United Airlines’ lofty margin goals draw scrutiny, after a tepid market guide for 1Q2017
United Airlines has now joined most of its airline peers in officially declaring it too will achieve a positive unit revenue result in 2017; but its unit revenue and margin outlook for 1Q2017 have created some uneasiness among investors who were clearly looking for a better forecast from the airline.
The company’s margin pressure and more conservative unit revenue outlook in early 2017, versus its rival Delta, are driven by rising labour costs, United’s higher exposure to the Pacific – where overcapacity has created challenges for the large global US network airlines – and, compared with the networks of its peers, the structure of its hub network in capturing traffic flows to warm weather destinations during the US winter season.
In late 2016 United ambitiously declared it would best Delta’s margin performance by 2020. Now that the airline has drawn that line in the sand, United’s margins will be closely watched as a benchmark for progress in meeting that goal.
United joined its larger global network rivals and Southwest in late 2016 in refining its 4Q2016 passenger unit revenue forecast due to a better than expected Dec-2016 in which close in bookings continued to strengthen and yields also started a slow recovery.
See related report: US airlines: a turnaround in unit revenue just as cost pressures rise in 2017
Originally, United projected a 3% to 4% decrease in passenger unit revenue for the final quarter of 2016, but later revised its outlook to a decline of 1.25% to 1.75%.
The airline recorded a decline of 1.6% in PRASM for 4Q2016 and a 1.8% drop in total unit revenue, which was a better result than Delta’s decline of 2.7%. United outperformed Delta in its unit revenue performance in every geographical entity in 4Q2016.
United and Delta's 4Q2016 PRASM performance by geographical regions
|United||1.2% decrease||2.8% decrease||6% decrease||7.3% increase|
|Delta||2.7% decrease||6% decrease||8.8% decrease||5.2% increase|
United joined Delta and Southwest in recording a bump in US demand after the country’s presidential elections in Nov-2016, and cited higher than expected business demand in Dec-2016. The company stated that it believed the US pricing environment would continue to improve, but that many unknown risks remain in the market place.
United offers a more conservative 1Q017 unit revenue forecast than Delta's
The domestic entity was United’s best geographical performer in 4Q2016 as the strength in close in bookings among corporate travellers that had begun to take hold in late 3Q2016 continued throughout YE2016, and this appears to be holding steady in early 2017. United’s passenger unit revenue forecast for its domestic markets during 1Q2017 is a flat to positive performance.
United recorded its worst unit revenue performance in the Pacific during 4Q2016, driven by competitive overcapacity, a trend that has remained stubbornly in place for more than a year. United expects to post a PRASM performance in 1Q2016 that is similar to that of 4Q, when its Pacific PRASM fell 6% year-on-year. (See chart above.)
United president Scott Kirby has said that industry supply pressure on Pacific routes would be the most intense in 1H2017, but that caps in the bilateral between China and the US should be met by 2H2017, which will drive some improvement later in the year.
However, Mr Kirby cautioned that he was uncertain that United would achieve a positive PRASM result in the Pacific during that period. United has a larger exposure to the Pacific than its peers. For the week of 16-Jan-2017, United has the greatest ASM deployment into Northeast Asia among the large US global network airlines.
American, Delta and United ASM deployment to Northeast Asia: 16-Jan-2017 to 22-Jan-2017
The company has determined that capacity pressure in the trans Atlantic was starting to ease in 1Q2017, but is forecasting a PRASM performance for the quarter that is similar to 4Q2016, when its passenger unit revenue fell 2.8% year-on-year.
A 40% improvement in Brazil’s PRASM helped lift United’s Latin America PRASM 7.3% year-on-year as capacity between the US and Brazil became more rational in 2016. The airline expects to maintain a positive PRASM performance in its Latin entity in 1Q2017, but its performance will not be as strong as in 4Q2016.
