2023-07-17 09:00:00 ET
Summary
- United Airlines is expected to announce its earnings after the market closes on July 19, 2023.
- United faces pressures from weather and air traffic control disruptions as well as a costly new pilot contract.
- United has committed to an aggressive growth plan which will stress its finances and external systems.
United Airlines ( UAL ) is expected to announce earnings after market close on Wednesday July 19, 2023. Although United has frequently announced after Delta ( DAL ) but before other airlines, this year United will be announcing at the same time as American ( AAL ) and other airlines.
DAL reported a strong 2 nd quarter , beating estimates, some of which were raised less than a month before at its investor conference. Delta made a number of positive comments during its earnings call that could indicate strength for AAL and UAL as well. In order to assess how well UAL might do with its earnings announcement, let’s examine UAL’s first quarter performance, its guidance for the 2 nd quarter as well as its strategies, and DAL’s 2 nd quarter 2023 earnings.
United’s Covid Strategies Paid Off
United made the decision during covid to not retire aircraft and to keep crew members ready for what the company expected would be a quick return of demand when covid ended. That strategy paid off handsomely last summer esp. when transatlantic demand returned in force, within six months after domestic U.S demand began its rapid return. Although UAL trailed DAL’s margins during the pandemic, UAL handedly outperformed not just DAL but nearly all of the rest of the industry in margin performance in 3Q2022. The gap narrowed in the 4 th quarter of 2022 as AAL DAL and UAL posted some of the closest margins that the three have seen in decades but all were decidedly more profitable than the low-cost carrier segment. Although the fourth and first quarters are traditionally UAL’s weakest due to its heavy exposure to long haul international traffic which is more seasonal than the domestic market as well as its small presence in Florida, its losses were in line with analyst estimates in 1Q2023 and its stock continued a strong march in the first half of 2023, paralleling a similar trajectory as DAL. By June 2023, DAL stock began to strongly pull ahead of UAL and the rest of the industry as the Atlanta-based carrier continued to tout its strong revenue outlook, something that has decidedly not been spoken of by its Chicago-based competitor.
UAL’s guidance for the 2 nd quarter, given at the time of its 1 st quarter earnings, was for a hefty 18% plus growth in capacity, lower fuel cost compared to a year before, and strong unit cost control. Wall Street has used that information to expect a strong increase in earnings for the 2 nd quarter continuing into the remainder of the year although peaking with the end of the summer.
Factors Impacting UAL’s 2 nd quarter Earnings and Beyond
Although United has not updated its investor guidance, several significant factors could influence its earnings. United’s operations have been significantly disrupted during the month of June 2023 more so than any other competitor. Even before its operational disruptions in the latter half of the month, UAL was regularly cancelling a higher percentage of its flights at the beginning of the day than any other airline even if only 1-2% of flights; although airlines have traditionally been able to absorb low level cancellations on a sustained basis, the indications have been that United was pushing its system more than it could absorb. Nearly a month ago, severe storms set up in the New York City area and significantly impacted operations at all three major NYC airports throughout the last weekend of June. United’s CEO on the following Monday sent an employee memo which blamed the high number of cancellations and delays on the FAA and air traffic control staffing. The FAA met with CEO Kirby and showed him why the location of storms in the NYC area required such dramatic reductions in airspace capacity. Some of United’s labor unions also said that the company has not staffed sufficiently for the size of the schedule the company is operating this summer and also said that crew scheduling systems failed when they were needed to put the operation back on track during the last week of June, traditionally one of the largest travel weeks in the United States. Not only did United’s cancellations reach 20% on some days – far larger than competitors - but UAL took much longer to stabilize its operations. There have been significant ATC delays due to thunderstorms thus far into July and United’s rate of cancellations and delays have remained above average. Extended operational disruptions esp. when compared to other airlines that have not experienced the same levels of disruptions have historically resulted in reduced revenue and increased costs. There is a strong likelihood that UAL’s revenue and profits could miss estimates for the 2 nd quarter and result in reduced estimates for the 3 rd quarter.
