2023-08-18 03:06:29 ET
Summary
- United Airlines' financials and valuation indicate that the stock is undervalued.
- The second quarter results show that the United Next strategy is working well, thereby assisting the airline to reach its guidance.
- United Airlines' profitability condition in terms of margin and return ratios is better than that of its peers.
Introduction
United Airlines Holdings ( UAL ) has the most comprehensive route network among other North American carriers. The airline operates in the U.S. mainland hubs like Chicago, Denver, Houston, Los Angeles, New York/Newark, San Francisco, and Washington D.C. After the downturn of 2021 due to the COVID-19 outbreak, airlines suffered high costs. Moreover, global phenomena like inclining energy prices and declining purchase of power caused more tough circumstances for airlines. In this analysis, I have investigated United’s financials and business outlook. Based on my valuation, I conclude that UAL is undervalued.
UAL’s business and market outlook
The previous month was a challenging month for United Airlines in Newark. It is worth mentioning that the highest portion of United’s operations is in Newark. The last month’s weather events brought challenging circumstances for the company, and thus they had to cancel many flights. Currently, the management is striving more than ever to mitigate the financial results of weather impact and build a manageable schedule at Newark. In doing so, reducing the total flying in the rush hours is one of the new initiatives to handle the constrained operating environment these days in Newark.
The impact of higher inflation on travel and tourism
The company’s strategy to overcome the pilot shortage issue was to aggressively hire more pilots. They also are growing their Mid-Continent hubs, up-gauging their fleet, and ultimately, wide-body their fleet under the United Next strategy. The success of this strategy is reliant on economic stability. During the last year, the higher inflation caused by the COVID-19 pandemic resulted in higher interest rates and thus impacted households’ purchase of power to a great extent. This phenomenon, coupled with the economic impact of the Russian invasion of Ukraine. The war brought several supply chain constraints, including rising the price of energy. All in all, these circumstances led to a surge in travel-related costs. Notwithstanding a strong rebound in 2022, the impact of macroeconomic circumstances caused most travelers to choose shorter routes to shrink their costs. Overall, as is indicated in Figure 1 , international tourist arrivals are expected to reach 80% to 95% of pre-pandemic levels by the end of 2023.
Figure 1
U.S. inflation rates are on a decreasing path, and after reaching the Federal Reserve’s target of 2%, there is no need for keeping interest rates high. It is worth mentioning that in July 2023, the annual inflation rate in the U.S. accelerated to 3.2% versus 3% in June, albeit remaining below the forecast of 3.3%. A year earlier, the inflation rate started to fall from its peak level of over 9%. Recently, energy costs fell by 12.5%, albeit less than a 16.7% fall in June. Overall, the inflation rates are heading to their previous levels leading to a solid demand environment and thus bringing more opportunities for Airline giants like United, Delta Air Lines ( DAL ), American Airlines ( AAL ), and Southwest ( LUV ).
Regarding the strategy of solving pilot shortage, United has settled an agreement with the Air Line Pilots Association ((ALPA)). This agreement will cost approximately $10 billion in value over the four-year lifetime agreement and includes packages of improvements to the quality of work-life balance, compensation, benefits, and more for United’s pilots. This agreement can be a milestone in supporting the airline to reach its 14% pretax margin by 2026.
UAL’s financial outlook
United’s financial results in the second quarter of 2023 indicate that the management’s Unite Next strategy has been working well until now. Their revenues in the quarter were 17% up, while the guidance was 14-16%. UAL’s Passengers Revenue Per Available Seat Mile ((PRSM)) improved by 2.2%, with a capacity increase of 17%. PRSM is a crucial measure to compare the efficiency of each airline. Moreover, as the supply chain constraints have mostly been solved and COVID-19 recovery has improved, the demand side is boosting again. In this regard, United’s International PRSM boosted by 44% year over year as compared with the prior year.
For the third quarter of 2023, it is expected that United will improve its capacity by 16%, and thus its total revenue surge by 10-13% year over year versus the third quarter of 2023. Additionally, the full-year capacity is expected to be up 18% as compared to 2022. Also, the management expects that the international demand will remain higher than the domestic. Thankfully, United’s domestic margins reached their 2019 levels, while the international margins are well above the pre-pandemic levels.
To analyze United’s performance more accurately, I have compared its profitability condition with other airline giants across the board of their margin and return ratios. As you can see in Figure 2, United has performed the highest margin ratios among its peers. During the second quarter of 2023, all peer airlines could surge their margins considerably, while United surpassed its peers and reached 34.4% of gross profit margin and 16.7% of operating margin. As a result, UAL’s margins depict the airline’s strength in providing profit in comparison with peers.
Figure 2 – UAL’s margin ratios vs. its peers
Moreover, observing the peer group’s return on equity shows that although Delta experienced the deepest plunge in ROE in 2021 due to the COVID-19 outbreak, it could recover successfully and surpass others and reach over 25% of ROE. United Airlines’ annual ROE is 12.3%, which shows the airline's ability to turn its equity investments into profit (see Figure 3).
Figure 3 – UAL’s ROE vs. its peers
UAL stock valuation
After analyzing United’s financial performance during the recent quarter and comparing its metrics with its peers, I believe the stock is still undervalued, and its well-performance has not been reflected in its market price yet. In doing so, comparing United’s valuation metrics with its peers shows that EV-to-EBITDA is 4.32x, which is well below the peers’ average of 5.64x. Moreover, the airline’s PE ratio sat at 6.3x, which is in line with the average. It is worth mentioning that American Airlines has the lowest PE ratio of 3.8x. Additionally, United’s EV-to-Sales sat at 0.66x, which is lower than the others. As a result, United’s valuation metrics indicate that the stock is undervalued, and I calculate that its fair value is approximately $60 per share (see Figure 4).
Figure 4 – UAL stock valuation
Conclusion
In this thorough article, I have analyzed United Airlines’ business and financial outlook. Based on the airline’s second-quarter results and promising financial metrics such as margin and return ratios, it is proven that the United Next strategy is working successfully, and the airline expects to reach its growth guidance. In comparison with other peers, United generated a higher operating margin and gross profit margin in the recent quarter. Moreover, investigating the United States inflation trend indicates that notwithstanding being higher than the Fed’s target of 2%, the inflation rates are heading down. As a result, the demand side will be improved more in the years coming. Ultimately, my valuation indicates that the United Fair stock price is approximately $60, and thus I conclude that a buy rating is appropriate for UAL stock.
As always, thank you for your time, and I welcome your comments.
For further details see:
United Airlines: The Stock Is Worth Approximately $60