Now United Looks Smart

After a three-year odyssey in bankruptcy, the carrier produces jealousy-inspiring financials.
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The financial results reported in the third quarter upended the airline industry's recent hierarchy.

Low-cost industry darlings counted their losses, while long-bankrupt, long-doubted

United Airlines

came out on top.

Despite the belief by some that its three years in bankruptcy court were too long, too expensive and too unproductive, and even with continuing questions about its long-term strategy,

UAL

(UAUA)

, the parent of United, earned $190 million in the quarter, the most of any carrier that's no longer under court protection. It also produced better margins than its legacy peers.

In fact, excluding special items, reporting legacy carriers all produced triple-digit profits. That includes

Northwest Airlines

(NWACQ)

which, while still in bankruptcy, reported net income of $252 million. Bankrupt

Delta Air Lines

(DALRQ)

will report next week.

Two carriers were money losers:

AirTran Airways

(AAI)

and

JetBlue Airways

(JBLU) - Get Report

. Both have cost-per-available-seat-mile numbers at the low end of the scale, and both suffered more than United from the August implementation of enhanced security regulations.

Among the low-cost carriers,

Southwest Airlines

(LUV) - Get Report

reported its 62nd consecutive profitable quarter, while

Frontier Airlines

(FRNT)

made $500,000.

United's success surprised analysts, prompting several to raise estimates after the carrier said per-share earnings would have been 43 cents higher had it not accounted for income tax expense.

"We (and we believe consensus) were assuming zero tax," wrote Merrill Lynch analyst Mike Linenberg, in a recent report.

Cathay Financial analyst Susan Donofrio recently rated United outperform and raised her price target to $40 from $38, lauding the airline's "exposure to high-margin international routes, proven ability to capitalize on cost-cutting opportunities and attractive valuation."

Meanwhile, Linenberg says that "after lagging its competitors for the past several quarters, United's operating income of 5.9% now exceeds its peer group." American has a 4.9% margin, while Continental has a 5.5% margin, he noted. He maintained a buy rating. Merrill Lynch has a financial relationship with United that includes acting as a market maker and providing other services.

Still, questions remain. CreditSights analyst Roger King recently said that United reported its seventh straight quarter of increasing revenue per available seat mile, while CASM has generally declined during that time. That's good, of course, but King noted that United's strategy is to produce industry-high RASM by providing superior service to high-end customers. "Higher RASM needs higher CASM to support it," King said.

On Monday, United reported its preliminary traffic results for October, including a passenger load factor of 80.6%. Total scheduled revenue passenger miles increased 2.3% from last year. Capacity also rose 2.3%, measured by scheduled available seat miles.

United employees may be coming up with a wide variety of cost-savings initiatives, as CEO Glenn Tilton said on a recent conference call, but some are restive. United's pilot leaders voted last month to "insist negotiations begin immediately to restore pay, work rules and benefits," the

Chicago Tribune

has reported, despite being locked into their present contract until 2009.

A pilot spokesman declined to comment for this article.

Aviation consultant Mike Boyd contends that United seems to lack a long-term plan beyond seeking a merger. United recently retained Goldman Sachs to explore strategic options. At the same time, the five other legacy carriers have clear strategies, Boyd said. "The difference is that Tilton called a realtor to sell the place," he said.

On the conference call, Tilton reiterated his long-standing contention that consolidation would benefit the industry, but acknowledged that industry response has been muted. "I think the reaction has been personal

to individual companies," he said. "Other industries have benefited, but at the end of the day it's at the discretion of individual participants."

Like

AMR's

(AMR)

American Airlines, United has so far not defined how it will restock its aging fleet. On the call, CFO Jake Brace said United has one of the youngest legacy fleets but acknowledged that it's getting a year older every year. Brace said United's oldest Boeing 737s, now 17 to 18 years old, "would typically fly ... well into their 20s."

There will be options, eventually. "The 787 is an attractive aircraft

and the A350 may or may not be an attractive aircraft," said Brace, adding that United will wait a year "before we start thinking about that kind of thing."

In the meantime, said Executive Vice President John Tague, United is "making significant investment in ... our current fleet," including planning premium cabin upgrades that will be unveiled early next year.

Nevertheless, industry consultant Robert Mann said that despite having a better second quarter than their low-cost competitors, United and its peers are at a long-term disadvantage when it comes to fleets. Airlines may get lucky on fuel hedges, he said, but "the best fuel hedge you can have is the most efficient fleet, and most of these guys are driving around 20-year-old fleets."

The future may still belong to the out-of-favor low-cost carriers, Mann said, because "they are the guys driving around the shiny new airplanes."

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