The FAA warned airlines earlier this year that air traffic control staffing shortages could negatively impact airlines esp. in the Northeast; some airlines reduced the number of flights esp. to NYC airports at the FAA’s request while others filed much smaller capacity reductions. ATC staffing is unlikely to be enhanced for the remainder of summer 2023 but UAL faces unique challenges. The largest airline in the NYC area is Delta with hubs at both New York’s LaGuardia (LGA) and JFK airports while United is second largest with 90% of its flights at Newark (EWR) airport and the remaining 10% at LGA; UAL does not serve JFK airport. United obtains more local market revenue from Newark than any other airline receives from any other airline in the U.S. While EWR is a well-developed global hub for UAL, it is much more vulnerable to operational disruptions than probably any other airport in the U.S with some of the lowest on-time percentages. EWR airport, like LGA effectively has 2 usable runways for large jet operations while JFK typically uses 3 of its 4 runways at the same time. NYC airspace is some of the most complex in the world as air traffic control balances the needs of all 3 airports. United has also routinely asked ATC to issue ground stops for its own Newark operation this summer because of ground congestion, esp. in the aftermath of weather disruptions; multiple longhaul international United flights this summer have waited hours for an arrival gate upon landing. It seems clear that United has overscheduled its Newark operation and the disruption will not only diminish UAL’s revenues but also increase its costs.
United’s Growth Plan is at Risk
United Airlines has committed to an aggressive fleet acquisition and revenue growth plan that involves over $50 billion in spending. They have said that a significant portion of the new aircraft will be used for growth, esp. in the next 3 years. While United has not publicly said how much of their fleet acquisitions will be used for growth and how much will be for replacement of older aircraft, a recently released internal document reveals that the majority of its new aircraft will be used for growth in the near to medium term. UAL has projected significant increases in revenue and profitability so understanding their ability to manage their growth plan is important to understanding the outlook for UAL stock.
There are several significant factors which have influenced United’s decision to engage in aggressive growth.
- A byproduct of its merger with Continental Airlines almost 15 years ago, United has a smaller domestic route system and lower revenues a larger international route system and proportionately more international revenues than American or Delta.
- Although United has had a strong market position in its major hubs, it has had one of the smallest market positions in non-hub markets. For example, in the large Florida market, United is smaller than not only each of the big 4 including Southwest ( LUV ) but also is smaller than several low-cost carriers.
- Part of UAL’s smaller size in non-hub markets is related to its higher dependence on regional jets, especially 50 seat regional jets, compared to other U.S. airlines. While it is making progress, nearly 50% of its domestic flights pre-covid were operated by contracted regional carriers.
- The pilot shortage has led to increased labor costs for regional airlines and yet the ability of regional carriers to operate all of their aircraft has still been eroded. American, Delta and United have all stated that they have scores of regional jets, including 76 passenger large regional jets, which they cannot schedule because their regional airline partners do not have the staff to operate all of their aircraft.
- Many of United’s hubs do not have the physical capacity to handle an increasing number of regional jet flights and yet capacity growth can come by upgauging flights from regional jets to mainline aircraft.
- Legacy carriers such as United are seeing strong demand for their premium and international services, giving them a financial advantage over low cost carriers which typically have a less complex product but also fewer opportunities for revenue growth. The big 3 are generating the best margins in the U.S. airline industry for the first time in decades.
United’s growth plan, therefore, seems rational and well-timed for many reasons. The size of their growth plan and the ability of many dependencies to respond to their plan appears to be problematic.
An Older, Less Efficient Fleet
Each of American, Delta, and Southwest currently have approximately 750 to 800 narrowbody (single aisle) aircraft which are used primarily on their domestic and near international route systems while United started its fleet expansion with 690 narrowbody aircraft. There are significant differences in the size of the legacy carriers’ regional jet fleets. Southwest does not use regional jets while Alaska ( ALK ) along with AAL, DAL and UAL do. AAL has approximately 536 regional jets of which approx. 120 are 50 seaters. Delta has 326 regional jets, none of which are 50 seat aircraft while UAL has 470 regional jets of which approx. 170 are 50 seaters. The big difference in the big 3’s mainline fleets comes in their widebody fleets; American has 125 widebody aircraft, Delta has 160, while United has 219. Including its regional jets, United has the smallest gauge, or average aircraft size in the industry while, of the big 3, Delta has the highest gauge.
