United Has Long Path to Recovery From COVID-19 Pandemic

No-moat-rated United Airlines UAL reported a difficult second quarter as the coronavirus pandemic ravaged commercial airline passenger traffic. We are maintaining our $40.50 fair value estimate for the firm, and we think the worst days for U.S.-based airlines have already passed as the U.S. Transportation Security Administration throughput has remained at roughly 26.5% of 2019 levels in July (versus 6% of 2019 in April) despite increasing virus cases. We expect that a robust recovery will not occur until a vaccine is widely distributed, which Morningstar expects by mid-2021. United is in a structurally difficult competitive position relative to peers due to its high exposure to international travel, but we give credit to management for rightsizing supply early on into the crisis.

Quarterly revenue declined by about 87%, which is largely reflective of the rapid decline in passenger traffic due to the pandemic. We were encouraged to see that other operating revenue, which includes loyalty revenue from co-branded card spending, outperformed the portfolio and decreased by 37% and that the premier members that drive much of the program are increasingly utilizing frequent flyer miles for leisure travel. This suggests to us that the most valuable members of the program continue to stay engaged with the program and would be less likely to switch to a cash-back card. The frequent flyer program is highly margin-accretive and accounts for a considerable portion of our valuation, so we will be closely watching frequent flyer engagement.

We think the firm also did a good job of cutting expenses. Excluding fuel and the CARES Act grant, the firm cut roughly 41% of operating expenses this quarter. While this is partially due to lower capacity, we think management deserves credit for cutting costs decisively. Management is targeting break-even at 50% of 2019 demand, which we think will require more cost-cutting, particularly within compensation expense.

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