United Airlines Holdings, Inc. (UAL)
Barclays Industrial Select Conference Call
February 23, 2023 09:45 AM ET
Company Participants
Michael Leskinen - VP, Corporate Development and IR
Conference Call Participants
Brandon Oglenski - Barclays
Jamie Baker - JPMorgan
Presentation
Brandon Oglenski
All right. Good morning. And welcome to day two, session four. Barclays Industrial Select Conference. I'm Brandon Oglenski, airline and transport analyst and very excited to be hosting United Airlines next [Technical Difficulty] Before we get started, to the ARS questions really quick. Question one and I'll pick up the keypad here. Do you currently own United? Mike, sorry, we'll get you a keypad next time. That's other way to mark with it for now. Good for my answers.
All right. Some share owners in the room. Question number two, what the general bias towards United right now? Positive, negative or neutral? Okay. neutral. And then question number three, in your opinion, through cycle...
Michael Leskinen
I thought that was positive. Should go back to that.
Question-and-Answer Session
Q - Brandon Oglenski
Through cycle EPS growth for United, will be above peers, in line with peers or below peers? And thank you all for participating. We do distribute this data after.
All right. Well, Mike, thank you so much for joining.
Michael Leskinen
How that's consistent? 62% above peers but 60% of the audience doesn't own our stock. EPS growth not matter anymore?
Brandon Oglenski
Well, Mike, thank you again for coming down. Obviously, airlines do have pretty low valuations here, you believe the guidance of United and others. And I think not that investors don't like the sector, but just skeptical that cyclical earnings power won't go back down very quickly. You guys have laid out a pretty aggressive plan, very attractive guidance this year $10 to $12 in EPS versus a roughly $50 stock price. So how can you help us with -- what's different about this industry? Your CEO, Scott Kirby's talked a lot about real constraints on pilot availability and infrastructure. So can you just talk to the outlook here?
Michael Leskinen
Yes. Thanks, Brandon. I have spent 18 years as an investor before joining United, covering the airline sector, and I spent another 5 now at United, so 23 years. Following in some way, shape or form the airline sector. And we have never had a better setup. The setup we have over the next 3 to 5 years is better than anything I've ever seen in my career. And there are a number of reasons for that. If you think about the airline industry post deregulation, what we were always doing is we're just chasing each other to commoditize the business, to add more seats to the same aircraft in to lower prices. And that's all we did to compete.
And because of the way pattern bargaining works, because of the way that seniority and the labor force works, the established players had higher costs than the new entrants. So the new entrants always said, "Geez, it's our job to grow, grow, grow because we're cheaper and this is a commodity industry and we're low on the cost curve. And frankly, that's what commodity businesses are supposed to do, but we're not a commodity business anymore, and we're decommoditizing the business.
You layer on top of that flattening of the cost curve and maybe we'll get into that with some questions, but big flattening of the cost curve. We're now the incremental capacity coming from legacy carriers is going to be similar cost or lower cost and incremental capacity coming from the ultra-low-cost carriers, almost need to change their name because it's a new paradigm.
But you layer on top of that significant supply constraints that nobody controls, whether that be pilot shortage. And for those of you in the room that aren't familiar with how pilot training works, you get 250 hours training at a pilot academy. But before you can fly commercial, you have to have 1,500 hours of experience. There are not a lot of productive activities in the world to go from 250 hours to 1,500 hours.
If you're wealthy and you can buy your own aircraft, you can fly around and get those hours. But a lot of people can't and there's no quick fix for that, which means the industry is going to be chronically undersupplied pilots for 3 to 5 years, which means there's no carrier out there, whether it's a regional carrier, a LCC or ULCC, that can attract pilots unless you want to pay the going rate for pilots. So what used to be a pretty steep AB pay scale is now going to be very flat.
And you can't get enough of them. The OEMS, the supply chain issues across the economy, but nowhere is it worse than in aerospace. And so the production in narrowbody aircraft, the availability of spare parts, it's completely constrained. The skyline for Boeing and Airbus for their narrow bodies has never been stretched further to the right for those of you, aerospace analysts in the room. You can get a you've got to wait until very late this decade if you want to get an additional narrowbody.
And the narrowbodies, you have on order, by the way, they're coming late. And so you've got a real constraint there. And then you have a real constraint also with air traffic control. We've under-invested in this country in the systems to manage this aerospace and aerospace has never been more congested. And so when you see a weather event happens somewhere on the East Coast, it kind of screws the whole system up for not just that -- for that not just that day, but sometimes multiple days.