While data indicates a need for UAL to replace more regional jets with more efficient mainline aircraft, fleet age is also a significant factor that impacts its fleet spending. American spent aggressively over the past decade to replace older aircraft and now has the youngest fleet of the big 4 at 12.2 years. Delta’s average fleet age is 14.4 years but, more significantly has 422 aircraft in fleet types that are older than 20 years – which means that those fleet types (not just specific aircraft) will need to be replaced this decade. Using the same metrics, United’s average fleet age is 16.7 years and it has 430 aircraft in fleet types older than 20 years on average. It is also worth noting that United’s international widebody fleet is even older proportionate to American and Delta’s international fleets. Given that new technology has a bigger impact on operating profits, UAL’s international fleet age translates into a cost disadvantage.
Aircraft order books appear to be heavily influenced by fleet age. American has 182 mainline orders, Delta has 328 firm orders +126 options while United has 700 mainline aircraft on firm order. Based purely on the number of older aircraft alongside new aircraft orders, American and Delta expect to be able to cover the majority of their fleet replacement needs via their current order books and have modest capacity to grow while United is planning on using hundreds of new aircraft for growth.
However, internal planning documents show that United intends to use nearly all of their deliveries through 2026 for growth, resulting in a mainline fleet approaching 1500 aircraft – a 40% increase from their pre-covid fleet size.
Given that UAL’s current order book of $51 billion is three times larger than DAL’s current order book and an even larger multiple more than AAL’s, UAL is committing a significantly larger amount to fleet spending than any other U.S. airline without addressing its fleet age or gaining the efficiencies that come from newer aircraft.
1000 aircraft mainline fleets
United’s internal document as well as aircraft order books for all three of the U.S. global carriers shows that all are heading for 1000 mainline aircraft fleets and beyond, a level that has never been seen by U.S. airlines. It is likely that Delta and United will both reach 1000 aircraft in their mainline fleets in 2024 while American should achieve that level in 2025 or 2026. Not only will the sheer size of the big 3 be unparalleled in U.S. airline history and in terms of revenues among all global airlines but the complexities of their operations will grow exponentially.
United’s fleet spending is insufficient to address the amount of needed fleet replacement and will appear to result in a larger projected mainline fleet within 3-5 years than American or Delta, although both of the latter are likely to order new aircraft later this decade. As I note in this Seeking Alpha article, Delta continues to contemplate a new order for new generation widebody aircraft and is very likely to exercise options for narrowbody aircraft in order to meet its fleet replacement needs as well as growth. However, Delta has incorporated used aircraft acquisitions, even of new technology aircraft, to reduce its fleet spending while also stating replacement of its older aircraft will begin even from its current order book. American is also bringing back small numbers of aircraft previously planned for retirement. By using much of its current order book for growth rather than fleet replacement, United will increasingly be at a significant operating cost advantage to other airlines; new generation widebody aircraft reduce fuel consumption by 25% or more compared to the aircraft they replace while new narrowbody aircraft yield half that amount.
Longer-Term Limits on United’s Growth Plan
Beyond the current operational limits at Newark, some of which will be addressed by terminal growth which is in progress, United has indicated that it will grow at a number of its other hubs. At Washington Dulles (IAD) which is also a major international gateway, UAL is talking about significant growth in its flight schedule and a willingness to fund an expansion and rebuilding of the aging concourses which have been in “temporary use” for decades. IAD is strategically protected by the perimeter restriction at nearby Washington National airport but the close-in airport has long had lower operating costs per passenger than the larger international airport. A major building campaign at IAD will certainly lead to much higher costs but will help provide an overflow for UAL’s congested Newark hub; for years, the company has moved aircraft and schedules between the two hubs to try to route as many connecting passengers as possible through IAD while leaving as many seats as possible at EWR for local NYC passengers.
