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What is wrong with United Continental Airlines?

December 27, 2013 | About:
patokehoe

Pato Kehoe

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The U.S. airline industry is characterized by minimal barriers to entry, rising fuel costs, and hefty competition. Especially in the domestic market, low-cost carriers such as Southwest Airlines Co (LUV) and JetBlue Airways Corporation (JBLU), have put a significant strain on large carriers. United Continental Airlines (UAL) has thus seen competition rise steadily, and as of late, has fallen out of favor with investors. George Soros, Ken Heebner, and Caxton Associates, have turned bearish regarding the company, dumping their entire position over the past months. Let’s take a closer look at United Continental and figure out why the airliner no longer has the support of important investment firms.

Weak third-quarter results

Weak financial results in the third quarter of 2013 is one of the factors affecting United Continental. Performance was quite poor due to a much weaker cargo market, and subduing operations in the Asia-Pacific region. Increased competition in China, one of the firm’s most profitable operations, has gone from lucrative to risky. To put it in simpler terms, throughout the third quarter, revenue decline in the region by 9.4% year-over-year. Thus, despite rising demand for travels to the Popular Repulic, fresh competition represents a significant challenge to United Continental’s dominance in Asia. According to Vice Chairman James E. Compton, “Demand for travel to and from China continues to grow at one of the highest rates globally, and in response, there has been a flood of new competitive capacity into that market”.

Low-cost competition

Another large challenge for United Continental is the strong competition stemming from low-cost carriers such as Southwest. Nevertheless, United Continental does not seem too worried, as it recently leased 36 slots at Newark Liberty to its rival. I consider this a huge mistake, as it has allowed Southwest to enter a very profitable market, and could eventually lead to a deterioration of market share for its premium counterpart. Also, with the substantial price competition which characterizes the U.S. airline industry, United Continental should try to limit low-cost rivals with every chance it gets. As the low-cost carriers grow, they will surely not sit on their laurels, and the last thing the firm needs is further competition in international operations.

Looking forward

United Continental is well-known for its good customer service and solid operational performance, yet recent results are beginning to suggest otherwise. Rising operating expenses will be one of the main obstacles the firm will have to face going into 2014, while maintaining service at its highest level. No easy task. Salaries and wages are especially bound to experience inflation, further adding to the cost increase from elevated fuel prices. As revenue has remained rather stagnant, United Continental will surely face troubles next year.

A look at future projections clarifies the firm’s deteriorating situation further. EPS growth is at –20.4%, and cash flow is plummeting. United Continental has been suffering from low revenue growth rates which barely exceed the 1% mark, leaving shareholders with a small 0.2% return on invested capital. With shrinking margins and increasing competition, this stock is looking quite bearish going into 2014, thus explaining why several investment firms have opted to shed their holdings before the end of the year.

 

Disclosure: Patricio Kehoe holds no position in any stocks mentioned

About the author:

Pato Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 3.5/5 (6 votes)

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