THE HEDGEYE EDGE
United Continental (UAL) is a high cost airline that has struggled to generate consistent positive free cash flow in a favorable economic environment.
The road ahead looks increasingly rough for UAL. Our pricing data suggests they have exited a price war with a lower cost airline. What did UAL gain? Flat market share growth and lots of shareholder pain.
It is typically easier to take fares down than back up, particularly if the goal is to drive higher utilization and ASM growth in a higher fuel price environment. The highest cost, legacy operators, like United Continental (UAL), who have basically ceded share to keep pricing high, are losing share to nimble, low-cost providers. We continue to think that UAL will be trapped by an ‘unpossible’ dilemma, choosing between lower fares, higher share, and more rapid cash burn versus higher fares, more rapid share loss, and slower cash burn.
If one values UAL as an operating company, it should be worth the present value of future free cash flows to equity. If an airline burned cash over a 6 year period during decent economic activity, and burned cash in 2017, which was a very robust macro economy, a period over which its fleet aged and it “was shrinking”, what would that equity be worth?
Intermediate Term
UAL is gaining a tailwind from aggressive (for them) capacity additions in an otherwise robust demand environment, which is facilitating absorption. Our firm’s macro view is that growth will decelerate in 4Q18. That may prove a key risk for UAL’s new strategy. So far, however, we’ve been wrong as the shares have performed well in a rising fuel environment.
BOTTOM LINE
We continue to see UAL struggling to generate cash. The company is flailing as it copes with an inferior cost and hub structure in addition to a deteriorating balance sheet. With fuel prices and competitive intensity both looking like headwinds in late 2018 and early 2019, we expect shares of UAL to trend lower.
ONE-YEAR TRAILING CHART
