United Airlines Holdings, Inc. annual report, FY2018

Business context and reporting period

United Continental Holdings, Inc. (UAL), the parent of wholly owned United Airlines, Inc., filed this combined Form 10-K for the fiscal year ended December 31, 2018. United accounts for nearly all of UAL’s revenue, expenses, assets and operating cash flows. The airline operated more than 4,800 daily flights to 353 airports, with domestic and international passenger, cargo and MileagePlus loyalty operations.

Financial and operating performance

Passenger revenue rose 9.4% to $37.706 billion; cargo revenue increased 11.0% to $1.237 billion, and other operating revenue rose 6.8% to $2.360 billion. Passenger revenue growth reflected 6.4% higher traffic and 4.3% growth in PRASM. ASMs increased 4.9%, RPMs 6.4%, and passenger load factor improved to 83.6% from 82.4%. Total revenue per available seat mile was 15.00 cents and cost per available seat mile was 13.81 cents.

Fuel remained the largest operating expense: expense increased 34.6% to $9.307 billion as average fuel price rose 29.3% to $2.25 per gallon and consumption increased 4.0%. Operating expenses grew 11.4% to $38.011 billion, faster than revenue. Salaries and related costs increased 4.7% to $11.458 billion, while regional capacity purchase costs increased 16.5% to $2.601 billion. Net income was broadly flat; lower income tax expense largely offset reduced operating income.

At year-end, UAL reported $6.0 billion of unrestricted liquidity, including $3.950 billion in cash, cash equivalents and short-term investments and the full $2.0 billion revolving credit facility available. The company reported $1.4 billion of debt and capital lease obligations due within 12 months. Current liabilities exceeded current assets by about $6.0 billion, but management noted that approximately $6.7 billion of those liabilities related to advance ticket sales and frequent-flyer deferred revenue, generally to be recognized as travel or other services are provided. Ratings were below investment grade: BB from S&P and Fitch and Ba2 from Moody’s for UAL.

Fourth-quarter data

Unaudited Q4 2018 revenue was $10.491 billion, operating income $652 million, net income $462 million and diluted EPS $1.70, compared with Q4 2017 revenue of $9.451 billion, operating income of $776 million, net income of $579 million and diluted EPS of $1.98. Q4 2018 included $301 million of operating special charges and $56 million of nonoperating mark-to-market gains.

Material changes versus the prior comparable period

• Revenue increased 9.3%, but operating income fell 10.3% and operating margin contracted by about 1.7 percentage points, principally as fuel costs rose sharply.
• Operating cash flow increased to $6.181 billion from $3.413 billion. Management cited higher MileagePlus partner receipts and growth in advance ticket sales and frequent-flyer deferred revenue; the latter also reflect timing of cash receipts and revenue recognition.
• Operating special charges increased to $487 million from $176 million. The 2018 total included $377 million of impairments and a $64 million engine-maintenance agreement termination charge.
• UAL repurchased approximately 17.5 million shares for $1.2 billion in 2018; about $1.8 billion remained under the authorization at year-end.

Outlook, risks and unusual items

Management described 2018 as the first year of a multiyear growth plan. For 2019 it prioritized operational reliability, customer service, efficient domestic network growth, and investment in employees and the product. It expected approximately $4.7 billion of gross capital expenditures and 4.3 billion gallons of fuel consumption. Management estimated that a $1-per-barrel change in crude oil would change projected annual fuel expense by about $104 million. The filing does not provide a specific 2019 earnings or margin forecast.

Notable impairments included $206 million for Hong Kong route assets, attributed to costs rising without adequate revenue growth, and $105 million to write off Brazil route authorities after ratification of the U.S.-Brazil Open Skies agreement. Other 2018 impairment charges included $66 million related to aircraft, purchase options and international slots. The company does not currently hedge fuel or foreign-currency exposure. It estimated that a uniform 1% strengthening of the U.S. dollar against exposed currencies would reduce 2019 pretax income by approximately $24 million.

Key risks include fuel-price volatility, intense fare and capacity competition, economic and geopolitical weakness, operational or technology disruptions, cybersecurity and third-party provider failures, pilot shortages affecting regional service, labor negotiations, airport and air-traffic constraints, and extensive regulation and environmental compliance costs. The company had $24.7 billion of capital purchase commitments, primarily for aircraft and related items, and total contractual obligations of $73.4 billion. It also disclosed ongoing DOJ investigations and consolidated antitrust class-action litigation concerning airline capacity, as well as DOJ investigations concerning mail-delivery data; outcomes were uncertain. In November 2018, United made a secured $456 million loan to Synergy affiliates associated with Avianca and entered related arrangements including a potential guarantee/put exposure capped at $217.2 million; United recorded a $31 million liability for the guarantee’s fair value.

Important facts for investors to verify

• Whether passenger revenue and PRASM growth can continue to outpace capacity growth, and whether fare gains can offset fuel and labor inflation.
• Fuel-price sensitivity, the absence of current fuel hedges, and the effect of future fuel costs on margins and liquidity.
• The sustainability and composition of 2018 operating cash flow, particularly MileagePlus receipts and advance-ticket/deferred-revenue movements.
• Debt maturities, below-investment-grade ratings, covenant headroom, aircraft commitments and the planned 2019 capital expenditure level.
• Potential further impairments or changes in route-asset values, and the performance and credit protections of the Synergy/Avianca loan and related agreements.
• Progress and possible exposure in the disclosed DOJ matters, antitrust litigation, labor negotiations and regional pilot availability.