United Continental Holdings stock (ticker: UAL) has had a difficult year, down 11 percent, and the company was recently sued by the Justice Department to stop its expansion of takeoff and landing rights at Newark Liberty International Airport.
But analysts are still bullish on the long-term prospects of UAL stock, particularly given the drop in fuel costs and other cost-cutting measures it is undertaking.
UAL earnings. United Airlines, the world’s third-largest airline in terms of revenue, reported third-quarter earnings last month. Revenue was $10.3 billion, but UAL slightly missed analysts’ expectations by recording earnings per share of $4.53.
United’s revenue is down 2.4 percent for the year, but UAL is doing a good job of reducing expenses, which fell by more than 10 percent from the same period in 2014. UAL is also spending heavily on capital expenditures, including aircraft purchases and upgrades, and in upgrading its hubs in San Francisco, Newark, Chicago and Houston.
UAL stock is also performing worse than many of its competitors this year. It’s year-to-date stock performance pales compared to JetBlue Airways Corp. (JBLU) and Hawaiian Airlines parent Hawaiian Holdings (HA), which are up 60 percent and 94 percent, respectively. Alaska Air Group (ALK) and American Airlines Group (AAL) are also having good years, up 28.8 percent and 18.3 percent, respectively.
Stock for Southwest Airlines Co. (LUV) is up 8.9 percent on the year, while Delta Air Lines (DAL) is essentially even. And low-cost carrier Spirit Airlines is having a horrendous 2015, down 55 percent.
The DOJ dispute. Part of United’s strategy was to shut down its unprofitable operation last month at New York’s John F. Kennedy International Airport, and to expand its already dominant share at Newark. As part of the strategy, it agreed to give its JFK slots to Delta in return for Delta’s spots at Newark.
According to the Justice Department’s complaint, United already controlled 73 percent of the slots allocated by the Federal Aviation Administration to carriers there, more than 10 times more slots than its closest competitor. American, Delta, Southwest, JetBlue, Virgin American and Alaska also operate at the Newark airport.
“Airfares at Newark are already among the highest in the country, while United’s service at Newark ranks among the worst,” says Bill Baer, assistant attorney general in the Justice Department’s Antitrust Division. “Allowing United to acquire even more slots at Newark would fortify United’s monopoly position and weaken rivals’ ability to challenge that dominance, leaving consumers to pay the price.”
Four U.S. airports are slot-restricted: the three that serve New York, and Washington’s Reagan National Airport. An airline can only fly as many trips as it has slots; if an airline wants to increase its total number of slots, it must buy those slots from an incumbent.
If the Justice Department successfully blocks the Newark portion of the deal, United will still sell the JFK slots for a price of anywhere from $800,000 to $2.5 million per slot, which could mean an overall return of $10 million to $30 million to United, says Vinay Bhaskara, senior business analyst at Airways News.
“So in the end, United shareholders will still receive the benefits from the savings of shutting down operations at JFK, plus some sort of cash return from the JFK slots. The only thing the DOJ action will change is the form of that cash return: Instead of indirectly accruing from the profits of flights flown with the new slots at JFK, they will instead directly accrue from the dollars that other airlines pay for the JFK slots,” he says.
United’s long-term outlook. UAL stock is trading at an exceptionally cheap price-to-earnings ratio of 3.4 with a mean target price of $80.57, which represents a 36 percent premium over United’s current stock price. It’s rated as a “buy” or “strong buy” by 14 of 16 analysts following the company, and the other two other analysts rated the stock a “hold.”
The drop in fuel prices has been a game-changer for airline stocks. While the cost of jet fuel dropped by more than 40 percent, airfares only dropped about 2 percent.
“Airlines have really become masters on how they manage the interplay between pricing and availability. So that’s why you’re seeing such fantastic operating margins,” says Michael Churchill, a financial advisor at Churchill Research in Falls Church, Virginia.
But the lower fuel costs probably won’t last forever. A more important long-term factor is wages, which can be offset by running larger jets with more seats.
“So if you run a 70-seat plane and pay the stewardess $16 an hour, and then run a 120-seat plane and pay a stewardess $19 or $20 an hour, you still come out ahead. And as overall traffic rises, you can do that,” Churchill says.
Speaking to reporters at a conference in October, Jim Compton, vice chairman and chief revenue officer of United Airlines, said United will be focused on delivering more “out and back” flights to combat significant weather problems that can delay flights that cross the country.
“Instead of having an aircraft start in Newark going to Orlando, over to Houston and out to L.A., what we’ll do is have more often the aircraft go back and forth from Orlando to Newark,” he said. “So when we have severe weather and we have multiple frequencies out of Newark, we won’t be canceling flights from Houston to L.A.”
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Why Analysts Are Bullish About United Continental Stock originally appeared on usnews.com