UAL's presentations and published plans will take at least four years to close $2bn of the gap on AAL/DAL margins and returns. With that, we believe it may also take four years for UAL shares to close the gap with shares of DAL and AAL. UAL’s November 2013 Investor Day presentation outlined a four-year $2bn program of cost and revenue improvement. Importantly, during those four years, DAL and AAL will be similarly working to increase earnings.
While we believe UAL’s published objectives are logical and their efforts will likely reduce costs and increase revenues, in our opinion, the scope and scale of the overall plan seem myopic in the post-merger context of what was recently the largest airline in the world. We believe the list of objectives addressing how UAL’s results will be moved to higher levels seemed more likely to be found in a typical operating department’s annual budget presentation than in a corporate presentation as to how UAL’s results would be lifted to record levels. The outlined operating adjustments, such as reducing employee overtime, while important, will not close the gap with DAL and AAL, in our view.
UAL has yet to adopt key steps taken in recent successful airline mergers and we are unsure why.
Regardless, lacking certain sweeping network and fleet changes, it may be difficult for UAL to produce returns comparable to its peers. Although United has recently begun dismantling its Cleveland, OH, hub, indicating substantial losses as the reason, it seems unwilling to eliminate its unprofitable Washington Dulles International Airport (IAD) flying. Flying at IAD would be better focused on simply flying passengers to and from IAD, allowing most connecting customers to flow over Newark, NJ, Houston, TX, or Chicago, IL, in our view.
Using UAL’s own DOT-filed metrics as the benchmark, the vast majority of IAD markets are similarly or even more unprofitable than was Cleveland. UAL would not operate two payroll departments, so we wonder why it would operate two hubs only 211 miles apart. When a merger is announced, there are a number of common assumptions made by management, investors, and employees, including the elimination of duplicate departments, services, and staff.
Just as UAL no longer operates separate payroll departments for United and Continental, it is our opinion that perhaps the airline should no longer operate separate hubs in Newark, NJ, and Washington DC. Both hubs currently connect traffic from the eastern third of the country to Europe as well as connect north/south domestic traffic. By eliminating the smaller of the two hubs, UAL would see outsized savings and improved profitability across the entire UAL route network, in our view. This model has been utilized in past airline mergers with high degrees of success including DAL’s closure of Cincinnati, OH, in favor of Detroit, MI, and Memphis, TN, in favor of Atlanta, GA, as well as US Airways closure of Pittsburgh, PA, in favor of Philadelphia, PA.
United continues to operate more inefficient 50 seat regional jets than any other U.S. airline. Although it has negotiated labor agreements which we believe would allow it to replace 50 seat flying with 75 seat flying, it appears that United continues to operate more 50 regional jets as a percentage of total flying than its peers. As a percentage of the total, 7.6% of UAL’s available seat miles (ASMs) are currently carried by 50 seat, or smaller, regional jets.
This compares to 5.3% at AAL and only 3.4% at DAL. Furthermore, it appears that both DAL and AAL are acting more quickly to replace 50 seat regional jet flying with more efficient 75 seat regional jets. This is represented by a more significant year-over-year (yoy) decrease at both DAL and AAL vs. UAL. The decision to continue to fly more regional jets, we believe, is likely driven by a desire to grow market share rather than generate higher returns.
UAL’s Washington Dulles Hub was created to compete with Continental’s Newark Liberty International Airport (EWR) hub. Almost four years after the merger, it is still competing. United began building its IAD hub in the early 1990s as international routes were first being deregulated with new open-skies treaties.
UAL chose to operate its international routes at IAD rather than in the NYC area as AAL had already established a meaningful operation at John F. Kennedy International Airport (JFK) and Continental was already operating a meaningful hub with international destinations in Newark. UAL thus chose IAD despite the local population pool in Washington being significantly less than the New York/New Jersey area. United shortly established a short haul network, mostly with 50 seat aircraft, in an attempt to attract connecting North/South domestic traffic away from nearby hubs including Continental’s Newark hub, to support their Dulles hub. This competitive regime is still continuing today.
However, Department of Transportation data suggests that if Cleveland were generating losses, then IAD is likely less profitable than was Cleveland. Even if IAD is profitable, we believe the combined EWR/IAD region would be more profitable without the IAD hub capacity in the region, both domestic and Europe. Operating results from peers, including Delta and US Airways, suggest that their broad stroke changes at Cincinnati/Northern Kentucky International Airport (CVG) and Pittsburgh International Airport (PIT), the closure of nearby hubs, had a significant positive effect on earnings. United itself seems to acknowledge this by winding down Cleveland in favor of connecting traffic over nearby Chicago.
