View: United Continental's Disappointment - Barrons.com

Maxim Group

The U.S. airline industry produced solid second-quarter results, with most airlines matching projections.

The nine major nonbankrupt airlines produced a quarter profit of $2.0 billion, versus our projection of $2.1 billion.

This compares with industry profits of $1.3 billion in second-quarter 2011 (which excludes AMR losses). Bankrupt AMR continues to improve its revenue position and had some of the top passenger revenue per available seat mile (Prasm) increases in May and June, which may be indicative that the changes are having a positive effect on results.

We expect the third quarter to be even stronger due to seasonality, strong demand, high load factors, and a further increase in Prasm. As a result of the more difficult year-over-year comparables, Prasm increases we expect should be smaller, probably single digit for the third quarter.

To our surprise the industry did initiate a ticket price increase in July that stuck, the first attempt since March. Moderately reduced fuel costs should also help third-quarter earnings.

We are expecting industry earnings of $3.0 billion (excluding bankrupt AMR) in third-quarter 2012 versus $2.0 billion in third-quarter 2011.

The main disappointment was United Continental Holdings (ticker: UAL), which revised its June Prasm numbers downward from 6% to 3.5% just before the earnings release due to problems with the revenue accounting system.

This took down earnings results for the quarter, producing a weak Prasm increase of 3%. United also indicated that it expects July Prasm to be roughly flat, while we expect the industry to see increases in the mid-single digit area.

Delta Air Lines (DAL) announced that it is shutting down one of its regional feed airlines, Comair, which operated smaller regional jets (RJs). This continues to demonstrate that the legacy carriers are still committed to using regional airline services to fly to smaller markets and that it will now be concentrating more on expanding 70-seat and larger RJs and shrinking operations of 50-seat and smaller aircraft due to higher fuel costs.

We expect a major restructuring of the American Eagle fleet (in bankruptcy) to move to the larger RJs—another indicator of this trend.

Although the fourth-quarter outlook remains uncertain, we believe that the industry should have a solid third-quarter as traffic and pricing remain strong for this period.

In an uncertain economy, we still favor the growth-orientated niche carriers such as Copa Holdings (CPA) and Alaska Air Group (ALK).

Our overall economic outlook looks for weak economic growth (around 2%) through the end of the year and stable oil prices, which should enable the carriers to produce positive results, possibly beating last year.

Our main worry is the potential "tax cliff" due to take effect in January 2013, in which a whole series of federal taxes are due to hit the economy, possibly causing a recession. Airlines must be prepared for this possibility, and we believe that it may already be taking a toll on the economy due to the uncertainty.

-- Ray Neidl

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