UAL’s Chicago hub is also embarking on a multi-billion dollar terminal rebuilding and expansion project which is expected to make O’Hare (ORD) airport the most expensive large hub airport in the U.S. on the basis of cost per enplaned passenger. While all passengers that end or begin a journey at an airport have the same fees included in their ticket price, an airline that hubs at a high cost airport is at a disadvantage to other airports when they compete for the same connecting passengers that another airline can route through a lower cost airport. While American also operates a hub at ORD, it has significantly reduced the size of its operations at ORD, shifting flights to other hubs including its massive and much lower cost hub at DFW airport in Texas. Southwest operates one of its largest hubs at Chicago Midway airport while Delta’s twin Midwest hubs at Detroit and Minneapolis/St. Paul each have much lower costs than ORD.
United is spending money at its Houston Bush Intercontinental Airport hub in order to convert many of its gates from regional to mainline jets while it has recently occupied new gates at Denver, where United and Southwest have both been aggressively growing. United’s San Francisco hub is not seeing the levels of recovery as in other major hubs due to changes in economic trends in the Bay Area, depressed numbers of flights to China and Hong Kong, and more significant decreases in travel by the tech industry compared to other industries. At Los Angeles, UAL continues to talk about building an additional terminal that would dramatically increase its capacity but also cost far more than any other airline has spent to grow at LAX.
United’s Growth Plan Will Strain Support Systems
The fact that United, or any airline, can financially justify aggressive growth does not mean that external systems to the airline are capable of delivering or supporting that growth. First among United’s needs to support aggressive growth is the delivery of new aircraft. United’s domestic growth plan is heavily built around the Boeing ( BA ) 737MAX and specifically the MAX 10. However, Boeing has yet to certify the MAX 7 and MAX 10, the smallest and largest members of the Boeing 737 MAX family. Southwest is the launch and largest customer for the MAX 7 while United is the largest customer for the MAX 10. The MAX 7 certification will happen first; Southwest says it expects to receive its first MAX 7 this year but does not expect to be able to put the MAX 7 into revenue service until 2024. The MAX 10 certification should follow shortly after the MAX 7 but, given the repeated delays from Boeing, it is far from certain that Boeing will achieve either of these carriers’ expectations. While there are dozens of MAX 7s and 10s that have been built but cannot be delivered, Southwest and United have both converted dozens of orders to the mid-sized MAX 8 and 9 models with LUV having to buy aircraft larger than it wants and United having to buy aircraft smaller than it originally planned. Given the lead time for aircraft production, UAL’s capacity plans based on the MAX could be altered for two years or more.
Just as has been noted with second quarter 2023, United’s growth plan is limited by air traffic control and airport capacity. While the FAA is being pressured by Congress to increase hiring and training, even a return to pre-covid staffing levels, let alone ATC expansion sufficient to accommodate significant airline growth, will be a lengthy process. And airports such as Denver which were built with significant expansion capabilities are seeing many more ATC delays as a result of the expansion that is happening from many carriers at that airport.
Escalating and Competitively Driven Labor Cost Increases
United’s financial outlook is even more clouded by the announcement that it has reached agreement with its pilot union for massive pay increases , a year and one half after United pilots rejected the industry’s first post-covid pilot labor contract. This four year contract is estimated to cost United $10 billion as valued by the union, making it the richest U.S. airline labor contract ever, including a $1.2 billion signing bonus and retroactive pay spanning since the time the contract became amendable; airline labor contracts do not expire. United joins first Delta and then American with massive pay increases with each new contract more expensive than the one before; in fact, UAL’s agreement in principle will trigger a “me too” clause that will slightly raise DAL pilot pay. It is certain that UAL will take a significant charge for the retro pay as well as reduce earnings for the remainder of the year since it is unlikely they can significantly increase revenue or capacity. It should also be noted that United’s flight attendants are also waiting for a new labor contract; Delta is the only one of the big 4 airlines that has increased pay for its flight attendants as well as all other Delta employees. In total, United’s labor costs could increase by more than $2.5 billion per year.
