United Airlines

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 2/5

A major global airline that provides passenger and cargo transportation services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

United Airlines, a major player in the airline industry, faces a complex landscape defined by a mix of competitive pressures and cyclical demand. It is essential to approach UAL’s analysis with a focus on its operational efficiency, financial health, and the sustainability of its competitive advantages. The airline industry in general is characterized by low profitability and intense competition.

Business Overview

  • Revenue Distribution: United’s revenue is primarily driven by passenger travel (domestic and international), with cargo contributing a smaller portion. A detailed revenue breakdown by region and type of customer, while present in the reports, is not immediately relevant to a moat analysis. But it’s important to understand that, due to the nature of air travel, most revenues come from the more lucrative international segment and domestic segment, which are also the most vulnerable to disruption.

  • Industry Trends:
    • The airline industry is highly cyclical. Demand is volatile and influenced by macro factors, such as recessions and global events like the pandemic. This is reflected in earnings going down when people aren’t traveling.
    • Competition is fierce as companies strive for market share and to fill seats. As the industry matures, airline operators are looking to consolidate to build a moat.
    • Fuel costs and labor costs are major input costs that can erode profits when rising.
    • Airlines face constant technological disruption, both in operations and in the passenger experience.
  • Competitive Landscape: UAL operates in a hypercompetitive market, with numerous carriers vying for market share. The key challenges include:
    • High competition from other network carriers and low-cost carriers. Southwest, Delta, American airlines and other discount carriers fight for the same passengers, creating the hypercompetitive environment.
    • Capacity management is crucial as airlines must adjust flight frequencies to match demand fluctuations. This also creates an environment where airlines are fighting for market share by offering low prices to increase seat occupancy, thus reducing profitability.
    • Pressure on margins is ongoing because of high input costs and consumer willingness to pay (or not pay) more for airline tickets.
  • What Makes UAL Different: UAL emphasizes a focus on connecting people, uniting the world, and providing a safe experience. UAL, as a large airline, tends to prioritize hub routes, connecting flights through major hubs to increase profitability and efficiency of flights, compared to low-cost carriers, which tend to take point to point routes. UAL also emphasizes premium and first class sections, which gives them extra margins at the cost of increased risks in higher-income consumer behavior. A key advantage is that United is part of the Star Alliance, which allows for interlining with other major airlines worldwide.

Financial Analysis

The latest quarterly results show revenues of 14.2 billion dollars, compared with 12.4 billion dollars in same time last year. Operating income for the first 3 quarters of 2023 were a positive $1.756 billion, with net income of $1.124 billion, which can be compared with loss of $378 million in net income for same period last year, highlighting improvements in profitability compared to last year.

  • Profitability: The airline has high volatility in profitability with some swings in income. Some profits are offset by higher fuel and labor costs. UAL can have strong quarters in better economies with more people travelling, yet can perform poorly in other times, indicating a business that can not withstand bad times. Although net profit was positive for the first 9 months of 2023, it’s important to note that this is compared with a loss in the same period last year. It remains to be seen if UAL can be consistently profitable.

  • ROIC: ROIC (Return on Invested Capital) is a measure of a company’s profitability based on its total invested capital. Although UAL has improved its ROIC in recent years, as per the latest quarterly results, it is still low and will take time to increase. ROIC continues to be volatile, depending on input costs and number of passengers and is highly dependent on the market environment of the time.

  • Margins: Operating margins are low and are also volatile, as airlines face pressure to offer competitive prices while struggling with high operating expenses. Most notably, fuel prices and labor costs can significantly influence margins, as they are major costs.
  • Balance Sheet: UAL has a complex balance sheet because of its large amounts of assets with long-term debt. The company has increased debt to fuel growth during COVID and post COVID. While it has been trying to bring down the debt, it will take time to stabilize.

Current financial data available for UAL indicates significant levels of debt, with long-term debt over 20 billion dollars, along with total liabilities over $40 billion. While liquidity positions have improved over the past year, risks persist. The company’s net debt to EBITDA remains high. UAL has made large debt and capital expenditure commitments to purchase new aircraft in coming years, which can be a risk.

Moat Analysis

  • Moat Rating: 2/5
  • Justification:
    • UAL has a brand name which helps with some loyal customers, but is by no means a powerful competitive advantage.
    • UAL benefits somewhat from a network effect by having hubs and a wide array of interline agreements and route planning, but low-cost airlines that take point-to-point routes are still competitive.
    • Switching costs are non existent, and it is easy to switch from airline to another.
    • UAL has little to no cost advantages because fuel and labor costs are generally similar across all airlines.
    • Although UAL has a broad route system, most major airlines have a vast global reach, so it is hard to identify a sustainable competitive advantage that would shield them from aggressive competitors for a long time. Also, it should be noted that the large commitments to new aircraft, can also lead to a disadvantage if demand doesn’t increase, or if other airlines offer better options.

While United possesses certain advantages like its global network and alliances, these are easily replicable by competitors and there are little to no switching costs. Therefore, UAL’s moat is limited and not very wide.

Risks and Resilience

  • Risks:
    • Economic Downturns: Reduced passenger demand due to recessions directly impact revenues and profitability.
    • High Input Costs: Rising fuel costs and labor costs can significantly compress margins.
    • Intense Competition: Price wars among airlines squeeze profitability.
    • Geopolitical Risks and Global Events: Airline revenues are very sensitive to international relations, terror threats and pandemics.
    • Technological Disruption: The industry will continuously face new technologies that threaten their existing moats and business models.
  • Resilience: The company has some resilience due to:
    • A well-known brand and loyal customers.
    • Its presence in the global market, especially its interline agreements, which create a barrier for the entry of new players.
    • Its large size, which allows it to achieve economies of scale for some of its operations.

Understandability Rating: 2 / 5

  • Justification: UAL’s business is inherently complex due to fluctuating economic factors and many competitive aspects. While the business model is easy to understand, analyzing its financial statements, particularly its balance sheet and capital structure, is extremely difficult, requiring detailed knowledge of the airline industry and its accounting practices.

Balance Sheet Health: 2 / 5

  • Justification: UAL’s balance sheet is very weak due to the amount of debt it has on the books, but it has improved its liquidity and lowered its debt in recent times. However, liabilities are still high and the company’s long term profitability is not clear. It remains to be seen if management’s strategy of adding new planes with heavy debt financing will pay off.

Recent Problems and Concerns

  • Debt: The company’s balance sheet remains burdened with substantial debt. Management believes that profits from added flights will lower that over time. However, with high interest rates and market volatility, this remains a concern.
  • Fuel Costs: Fuel is a volatile and significant expense, and increases can have a drastic effect on UAL profitability and may put it at risk of bankruptcy.
  • Labor Costs and Shortages: Labor issues, especially with pilots and other specialized roles, are an ongoing challenge that the company is forced to resolve by giving higher wages.
  • Airline Accidents and safety ratings: Any major airline accident or major reduction in safety ratings can destroy investor confidence and impact the company drastically. Management takes safety extremely seriously and it shows in their financial statements, in that they have significant investments in safety upgrades and equipment.
  • Acquisition Integration: UAL has recently acquired other airlines such as Hawaiian Airlines, but integrating the operations of different businesses can be an obstacle that management would need to overcome.

In conclusion, UAL’s moat is limited and its ability to generate stable returns can be seriously impacted by its financials and other factors. Although the airline industry has been an attractive sector in the past, it now requires high discipline and ability from managers to become a leader. UAL will have to be consistently profitable to convince investors of its quality.