28-Apr-2010 6:00 PM

United Airlines seeing signs of recovery, considering options for consolidation

Analysis

UAL Corporation posted a first quarter GAAP net loss of USD82 million, representing a USD300 million positive swing from the 1Q-2009 net loss of USD382 million, leading analysts generally to praise the Chicago-based carrier. It also reported a USD58 million operating profit compared to a USD282 million operating loss.

United Chair and CEO Glenn Tilton pointed out that the operating profit was the first 1Q operating profit in a decade, a feature especially significant since the quarter is traditionally its weakest period. He fairly crowed that United ended the quarter with the best net margin (-2.2%) of the five network carriers, while its 11-point unit revenue growth bested the industry. The net margin represented a 13-point improvement year on year. The company posted a 9.2 point improvement in operating margin to 1.6% and an 11.4 point improvement in adjusted operating margin to 1.4%.

UAL operating margin vs net margin: 1Q2007 to 1Q2010

Asian revenue up 30%

"This did not simply happen," he told analysts during the call yesterday. "[Our work is] generating returns, enabling us to leverage the improving demand environment and produce results in sharp contrast with our peers. These results are evident in Asia where our unit revenue was up 30 points compared to the largest carrier which reported essentially flat results for the Pacific."

Leading in PRASM

Mr Tilton also said the carrier's PRASM growth was up 19% to 11.73 cents calling it industry leading at some 11 points ahead of its peers. It was also up 6% year on two. He said that the company is not adjusting year-end guidance. In April, the company had USD4.5 billion of unrestricted cash, about 27% of trailing 12-month revenues. He called its liquidity position among the best for network carriers and reported limited fixed obligations.

UAL consolidated PRASM and PRASM growth: 1Q2008 to 1Q2010

On a year-on-two basis, the company reported a 5.2% increase in Mar-2010.

UAL PRASM year-on-two growth: Jan-2010 to Mar-2010

Consolidation - "thoughtfully considering our options"

He tossed off inquiries about mergers by saying: "In the last several weeks much has been written about consolidation. At this time we are thoughtfully considering our options in that regard. Our position advocating consolidation as one of the transformational changes necessary to move our industry into a position of sustained profitability is well known. We will not comment further unless and until we have something to announce." And no matter how analysts crafted their questions, the company would not budge.

However, reports circulated in the Chicago Tribune during the day that the current negotiations with Continental could end in a deal by week's end although Monday the New York Times reported the talks were stalled on price. "A source close to the talks told the Tribune that the carriers remain on track to wrap up a deal during the next few days and that price is the only major issue yet to be resolved." The Continental brand would vanish with so many other venerable airline names.

The price issue made Stefel Nicolaus Hunter Keay's question interesting as he tried to get Mr Tilton to discuss what Keay said was a stock price that was woefully undervalued. He wanted to know whether the company could justify selling at that price. But no dice, the United CEO wasn't talking.

Must be "net of synergy, net of complexity, net of dis-synergy, net of breakage"

However, in response to JP Morgan's Jamie Baker asking Mr Tilton to describe the key criteria for closing a merger, he noted that mergers not only come with synergies but dis-synergies. "The stars have to be aligned across the full spectrum for any two companies to consider going down this road," he said, adding that in that respect airlines are no different than any other industry. "But the unique considerations airline managements have to consider are the solutions created by the value of any particular deal. Net of synergy, net of complexity, net of dis-synergy, net of breakage."

Responding to an earlier suggestion from US Airways Chair Doug Parker there is more to be realized from that airline's participation in the Star Alliance, Tilton noted there was more value to be extracted from every single alliance situation in which United is now involved. "These are relatively immature constructs across the Atlantic and Pacific," he said. "There is more work to be done to come together in ways no one previously imagined."

When asked if the company is worried US Airways, the merger negotiations with which were dropped, would leave Star, Tilton quoted Parker has saying what is good for Star is good for US Airways. Indeed, Parker indicated he considered Star still the best alliance during his conference call yesterday.

