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3 Reasons United Continental Stock Could Fall

By Dan Caplinger - Mar 7, 2016 at 8:03AM

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Good times for airlines have lasted for a while, but there are reasons to fear that a reversal is at hand.


Image source: United Continental.

Airline giants United Continental Holdings (UAL -1.64%), Delta Air Lines (DAL 0.00%), and American Airlines Group (AAL -1.37%) have all posted impressive share-price gains in recent years, and favorable conditions in the industry have conspired to bring huge profits to the industry. In particular, United Continental has benefited from a combination of new revenue from baggage fees and other ancillary charges as well as reduced expenses on fuel. Yet over the past year, investors have gotten nervous about the sustainability of the airline industry's upward movement, and they've left United Continental stock largely unchanged since early 2015. Let's look at three reasons United Continental stock could fall from current levels.

Labor issues
United Continental has run into some recent difficulties in contract negotiations with key labor groups, and the impact on worker morale remains to be seen. According to the latest updates from the United Negotiations website, the airline has made progress with the machinists and aerospace workers union, but the technicians union voted against a proposed agreement and will require further negotiations. Pilots ratified a contract extension, and dispatchers reached a tentative agreement with the airline. Flight attendants met for mediated negotiations back in January, having reached tentative agreements on certain issues while leaving others unresolved.

Labor discussions can be difficult, but the challenge United Continental faces right now is how to share its profits in a way that won't become problematic if the industry turns. More importantly, if poor results in negotiations lead to a drop in profits, shareholders could send the stock lower in response.

A jump in fuel costs
United Continental has watched its earnings climb dramatically as a result of the plunge in jet fuel prices. Those costs have continued to come down throughout 2015, and the positive impact on United Continental's bottom line has been sizable. Annual spending on aircraft fuel dropped more than 35% to $7.52 billion in 2015, which was down about $4.15 billion from the previous year. If you note that United Continental's operating income was $5.17 billion, you'll realize that fuel savings made up about 80% of the airline's bottom line last year.

Yet energy prices can rise as quickly as they can fall, and if they do, higher costs could have a lot of downward pressure on earnings. One reason why earnings multiples for shares of United Continental, as well as Delta and American, are so low is that investors already anticipate some declines in net income when fuel returns to more normal levels. Nevertheless, a quicker than expected rise in fuel costs could hurt earnings even more, and the stock could fall in response.

Heightened competition
United Continental has a reputation for lagging behind fellow major airlines Delta and American. In particular, the company has suffered from a profitability gap, sporting margins that in some cases were substantially lower than those of United's peers.

In 2015, United Continental closed the gap considerably, using its fuel-cost savings and other factors to bring pre-tax margins to 11.9%. That was within 2.5 percentage points of Delta. However, its guidance for early 2016 suggested that margins could start falling again because of reduced passenger unit revenue. By contrast, Delta expects widening operating margins, the net result of which would be to make the profitability gap even larger than in the past.

One big challenge for United is that traffic to and from its Houston hub is especially sensitive to energy-market conditions. That gives it a competitive disadvantage during times of weakness for the energy sector. Investors hope that United's margin issues will prove to be seasonal and fleeting in nature and that the airline will improve its performance as 2016 progresses. If that doesn't happen, though, disappointed investors will likely respond by bidding down the stock.

United Continental has a history of doing well, but recent share-price performance has been subpar. If these issues go against the airline, outright declines in the stock price are quite likely.

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Stocks Mentioned

Delta Air Lines, Inc. Stock Quote
Delta Air Lines, Inc.
DAL
$29.53 (0.00%) $0.00
United Airlines Holdings, Inc. Stock Quote
United Airlines Holdings, Inc.
UAL
$36.06 (-1.64%) $0.60
American Airlines Group Inc. Stock Quote
American Airlines Group Inc.
AAL
$13.70 (-1.37%) $0.19

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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