Can United Catch Delta?
“If there’s a worse place than hell, I’m in it.” So said President Abraham Lincoln during the Civil War. And so must have felt United Airlines executives during its two-plus years of Covid agony.
But then came a sudden reversal of fortune this spring, leading to a summer of roaring demand, record revenues, and rebounding profits. United generated nearly $1 billion in operating profits during the June quarter, with July and August surely producing similar earnings as well. Will September and subsequent months yield more of the same?
United just gave reason to be optimistic. In a regulatory filing last week, the Chicago-based carrier said demand remains strong, with total revenues for the third quarter now forecast to be 12 percent higher than they were during the same period in 2019. It noted improving operational reliability as well, which will leave it with more capacity than expected; third quarter ASMs should be down only 10-11 percent year-over-three-years. More capacity in this case also implies better utilization of assets, which drives down unit costs. Indeed, United’s cost per available seat mile (CASM), excluding fuel and extraneous items like profit sharing, should come in at the lower end of previous forecasts, or up about 16 percent than in 2019. Fuel prices have dropped too, though United accounted for that in earlier guidance. For the record, U.S. Gulf Coast jet fuel averaged $4.12 per gallon in July, according to the U.S. Energy Information Administration, but fell to an average of $3.48 per gallon in August. United’s current assumption for the entirety of the September quarter is $3.83 per gallon.
At an investor event hosted by Cowen last week, United’s network chief Patrick Quayle stated without subtlety: “What I would say is we’re seeing a really strong September … it does not appear that summer has come to an end.” Simply put, revenues are trending in the right direction. Unit costs are trending in the right direction. And fuel prices are trending in the right direction. Maybe this is what heaven feels like.
Well, not quite.
At the same event, Quayle, joined by United Chief Financial Officer Gerry Laderman, also expressed frustration — “one disappointment after another” — regarding the inability to fly as much as it wants to fly. Staffing shortages and other bottlenecks throughout the aviation ecosystem, including deliveries of new aircraft, mean the airline simply can’t accommodate all the demand in the market. Fortunately for United, it’s an issue that rivals face as well. More generally, one of the airline industry’s major challenges this summer was underutilization of planes and other assets. In United’s case, this includes large widebodies removed from their usual assignments to Asia, where markets like China and Japan remain stifled by government travel restrictions.
To be sure, United has its eyes on the U.S. economy, watching with at least some degree of trepidation as climbing interest rates, falling stock markets, and sky-high inflation pressure both households and businesses. But, as its investor update made clear, there’s no visible distress yet, even from advance bookings. In addition, pent-up travel demand might, at some point, dissipate. And expectations of more business travel once workers return to offices, meanwhile, may prove overly optimistic. One of United’s top hubs, incidentally, is San Francisco, where tech companies have been among the slowest to revive business travel — and among the least successful at getting people back to offices.
On the opposite side of the country, United faces frustrations at New York JFK, where limits on capacity reduce its competitiveness. Recall that a previous United management team exited JFK in 2015, eager to cut losses there and focus on its New York-area operations at Newark Liberty. The airline returned to JFK last year, however, hoping to placate California corporates not keen on doing deals with an airline that could not get their people to New York City proper, never mind Newark’s proximity.
And United is now about to do something that would have seemed unthinkable not long ago: Team with Emirates. It will provide more details this week, but the rapprochement with a former enemy (recall the angry denunciations of Gulf carrier state aid) is likely motivated by a desire to cover more destinations in India, most notably. Emirates serves all of United’s hubs except Denver; i.e., Newark, Washington Dulles, Chicago O’Hare, Houston Bush, San Francisco, and Los Angeles. Perhaps a Dubai-Denver flight isn’t far off, or a return by United to Dulles-Dubai (a route Emirates pushed it out of in 2016).
Speaking of United’s hubs, Denver, Chicago, Newark, and Houston are all similar in size measured by seat capacity and flight departures. That’s according to the latest data from Diio by Cirium. There’s an important fact here: United doesn’t have a dominant hub like Atlanta, which is by far and away Delta’s busiest. At American too, Dallas-Fort Worth is much larger than its other hubs, with only Charlotte even coming close. United’s hubs are generally more dependent on intercontinental traffic as well, though that’s fast becoming a strength, not a weakness.
Unlike Delta, American, and many of its foreign rivals, United kept most of its widebodies during the pandemic. That positioned it to offer more transatlantic flights than any other airline this summer, allowing it to capture more of resurgent travel demand. Comparatively, Delta and American each offered more flights to Europe than United in the summer of 2019. But surely, Asia is a problem area.
Or maybe not. Quayle said last week that of the airline’s four geographic entities — domestic, transatlantic, Latin America, and Asia-Pacific — Asia-Pacific is currently producing the strongest profit margins. If that seems counterintuitive given the inability to properly serve China and Japan, keep in mind cargo’s important contribution. Also consider markets where demand is strong, like Singapore, Seoul, Sydney, Melbourne, and Auckland.
United is also more exposed to corporate travel than most airlines. But here too, there’s good news. Even as corporate volumes still lag pre-Covid levels quite significantly, corporate revenues have regained their strength. For that thank extremely high yields. A more difficult area is the regional network, critical to feeding traffic onto mainline flights, both domestic and international. At the Cowen event, Laderman alluded to American’s decision to sharply increase regional pilot pay, which “really changes the economics of regional flying.” He added: “With regional pilot pay moving towards what has been traditionally mainline, let alone ULCC costs, it really changes the whole dynamic of the regional flying.” United and others are already having to end many regional flights, which again bodes ill for the amount of longhual international flying it can support.
Longhaul flying more generally, according to United, is where it formerly enjoyed a large profit advantage, at least versus foreign foes. It claims its longhaul margins were in fact the best among its peers pre-crisis. That must mean it has a domestic margin problem, given that systemwide, it consistently underperformed Delta. In 2019, United’s operating margin excluding special items was 10.5 percent, compared to Delta’s 13.9 percent. American’s was 8.1 percent. Like American, United has a much more unionized workforce than Delta, which infers structurally higher unit costs, all else equal. And of course, none of United’s hubs are quite like Atlanta in their profit power. Talking to investors pre-crisis, executives made no secret that its mid-continent hubs in particular — Chicago, Houston, and Denver —have underperformed.
Can United achieve its long-held goal of catching Delta? Last summer, it presented the principal ways in which it hopes to do so, embodied in its United Next business plan. A critical component is aircraft upgauging, or moving to larger planes with lower unit costs. Chicago, in particular, will see a dramatic decline in small-jet regional flying. More mainline jets will enter the scene, hence a giant order last year for Airbus A321neos and Boeing 737-10s. These are the largest Neo and Max variants, underscoring the notion that bigger is better, not least because they offer more premium seats — seats that don’t exist on most 50-seat regional jets. If all of this sounds like a recipe for aggressive capacity growth, it’s really not — much of the new real estate will be used for premium seating, which will in fact grow sharply.
The United Next plan also aims to capitalize on the large pool of premium traffic at its top hubs (for all of Atlanta’s many strengths, its premium corporate market is relatively small; the same is true for hubs like Charlotte and Minneapolis). The United plan also features ongoing premium product upgrades.
This year, United still lags Delta in the margin race. So it’s not all smiles in Chicago. But with revenues and costs moving in the right direction, it feels closer to heaven than to hell.