Continental Airlines reported a second quarter net profit of USD233 million, on a 19% increase in revenue to USD3.71 billion, matching analysts’ forecasts. The company cited higher fares and fees for the increase in revenues. Executive Vice President and Chief Financial Officer, Zane Rowe reported EBITDAR margin, excluding special items, was 19% - the best result for the carrier since 2003.
Operating income for the second quarter of 2010 was USD328 million, up USD482 million compared to the same period of 2009. The company cited an improving revenue environment, the slow return on business traffic and strong leisure demand, which is expected to continue throughout the summer.
Noting the carrier has been focused on reducing capacity, especially in underperforming markets, Chairman and CEO, Jeff Smizek said the carrier is continuing to do that by cutting domestic capacity this year by 12% compared to 2008. “I expect to continue this rigorous domestic capacity discipline as we look to optimise the merged carrier suite across the combined network,” he said. “Historically, substantially all of our profits have come from our international operations, so we are highly motivated to achieve an appropriate balance between our domestic and international capacity.”
Smizek was so adamant on this point that he drove it home again in response to a question. “I'm saying that we at Continental are very focused on returning to profitability and sustaining it, and in our merger with United, that is our focus as well,” he said. “We will have the capacity that we think is appropriate to make sure that we maximize our profitability and we will also allocate our capacity appropriately to markets where we're making money and we'll be thoughtful about capacity in markets where we're not making money.”
When asked if all this fiscal discipline across the industry was indicative of a new era in the airline industry, Smizek wasn’t sure. “I don't know that we're in a new era. I think that we went through some pretty rough times. The economy is recovering. That's a good thing. Airlines are focused on profitability, certainly we at Continental are, and we, combined with United, will be. We'll take all the actions that we need to take to not only restore ourselves properly, but to be able to sustain those through the business cycle. That's our goal and we're going to be very focused on that.”
Merger with United
Expressing confidence the two would gain approval and begin the merger process by year-end, Smizek briefed analysis on the progress. The two companies have several hundred employees divided into 30 functional teams which have already started meetings to outline the path for integration. It has also made all the necessary government filing here and abroad. It is working on compliance with the Department of Justice’s second request for information issued in early June but they have already granted DOJ an extension on its review of the second tranche of information beyond the 30-day statutory requirement.
The merger is expected to deliver USD1.0 billion to USD1.2 billion in net annual synergies by 2013, including between USD800 million and USD900 million of incremental annual revenues, in large part from expanded customer options resulting from the greater scope and scale of the network, and additional international service enabled by the broader network of the combined carrier. The companies continue to make good progress with merger integration planning and have achieved important milestones on their path toward closing the merger, including making required filings with the Department of Justice, the Department of Transportation (DOT) and the European Commission, and launching functional teams to oversee and implement integration planning. The companies remain on track to close the merger in the fourth quarter of 2010.
In the second quarter of 2010, Continental recorded USD18 million of merger-related costs, relating to financial advisor, legal, accounting and consultant fees and communication costs. The company also had USD6 million of special charges in the second quarter of 2010, primarily related to a change in the company's reserve for unused space at its maintenance facility in Denver.
Ancillary revenues - growing, but some IT issues
He also addressed ancillary revenue, saying that new products such as day of departure upgrades, and premium seating are currently generating over USD200,000 per day in additional revenue. Prompted by a question from an analyst, Smizek agreed with other airline executives that there was still a lot of upside to this new revenue stream. However, it sounds as though Continental needs to beef up its IT in order to take advantage of it.
See related report: Qantas scores highly in ancillary revenue survey
Other revenues reached USD286 million during the quarter, an increase of 3.2%. Meanwhile, total passenger revenue was USD3.3 billion, up 19.7%.
“I think ancillary revenue is a significant opportunity for Continental and I think that United has done a very good job,” he said. “There are many issues related to rolling out our products, our ancillary revenue products, there are IT issues, there are global distribution system issues, there are timing issues in terms of where it is in the chain of purchase, whether it's a pre-purchase or day of departure or post purchase. So there are many opportunities and I think we are beginning to explore many of those opportunities and will announce them as they come out. But I think that there are significant benefits to ancillary revenues. I think there will be significant future benefits and I think ancillary revenues will be a growing revenue stream for Continental and I believe it will be a growing revenue stream for the combined carrier as well.”
Regardless of the robust, double-digit growth statistics being universally reported by the carriers, autumn remains a question. Airline executives are buoyed by the revenue and demand trends, but also expressed concern about the economy and the tardy pace of business travel return, the numbers for which were down 20% in June from the same period in 2009. Revenue from high-yield passengers was down 10% in Jun-2010 compared to Jun-2008. Continental noted advanced bookings out six weeks are 1-2% behind last year at this time.
