." In a memo to staff, he elaborated that he wanted to return to "more entrepreneurial pursuits."
However, it's unusual (to say the least) for a relatively young executive with one of the most prestigious positions in his field to leave after less than two years with no job lined up.
Indeed, several reports of conflict among United Continental's top executives came to light after Levy's abrupt exit. "My understanding is that Mr. Levy had become frustrated with some things at United that led to a point of no return," said industry analyst Henry Harteveldt (via Forbes). No specifics of his grievances have become public, other than that he may have had major disagreements with United's president, Scott Kirby.
Plenty of questionable moves being made at United
The news of recent executive clashes at United Airlines isn't very surprising. The company has embarked on an ambitious and extremely dangerous strategy in the past year or so. And while United's first-quarter performance and second quarter guidance were better than expected, there will be plenty of potential pitfalls in the months and years ahead.
First, United's profit margin is still on the decline. For the second quarter -- often the most profitable of the year -- the company expects to report an adjusted pre-tax margin between 9% and 11%, down from 13.2% a year earlier. For comparison, United Continental's full-year adjusted pre-tax margin was approximately 12% in both 2015 and 2016.
Second, despite this weakening profitability, United Continental has been taking on more debt to enable share repurchases. Total debt and capital leases surged by nearly $2.7 billion last year, while United's cash balance fell by more than $600 million. This strategy has helped prop up earnings per share (to some extent), but at the cost of making United more vulnerable in the event of an industry downturn.
Third, United Airlines plans to ramp up its capacity growth in the second half of 2018. Much of this additional capacity will operate during off-peak periods. While this strategy will reduce nonfuel unit costs, it will also put pressure on unit revenue, which United can hardly afford after the recent surge in fuel prices.
The exact subject of the disagreements between Levy and Kirby isn't known. However, many of United's recent strategic moves could have elicited sharp criticism internally.
Will management adapt?
In the years after the Great Recession, U.S. airlines routinely responded to rising fuel prices by tapping the brakes on growth. Airline executives reasoned that this was necessary to achieve the level of unit revenue growth that would offset their increased fuel costs. This strategy proved fairly successful over time, allowing airlines to gradually gain credibility with investors.
It will be interesting to see if United Continental's remaining management team proves equally adaptable. Just in the past month, the price of jet fuel has surged by about $0.20 a gallon. This will make it tough for United to stabilize its already-weak pre-tax margin in the second half of 2018 -- particularly if it increases capacity by 5% to 6% or more as planned.
Thus, even if the growth strategy formulated over the past year made sense with oil at $50 or $60 per barrel, it may not be viable with oil near $80 per barrel. If United forges ahead with its growth plan in an environment of high fuel prices, the results for shareholders could be ugly.