United Continental Looks to Close Profit Gap with Delta

To convert $12.4 billion order for Airbus’s largest twin-engine jet to smaller long-range models

u1United Continental Holdings Inc. (NYSE: UAL), the third largest U.S. airline by passenger traffic after Delta Air Lines Inc. (NYSE: DAL), is reviewing its order portfolio with Airbus Group SE as it looks to revamp its fleet strategy, as reported by Bloomberg on November 30th, 2016. The new management hires President Scott Kirby and Chief Financial Officer Andrew Levy hope that the fleet revamp will close the profit gap with rivals American Airlines Group Inc. (NASDAQ: AAL), Delta Air Lines, and Southwest Airlines Co. (NYSE: LUV), the world’s largest low-cost carrier.

As part of its these plans, United is looking to convert a $12.4 billion order for Airbus Group’s largest twin-engine jet to smaller long-range models. United is also weighing the conversion of Airbus A350-1000s to replace its existing fleet of 747 jumbo jets. The carrier could also switch to a smaller version of the aircraft, or even the mid-sized A330.

Source: Company’s Website

The airline has also evinced interest in The Boeing Company’s (NYSE: BA) new 737 Max, the preferred choice of budget carriers. United Continental is considering investing in the Max 10X, Boeing’s longer version of the largest 737 model, after deferring 61 of the company’s smallest jets on November 15th, 2016. United plans to convert the order to the larger, newer Boeing 737 Max, thereby slowing down near-term capacity growth. United expects the fleet changes to cut capital spending by $1.6 billion over the next two years. The fleet changes are part of $4.8 billion in initiatives intended to bolster the airline’s profitability through 2020.

United joins the list of other major carriers in deferring aircraft deliveries, as it looks to trim capital spending in the near-term. After it canceled an order for 12 Airbus single-aisle planes in late 2013, United plans to accept delivery of 14 of Boeing’s ultra-long 777-300ER, the first of which is due to arrive within weeks. Meanwhile, the carrier is switching four of the current generation 737s on order to the -800 variant to be delivered over the next two years as planned. The new strategy will leave United with a fleet of 150 Max, including 99 of Boeing’s largest narrow body model. Boeing plans to start delivering the upgraded 737 family next year with the Max 8, followed by the Max 9 in 2018.

Share buybacks

Chief Financial Officer Andrew Levy stated that United is also rethinking its share buybacks after announcing a $2 billion repurchase plan this summer that followed a $3 billion effort from a year earlier. The pace may need to slow because of significant increases in labor expenses from several new union contracts as well as rising fuel costs, he said.

Cost saving plan

United Chief Executive Officer Oscar Munoz unveiled a $4.8 billion plan in November 2016 to reap greater revenue and savings from its worldwide route network. As part of these plans, United will make changes to flights at its three big hubs in Chicago, Newark, and Houston that it hopes will add $900 million in incremental revenue by 2019. Changes include using larger aircraft on some routes and changing flight times to improve connections, as well as revamping its demand forecasting systems. Cost-cutting measures are expected to save another $700 million by 2020, compared to last year’s level.

After adopting these changes, costs for each seat flown a mile, or unit costs, are expected to grow by 3.5% to 4.5% in 2017, excluding fuel costs. However, unit costs are expected to grow by less than 1% from 2018 to 2020, after the effect of new labor deals tapers off. With new agreements with workers in hand, United is also focusing to improve operating profit, which amounted to 13.6% of sales in 2015. Industry leader Delta had a 19% margin and American’s was 15.1%.

Introduction of Basic Economy

u3United, like rival Delta, has rolled out a new Basic Economy fare, which will go on sale in January 2017 with discounted tickets that have fewer benefits than the traditional Economy tickets. Customers buying United’s new offering will not be entitled to store a bag in the overhead bin. Instead, passengers in Basic Economy will be able to bring a small personal item on-board and store it under the seat. United’s approach will resemble the policy of discount carrier Spirit Airlines Inc. (NASDAQ: SAVE), which charges extra for any carry-on bags.

Basic Economy will anchor United’s efforts to segment its cabins, or create additional fare classes with different amenities and privileges. The company also is evaluating adding a Premium Economy cabin, which would have wider seats than traditional coach and come with more amenities. u4United hopes to generate another $1 billion with these new cabin offerings.

Revamp of domestic strategy

The company is also reshaping its domestic strategy. United had ordered 65 of Boeing’s 737-700 jets in two batches over the past year, taking advantage of attractive prices for aircraft near the end of their production run after reviewing Bombardier Inc.’s C Series to replace flying handled by regional affiliates. In a switch, the carrier is bolstering its United Express regional fleet. United will now acquire 24 of Embraer SA’s E-175 regional jets that earlier were going to be purchased by Republic Airways Holdings Inc. Republic is expected to operate the jets on behalf of United.

Stock Performance

u5United’s stock ended the day at $68.47, slipping 0.70%, at the close on Thursday, December 1st, 2016, having vacillated between an intraday high of $69.87 and a low of $68.30 during the session. The stock’s trading volume was at 3,213,032 for the day. The Company’s market cap was at $21.72 billion as of Thursday’s close.

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