Why United Isn't Cleared for Takeoff


By David Shook No industry has been more adversely affected by September 11 than the airlines. And no carrier has posted bigger losses than United Airlines. Its parent company, UAL Corp. (UAL), is set to land another enormous quarterly net loss on Apr. 19.

Analysts expect UAL to report a loss of about $550 million, equal to $10.24 per share for the period, compared to a negative $4.28 a share the year earlier. The most recent red ink follows its fiscal 2001 loss of $2.15 billion, equal to $40 per share -- the largest in airline history. Any way you look at it, Chicago-based United is in a crunch.

The short-term outlook is grim. The nation's No. 2 airline may need to apply for federal loan guarantees by the June 28 deadline, even though Wall Street's speculation over a possible bankruptcy filing or the necessity of a merger has receded with the improving economy. United President Rono Dutta, speaking at a conference in New York recently, said that while United doesn't see bankruptcy as a likely option anymore, the company very much needs business travelers flying again. Until then, he says, it can't completely rule out any option.

"TOO WEAK TO COMPETE." Before September 11, United had about 2,400 flights a day. That fell to 1,650 in the immediate aftermath of the attacks and has since recovered only to 1,800 a day. So United has had to reduce schedules, cut payrolls through layoffs, voluntarily leaves, and early retirements, and it has deferred aircraft orders and plans for new terminals.

Dutta also said consolidation in the industry is needed and may happen soon if airlines don't see a pickup in business travel. "All of us are in many ways too weak to compete against one another. We try to, but eventually we retreat to our respective corners of the market," Dutta said. "Consolidation is inevitable."

The airline is banking on an economic recovery that brings back the corporate flyer (see BW Online, 4/18/02, "Flying in Today's World"). Not to mention a crucial need to smooth out relations with labor unions.

Those are both big orders, and United may have a hard time filling them. Most analysts aren't recommending United's stock even though it's up about 50% from its post-September 11 low of $9 in early November. That's still well below its 52-week high of $38 early last year and light years from its five-year high of nearly $100 per share in late 1997. The current share-price recovery has coincided with a wider rebound in airline stocks, spurred by a slow return of passenger travel worldwide. So, United's stock pickup may be a bit premature, some analysts think.

"SERIOUS PROBLEM." What must United do to get its house in order? First, it needs business travelers to return en masse, since it relies on companies buying lucrative walk-up fares to strengthen its quarterly sales. This industrywide predicament is compounded for United. "One of the problems we've had is that we're a business-travel airline, but it's leisure travel that has bounced back faster," says spokesman Joe Hopkins. "People are flying again," he says. The problem is that the yield -- the amount of revenue generated on each ticket -- "is way below where we need it to be," Hopkins says, "and is a serious problem for us."

According to Kevin Mitchell, chairman of the Business Travel Coalition, a trade group for corporate-travel buyers, companies have cut travel volume at least 20% since the beginning of 2001, and they may not be finished. "We could see another 6% to 10% off travel budgets this year," he says.

Even if demand returns, United has among the worst labor relations in the industry, says Standard & Poor's fixed-income analyst Phil Baggaley. And that could jeopardize its ability to secure federal loan guarantees, Baggaley says.

RAISE -- THEN CUT? United not only needs to extract pay concessions from all its unions but it also still has one major contract in negotiations. The 23,000-member union representing baggage handlers and customer-service agents is without a contract and is now posturing for a possible strike as talks remain at a standstill, according to the union's Web site. With the negotiations so close to the deadline to apply for the federal guarantees, signing the contract is a high priority for United interim Chief Executive John Creighton Jr.

He's the successor to Jim Goodwin, who was ousted last fall by the UAL board of directors under pressure from the company's unions, which have seats on the board and own more than 25% of the stock. Goodwin angered the unions after he sent a letter to employees warning that the airline could perish in 2002. While that may have been a shortsighted move, Creighton's only way around the difficult spot today may be if management can quickly sign this last contract, then ask the unions for concessions. "Essentially, United has to raise everyone's pay just so it can turn around and talk about cutting it," says Baggaley.

Creighton will need deft maneuvering to pull that off. But it could be essential if United wants to make its case for federal loan guarantees. Says Mike Dyment, managing director for Arthur Andersen's global aviation consulting practice: "The feds want the airlines that apply for guarantees to show some willingness to control costs. So they won't throw billions in support to United just to see the financing go toward a pay hike for the unions." It'll be much easier for United to obtain federal assistance if the unions give concessions. But over the past few years, they've shown a willingness to be militant.

UNQUALIFIED? The government is offering loan guarantees under strict conditions to airlines that prove they need financing to survive and can't obtain it in the capital markets without federal assistance. America West has already secured loan guarantees, while several other airlines are expected to apply for them.

Given United's poor labor relations, analysts say it most likely won't qualify under the guidelines of the Air Transportation Stabilization Board, the authority established by Congress after September 11 to dole out as much as $10 billion in guarantees to airlines. United declined to comment on this issue.

United still has at least $2.8 billion in cash and a fleet of new aircraft that give it at least some financial flexibility. While that might be enough to maintain its stability this year, it's not enough to get it back on sound financial footing, which it needs to spark a rally in the stock.

HIGHER PRIORITIES. Certainly, Creighton's task is unenviable. But the United board member and former chairman of Weyerhaeuser has done a respectable job in his first few months in office -- especially considering that he has never worked in the airline industry before.

One recent accomplishment: In March Creighton jettisoned United's money-losing business-jet division, Avolar, concluding that any funds for it were better spent on more essential priorities. "Creighton has shown a willingness to focus on the core business. That's a start in the right direction," says Mike Boyd, president of Boyd Group, an aviation consulting practice in Evergreen, Colo.

What's more, United has taken advantage of a new way to benefit from the losses it incurred over the last several quarters. On Mar. 9, President Bush signed an economic stimulus package that included a provision allowing companies to "carry back" for tax purposes net operating losses incurred during the recession into previous years. The major air carriers paid out more than $10 billion in taxes from 1996 through 2000, and United has taken advantage of this tax change more than any other airline. It received a $464 million tax refund as a result of the law.

RASH ASSUMPTION? The bottom line seems to be that while the accounting change will temporarily ease United's quarterly loss numbers, analysts believe the continuing labor unrest and slack demand for business travel will ultimately hamper the company's outlook in the market for the next few quarters.

Merrill Lynch's Michael Linenberg is playing the contrarian. While he has a neutral rating on United's stock and calls it one of the "lower quality names" in the business, he says it could benefit "assuming that a robust recovery is in the cards for the latter part of 2002." Given the unwillingness of corporations to begin spending again on travel, that assumption may turn out to be wrong. If that's the case, this stock's recovery will probably be short-lived, with no price run-up in the cards. Shook covers financial markets for BusinessWeek Online in New York


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