We've seen it in Denver a number of times this year. As you put all that together, and there are aspirations to grow for the industry to grow quite a bit because there's tremendous demand for air travel. But we won't be able to grow as much as everyone thinks. And so that constraint is going to be, I think, a relatively -- it will be a relatively healthy setup for the industry, number one.
Number two, on the demand front, demand for air travel has never been stronger, particularly from the white collar workers in the big cities that United disproportionately is exposed to because those customers now, and I think permanently, and it'd be interesting to that as a poll question.
Have remote work. Very few folks on back in the office Monday through Friday. Maybe it's through Thursday, but not Monday through Friday, which means there is a much greater propensity to say, "Hey, I'm going to -- I'm going to Breckenridge for a 2- or 3-day weekend in the past, now you're going to stay there for 4 or 5 days. You are going to work, but you're going to be working remotely. I know I do it. I know many of my friends do it in the finance industry. And I don't think that is -- if you're a payer in the industry, people are saying, "Well, no, well, that's just travel demand because I didn't get the job for a while or it's for avenge travel. It's not. It's the new normal unless there's a backlash and we all decide we need to get back in the office. I know from my teams that I managed at United, we're pretty damn productive remote. We've got to figure out how to train younger folks coming up through the organization. So that's something we all need to solve for.
But the net gain in productivity we get from being able to work remote is too big to give up. So you've got tremendous demand that is going to exceed 2019 levels. And I think as a ratio of GDP is going to be higher than that 2019 ratio permanently. You've got constrained supply and you've got a cost curve that used to be pretty steep between the low-cost carriers and the legacy carriers that is flat now. You put those 3 things together, it is a great time to own an airline, a legacy carrier in particular and United has invested uniquely more than anyone else for this combination of great setup for this sector.
Brandon Oglenski
I'm saying that my team have to go to Breckenridge every other week, so.
Michael Leskinen
Breck is the favorite mountain.
Brandon Oglenski
So can you talk about some of these capacity constraints, obviously, for the industry, but what United has done specifically to address them?
Michael Leskinen
Pilot shortage, number one. Three years ago, we invested in Aviate Academy in Phoenix. So we have our own training academy that we're going to continue to grow. I think eventually we'll be able to get that to 1,000 pilots a year of throughput. And so a serious investment there. We've got a couple of other airlines that have had Pilot Academies in a small way, but I think that is going to be a leading training academy.
But we've set up partnerships with an ecosystem of players that will help train those pilots to get them to the regional carriers that we utilize and eventually for the mainline. So we saw this pilot shortage coming, and we prepared for it. Now that it's upon us, maybe we could have even done more, but we are definitely a couple of steps ahead of the competition on pilots.
We expected -- we shut down the airline just as fast as anyone. In fact, when the pandemic started to hit in China and in Italy. We've kind of pulled all hands team, the side, this is going to be really bad for an extended period of time, so we shut down very rapidly. But 3 months after that, we couple up and say, well, what's travel going to look like on the other side?
And the consensus was that it was going to be really robust. This wasn't going to be a permanent change to people's desire to travel. And I think that was pretty unique among the airlines. And because of that view, we did not permanently retire aircraft, whereas every major carrier around the world, we have those aircraft, we maintain those aircraft to cost some money to maintain them through the crisis, but now we have them fly today. And then we supercharged by placing a large narrow-body order and a large wide-body order so that we could spring load that growth on the other side. So we've been preparing pilots. We've been maintaining aircraft, ordering new aircraft because we saw this very strong set up coming.
Brandon Oglenski
What about on the sector side, things like that's more of an industry challenge. How do you navigate that?
Michael Leskinen
You have to create some extra buffers. And we target extra buffers. These extra buffers cost a couple of percent of CASM, not a huge expense. But you have to create extra buffers so that your crews have extra reserve time, while there's irregular operations. You need to make sure you have a few extra pilots versus what you could do if you wanted to run absolute max people. You need to make sure you have some spare aircraft. You need to fly aircraft in a hub-and-spoke system where you do point -- where you do back and forth, so that you don't put the entire network by days the aircraft on entry. You build -- you need to build technology systems that allow you to reposition the crews where you need them in real time and make that very dynamic.
And United has uniquely invested in preparation for that. I think that there are some carriers out there talking about how we're going to get back to 2019 utilization and we're going to remove all these buffers because our job is to be the lowest cost carrier out there. If the world turns out to be that way, we'll follow them pretty quickly. It will take 3 months to make some adjustments and we'll get some extra capacity out of our system, but I don't think that's true. You need to calibrate the airline the way that we have, we think that realization pretty quickly. I think that some of our competitors are getting there, but it's going to take another quarter or 2 and another big weather event or 2 are going to say, wait a second, the right approach.
