Can United Continental Stay on the Rise?

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United Continental (NYSE: UAL), the nation’s largest passenger air carrier in terms of revenues, just closed out a year when it earned $1.78 a share excluding one-time charges mostly stemming from merger integration. Certainly, UAL continues to combine its October 2010 Continental Airlines purchase into operations. This year should bring a reduction in merger-related costs, as well as a boost to synergies. Given this backdrop, if the air travel environment is favorable and fuel costs remain stable, it may be destined for a strong 2013. UAL shares could potentially ascend further from its recent 52-week high as it pursues an ongoing efficiency strategy.

Merger Benefits

Management is now looking to achieve between $1 billion and $1.2 billion in annual revenue and cost synergies from the Continental merger, $650 million of this amount having been realized in 2012. It is possible that the total planned amount will come to fruition in 2013, but some will likely spill into 2014. That said, through the optimization of the two airlines’ combined networks and bringing together of their operations to cut expenses, profitability ought to improve somewhat. The merger should thus be seen as a positive for the company and industry as a whole.

Similarly, I would refer to Delta Air Lines (NYSE: DAL) and its 2008 buyout of Northwest Airlines. In the years subsequent to the deal, Delta’s productivity improved significantly, as it pared down the sizable aircraft fleet and altered its route network. Delta earned a $1.85 profit in 2012 and its shares have soared considerably since mid-November.

Keeping Capacity in Check

Even more so than Delta, UAL has aimed to boost its seating occupancy (load factor) by maintaining available capacity at a profitable level. Available seat miles declined slightly in 2012, and plans are for a 1.5% decrease in that metric this year. As a result, the average airfare, up 2% in 2012, may well increase further on lower seating supply.

UAL intends to cut its fleet count by 10 aircraft this year while also replacing 26 aircraft. More importantly, it will probably continue to increase the profitability of its total system. Along with cutting service in some markets, it will in fact add numerous international flights and eight new domestic routes. In all, the carrier will likely better match capacity with demand while flying a larger number of lucrative routes and is substantially less apt to incur large net losses than in previous decades.

The United Continental Network

UAL’s breadth includes nine domestic hubs, including at airports in Los Angeles, Chicago, Houton, and Washington D.C, whereas in the past the largest airlines would operate with half that many hubs. It can thus accommodate passengers on more routes than ever. Furthermore, alliances with overseas-based carriers contribute to its service, as well.

What differentiates the company for one is its higher proportion of Pacific-based revenues. It has long served Japan, and China is now becoming a source of heightened yields. As such, UAL’s outlook is partly dependent on economic conditions in that region, more so than other major carriers.

Its Cost Structure

Of course, UAL’s fate rests considerably on jet fuel prices, as that is by far its largest expense. Fortunately for carriers, oil prices have remained relatively stable for about two years now. Hedging activity helps to reduce the added cost burden in times of rising prices, but only to a limited extent.

Labor, the second largest expense, is a bit of a concern. Non-fuel unit costs are set to increase modestly this year on labor agreements and pension outlays. Finally, due to a massive debt balance, interest costs are elevated, though not enough to be a concern.

The Stock

UAL shares are poised to outperform the S&P 500 should conditions hold. More business flyers ought to be taking to the skies, assisting revenue yields. Plus, the effects of the merger integration may well support margins. Like all air transport stocks, UAL shares are risky, as the company’s performance is tied to corporate travel and fuel costs. Nevertheless, the industry leader appears to be taking the proper steps toward improved and consistent profitability. It is thus worth consideration at this time. If you would prefer an airline with a growth and expansion strategy there are several to consider, but the best at this juncture is possibly Alaska Air Group. ALK is adding routes between Northwest cities like Seattle, Portland, and Anchorage and U.S. destinations. ALK's productivity is improving as fleet additions have been minimal and traffic has risen nicely.


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