Ancillaries up 4.5%

CFO Kathryn Mickells reported that ancillary revenues per passenger rose 4.5% year on year, to USD14, which offset a reduction in third-party maintenance work. United records much of its ancillary revenue for seat upsells, first and second bag fees and ticketing and change fees under passenger revenue. Increases in these fees, it said, resulted in a 0.8 point improvement in consolidated PRASM year on year and a 2.8 point improvement compared to 1Q-2008.

USD3.5 billion cash, USD12 billion in total debt

Ms Mickells also reported that the company finished the quarter with USD3.5 billion in unrestricted cash and that net debt was down nearly 30% since United exited bankruptcy in 2006. It closed the quarter with USD12 billion in total debt including off balance sheet obligations and USD7.8 million in net debt.

International unit revenue up nearly 30%

President John Tague reported that the 11-point consolidated unit revenue growth over its peers reflected the fact that United was the only one to report unit revenue growth versus 2008. "Whether you measure year on year or year on two or as a premium relative to the industry, we are delivering unmatched revenue results," he said. "International unit revenue was up nearly 30% and the paid load factor in the international premium cabins was up 16 points with yields up 20% driving and international premium cabin unit revenue improvement of over 40%."

He reported the largest increase in unit revenues year on year was in the Pacific at 30% against "our two competitors who were either flat or negative." Tague added that the Pacific performance was driven by a double digit increase in load factor and a 13% improvement in yield. China also showed strong unit revenue growth at 50% year on year.

Mr Tague broke out the Japan statistics, saying United's competitor networks were more concentrated in Japan. Unit revenue growth in that market grew by 20% for United with a like increase in the Australian market. The Atlantic unit revenue was up just over 25% on a 6% increase in load factor and a 17% increase in yield. He also reported that down gauging at Heathrow led to a 40% unit revenue increase year over year in that market.

April domestic passenger unit revenue expected up between 23% and 25%

Domestically, consolidated unit revenue jumped 14% on a two-point increase in load factor and an 11% increase in yield as capacity fell 1%. Mr Tague reported that April passenger unit revenue is expected to jump between 23% and 25% year on year, despite the impact of the Iceland volcano which forced the cancellation of 325 flights to Europe. This resulted in a 2.6-point drop in anticipated capacity and a revenue impact of between USD30 to USD35 million, already included in the April outlook.

"This management believes there is much more work to do and much more potential to be realized," he said. "The company that does the best work wins. More and more we are that company and more and more we realize just how much left to be done. Our relentless pursuit of United's full potential is not just borne of necessity but rather of the opportunities available to us."

Ms Mickells said mainline capacity for the second quarter would be down 1.4-2.4%, while consolidated would be up .3% to 1.3 percent in the second quarter including the volcanic disruption. She also reaffirmed earlier guidance for the year that mainline capacity would be up 1.1-2.1% while consolidated would rise a restrained .5% to 1.5%. She said for the year, CASM would rise 2%-3% on both a mainline and consolidated basis.

United follows industry in narrowing 1Q loss - "committed to margin leadership"

The company also reported a 19% year-over-year increase in consolidated passenger revenue per available seat mile (PRASM) to 11.73 cents for the first quarter, while keeping consolidated CASM increases to only 8.6% to 12.66 cents on a 3.3% capacity reduction to 32.9 billion. Consolidated yield improved 12.2% to 14.56 cents and consolidated load factor increased 4.7 percentage points year-over-year to 80.4%.

The severe winter storms in February reduced revenue for the quarter by approximately USD40 million. The reduction in capacity increased consolidated CASM excluding fuel by about a percentage point.

"We are pleased to report an operating profit in what is traditionally a weak quarter for United compared to our peers, clearly reflective of our efforts to drive systemic improvements that are delivering results across the company," said Mr Tilton. "We are committed to margin leadership, having produced the best net margin of the five major carriers this quarter, and are doing the work to put our company on the path to sustained profitability."

Mainline passenger revenue reach USD3 billion, on a 6.1% decline in ASMs to 28.1 billion, while regional affiliate passenger revenue came in at USD840 million, an increase of 27.5% while PRASM increased 8.7% to 17.55 cents on a 17.3% growth in ASMs to 4.7 billion.