Brandon Oglenski
I want to come back to service, but touching on pilots, I'm not sure if you have a tentative agreement yet with your union. Where does that process stand? And maybe more broadly, labor inflation this year, I know it's, I believe, in your full year CASM outlook, is that correct?
Michael Leskinen
It is. I think there was various guidance practices among the legacy carriers at least. And the approach we took is we just put our full expectation in the full year number. It's not in our Q1 guidance, but we expect to get it true-up in Q2 that would make it -- that gives you the full year run rate in our 2023 guide. This is pattern bargaining. We love our pilots. We want to make sure our pilots and all of our employees, frankly, are the best paid in the industry, and they'll end up being the best paid in the industry. But it's a pattern bargaining and what's Delta's deal gets done. I think that, that increases the likelihood that ours gets done relatively quickly.
But it's for the pilots to decide. We've got a good leadership team there. The key is that because of the scarcity, the wages for pilots are going to be, it's going to be flatter than it used to be. And that's a healthy dynamic very well, highly compensated pilots and that compensation should be similar with your United, American, Delta or one of the smaller carriers.
Brandon Oglenski
You hit on thinking about this is not a commodity product anymore. How important is employee culture at the company to driving that outcome?
Michael Leskinen
It's tremendous. I mean, just attracting talent. You want to be proud of the company you're working for. So you think about, frankly, some of the things that my team has done doing around United Airlines. You need to be an innovative, leading company doing the right thing for the environment, the right thing, societal to get pilot -- to get potential employees excited to come work at your airline and United done a heck of a lot in that respect. Oscar, our previous CEO, did a time to repair the culture and the morale among employees and Scott and has taken that baton.
And I don't know how many times I get on a flight and flight attendants you're talking about how amazing what we did with some sustainable aviation fuel project or tell me about what's happening with toll and the pilots come out and talk about it. It is just -- it is exciting to be working for a company that is leading the way, that is innovating. And that culture has done a 180-degree shift to United over the last 5 years.
Brandon Oglenski
I definitely want to talk about United Ventures, but maybe before that, you hit on service reliability. We're seeing some of your competitors face some challenges day in, day out here whether that's pretty much usual in the winter time. What's United doing differently because we are seeing definitely a differentiation?
Michael Leskinen
Well, this goes back to the buffers I was talking about, and you don't have to have big buffers that are super expensive, but you need to be prepared or making excuse at all, there was a storm that hit and then 3 days later, you're still recovering, that's not acceptable. You need to have -- you need to build a system that has some resiliency and it's really critical. I mean also, it talks to the frequency. If you're a big carrier, you have multiple frequencies day and week. And so if there is a cancellation, you can reaccommodate your customers, if not 2 weeks later. I think that's really, really important.
And so when you talk about a decommoditized product, first having a first-class cabin, absolutely. The clubs that we have, absolutely. The app that we have, absolutely. The customer service to receive, absolutely. But also how about the ability to recover when bad weather hits. And yes, maybe the airport has shut down on Tuesday, but you can get you on Wednesday, not next Tuesday, so it doesn't cancel your whole trip. So I think that all of those elements are important. I'm a math geek. So I will say that as you -- and I would encourage everyone in the audience to go out because I think operations is going to be a leading indicator of how our stocks perform for precisely the point you make, Brandon.
So you still have to look at cancellation rates, but don't just look to cancellation rates for the mainline sometimes we send out some stats are like, "Oh, Frontier, Southwest, they canceled all these flights." Versus United, but we are pulling down our regional carrier to make room for the mainline aircraft to fly. What you need to do is you need to adjust it on a per seat basis because it's your average customer. And so look at a weather event in Denver and look at what United does for the average customer? How many seats were canceled versus how many seats are canceled as a proportion of what Southwest flies or Frontier flies. That is going to show, I think, a growing competitive gap that says if you're a customer in Denver, you should just plan on United, if you care about being able to get where you want to go even when the weather is not perfect.
Brandon Oglenski
All right. I want to talk about capital to and the order book, but if I can, how are booking trends write down in first quarter, you guys do have a pretty robust revenue guidance this year, too. What's driving the confidence there?
Michael Leskinen
The bookings have never been stronger. The travel pattern is changing because of these 4-day weekends. January and February were a little bit soft. We expected them to build it soft, just like December because around the holidays, this is our thesis, around the holidays, thanksgiving and Christmas and the New Year's holiday and customers are saying, "Well, geez, I already took a trip or 2. Maybe I don't need that for the weekend." And so you don't see that extra travel demand that existed -- that exist the rest of the year. But October was gangbusters for the airline industry. And then you saw that slow down in November, December, January.
