Great expectations
United posted a slightly larger loss year over year in Q1. With the company on track to produce a Q2 profit similar to last year’s $1.41 per share, overall first-half earnings will be slightly lower in 2013 than in 2012. Nevertheless, analysts still expect United Continental Holdings Inc (NYSE:UAL)’s adjusted profit for 2013 to more than double compared to 2012! This implies that the company’s profit margin would increase by 450-500 basis points in the second half of the year compared to the same period in 2012.
While the company faces easier comparisons in the second half of the year, investors seem to be asking too much of United. First, the company cut capacity significantly in the first half of 2012, which tends to boost unit revenue by restricting supply. By contrast, United has projected slight increases in capacity in the second half of the year, including significant capacity growth on its routes from Newark to San Francisco and Los Angeles.
Furthermore, based on the current price of jet fuel, United will realize a smaller benefit from fuel prices in Q3. The company currently projects an average fuel price of $3.02 after hedging costs, compared to $3.18 in Q3 2012. The year-over-year decrease is thus projected at $0.16 for Q3, compared to a $0.25 decline last quarter.
Be careful
Like most airline investors, I expect United to return to solid profit growth in the third quarter, as it bounces back from a weak 2012. However, this alone does not seem like a good reason to buy the stock. United already has perhaps the highest cost structure in the airline industry, and the company is likely to experience above average cost increases for the next year or two as it signs new labor agreements with flight attendants, mechanics, and other workers.
United’s high cost structure might be manageable if it could sustain a revenue premium against competitors like Delta Air Lines, Inc. (NYSE:DAL) and AMR Corporation (OTCBB:AAMRQ). However, United was the worst airline in the U.S. according to most customer service metrics in 2012, destroying customer goodwill. Unless the company can make a miraculous turnaround and justify higher fares than competitors, United’s high cost structure will doom it to mediocrity in the long run.
The article United Airlines: The Outlook Brightens (a Bit) originally appeared on Fool.com is written by Adam Levine-Weinberg.
Adam Levine-Weinberg is short shares of United Continental Holdings (NYSE:UAL) and long Sep 2013 $33 Puts on United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned.
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