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Old 11-23-2016, 08:34 AM   #1  
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Default Detailed Recap Anaylsis of UAL's Investor Day

From today's Plane&Busuness Bantor a weekly industry newsletter.


By Holly Hegeman
Current IssueMonday,November21,2016|Volume 20Issue 37



Printable Version


United Airlines Investor Day: The Wizard of Odds Holds A Revenue Management Seminar

Last Tuesday United Airlines held its long-anticipated Investor Day in Chicago. Everyone who was anyone in the Wall Street analyst community was there at Willis Tower to hear, in person, how the airline plans to reduce the margin gap it now suffers relative to its competitors. More specifically – to Delta.

There was a lot more to discuss – but let's face it. That has been the big question hanging over the airline since Oscar returned from getting a new heart, and he named his new management team leaders – the new brain – in August.

Would the airline now have the courage to put all the pieces together in a way that would convince Wall Street it wasn't just sleeping in a bed of poppies, hiding out from the usual flying monkeys?

The airline did indeed have the courage. Not only that but when the Wizard of Odds, Mr. Scott Kirby, took the stage, all of us who were either listening to the call on the web, or who were there in person, got not only a detailed analysis of the airline's network and its strengths and weaknesses, we got a dissertation on the finer points of revenue management. We heard about the good (the potential to upgauge hub to hub flying and rebank hubs), the not-so-good (antiquated yield management systems), and the unexpected (who knew Denver is the airline's most profitable hub?)

After all was said and done, Wall Street was convinced – United Airlines has the heart, the brains, and the courage. All it needed was a Wizard to help guide it down the yellow brick road paved with golden revenues.

Too much?

Okay, how's this? Scott rocked the house last week. That more than 13% increase in the price of United's shares last week? You can thank him. And his little dog too.

Let's get the basics out of the way. Because there was a new product rolled out last week we need to talk about before we get into the rest of the call, as well as a major aircraft delivery deferral.

This means we have to talk about BE, or United's new Basic Economy. Or, as I generically call these attempts to be all things to all passengers, "Economy Minus".

While what United announced last week followed the script for the most part, the new product did come with a twist on the comparable product that has been offered by Delta for roughly two years. That twist: Passengers who purchase a BE ticket will not be allowed to bring a rollerboard onboard. No overhead storage permitted. All they can bring on board is a personal bag that will fit under the seat. Unless they want to pay for an overhead bag. And if they are going to do that, they might as well spring for a normal coach seat with the extra benefits that come with it.

As the U.S. major carriers (with the exception of Southwest) continue to march towards further product segmentation onboard, the move by United should not come as a surprise to anyone. What remains to be seen now is whether Delta will match the bag restriction United has added to the mix. (American should roll out their "Economy Minus" product early in 2017.)

Wall Street analysts cheered the move, while consumer rights activists – predictably – saw the move as another attempt to extract more money for an even crappier product. Not exactly the case. But as I always say, if something is good for the airline's bottom line, it's probably something passengers won't like. Or understand. Frankly, given that Delta has already fought this battle with both its corporate customers, and its passengers in general, for more than two years, I am surprised there was as much blow-back as there was last week over the BE announcement from the usual online sources. I think the surprise overhead bag restriction was key.

Another announcement that was met with a positive response from Wall Street was the news the airline was deferring the delivery of 61 Boeing 737-700s that were scheduled to be delivered over the next year. The first four aircraft of the order will be delivered in the back half of 2017, but they have been bumped up to 737-800s. As for the rest of the order? Your guess is as good as mine. As Andrew Levy, United CFO said in the call, "We don't know when they are going to come, but they are going to come as MAX airplanes, 737-MAX, most likely MAX 800s or 900s, but at this point in time all we can tell you is that we are going to defer that out."

They don't know either.

A couple of comments here. One, this means the airline is scaling back additional capacity. These types of things make analysts happy. This decision comes on the heels of a number of other aircraft deferrals of late. You can discuss amongst yourselves whether this perhaps indicates a slowing in demand for new aircraft. If you're Boeing or Airbus, I'm sure the answer is no. But that doesn't mean that's an accurate answer.

These are also the aircraft that Boeing sold cheap – in an effort to keep Bombardier and the CSeries out of United. This is also the order we said here in PBB earlier in the year made no sense. I didn't like it then. I still don't like it.

But what I do like is the idea that United is pausing, taking a deep breath, and deferring the order.

Which, as more than one of you have suggested – might, maybe, just possibly – signal that perhaps United is not done altering the order. Or to put it another way, perhaps that rumored C-Series deal might be resurrected after all. If Bombardier would entertain selling their aircraft to United for the same amount of money apparently paid for the original 737-700 order (which is now estimated to be around $26-$27 million per aircraft.)

