Searching for the most contentious relationship between airline management and Wall Street? Take a good, hard look at United Airlines these days. The company released its 2017 annual earnings report on Tuesday and rather than a traditional investor call the carrier hosted a more forward looking briefing for the analyst community. There were definitely a few points where things got dicey and the share price today reflects some of the concerns Wall Street has; shares are trading down 10%.
Much of the investor concern comes around United’s plan for significant capacity growth through 2020. The carrier will not be trying to pace GDP growth rates but expanding 6%+ through the end of the decade. That sort of move sets off alarms all over Wall Street where concerns about revenue and yield are significant. And it doesn’t help that United generally lagged its peers on yield growth recently. Improving those numbers while also significantly growing capacity is not easy. President Scott Kirby spent a lot of his mic time trying to explain how it is a good thing.
I gotta say that Kirby sounds legit angry about the way $UAL shrank to protect RASM while ignoring CASM spiking because of fixed costs.
— Seth Miller (@WandrMe) January 23, 2018
Kirby attacked the idea that Analyst’s concerns forced the carrier to contract previously. Maybe the contraction was justified, but Kirby certainly believes the carrier implemented it badly.
What happened at United is United was shrinking and frankly shrinking because they’re getting pressure from rooms like this to shrink. And as United was shrinking, what United did was took the regional jets out of markets like Rochester, Minnesota and put them into markets like Newark [to] Atlanta and DFW to Chicago and that caused three damaging effects at United Airlines.
He’s suggested before that shifting the regional jets off the business routes will help yields and those changes are mostly in place already. That should mostly make Wall Street happy. But Kirby also believes that there can be growth across the network in a manner that will help the bottom line in ways that the investors hate. Mostly because it hurts the “all holy” PRASM number. Those changes will come by adding back in service – particularly long-haul – as daily where it was previously trimmed to less than that. His example in the briefing was the route between Dulles and Sao Paulo.
Read More: United celebrates Frontier’s growth in Denver
During the crater of the Brazilian economy United dropped Tuesday and Wednesday flights southbound on the route. It cut costs (CASM) and propped up the RASM by reducing the total ASMs. But CASM dropped much less than RASM grew. Kirby blames this on the relatively high fixed costs of operating as a network carrier. And so when the company switched back to daily service on the route it expected to take a hit on the RASM for those extra flights. It did, to the tune of 17%. But Kirby believes the CASM to run the additional frequencies was even dropped far more substantially:
We knew adding it back on Tuesday and Wednesday was going to be lower RASM. And in fact, it came in actually a little better than our forecast, but it came in with RASM that was 17% below average. So our RASM was lower, because we flew Dulles – Sao Paulo on Tuesdays and Wednesdays. But the CASM on that flight was even conservatively estimated over 40% lower, because the airplane was free. The gates were free. The slots were free.
Put another way, taking a lower RASM is okay so long as the CASM drops more. And increasing fleet utilization does that in many ways. Adding back the “missing” selective frequencies comes at a relatively low cost compared to the revenue it can generate.
Or it doesn’t. And that’s what Wall Street worries about.
Kirby is convinced that there is a “natural share” of market that United will draw as it adds flights back in various markets. It is unclear that will truly develop. He cites hub flow as critical to the process of “manufacturing connections” at the airline, ideally to a point that the nonstop markets to your hubs are too small for a U/LCC model to work. If the network carrier can offer enough cheap seats to the O/D traffic – subsidized by the connecting passengers – the U/LCC no longer has enough passengers to fill its planes.
The problem with that take is something else that Kirby bragged about early in the presentation. United’s hubs are in large and growing markets. Denver, Houston and Chicago (the coastal hubs thrive on long-haul premium traffic more than the LCC-focused domestic routes) are not small cities without O/D demand. Yes, United might be able to incrementally grow some markets but it is unclear that it can grow enough to fend off the significant local demand at those airports.
Oh, and there’s also the part where Frontier is hoping to convert Denver into a true hub rather than remain focused only on non-stop routes. Kirby cheered that development in a prior earnings call.
Call transcript quotes excerpted from SeekingAlpha.
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It’s hard to get a PRASM premium when for most customers most of the time DL, AS, WN, B6 and maybe AA offer a better product.
As an AA hub captive who isn’t offered comp upgrades as an elite member (without using 500 mile E vouchers and just got off a flight where first was half empty – I sat behind the curtain) I say “maybe.”
Tyson Vilhauer if it makes you feel better United rarely offers even top tier elites upgrades; they sell them to non-elites first.
You guys are cute talking about elite upgrades as though they are what drives the business.
Seth Miller I know they don’t. I was just venting about my experience yesterday!
Seth Miller The business is driven my many factors. If elites feel the value proposition is reduced, they will become more transactional which reduces PRASM. E.g. as a UA Gold this month I’ve flown on five WN flights and two AS flights. Historically all would have gone to UA, even if at a slight premium.
Anything that drives a price war suits me fine
Personally, in my opinion this is the right move for UA. UA’s shrinking to profitability thinking under Glenn Tilton and Jeff Smisek is the very reason I left United for AA. Their schedule simply no longer worked for me out of PIT after so many cuts and it was so bad to the point I had to overnight several times at UA hubs due to IROPs as the alternatives were either overbooked or they didn’t have a viable alternative.
UA has the best international route network – by a mile – and their domestic infrastructure undermined that.
Scott Kirby came in with a goal of making UA the best of the three (currently it’s the worst) and you simply can’t be the best with a meh domestic route network.
Wall Street wants the airlines to “indirectly” work together by following each other and leave customers with very few choices rather than actually viewing the whole thing as a competitive opportunity.
Agree generally that replacing the decimated domestic network is important. And Kirby believes that pax in non-hub cities will tend towards the airline with the most options. What he doesn’t necessarily see is that some (not all, but an increasing share) pax also notice when the aircraft they’re booked on is a tiny, uncomfortable RJ compared to a larger aircraft operated by the competition.
UA’s choice to rebuild the domestic network with CRJ200s is going to be challenging in that context.
Good point there… I suspect its more about being able to quickly add this kind of aircraft capacity in such short period of time. At least UA has been trying to make some positive strides in bringing mainline back on many prime flights.
Only if they could get 60 Airbuses/Boeing narrow bodies in the fleet in just 12 months without breaking the bank 😉
I do hope that UA/DL/AA will somehow be able to convince the unions to lump 50 seaters and 76 seaters in one category. That way they can put more 76 seaters (especially the E175s) on routes served by CR2s and E14xs. From my perspective, whether a route is operated by a CR2 or an E175 has absolutely zero impact to mainline employee jobs (heck it will benefit them). If they can somehow keep the same # of equipment but lump them all in one category everyone wins IMHO.
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