“This demand strength, together with the capacity reductions over the last couple of years, have helped us to manage yields up,” said Smizek. “It's too early to tell what the fall trends will be like, but we're pleased with the revenue and demand trends we've been seeing so far. We continue to exercise capacity discipline and for the full year 2010, we expect both our consolidated and mainline capacity will be up only about 0.5% to 1.5% year over year with our mainline domestic capacity down 0.5% to 1.5% year over year. As for next year, it's too soon to say what the capacity of the merged carrier will be, but I can tell you that I'm pleased with the benefits Continental has experienced from capacity discipline.”
Second quarter revenue and capacity
Executive Vice President and Chief Marketing Officer, Jim Compton reported that improved yields and higher load factors were driving year-on-year RASM improvements in both the trans-Atlantic and trans-Pacific markets. The carrier has experienced sequential improvement in high-yield passengers.
“Moving on to our second quarter revenue results, our mainline RASM was up 18.8%, due primarily to strength in mainline yields, which were up 16.3% year-over-year,” he said. “We also continued to run strong load factors, setting a second quarter mainline load factor record of 85%, up 1.8 points year-over-year. During the quarter, our mainline passenger RASM, on a length-of-haul-adjusted basis, outperformed the industry average. In the second quarter, our RASM outperformed the industry by 9.8 points.
“On a year-over-two-year basis,” he continued, “both trans-Atlantic and trans-Pacific BusinessFirst load factors were up nicely for the second quarter, and both trans-Atlantic and trans-Pacific BusinessFirst yields were positive in May and June,” he said. “On a year-over-year basis, our second quarter total passenger revenue was up 19.7% to USD544 million, but our total partner revenue was up 73%, illustrating the power of our membership in Star. On a year-over-two-year basis, our second quarter total passenger revenue was down 9%, but our total partner revenue was up 16%. The value of Star to Continental continues to outperform our expectations, and is significantly better for us than our former alliance.”
However, he also reported that Star partners in the trans-Atlantic JV are now negotiating revenue-sharing structures retroactive to 01-Jan-2010. “As currently contemplated, we estimate that our liability for revenue sharing payments to joint venture carriers whom we have outperformed would be approximately USD40 million for the six months ended June 30, 2010,” he said. “However, this estimate of our revenue sharing obligation for the first six months of 2010 is not indicative of our expectations for the full year as we currently expect our net obligation for 2010 to be substantially less than this amount.”
July RASM is expected to be up 21% year on year based on current projections. Consolidated revenue passenger miles (RPMs) for the second quarter of 2010 increased 2% while capacity remained flat year on year, resulting in a record second quarter consolidated load factor of 84.6%.
Express revenue rose 28.1% to USD598 million on a 3.4% increase in capacity. RASM rose 23.8%, while yield jumped 19.9%. Regional capacity purchase expense dropped 2.8% to USD211 million, on a 3.4% increase in capacity to 3.1 billion. This is indeed a very nice return for the regional program.
Consolidated yield for the quarter increased 17.3% year on year. Combined with the 1.9 point year-on-year increase in consolidated load factor, second quarter 2010 consolidated passenger revenue per available seat mile (RASM) increased 19.9%.
Continental's mainline yield increased 16.3% to n the second quarter over the same period in 2009. Mainline load factor of 85% was also a second quarter record, up 1.8 points year on year. Second quarter 2010 mainline RASM increased 18.8%. Mainline RPMs in the second quarter of 2010 increased 1.5% on a mainline capacity decrease of 0.7%.
Continental Airlines operating statistic by region: 2Q2010
Cargo revenue in the second quarter of 2010 increased 35.4% (USD29 million) compared to the same period in 2009, principally due to increased freight volume.
Second quarter costs and end of quarter cash
Second quarter mainline CASM, according to Rowe, was up 2.2% year on year holding fuel rates constant, and excluding special items. He cited revenue-related costs, such as commissions and reservations and sales expense were the primary drivers and added that is expected to continue in the second half.
However, CASM for the quarter came in lower than expected largely because it received a refund on security fees from TSA which resulted from a law suit the industry won recently. Also pressuring costs is higher frequent flier activity as members take advantage of Star. “For the full year 2010, excluding special items and holding fuel rates constant, we expect both our consolidated and mainline CASM to be up 2.5 to 3.5% year-over-year,” he said.
He reported that as part of the effort to gain a better balance between domestic and international, the company was deferring three 737, originally scheduled for delivery next year until 2015.
Continental ended the second quarter with USD3.5 billion of unrestricted cash and short-term investments, the highest quarter ending cash balance on record which will also be the tally at the end of the third quarter. As a percentage of the last 12 months revenue, cash was approximately 26%.
"These results represent another quarter of strong operational performance and cost control by the entire Continental team," said Rowe, Continental. "While there is still a lot of work ahead in order to sustain profitability, we are pleased with this quarter's results."