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United's Smooth Takeoff


United Airlines' parent UAL (UAUA) sprang a surprise in July when it posted second-quarter earnings that handily beat Street forecasts. Another surprise was how the stock has bounced up after UAL emerged from bankruptcy in February, 2006--despite high oil prices, rising competition, and public outcry about the airlines' disruptive flight cancellations and delays. The stock climbed from 21 in February to 49 on July 23, 2007, the day before the market's plunge. Analysts see the stock, now at 44.44, rising to 52-58 on strong revenue growth and continued cost cutting. Another plus that could kick up the stock: private equity interest.

"We believe UAL is a potential private equity play, given the $4 billion we estimate it can earn in free cash flow over the next four years," says Daniel McKenzie of Credit Suisse (CS) (it has done banking for UAL and owns shares), who rates UAL "outperform." He says such groups "could take UAL private today, collect dividends, and go public when the industry consolidates, thereby capturing the valuation arbitrage." At the end of the second quarter, UAL had $5.1 billion in cash, matching its market cap. Given pressure from the growth of low-cost carriers and other industry challenges, McKenzie sees more consolidation as nearly certain. The analyst also believes UAL may spin off its Mileage Plus program and/or pay a dividend later this year. If the Mileage Plus is spun off, he says the proceeds could be used to pay down additional debt or for repurchasing shares. McKenzie figures UAL will earn (fully diluted) $2.55 a share in 2007 and $4.30 in 2008. His 12-month stock price target is 58.

Vincent Carrino, president of Brookhaven Capital Management, which owns shares, says UAL brass has expressed interest in an alliance or merger. He thinks UAL is worth 60 to 80 in a deal, which he expects would be on a stock-for-stock basis. Another airline, says Carrino, may propose a merger even before private equity makes a move.

Frank Boroch of Bear Stearns (BSC) points out that UAL, which runs 3,600 flights a day to 210 U.S. destinations and in 28 other countries, is one of the "more vocal proponents of consolidation among the airlines, even pointing out that [greater] East Coast presence and a Southern U.S. hub could complement its existing network."

"Despite the negative fuel environment, the company exceeded its cost-reduction targets," says Ray Neidl of Calyon Securities, who recommends the stock as a buy. The company, he figures, is on track to meet its goal of reducing costs by $400 million this year. A big advantage to major carriers is that additional airline capacity is unlikely to occur, according to Standard & Poor's, even though demand for air travel is likely to remain robust in 2007.

Note: Unless otherwise noted, neither the sources cited in Inside Wall Street nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

By Gene G. Marcial


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