Last week, United Airlines Holdings (UAL -2.52%) announced a massive aircraft order and a bold new five-year plan. The airline giant plans to grow dramatically while shifting its fleet to significantly larger aircraft by 2026 to improve its profitability.
Management clearly recognizes the key shortcomings that have weighed on United Airlines' financial performance over the past decade. The company's growth plan tackles those issues head-on. But its planned expansion is likely to create new problems, as it will flood the domestic travel market with capacity.
Extraordinary growth plans
United Airlines announced two big aircraft orders on Tuesday. It will buy 50 more 737 MAX 8s and 150 additional 737 MAX 10s from Boeing, along with 70 A321neos from Airbus. These deals add to United's nearly 300 outstanding orders for mainline aircraft as of March 31: 180 737 MAX jets and nine 787-10 Dreamliners from Boeing, along with 50 A321XLRs and 45 A350-900s from Airbus.
Most of these jets will arrive by 2026. In fact, United now has 138 aircraft deliveries scheduled in 2023 alone. About 300 of the nearly 500 deliveries coming between now and 2026 will replace older, less efficient jets. But most of the jets being retired are single-class 50-seat regional jets, whereas the bulk of the new deliveries are 737 MAX 10s and A321neos that will likely accommodate 190 to 200 seats each.
A United Airlines 737 MAX 9. Image source: United Airlines.
As a result, the combination of growing the fleet count and shifting to much larger jets will increase United Airlines' capacity at a 4% to 6% compound annual rate through 2026, relative to 2019.
That might not seem especially fast. But U.S. air travel demand won't fully recover to 2019 levels until at least 2022. At the midpoint of its target range, United's 2026 capacity would be up 41% from 2019, with double-digit growth in 2023 and rapid capacity expansion continuing over the subsequent years.
What will happen to fares?
Replacing small regional jets with large narrow-body aircraft will boost United's average number of seats per departure in North America from 104 in 2019 (the least of any major airline) to 134 by 2026. This will help it reduce its non-fuel unit costs by 8% and boost its fuel efficiency by 11% compared to 2019. On the flip side, growing so quickly could weigh on average fares.
The carrier hopes to mitigate that fare pressure in several ways. First, its fleet transition will increase the proportion of premium seats (which command higher fares) in its domestic fleet. Second, by operating more flights in each bank at its big hubs, United will significantly increase the number of feasible connecting itineraries. That should help it gain market share, all else equal. Third, the aircraft replacement program and cabin upgrades for the remaining fleet will improve the customer experience, making United a more desirable airline to fly.
Management estimates that it could generate an adjusted pre-tax margin of 14% by 2026 -- up from 9.4% in 2019 -- even if unit revenue remains 1% below 2019 levels at that time. The carrier believes this target is conservative.
Source: United Next investor presentation. TRASM = total revenue per available seat mile. CASM = cost per available seat mile.
However, United Airlines is planning for an unprecedented amount of growth for an airline its size. Meanwhile, there's very little chance that U.S. travel demand will grow 40% or more by 2026. Indeed, it's possible that business travel would only get back to 2019 levels by around then. And rivals aren't going to let it gain massive market share without a fight. Thus, United's growth plan could cause fares to erode far more than management anticipates, offsetting the benefit from its unit cost reductions.
Going way out on a limb
To pull off its growth plan, the airline expects to ramp up adjusted capital expenditures from $4.5 billion in 2021 and $4.2 billion in 2022 to a stunning $8.5 billion in 2023. Capex will likely remain elevated at least through 2026.
Despite this heavy capital spending, management claims that adjusted net debt will top out at $25 billion for the next few years. By 2026, United projects that adjusted net debt will fall below its pre-pandemic level of $18 billion.
Yet if demand grows less than projected or the company's rapid growth triggers fare wars, unit revenue and profitability could fall well short of United's targets. That would lead to lower cash flow, driving the company's debt load higher. While the airline could change course and retire additional mainline jets to slow its growth rate, it still runs the risk of having significantly more debt and lower profits than anticipated a few years from now.
If everything goes exactly to plan for United Airlines, shares of the airline giant will soar over the next five years. However, I'm skeptical that it will be able to grow as much as it plans without driving its fares significantly lower. Investors should probably stick with proven winners in the airline industry for now.