And I think the Street, and that's why our stocks are where they are. I think the Street said, o geez, okay, where bench travel is over, demand is open. Well, I've got to tell you, March bookings are back to October level and exceeding. In fact, if you look at the tail end of 2022, you were looking at business demand, it was about 80% recovered to 2019 levels. We are now at 97% recovery over the last 3 weeks, 97% recovery for business.
So that extra gap that we were like maybe barriers would say, well, like maybe Zoom travel. Zoom and Teams means that 80% is what you can get and oh, look, what's happening in the tech industry. Despite all of that, we're now 90%. But even more critical than that pace of leisure travel, and this is -- it's hard to some of this leisure travel. It's hard to say is what is we see through distribution channels. And for leisure that I think includes some of that business, we're at 130% plus. And so March is -- March has some of the best booking trends we've seen. As you get beyond March, we have some data, and that data looks very consistent with what you see from March.
But for anybody that was looking at the ARC data and said, "Geez, look at the slowdown in December, January, maybe this is time to lighten up. Maybe that's why I was in the survey. We had a few people not owning our stock. Look at the data, the data is really robust.
Brandon Oglenski
Okay. And then any differentiation here on international as we're getting to that with the fleet strategy. But you guys kind of stand alone here with not parking planes.
Michael Leskinen
Well, I think it's special when it goes to trying to look to where the puck is going and to state there ahead of the crowd. And during the pandemic, in the North Atlantic, in particular, there were a lot of aircraft that were parked that can't come back. We didn't do that. And so we kind of spring loaded to the #1 carrier in North Atlantic, and we're not looking back. Profitability in the North Atlantic has never been stronger.
The demand is insatiable right now. Central America feels really, really good. In fact, Pacific is recovering quite nicely with the exception of China. And we've got some healthy skepticism about the pace of recovery for China. If it recovers, we'll be there and we'll be ready and United is to be better than any other U.S. flag carrier, but travel to Japan, travel to Australia. Travel to New Zealand is now recovering in a similar fashion to what we see in the North Atlantic.
Brandon Oglenski
Appreciate that. Can we queue up audience question number four. In your opinion, what should United do with excess cash? Bolt-on M&A, larger M&A, share repurchase, dividends, debt paydown or internal investment? Debt pay down. This is going to be an interesting conversation. So can we go to question #5, please? In your opinion, on what multiple of 2023 earnings should United trade?
Michael Leskinen
Those are good multiples, by the way. I like those.
Brandon Oglenski
All right. And then question number 6. What do you see as the most significant share price headwind facing United? Core growth, margin performance, capital deployment or execution and strategy?
Margin, okay. And then question number even does ESG play an active role in your investment decision related to United? One, yes, positive; two, yes, negative; or 3 or 4, no. Get the responses here.
Can you talk about -- you guys do have a pretty significant order book, I think, gross CapEx around $20 billion.
Michael Leskinen
Well, that's great.
Brandon Oglenski
We'll talk about United interest to you. But how do you justify, I guess, all the investment that this company is going to make in the next 2 years? And what's the priority for managing the balance sheet?
Michael Leskinen
Yes, I'll try to come back to that, Brandon. I want to address the questions here because I thought they were great. We are in a path right now. We've talked about delivering $10 to $12 in earnings this calendar year. We have not missed our guidance since I joined the company 5 years ago. There's some problems are in the pandemic that we've been pretty good at making promises to the investor base and then delivering. We've now promised $10 to $12 for earnings this year. Nobody seems to believe us. And so as we deliver on that $10 to $12, if we got a multiple, it would seem like there was a plurality around 10x. Well 10x the low end is a number that is twice where our stock is trading right now.
So you don't need to be much of a mathematician to understand the opportunity here. And that is that we just continue to do what we say we can do. And if we can deliver that 9% margin in 2023, and we're anywhere on that path to 14% margin in 2026, the incremental return on our aircraft greatly exceeds our cost of capital. It greatly exceeds our cost of capital. So you want us to put every nickel to work buying aircraft. And so to tie it into our order book. Order book is full of tremendous optionality, if we are hitting these numbers, you want us to take every aircraft that we have. If we're not hitting these numbers, we have tremendous optionality to slow that role. We have aircraft that are getting pretty old. So we can retire some aircraft. That will be the #1 lever.
