RealMoney Silver - Continental Airlines' Breakout Could Hold

Continental Airlines' Breakout Could Hold
By Andrew White
RealMoney contributor
10/17/2007 7:48 AM EDT

Updated from 7:48 a.m. EDT on Oct. 17.

Excluding extraordinary items, Continental Airlines (CAL) reported third-quarter 2007 fully diluted (ending September) EPS of $2.25 (+4% vs. earnings excluding extraordinary for the same quarter last year/+4% positive surprise) on revenue of $3.8 billion (+9% vs. same quarter last year/ in line). Results reflected higher fares, as domestic mainline revenue was up +7%, and more international flights, with Trans-Atlantic passenger revenue up +22%, which were partially offset by a -5% regional revenue decline and higher shares outstanding.

Management said it expects continued recovery in the current quarter. Specifically, management sees available seat miles up +6%, resulting in 80% to 81% load factor (flat vs. same period last year). Mainline capacity is projected to grow nearly +6% (primarily ex-U.S. routes). Management also stated it has hedged less fuel exposure, with 30% of fourth-quarter 2007 and 10% of first-quarter 2008 projected fuel needs, which could be something to watch considering continued oil price rises. To continue overall cost control, then, management stated it is close to finalizing supplier arrangements that could save $100 million annually beginning this quarter.

Continental shares traded down as much as -3% in morning trading, reflecting a week broad market concerned about record oil prices. Perhaps even more important than the fact that Continental has proven it can grow earnings despite fuel prices, the stock is testing (and appears to be holding) $35 support after previously holding $30 support. On-balance volume makes me twitchy, but I'm going to go out on the wing and say that Continental's current rally has legs on better-than-expected earnings, technical indicators' recent higher highs and an average -20% industry-relative discount -- in part, reflecting Continental's slower relative earnings growth. Upside targets are $40, $45 and $52, which translate to +13%, +28% and +47%, respectively.

Continental Airlines Preview: Tracking the Flight

Continental Airlines (CAL) is scheduled to report third-quarter 2007 earnings (ending September) in a conference call at 10:30 a.m. EDT on Thursday, Oct. 18.

The current consensus estimate for fully diluted quarterly EPS is $2.17 (flat vs. earnings, excluding extraordinary items, for the same quarter last year) on revenue of $3.84 billion (+9% vs. same quarter last year). Given the company's history of exceeding (even downward revised) estimates and recent strong upward revisions over the last quarter, this week's earnings results are likely to please, high oil prices notwithstanding.

In the recent quarter, Continental surprised analysts positively by growing EPS +10% reflecting 6% sales growth (from international routes), improved load factors and lower landing fees. After five tough years, Continental finally regained profitability in 2006, with 2007-2008 projecting further improvements in load factors and cost control.

Interestingly, though, the company plans to expand capacity by 5%-plus per year going forward, despite its large debt and pension obligations, running counter to industry trends. Accordingly, investors will be watching this week for strong execution amid record high fuel prices and salary pressure, U.S. domestic business yields demonstrating pricing power and an update on the freight business following the recent $350 million U.S. Postal Service contract.

Continental shares currently trade within a weakly defined four-year upward-sloping price channel. Having recently tested and effectively held eight-year, long-term $30 support, the stock has now also broken up through its year-to-date descending channel. With overhead resistance at $40, $45 and $52 (+13%, +27% and +47% from current price, respectively), Continental's earnings recovery/extension bull case is buoyed technically, though on-balance volume does justify current near-term weakness.

After outperforming its industry in the longer term, Continental shares also still sell at an average -20% industry-relative discount (in part reflecting Continental's slower relative earnings growth). If Continental can now demonstrate continuity of results, its shares will likely establish a base around $35, thereafter pushing higher regardless of oil price concerns.