Shares of United Continental Holdings (NYSE:UAL) are flying high these days. The company's stock is flying at an altitude not seen since 2008 after it announced plans to cut annual spending by $2 billion over the next few years in a move to boost profits. Fuel efficient planes will play a big part as the planes are expected to contribute half of the company's savings. So, should consumers expect cheaper flights?
Well, that's not exactly what United Continental has in mind for its savings. Instead, it's hoping to finally be able to return some cash to its investors. If all goes according to plan, the company could employ a share buyback or even a dividend as early as 2015.
To get to that point, United Continental is banking on fuel efficiency to do most of the heavy lifting. The company sees its investments in fuel efficient planes such as Boeing's (NYSE:BA) 787 Dreamliners playing a big role in helping achieve this reduction.
Fuel costs currently make up 35% of industry operating costs and is volatile with the price of oil. However, by adding more Dreamliners to its fleet, as well as equipping existing aircraft with winglets, United Continental believes it can cut its fuel expense by 7%. For a company that is expected to spend $13 billion this year on fuel alone, that's a big savings.
The company sees further efficiencies to be gained by a 20% increase on the per-mile-flown basis in employee productivity, as well as lower maintenance costs from the new planes. That's in addition to the plan to boost its fee revenue by over $700 million by 2017. This will come from both unbundling of services as well as offering more choices to customers. So, in one sense customers could see greater value from their airline experience, even if actual ticket prices don't fall.
United Continental must address costs because its margins are much slimmer than peers like Delta Air Lines (NYSE:DAL) and US Airways Group (UNKNOWN:LCC.DL). This past third quarter, for example, United Continental's pre-tax margin was just 5.8%. That's half the rate of its rivals as Delta's pre-tax margin came in at 11.5% while US Airways' was 9.2%. While there are many reasons why United is earning less, how it manages fuel costs relative to its peers does play a role.
Delta, for example, took a unique approach to its fuel issues by purchasing an oil refinery last year. This past quarter the refinery even turned a profit. It sees results improving more in the future as it accesses cheaper domestic crude oil from places like the Bakken.
US Airways, takes another approach all together. The company has actually abandoned the traditional airline practice of hedging its fuel costs. While that leaves it vulnerable to near-term volatility, it found the high cost of hedging wasn't worth it. The move appears to be working, at least it should until the next oil spike.
Fuel costs will always be a concern for the airline industry. However, as more fuel efficient planes are delivered it should help keep costs down, which will be an important profit driver for airlines like United Continental. That said, passengers shouldn't expect to see lower ticket prices as a result. Instead, the extra savings will be passed on to the industry's long-suffering investors. That still doesn't mean it's time to throw caution into the wind and actually invest in an airline.
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