United Continental Network Expansion Drives Yields And Cost Efficiencies

United Continental (NYSE:UAL) announced plans to launch service on several new international routes in the first half of 2012 yesterday in an attempt to leverage the expanded route network following the merger. The carrier is however maintaining capacity discipline by cutting capacity on unprofitable routes and right-sizing network in response to expected demand. Along with peers, Delta Airline (NYSE:DAL) and American Airlines (NYSE:AMR), United also reported a decline in October traffic on the back of lower capacity, though the same will prepare the network for potential demand slowdown and boost yield performance.

Active capacity management provides the flexibility to respond to changes in demand environment and aids in reducing the impact of the rising fuel cost pressures. The carrier’s bottom-line was hit by 20% y-o-y in the September quarter, as it braved the impact of more than $800 million in higher fuel bill following the sharp rise in fuel prices. Below, we take a closer look at the capacity and yield trends witnessed at United Continental in the past quarter.

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Corporate Segment And Capacity Management Support Top-Line Growth

In the past quarter, United Continental delivered robust unit revenue growth of 10% y-o-y on a pro forma basis, as the corporate segment focus improved yields and active capacity management supported high load factors.

Latin America led the yield performance internationally with about 22% higher yields year-over-year. The Pacific network also saw a solid yield increase this quarter as Japan market continues to recover from the tragedy last March. The carrier is  leveraging the potential of the high-yield business traveler through product investments, improved schedule utility, connectivity options and service to the right markets. This helped corporate yields grow 13% y-o-y in the September quarter.

The airline regularly evaluates the performance of each flight and the markets it serves to reallocate assets if a route is not generating sufficient returns. During the quarter, it reduced trans-Atlantic capacity by 1.6%, reducing and down gauging flights to Europe, which were not generating returns in line with the set goals and expectations.

Network Optimization To Boost International Capacity

A comparison of third quarter capacity to the last year pro forma data shows a modest expansion in the international markets and about 2% reduction in the domestic seat miles. The company is optimizing its network in favor of international markets in order to capitalize on the market opportunities enabled both by the merger and next-generation aircraft technology.

United will take delivery of 5 Boeing 787 Dreamliners next year, with the first coming into service in the second half of 2012. The aircraft is being viewed as a game changer creating new profitable market opportunities for the carrier, especially on long haul routes, with its excellent operating economics. On the other hand, domestic capacity is being reduced with the conversion of 14 Boeing 767 300 aircraft from the domestic configuration to the carrier’s international configuration.

As the airline expects demand to remain stable in the near term, the capacity is being kept flat for 2012 as compared to 2011. Although, the fourth quarter capacity is being lowered by 3%, y-o-y, to right size the airline for the expected reduction in leisure demand due to the higher fares that have been put in place to recover rising fuel bills.

Our pre earnings Trefis price estimate of $26 is UAL represents a 40% premium to the market price on the last close. We are updating our estimates on United and the other airline companies which should be reflected on our site in the coming days.

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