If we're not in that I guess. And the #2 lever would be to then after retiring some aircraft you can defer aircraft. We got great -- we've got a great relationship with Boeing. So I think there's great optionality there. But on the path we're on, you're going to want to take every aircraft we can. Now the balance sheet, there's lots to talk about the balance sheet. And for a good reason, we've got more leverage than we did going into the pandemic. We did a pretty solid job though of minimizing our cash burn through the pandemic.
And if you look at us versus our legacy peers. We've built in 1 case, $3 billion less incremental debt since the pandemic that they put on their balance sheet. So number one, there's been a flipping of where United was kind of in the middle of the industry as far as our balance sheet. Now our balance sheet among legacy carriers is the best. However, we were lagging on a margin basis, on a return basis going into the pandemic. You're now coming out of the pandemic, I think -- in the fourth quarter, we were.
And I think going forward, we're going to be the leading margin producer of the legacy carriers and frankly, leading to the industry, Alaska be the best estimate. They run a great airline. And so you combine that balance sheet that has been relatively protected and the margins that we think we're going to deliver and are -- we're going to grow into our debt and the balance sheet is going to I think if you deliver 9% margin and a 14% margin in '20, the debt that we have is quite manageable. We'll pay it down over time, but it is -- but our leverage metrics will look quite attractive.
Brandon Oglenski
Sorry, I should have said if there's any questions in the audience, raise your hand. There's one over here.
Unidentified Analyst
[Indiscernible]
Michael Leskinen
Well, we've got an amazing treasury team run by Pam Hendry, who has been in that market for decades. And so when we think about EETC, we think we look at sale leasebacks, we look at other private transactions with any loans. We're out there looking for the cheapest cost of capital quite frankly. And so there are times -- in the majority of the history, by the way, Gerry Laderman, our CFO, he invented EETC. So we're very familiar with that market.
Many, many times, the EETC achieves for finance and aircraft. But there are times when aircraft lessors offer us a better rate and there are times when banks offer at a better rate. And there are times when Japanese operating leases offer a better rate. And so we're going to go out there. We have the order book. There are aircraft, they're priced well, and so we'll go out in there and constantly say, okay, well, for this transaction, where can we shave 10 basis points off of our cost of capital.
Am I confident? So Boeing has been really slow to deliver planes. So is Airbus, by the way. It's not unique to Boeing. There's a lot of supply constraints. They're getting better. Over time, they're getting better. I don't think it's going to get fixed overnight. So as we look at the contracted deliveries we have for '23, we don't expect to get all of the deliveries that we have contracted. Some of those will lag into '24 and that daisy chain will probably continue with some lags, but they are getting better.
The worst of the constraints are past us, we believe, and they're starting to catch up, but it's going to take -- it's going to be a multiyear process to get all the way caught up. Mike, thank you. We're almost done here, but United Ventures what's most exciting right now, sustainable aviation fuel, you guys are making investments with battery technology, EV tools. Tell me what's the most exciting?
Jamie Baker
Thanks. So for those in the audience that don't know about 2 years ago, we launched a corporate venture capital team at United Airlines. It's about driving innovation into this sector. It's about getting -- making sure that United is first to bring EV tool, our customers in Chicago, New York, San Francisco, L.A., with battery technology, we're going to be able to get customers from the inner city to our airports later this decade really quickly, efficiently, carbon-free it's super exciting.
Many of the small cities, we don't fly to today, it's because of cost, electric fixed-wing aircraft like car aerospaces, ES30, will make it a lot cheaper to fly some of these small cities around our hubs, build a better catchment area around our hubs. But what we announced this week, Brandon is really an imperative we have for the entire airline industry, and that is -- it is very hard to decarbonize aviation. It is energy-intensive and jet fuel is energy dense in a way that most fuels aren't. And so we've embarked on -- we launched a venture capital fund, where we're taking money from big partners, Honeywell, GE, Boeing, JPMorgan Chase have all anchored the fund, and we're going to go out and invest and start up $5 million to $25 million checks that are pursuing sustainable aviation fuel from various feedstocks from power to liquids alloy-based sources, you have a trash to a municipal waste to sustainable aviation fuel.
All of this -- this is the way we decarbonize the business. United is in the lead we're not competing on sustainability. So we're hoping that many, many airlines around the world will join us. And you'll see more headlines around this in the weeks and months to come. We're just getting started.
Brandon Oglenski
Mike, unfortunately, we're out of time, but thank you so much for coming. This is a great chat.
Michael Leskinen
Thanks, Brandon. Good to see you.
Brandon Oglenski
Thanks guys.
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United Airlines Holdings, Inc. (UAL) Presents at Barclays Industrial Select Conference (Transcript)