The size of the labor cost increases at American, Delta and United should legitimately raise the question of whether the airlines can afford them. However, there is a significant competitive dynamic that is at play. For the first time since the U.S. domestic airline industry was deregulation, the legacy carriers are in a stronger financial position than their low cost competitors. The legacy/global model is built to gain premium revenue and also is better able to pass along higher costs than low-cost carrier models. The pilot shortage has already put a significant squeeze on the regional airline industry but is now resulting in high salaries and a growing inability to find enough qualified pilots. The shortage is impacting low cost carriers with growing reports of pilots at JetBlue, Southwest and Spirit leaving their companies to build careers at the big 3 global carriers in part because the widebody international routes which the big 3 operate often result in higher career earning potential. The big 3 global carriers are in a position to take market share and growth potential from low-cost carriers as labor costs become so high that low cost carriers cannot price at the levels necessary to stimulate traffic. Thus, United’s growth plan appears to be an aggressive but risky plan to grow its market share at the expense of low-cost carriers which currently carry more than one-third of U.S. domestic traffic.
The biggest target of United’s strategy appears to be Southwest, the largest low-cost carrier in the U.S. and the architect of the low-cost airline model which has been copied around the world. United has more hubs in metro areas where Southwest has major operations than any other airline. Southwest is negotiating with its pilots and its flight attendants recently rejected a contract offer. Without long-haul international revenue and with no premium cabins, LUV seems to be the most negatively impacted U.S. airline by the massive pay increases that AAL DAL and UAL are agreeing to with their labor groups.
United Might not be the Best Candidate for Aggressive Growth
United’s upcoming earnings represent not just a report card on how well the company is doing with its post-covid strategy but also about UAL’s ability to fund its future even on a status quo basis but even more so based on its aggressive growth plan. Faced with correcting the company’s overdependence on regional jets and its fleet which is the oldest among U.S. airlines, UAL would have had to spend tens of billions of dollars for the remainder of the decade even without much growth. Add in an aggressive growth plan that involves aircraft, airport terminal, and labor cost increases and United might be the most vulnerable to execute a major growth plan.
American is currently the most indebted U.S. airline but is rapidly paying down debt even as it benefits from a reduced need for fleet spending than Delta or United because of AAL’s massive fleet spending and lower fleet age. Delta has the lowest debt levels of the big 3, is paying down debt, and its execs say that it is taking a strategy in between AAL and UAL with growth and fleet spending but at lower levels. Delta began extensive redevelopment of facilities at many of its hub airports so its balance sheet already represents those investments. DAL also has demonstrated that it can more cost-effectively fund its growth which is demonstrated by its higher Return on Invested Capital ratio than AAL and UAL. Most significantly, though, Delta has demonstrated that its highest priority is financial performance rather than market share or growth and Delta routinely generates more revenue and higher profits than any other airline in the world.
The most significant factor that differentiates United’s growth plan from those of American and Delta is revenue generation, market strength, and revenue growth. Delta generated 12% more total revenue than UAL in 2022, driven by DAL’s industry-leading remuneration from its loyalty program and its American Express ( AXP ) agreement as well as its contract maintenance operation (Delta Tech Ops). American generated 9% more total revenue than UAL driven by its larger domestic network. Interestingly, Delta generated the least amount of the big 3 from passenger and cargo revenue. Highlighting UAL’s weakness in earning non-transportation revenue, AAL gained $3.2B or 7.2% of its total 2022 revenue from non-transportation (other sources), DAL gained $9.3B or 18.4% of total 2022 revenues from the same sources while UAL earned just $2.8B or 6.2% of total 2022 revenues from non-transportation sources which are generally higher margin than transportation sources. Thus, UAL is planning to fly more to increase revenue using lower margin transportation sources while DAL, on the other extreme, is expanding its much larger and higher margin non-transportation revenue even further. DAL is better positioned to fund higher costs than UAL and yet UAL is the carrier that appears to be aggressively growing the most.
When comparing revenue sources to debt, UAL’s strategy of increasing debt to gain revenue is far riskier than AAL’s which is based on using more of its existing asset base while DAL, like AAL, is not only reducing its debt but also spending considerably less to renew its fleet and grow than UAL.
United Airlines might not only miss revenue and profits for the second quarter but might also struggle to execute its aggressive growth plan. UAL stock might also be reaching the peak of its runup.
For further details see:
United Airlines Q2 Earnings Preview: Growth Plan Might Be A Miss