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Morningstar | We Plan to Raise Our Fair Value Estimate After United Flies Above First-Quarter Expectations

We plan to raise our fair value estimate around 2%-3% for no-moat United Airlines due to time value of money adjustments and after the carrier lowered CASM-ex (non-fuel unit costs) while simultaneously managing MAX groundings, a government shutdown, and spurts of severe weather in the first quarter. Concurrent with United’s lower year-over-year non-fuel unit costs, it grew unit revenue thanks to decent results in Latin American and Pacific markets. We find United’s late-cycle results impressive, and we plan to adjust our full-year unit cost expectations, but we will refrain from revising our long-term assumptions.

Despite stronger than expected capacity growth, passenger revenue per seat mile still finished 1% above the year-ago period. Passenger yields in Latin America and the Pacific drove United’s overall yield increase over last year, with each respective market improving a little over 2%. We left our assumptions for those markets unchanged, with yields finishing flat in Pacific markets and up 2% in Latin American markets. Ancillary revenue was less impressive, down around 2% versus the March quarter last year. Management pinned part of its results on a one-time benefit to its loyalty program last year that didn’t flow through this quarter.

A strong showing for non-fuel related unit costs helped the carrier reach guidance-topping adjusted pretax margins of 4.1%. In the wake of the MAX groundings, United staved off cost inflation by improving asset productivity and deferring expensive maintenance projects. While we think management will be hard-pressed to replicate this quarter’s non-fuel costs results, we did find support for management's reaching its unit cost targets. As such, we eased our non-fuel unit cost assumptions for the full-year 2019. Flying wide-body aircraft on routes formerly occupied by MAX narrow-bodies will eventually weigh on United’s productivity and drive costs higher as those planes incur higher per seat costs.

United handled the initial phase of MAX groundings well, rearranging its network and sending wide-body aircraft to routes planned for MAX aircraft. This strategy wasn’t detrimental in the first quarter, and guidance suggests the carrier will follow the same strategy through the June quarter. Though we do plan to lower our 2019 expectations for non-fuel unit costs, thanks to deferred maintenance costs and lower-than-expected labor costs, we are keeping CASM-ex cost inflation close to 1%. Management’s guidance includes flat 2019 CASM-ex compared with last year. As the MAX groundings slip into summer months and beyond our original estimate of three months, we believe declining asset productivity, network misalignment, and costlier wide-bodies on a per seat basis will weigh on margins and offset management’s cost-saving efforts.