How fickle is Wall Street? Less than a year ago, investors weren't keen on United's stock. But a couple of quarters later, they're jumping back on the bandwagon. But not all that much has changed.
Last October, during one of the more tense U.S. airline earnings calls in recent years, United Airlines CEO Oscar Munoz begged investment analysts for patience, saying he need more time to fix some of the more unsound decisions of the previous regime.
This week, perhaps earlier than some analysts expected — after all, a couple wondered whether Munoz could lose his job because the October 2017 call went so poorly — United seems to have returned to Wall Street’s good graces.
The airline Wednesday reported second quarter net income of $684 million on total operating revenues of $10.8 billion, and its pre-tax margin was 8 percent. Perhaps more importantly, its passenger revenue per available seat mile, a metric that gauges how much an airline makes for each seat it flies one mile, increased 3 percent, year over year. United showed unit revenue improvement in all geographic regions except Latin America, where it is relatively small.
Things are far from perfect at the Chicago-based carrier. Profit is down, year-over-year, mostly because United paid 43 percent more for fuel this second quarter than last. And like all airlines, United faces not only the short-term pressure of more expensive fuel, but also long-term threats, such as a possible trade war or global recession.
But for now, things are looking up, and investment analysts seem to be buying in.
“For the first time in a long time, we’re struggling to find things to complain about, despite our preference for the curmudgeonly,” Jamie Baker, a respected analyst with J.P. Morgan Chase, wrote in a research report. “With many investors (as well as ourselves) having questioned whether [United’s] relative equity outperformance was likely to lose momentum in the short run, we believe these results suggest the contrary.”
In the three hours after United’s earnings call Wednesday, the stock rose by more than 8 percent.
Analysts Were Skeptical
United’s customer service failures — notably the April 2017 incident when airport security officers in Chicago beat up a United passenger – caught most of the headlines in the past two years.
But for the most part, analysts didn’t worry about customer experience or product. Instead, they fretted about management’s increasingly aggressive posturing toward its competitors, and they wondered if United would ever match the margins produced by its peers, as management promised.
Last summer, many analysts complained when United President Scott Kirby insisted the airline match fares set by discounters Frontier Airlines and Spirit Airlines, arguing United couldn’t lose cost-conscious customers. United might lose out on revenue on the short-term, Kirby reasoned, but if it didn’t act, the discounters would grow and become more irritating competitors.
Analysts complained further in January, when Kirby unveiled an ambitious plan to increase capacity by 4 percent to 6 percent in three consecutive years, mainly by adding flights in Chicago, Denver and Houston. United’s key competitors each have a handful of massive hubs, Kirby said, and United needed to build similar scale in key markets. United’s previous management had tried to shrink the airline to better profits.
In the two days after it announced the growth plan, United’s stock plunged from $77.97 per share to $66.08.
United has calmed investors slightly by sticking to the lower end of the range this year, saying this week capacity should increase between 4.5 percent and 5 percent. But that’s still more than investors generally like, because more capacity generally pushes airfares down unless demand rises. So far, though, United is filling the extra seats, reporting a load factor of 84.8 percent, up 1.3 points, year-over year.
Baker said he supported the strategy from the start, noting United needed to grow to match American and Delta. But he said other analysts are coming around, too.
“United’s results appear to add credibility to its mid-continent hub strategy,” Baker said. “Recall this plan was maligned by investors as well as certain managements when first unveiled in January as being an early harbinger for reckless capacity growth and management’s supposed indifference to pricing trends.”
The demand picture could change at any point, of course, for reasons outside United’s control.
Thus far, Kirby said he has seen no indication that a possible trade war has hurt United’s bookings. But a recession or a trade war are possible. And United is likely going to have to deal with higher fuel prices for the foreseeable future.
Generally, airlines need time to recoup higher costs when fuel spikes. But on their earnings call Wednesday, United executives said they recovered about 75 percent of fuel price increases during the second quarter.
To further manage higher fuel prices, Kirby said United expects to trim some weaker flights to better align demand with capacity, as other airlines are doing. “Our scheduling team simply turns back some flights at the margin,” he said.
But if a bigger shock occurs, like a global recession, Kirby told investors United is prepared to retire or temporarily ground aircraft, though he said the airline would prefer not to defer deliveries or reduce aircraft utilization.
“We have the flexibility to reduce the fleet by up to double-digit percentages per year if that was required,” he said. “We built a fleet plan that allows us to capitalize on the opportunity inherent in the growth plan but while still maintaining the flexibility to quickly respond to adverse conditions. That, however, is not what we expect to have to do because everything we see today says the demand is strong.”
Despite the worst-case scenario planning, Kirby said he’s confident United can hit its financial targets, both for the remainder of this year and for 2020. By then, United has told analysts it can hit $11-$13 in earnings per share. Its guidance for this year is $7.25 to $8.75.
“We’re going to do everything in our power to hit those numbers, including making changes and making hard decisions when we have to because we view those as commitments that we’ve got to hit,” Kirby said.
But Kirby, who has worked for three airlines and is more honest than the typical senior executive, warned analysts that they can’t live and die by quarterly guidance.
“The biggest risks are in the kinds of things that have always been the biggest risk especially in the short term — fuel price, macroeconomic environment, geopolitical events,” he said. “Those things are sometimes going to happen, and there will be points in time that we will miss quarterly guides.”
Photo credit: United Airlines had a strong second quarter, producing net income of $684 million. Pictured is one of the airline's new Boeing 777-300ERs. United Airlines