We are upgrading our long-term recommendation on United Continental Holdings Inc. (UAL) to Outperform from Neutral.
The largest U.S. airline is benefiting from industry consolidation and improved economic conditions. Though we remain concerned about escalating fuel prices, United Continental has successfully passed on higher costs to its customers in the form of fare hikes.
The company is also well prepared to combat rising fuel costs by reducing flight frequencies, indefinitely postponing flight starts, as well as scraping unprofitable routes and less fuel-efficient aircraft from its fleet.
In addition, United Continental hedges its fuel position, which restricts its losses and provides increased profitability. For the remainder of fiscal 2011, the company has hedged 28% to 44% of its expected consolidated fuel consumption using a combination of calls, swaps and collars.
In the first quarter, United Continental’s earnings improved on increased fares and extra fees, despite higher fuel prices and capacity cuts. Adjusted earnings outpaced the Zacks Consensus Estimate by 4 cents and were 17 cents above year-ago earnings.
For the second quarter, United Continental expects lower-than-expected revenue growth due to tough year-over-year comparisons. The company expects the second quarter’s unit revenue to grow 8.3–9.3% year over year, compared with 9.9% in the first quarter and 11.5% in the fourth quarter of 2010.
United Continental’s expected second quarter revenue growth is lower than the projection of its rival Delta Air Lines Inc. (DAL) but higher than American Airlines’, a wholly owned subsidiary of AMR Corporation (AMR). Delta Air Lines expects double-digit unit revenue growth in the second quarter while American Airlines expects a 4.5–5.5% increase.
Furthermore, United Continental expects capacity growth of 1% year over year, which is toward the low end of its previous guidance of 0.8–1.8%. The Zacks Consensus Estimate for the second quarter is $1.48, representing a substantial 24.20% decline from the year-ago quarter.
Despite the expected sluggishness in the second quarter, we believe United Continental will outperform the market in the long term. A revival in the airline industry, reduced capacity, unit revenue growth, fleet and network optimization, its hedging strategy as well as the merger benefits from Continental Airlines bode well for United Continental’s future growth.
Our long-term rating is supported by the short-term Zacks #2 (Buy) Rank.
AMR CORP (AMR): Free Stock Analysis Report
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