Amounts include USD52 million and USD12 million of additional revenue within the mainline and regional operations segments, respectively, related to changes in the estimate of the number of frequent flier miles expected to expire.

Costs - mainline 1Q CASM up 8.3%, to 11.92 cents.

Total consolidated expense, including fuel and excluding non-cash net mark-to-market hedge gains and certain accounting charges, increased USD123 million, or 3.0% year-over-year for the first quarter. Consolidated expense, excluding fuel and certain accounting charges, was up USD39 million or 1.3%. Total GAAP consolidated expense, including these items, was up USD199 million for the quarter.

Mainline CASM increased by 8.3% in the first quarter to 11.92 cents. Consolidated CASM rose 6.5% year-over-year to 12.70 cents in the first quarter against a consolidated capacity reduction of 3.3% to 32.9 billion.

UAL CASM vs RASM 1Q2007 to 1Q2010

Mileage Plus

United has completed its annual estimate of the number of Mileage Plus frequent flyer miles that are expected to expire in the future, and reduced its net deferral of revenue by USD64 million for the quarter. The net deferral of revenue is expected to be reduced by a similar amount in the remaining quarters of the year. This reduction of the total net amount of revenue that is deferred to future periods better aligns our results with those of our peers, as United has historically deferred a higher percentage of the revenue it receives.

Regionals

United cited increasing capacity, rising fuel prices and changes in stage length and fleet mix for the increasing regional affiliate expenses. Expenses role 21.5% to USD815 million, but well below the USD840 million in revenue. CASM for regional affiliates rose 3.6% to 17.03 cents. Regional affiliate costs rose from USD107 million for aircraft rents in 1Q-2009 to USD111 million in 1Q-2010, while fuel expense increased $85 million or 51.8% to USD249, on a 34% increase in fuel price and a 13% increase in consumption. Regional affiliate costs, ex fuel increased USD59 million, or 11.8%, as a result of increase in regional affiliates capacity and changes in fleet mix.

In addition to rising fuel, the company said airport rents and landing fees created an overall unit cost headwind of about 0.8 points year-over-year during the quarter. This was coupled with rate increases on the completion of the two new O'Hare runways as well as infrastructure projects at Washington Dulles. In addition, the accelerated depreciation requirements of retiring aircraft set to be replaced by its new wide-body order, will cost the company USD24 million this year.

Total non-fuel operating expense increased by $39 million year-over-year in the first quarter, excluding certain accounting charges, or 1.3%, as the company continued its efforts to control costs and increase revenue. Distribution expenses increased $19 million, or 16.1%. The increase in passenger revenue was the primary driver of distribution expense increase. Other operating expense decreased $30 million, or 12.6%. The primary drivers for reduced other operating expense were better operational performance driving reduced interrupted trip expense as well as reduced capacity.

In the first quarter, the company generated $482 million of positive operating cash flow and $389 million in positive free cash flow, defined as operating cash flow less capital expenditures.

"While there is more work to do, we are encouraged by the significant improvement in all of our performance metrics that our people are delivering across the company," said CFO Mickells. "We improved our cash position, maintained our cost control, accelerated our revenue improvement and generated an operating profit. We made the right decisions to position us to outperform as the economic recovery takes hold, and, as our current results demonstrate, we are well on our way to margin leadership and profitability."

Guidance - a solid revenue recovery year

Current trends suggest that 2010 is likely to be a solid revenue recovery year, and we expect to see revenue-related distribution expense and the traffic variable cost from modestly higher load factors and higher cargo volumes rise as a result. We expect these revenue related expenses to drive over a point of increase in overall non-fuel unit cost.

The company expects both mainline and consolidated CASM, excluding fuel, profit sharing and certain accounting charges for the full year 2010 to be up 2.0% to 3.0% year-over-year. The company expects consolidated CASM, excluding fuel, profit sharing and certain accounting charges for the second quarter 2010 to be up 3.8% to 4.8% year-over-year.

For the full year 2010, "we are expecting mainline unit cost, excluding fuel and profit sharing, to be up 2.0% to 3.0%. Full year 2010 consolidated unit cost, excluding fuel and profit sharing, is also expected to be up 2.0% to 3.0% year-over-year."