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A United Airlines jumbo jet with Continental tail livery.


United Airlines shows strong potential, nears end of merger pains

by Rafael Bernal
June 06, 2012


United Continental Holdings Inc. is entering the last phase of a long and sometimes painful integration period. The largest airline in the United States, created through the marriage of air giants Continental Airlines Inc. and UAL Corp., still faces significant challenges but is viewed with optimism by most analysts.

“Maintain a positive long-term view, but expect a bumpy next couple of Qs,” writes Michael Linenberg of Deutsche Bank AG. Merger news still dominates the stage at United, but the company faces new challenges as the possibility of making decisions as an integrated unit becomes a reality.

 

Overriding United's first-quarter loss of $271 million (perhaps because revenue improved), analysts estimate earnings per share of $4.16 for 2012, a far cry from $2.26 in 2011. The consensus target price for the stock is $31.50, sharply higher than Wednesday's close of $23.53. 52-week high is $25.84. Most analysts rate the stock a buy or a hold.

For the full year 2011 the airline reported earnings of $1.8 billion, up 86.7 percent from 2010's $976 million, which was burdened by merger costs and lingering expenses related to United's long Chapter 11 bankruptcy process.


The 2010 merger between Houston-based Continental and Chicago-based United was the result of pressures faced by the airline industry in the wake of the 2008 financial crisis. Two years after merger announcement, one of the last steps to full integration was completed with the adoption of a single reservation system on March 4. Technical glitches plagued the first week of system use, leading to flight delays and stranded passengers. Much like the merger that caused it, the reservation system got off to a rocky start but soon managed takeoff.

Commercially, systems integration meant the Continental name disappeared entirely, although its tail livery was adopted by all United aircraft. In terms of operations, the customer service move ties in with a major regulatory stepping-stone--receiving a single operating certificate from the FAA--and, crucially, advancements in union negotiations towards an integrated labor force.

 

Amid the optimism, however, there is caution because, as Linenberg puts it, “it will still take a few Qs for United to get past the majority of its merger-related headwinds.”

Among the challenges the airline faces is competition from low-cost air service providers. At the center of this is a tiff over international air travel from Continental’s former hub, Houston. Competitor Southwest Airlines Co. recently announced its intention to provide international service from Houston’s William P. Hobby Airport, the city’s second biggest airport after George Bush Intercontinental. The move triggered concerns at United, which controls an 80 percent market share of international flights from Houston.

The resulting row involved the Houston City Council and threats of labor cuts at Bush Intercontinental, but provided United a stage to test its leverage as the nation’s largest airline. However, its push was not enough to stop Houston from voting to open up international flights at Hobby, a move finalized earlier this month. United responded by announcing layoffs, suspending expansion plans at Bush and cancelling a planned nonstop flight to New Zealand.

While all airlines face fuel price volatility as a major risk, United must also cope with risks related to its integration process, and not all analysts are sanguine about this. Jamie Baker, an analyst at JP Morgan, which rates United stock overweight, writes in a report, “Should the UAL/CAL merger prove more costly than expected, due to, e.g., extended difficulties in labor negotiations, our view on UAL may be negatively impacted.”

Analysts agree on one positive industry-wide outlook: demand remains strong. In that respect, United has a strong advantage because of its access to two major airlines’ worth of markets. Linenberg writes, “in the June Q, United will redeploy 15% of its mainline departures from weaker to stronger demand markets and accelerate the strategy in the fall and winter.”