UAL - Investing In United Airlines: A Sky-High Opportunity?

2024-01-03 20:02:26 ET

Summary

• United Airlines demonstrates resilience and strategic agility in navigating current challenges and positioning for future growth.
• The airline is capturing market segments by catering to both business and leisure travelers, enhancing customer loyalty and revenue potential.
• United's financial performance, including impressive capacity and revenue growth, strong earnings and efficiency, and record-breaking operations, make it an attractive investment opportunity.

In the ever-changing landscape of the airline industry, United Airlines Holdings ( UAL ) has been making notable strides, demonstrating resilience and strategic agility. The latest updates from United offer insights into how the airline is navigating current challenges and positioning itself for future growth. They also present some compelling reasons why the stock may be a good purchase for long-term investors at these levels.

Geographical Diversity and Market Adaptability

United boasts an unparalleled geographic diversity with the largest domestic network complemented by a significant long-haul international network. This diversity, while beneficial, has introduced some volatility, especially in light of recent global events such as the saddening events in Israel. This has led to a temporary impact on margins, but the company's agile response, including the suspension of flights to Tel Aviv and offering waivers to impacted customers, showcases its commitment to safety and adaptability. Which really is the story of United Airlines. The leadership team has always been a business-first outfit, and the more you look into the investment, the more you feel that this leadership team is as good as any with respect to delivering long-term gains for shareholders.

Capturing Market Segments: Business and Leisure Travelers

The airline has seen positive momentum in the business travel segment and is increasingly capturing the leisure market. By strategically pivoting capacity to leisure destinations, United is catering to its core customers who travel for both business and leisure, enhancing customer loyalty and revenue potential.

Long-term investors will remember that the business travel segment had gone dead during the pandemic, but for many airlines, the recovery has been taking longer than expected. We now look to have moved firmly past the pandemic disruption and barring another cataclysmic event; it's hard to see anything stopping business travel over the medium term.

This bullish overall sentiment is in line with most economic forecasts. We can see in the chart below that revenue industrywide is expected to trend upward so the task becomes how can operators like United Airlines capture a disproportionately large amount of that revenue going forward.

The plan for this is segmentation. United's ongoing efforts in market segmentation, a project almost a decade in the making, are yielding significant results. From offering Basic Economy for cost-conscious travelers to the luxurious Polaris for long-haul international flights, United provides a spectrum of choices catering to diverse customer needs.

This segmentation is a cornerstone of the United Next strategy, which aims to grow market share, enhance connectivity, and improve overall results. Investors will highlight that other airlines have rolled out similar strategies with respect to segmentation and pushing higher-cost products to travelers. It is important to remember that the airline industry is an oligopoly so high-level corporate strategy will often closely mirror similarly sized operators due to industry dynamics.

A Financial Flight to Success

• Capacity and Revenue: In Q3, United's capacity saw an impressive 15.7% increase compared to the same period in 2022. This uptick is a clear indicator of the airline's maturing recovery. The total operating revenue stood at a robust $14.5 billion, marking a 12.5% rise from the third quarter of 2022.
• Earnings and Efficiency: The airline reported a pre-tax income of $1.5 billion, with a healthy pre-tax margin of 10.3%. Adjustments considered, the pre-tax income rises to $1.6 billion, with a margin of 10.8%. These figures are a testament to United's strategic financial management and operational efficiency.
• Cost Metrics: A critical aspect of airline management is cost control. United's Cost per Available Seat Mile ((CASM)) decreased by 3.6%, while CASM excluding certain expenses (CASM-ex) rose by 2.6%. This balancing act between reducing overall costs and investing in necessary areas underlines a strategic approach to spending.
• Profitability: The net income stood at a commendable $1.1 billion, with an adjustment bringing it to $1.2 billion. These numbers, coupled with diluted earnings per share of $3.42 (adjusted to $3.65), paint a picture of a company that's not just recovering, but thriving.
• Record-Breaking Operations: The airline set a record for the highest daily average of revenue passengers carried in a quarter, alongside achieving the most ever quarterly mainline and widebody daily departures.
• Network Expansion: United has shown significant growth, especially in the Denver market, and has made a major international expansion to Asia. This includes nonstop services to Manila, Hong Kong, Tokyo-Narita, and Beijing, showcasing United's commitment to global connectivity.

Looping all this together, we are left with an airline that seems to be improving everything under the hood operationally, but the stock price has not yet fully appreciated to reflect these efforts, which is exactly the type of stock I love to buy. This is a relatively simple opportunity due to the strong tailwinds at the industry level, the respectable performance by management, and the relative strength of the brand in its industry. Sure, there are missing ingredients to the pie, like the lack of a dividend to reward shareholders while they wait or the poor track record of repurchases, but with the depressed prices and an appropriate allocation, investors may want to give some love here.

We can see that the current stock price is well below recent averages with respect to price-to-sales and price-to-earnings, which implies a discount if you believe in the company's long-term prospects. There is also a lot to believe in. The company has put in some really solid performances lately, beating in each of the last four reports.

While I acknowledge the potential concerns regarding United Airlines' cash balance, a deeper analysis suggests a strategic maneuver rather than a sign of distress.

It's essential to recognize that airlines, including United, often invest substantially in their fleet, especially when aligning with industry tailwinds. This approach is not just about expansion but about capitalizing on emerging opportunities in a highly competitive sector.

United's commitment to enhancing its network and operational capabilities is evident in its cash allocation strategies. The company is not recklessly spending; it's investing with a vision. The redirection of cash towards pivotal expenditures such as new aircraft acquisitions and operational enhancements is a calculated move. This strategy is about fortifying United's position in the market and ensuring it remains a formidable player in the airline industry.

Such investments are indicative of United's long-term planning and its determination to maintain and expand its dominance in both domestic and international networks. While this approach may momentarily impact the cash reserves, it's a trade-off for future profitability and market leadership. Therefore, rather than viewing the current cash balance trajectory as a red flag, it should be considered a component of United Airlines' broader strategy for sustainable growth and competitive advantage. The aggressive expansion does however present some downside risk. If the developed world does sink into a global economic slowdown, business and leisure travel will almost certainly take a hit. With the aggressive growth being pushed by the United Airlines leadership team, this would almost certainly leave the company exposed if revenue were to dip significantly. It would definitely be an industry-wide problem as most airlines mirror the strategies of sector leaders like United Airlines, but this would hardly lift the spirits of investors who would likely incur significant losses even at these attractive prices. For the time being a deep recession seems unlikely and it looks like there is pent-up demand on the business travel side. There are no alarming signs just yet but these are the things I like to consider with allocations and sector exposure.

The Takeaway

United's approach to managing its geographical diversity and market adaptability, particularly in response to global events like the recent situation in Israel, has been practical and focused on long-term gains. This strategy reflects a deep understanding of the airline industry's cyclical nature and a commitment to maintaining operational flexibility.

Financially, United Airlines' investment in its fleet and operational capabilities, despite the impact on its current cash balance, aligns with a long-term growth strategy. This should be viewed as a calculated investment aimed at future profitability rather than a short-term expenditure. United's focus on expanding and enhancing its network, both domestically and internationally, is a strategic move to strengthen its market position. While such investments might temporarily affect the company's cash reserves, they are essential for ensuring United's competitive edge and future market leadership. With these factors considered United Airlines is a buy.

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