Like virtually all passenger airlines, United Continental (NYSE:UAL) runs a cargo operation as a side business. Cargo makes up a very small percentage of United's revenue -- last year, cargo revenue of $1.02 billion represented 2.7% of United's total revenue -- and so investors often overlook it when analyzing the business.
However, cargo makes a significant contribution to airline profitability. The marginal cost of putting cargo on a flight that is already going to operate is fairly minimal. Unfortunately, United has been suffering from market share losses and weakness in the global cargo market. If anything, this weakness has been accelerating, and could undermine the company's already thin margins.
Falling cargo volumes
United's cargo issues began last year, and contributed to the company's collapsing profitability in 2012. United's cargo revenue of $1.02 billion in 2012 was down 12.8% year over year, after a relatively flat performance in 2011. Cargo revenue declined another 14% in the first quarter of 2013 but saw mild sequential improvement in the second quarter, falling 10.9% on a 9.2% drop in cargo ton-miles.
However, the bottom seems to have dropped out this summer, based on the monthly statistics United provides. United's cargo ton-miles dropped 18% in July and 16.5% in August, well below the already dismal pace established in the first half of the year.
We won't know until United reports third-quarter results next month whether the carrier was able to improve yields (the price charged for carrying a ton of cargo one mile). However, given the weakness of cargo traffic and United's performance in the first half of 2013, it looks like United's cargo revenue will fall by as much as 20% this quarter, relative to last year's $246 million figure.
Losing share in a weak market
It's no secret that there has been a recent oversupply in the global cargo market. FedEx (NYSE:FDX) has already reduced cargo capacity twice in 2013, and the company's management has forecast relatively weak global GDP growth going forward. FedEx has relied on cost-cutting programs to grow earnings recently, because of the weakness of the air freight market.
However, market factors are not the only thing holding United back. The company also seems to be losing cargo market share. While United's cargo traffic (as measured by cargo ton-miles) is down 12.8% year to date, Delta Air Lines' (NYSE:DAL) cargo traffic is down just 3.2%, while AMR's (UNKNOWN:AAMRQ.DL) cargo traffic is almost flat.
It's not clear why United is struggling so much in cargo compared with Delta and AMR. It may be that Delta and AMR are offering deeper discounts to gain share; both companies have seen deeper yield erosion than United this year. In any case, cargo performance is definitely something that airline investors should keep an eye on.
If United's cargo revenue falls by 20% in the third quarter, that would create a headwind to EPS of about $0.10. That's relatively small compared to the average analyst estimate for EPS of $1.97, but not insignificant (especially over the course of a full year). As long as cargo revenue continues to fall, United will have a hard time catching up to its competitors in terms of profitability.
Adam Levine-Weinberg is short shares of United Continental Holdings and is long January 2015 $100 calls on FedEx. The Motley Fool recommends FedEx. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.