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Morningstar | Raising Fair Value Estimate After United Impresses With Third-Quarter Results; Shares Fairly Valued. See Updated Analyst Note from 17 Oct 2018

We raised our fair value estimate to $87 from $85 after incorporating no-moat United’s third-quarter results. United’s choice to pursue an aggressive growth strategy in domestic markets is yielding positive results, with passenger yields showing 4% year-over-year growth and pretax margins remaining above 9.5%. We raised our capacity growth assumptions for 2018 to reflect an increase in United’s regional capacity. We now model 9% regional capacity growth in 2018, which coincides with 5% systemwide capacity growth and 6.7% unadjusted pretax margins.

United’s third-quarter results are similar to Delta’s, in that both reflect robust top-line growth and recouped losses from fuel costs through rising passenger yields. We raised our PRASM (passenger revenue per available seat mile)  expectations even with higher capacity growth assumptions. We previously assumed rising oil prices would force capacity growth closer to 4.5% for the year, but evidence in United’s third-quarter results and fourth-quarter guidance suggests that won’t be the case. Management grew capacity near 5% versus the third quarter of 2017 and guidance also implies about 5%. After updating our capacity growth assumptions and adjusting for United’s 4% yield growth over the prior-year period, our full-year PRASM forecast expands from 13.55 cents to 13.62 cents, or 4% higher than 2017’s 13.13 cents.

Fuel is still a burden for United, and management’s fourth-quarter fuel price per gallon forecast is $2.44, which is higher than the $2.32 booked last quarter and the $1.91 booked during the same period last year. But the carrier is successfully culling cost inflation elsewhere. In a quarter marked by aggressive growth, CASM-ex (costs per available seat mile excluding profit sharing, fuel, and other items) slid 0.4%, and management’s 2018 CASM-ex guidance in the range of 10.08 to 10.10 cents puts United on track to bring costs below last year’s 10.11 cents.

After considering United’s third-quarter results, we have greater confidence the carrier will sustain yield expansion and we updated our model to grow yields closer to 3% in 2018, rather than the 2.2% we previously projected. Assuming demand growth, primarily in U.S. markets, remains firm in 2019 and 2020, we have less reason to believe United will diverge from its plan to expand between 3% and 5% through 2020. With our raised capacity, or seat mile, growth assumptions we expect load factors will finish 200 to 400 basis points lower than previously modeled in our forecast period, but our normalized load factor still finishes above 83%, which implies the company won’t see material degradation of aircraft utilization.