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3 Reasons United Continental Holdings Inc.'s Stock Could Fall

By Nickey Friedman - Oct 7, 2014 at 11:08PM

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Why are a deadly disease, larger planes, and fuel hedging items of concern for United Continental Holdings?

It's hard to make a case against United Continental Holdings (UAL -0.62%), but in the interest of a more balanced view to go with my previous bullish article, I'm going to give it the old college try. Aside from the historical enormous volatility across the entire airline industry in terms of both fundamentals and stock prices, United Airlines may have a few warts unique to itself that you should keep an eye on. Here are three concerns.

Source:  United Airlines.

Concern 1: Ebola is no laughing matter
As Fools, we strive to educate, amuse, and enrich, but the subject of the deadly Ebola virus is no joke. There has been already at least one scare involving a passenger who flew two connecting United flights. He exhibited signs of the disease and was ultimately cleared, thank goodness, while the company rushed to contact "several hundred" passengers who were on the same flights.

But the incident reminds us how sensitive the public is to flying risks, and one of those risks is contracting disease. Often when something happens to a particular airline, even through no fault of its own, it ends up with a paranoid public and a negative image that ultimately hurts sales and profits. With United Airlines being the second biggest airline, there is a very real risk of further incidents and possible lasting damage to its reputation if further similar incidents occur.

The CDC says there could be as many as 1.4 million people affected worldwide by January with the Ebola virus. If so, that alone could keep many scared people out of the air and crowded spaces. That would affect the entire international airline industry, since people never know who sat on their seats before them and where those previous passengers were last. If nothing else, it may seem safer to stick with a regional airline.

Concern 2: Speaking of regional airlines ...
United Airlines is slowly getting out of the regional airline business. While the company is confident this is a wise strategic move aimed at greater long-term profits, there can be no certainty that will prove to be the case.

According to its most recent conference call, at the beginning of this year United Airlines had 8% of its overall capacity consisting of 50-seat and smaller aircraft. It is now targeting a reduction to 5% by the end of next year, with the hopes that the sacrifice of these revenues and profits will be made up for by easier overall logistics and ultimately lower costs for the rest of its planes sharing the same hubs.

Regional airlines such as Southwest Airlines (LUV -0.92%), Allegiant Airlines (ALGT -1.21%), JetBlue Airways (JBLU -0.34%), and Hawaiian Airlines must be salivating. These four in particular have been rapidly growing sales and profits, and seeing United Airlines getting off their turf can only help them.

Is there perhaps a trend brewing involving travelers who prefer the smaller regional planes, perhaps for the ease of getting on and off and a better flight experience, at least among the public company players? Maybe United Airlines is making a mistake as it loses regional customers who may have later opted for trips on its bigger planes.

Concern 3: You might want to hedge your bets, since United isn't
All the talk in the world about fuel reduction, cost savings, and operational efficiency is great, but it might not have enough of an effect on United Airlines' ultimate cost: aircraft fuel. According to the company's SEC filings, aircraft fuel is the company's single largest expense. Luckily for United Airlines, oil and fuel prices have been in a tailspin lately, which makes things easier. For now.

The problem and concern is, what happens with fuel prices suddenly rise again? As of June 30, only 21% of its anticipated fuel requirements are hedged for the remainder of this year, 19% for next year, and less than 1% in 2016. As Fools, we tend to be long-term investors, and United Airlines isn't very well prepared in the near, medium, or long term for potential oil price shocks.

Perhaps even more concerning on that topic is the company's $2 billion in annual cost savings plan by 2017, which includes $1 billion in fuel savings. If United Airlines starts to fall shy of its stated goals, the temptation to reduce hedging and take a gamble may be even stronger as the market probably won't react too favorably to missed targets.

On that note, how can the company really give reliable guidance when it can't possibly know where fuel prices will be in the future, or if it isn't fully prepared to hedge against the worst? The vast majority of its go-forward fuel costs is wide-open exposed.

Foolish final thoughts
Overall, I'm a fan of United Continental Holdings stock, as I like what I perceive as a favorable risk-reward ratio, but there are very real risks and concerns that don't necessarily point to blue skies ahead. The airline business is already tough, and if just one thing goes wrong, sales or earnings could get pulverized.

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Stocks Mentioned

United Airlines Holdings, Inc. Stock Quote
United Airlines Holdings, Inc.
$36.97 (-0.62%) $0.23
JetBlue Airways Corporation Stock Quote
JetBlue Airways Corporation
$8.73 (-0.34%) $0.03
Southwest Airlines Co. Stock Quote
Southwest Airlines Co.
$36.65 (-0.92%) $0.34
Allegiant Travel Company Stock Quote
Allegiant Travel Company
$116.66 (-1.21%) $-1.43

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