Headwinds Remain for United Airlines After Better-Than-Expected Quarter

The company's second quarter beat expectations but second-half guidance was weak, a reminder of the work still left to be done
By Lou Whiteman ,

An overhaul at the top of United Continental (UAL) - Get Report  seemingly has produced the desired results, stabilizing the airline and helping it report second-quarter results that beat expectations. However, the larger goal -- closing the gap between United and its rivals -- remains a far-off destination.

Chicago-based United after hours Tuesday reported a second-quarter profit of $2.61 a share, down 32% year over year but ahead of $2.56 a share consensus estimates. United also pledged to buy back $2 billion worth of shares and scale back capacity, responding to continued pressure on margins being experienced by the entire industry.

UAL repurchased about 4.4% of its shares outstanding in the second quarter, and this latest $2 billion authorization represents about 13% of the company's market capitalization as of July 18. The airline has been an aggressive buyer of its stock in recent years, reducing its share count 14% from a peak of 384.23 million shares in February 2015 to a recent 336.82 million.

United reported a second quarter that was stronger than expectations but warned that the rest of the year is likely to be weaker than the airline had hoped. The company guided to expect a pretax third-quarter margin of between 13.5% and 15.5%, slightly below consensus, and said passenger revenue per available seat mile is expected to be lower by 5.5% to 7.5% year over year.

The airline in the past 12 months has replaced its CEO, battled with activists, weathered a federal probe into dealings with government officials and has tried to make peace with labor groups that have been at odds with the company since before its 2010 merger with Continental Airlines. New CEO Oscar Munoz has succeeded in a short period of time in putting out some of the biggest fires raging inside United, but the airline still trails Delta Air Lines (DAL) - Get Report and American Airlines (AAL) - Get Report in terms of profitability.

Munoz and his team last month identified areas where they believe they can improve operating income by $3.1 billion in the next two years, including new fare structures designed to both better compete against discounters and extract a premium from business travelers, cost cuts and cutting delays and cancellations. A more reliable product is also a first step toward winning back lucrative corporate contracts, which analysts said have migrated to Delta and American in recent years as United struggled.

But even as United shows improvement, significant turbulence remains. The industry has blamed pricing pressure over the last year on low fuel prices that tempted participants to introduce marginal flying into the system, but the pressure on fares has remained even as fuel has begun to normalize. Aviation experts urge patience, noting there is typically a lag between fuel moves and corresponding capacity adjustments, but United seems unsure of when revenue per available seat mile will turn positive other than to say it won't happen this year.

And while United management is working to extract costs from the system, there are also new expenditures on the horizon. A new contract with flight attendants, the price for labor peace, is expected to be ratified next month and could add upwards of 50 basis points to expenses during the remainder of the year. Meanwhile, competitors are further along in taking many of the steps United has outlined, and are presumably not going to stop pushing to extract higher profits out of their systems.

More broadly, there is a growing fear that a new wave of ultra-discounters including Spirit Airlines (SAVE) - Get Report and privately held Frontier Airlines are beginning to reshape the domestic market similar to what Southwest Airlines (LUV) - Get Report  did three decades ago. The result back then was a permanent loss of market share for the incumbents. If that were to happen again United, with its current poor reputation among travelers and its significant exposure to discounters at hubs including Denver, appears at risk of losing a disproportionate share of business.

United has made great strides in recent quarters eliminating the chaos that has plagued the company for so long, but that is only the start of the journey. The hard part of a turnaround is still on the horizon.

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