United is predicting a system PRASM performance in 1Q2017 ranging from a decline of 1% to a positive 1% improvement. Its forecast is more conservative than Delta’s projection of flat to a 2% increase.
The disparate projections have triggered some questions among investors, even as United has joined its peers in declaring it will attain a positive unit revenue result in 2017. United's rivals American and Delta made those declarations weeks before United ultimately concluded that it would also achieve a positive performance.
United believes lack of visibility makes unit revenue forecasting difficult
In an attempt to explain the difference in 1Q2017 unit revenue forecast between United and Delta, the airline's executives remarked that basically – visibility in forecasting is poor due to the variability of available data.
Indeed, in the past Delta has missed targeted timeframes for a return to positive unit revenue, and has admitted weakness in predicting when it would turn a corner in its unit revenue performance.
See related report: Delta Air Lines: cost pressure drives margin compression in 2017. Revenue generation is paramount
United has also said that it has less exposure to Florida and the Caribbean, given that it does not have hubs in the US southeast to flow passengers to those warm weather destinations, such as Delta’s Atlanta hub and American’s hub in Charlotte.
Mr Kirby stated: “...the first quarter is always the lowest quarter for United compared to Delta and American, but it is just about where our hubs are”.
United sets itself up for margin scrutiny after declaring lofty margin goals
United has guided to 1Q2017 pretax margins that range from 0.5% to 2.5%, after recording a 4Q2016 margin of 10.4%. The company’s FY2016 pretax margin was 12.2% compared with 16.7% for Delta.
United has pledged to best Delta’s margins by 2020 (using each company’s 2016 performance as a baseline). United’s 1Q2017 margin guide does little to engender confidence that it will record marked margin improvement in 2017, but company management has reiterated that 1Q is typically the airline’s weakest of the year, and in 2017 (in particular) United is facing labour cost pressure and rising fuel prices. During 1Q2017 United is forecasting a rise in unit costs excluding fuel, profit sharing and special items of 4.5% to 5.5%, 4% of which is attributed to new labour deals ratified in 2016.
Delta is facing is own margin pressure in 2017, previously concluding that its operating margins would fall 100 to 200 basis points below its stated goal of 17% to 19%.
Its margin pressure is also driven in part by new labour agreements. The airline’s forecast operating margin for 1Q2017 is 11% to 13%, and its cost excluding fuel is projected to rise 5% to 7% year-on-year. Most of Delta’s cost pressure is weighted to early 2017, and the airline believes it should begin to see margin improvement in 2Q2017.
United is undeterred in its belief that it will close the margin gap with Delta, reiterating the opportunities it has with a new Basic Economy product debuting in 2Q2016. The airline has estimated that its product segmentation strategy should generate a USD1 billion benefit in 2020.
The company is also engaged in what it deems as other margin accretive activities, including a fleet renewal and improvements in its revenue management system. It is also trimming some management ranks – recently reflected in the departure of its chief commercial officer, who was only in the job for a few months.
See related reports:
- United Airlines Part 1: New management declares ambitions to usher in a new competitive era
- United Airlines Part 2: Sustaining balance sheet strength while declaring ambitious margin targets
As United works to begin and execute all the revenue generation and margin building initiatives it laid out in late 2016, the message the company is trying to communicate is that its goal to produce the best margins among the three large US global network airlines within three years remains intact. But by declaring those ambitions United has set itself up for close scrutiny of its margin performance on a quarterly and annual basis until it meets those goals.
United needs concrete goals for benchmarking, but also invites closer dissection
After flailing for many years, United is working through a significant effort to close the competitive revenue and margin gaps it holds against its large US global network rivals.
The company has outlined concrete plans to close the gaps and surpass the margin performance of rival Delta within three years.
Those goals are commendable, and arguably necessary in order for markets and investors to hold United accountable for meeting its goals. But it also sets United up for closer scrutiny, and if there is a quarter or two where United’s performance indicates it will fall short of meeting those goals, then markets will respond accordingly.