This brings up another point. How much will United pay Boeing for the larger, more fuel-efficient birds? I doubt Boeing will honor the deeply discounted price they had agreed to previously.

Again, a lot of questions, only fueled by less than complete answers, in addition to a comment from Andrew that the airline has only begun to take a look at its widebodies. I strongly suspect that Airbus A350-1000 order at United may be up for review as well.

The Wizard of Odds Takes the Stage

But enough of the mundane details of product rollouts and aircraft deferrals.

The most important and informative part of the call last week was the presentation by Scott Kirby, whom I have now officially dubbed The Wizard of Odds. I mean, after listening to how lame the yield management system is at United (and other airlines), it does seem that revenue management is a lot like playing craps, with humans making the final calls – overriding random program-generated forecasts that are based on industry norms that are no longer the case.

Maybe Scott should simply be addressed as Professor Kirby.

Whichever, if you did not have a chance to listen to the call last week, you missed a golden opportunity to learn about United's hubs, the airline's pitiful yield management system, the ineffective and unprofitable way the airline has continued to draw down its hub to hub traffic, and much, much, more.

Someone sent me a note last week and asked me how was it possible that Scott could get so "up to speed" on the inner workings of United in such a relatively short period of time. Well, there are two things going on here.

One, Scott has studied what is going on at United, from a competitive standpoint, for years. But also, something to consider is this.

People forget that US Airways had been working together with United management for almost a year on a potential merger – and the two airlines were one week away from announcing that merger – when United's then-CEO Glenn Tilton leaked the news to the New York Times. That leak was the reason then-Continental CEO Jeff Smisek called Tilton. You know the rest of the "ugly girl" story.

While at America West, and then US Airways, Scott not only kept close tabs on the revenue actions of competitors for years, but he was also involved with attempts to merge with three of those competitors – United, Delta, and then American. So he was privy to even closer inspection and review of the revenue management inner workings of all three airlines.

As a result, I doubt Scott had too much of a learning curve to master about much of anything when he arrived in Chicago.

One thing he has been surprised at however? The lack of a more functional integration between Star Alliance partner Air Canada and United. I can offer up a number of personal experiences to prove that point.

Opening up his comments to those assembled last week in Chicago, Scott told a story. "As I was walking in this morning, I rode up the elevator with Mike Linenberg, who reminded me of a conversation we had 10 to 15 years ago – and then several other investors had said this to me too – that he had asked me 10 to 15 years ago if there was one airline you look out at that you would like to go to, and that you think there is incredible opportunity, what is it? And I said United. So that was a long time ago. Took me a while to get here, but how cool is it that here I am today?"

Moving towards a map of the airline's route network in the presentation deck, he more or less summed up the rest of the day's presentation and set the stage for the airline's moves going forward, as he said, "All I have to do is look at a route map and know we have the best network potential of any airline in the world. We just have to go out and realize it."

Going forward, he said, United will do the following:

*Grow between 1% and 2% in 2017.

*Not only re-fleet. United is going to upgauge.

*Make more moves towards product segmentation, i.e., the Basic Economy product being announced the day of the presentation.

*Make additional investments in high-value customers.

It is crucial the airline deliver "top-tier reliability," he said."Our product is our network, how our people treat our customers, and getting our customers there on time. It's the most important thing we need to do. And we're making big progress. We've got a ways to go. We know we can continue to get better."

United's Domestic vs. International Revenues; Hub Rundown

Turning to a map of the airline's hubs, he pointed out that United is the only airline that has hubs in the five largest markets in the country. Those hubs are then complemented by two hubs in Denver and Houston.

Domestic Market

The challenge for United is to improve the efficiency and productivity of its domestic market while "maintaining its incredible international operations." As Scott pointed out, historically United has excelled internationally, but not on the domestic side. Or as he put it, the airline has historically been "break-evenish" on the domestic side. (That is a technical term.)

He noted that in the past United "just wanted to fly enough domestic to feed our profitable international flying, but we wanted to minimize our exposure to the domestic market everywhere else. So we built schedules, we built sales – we built everything around focusing on international, which we do really well. But we let the domestic slide in that environment because it wasn't historically profitable."

Scott pointed out that the problem here is that several years ago – all of this changed. With more competition on the international side, United then had a disadvantage to its peers. It had not paid enough attention to its domestic network.

Hubs

New York – United, according to Scott has "the only connecting hub" in the New York market. United now has about 400 flights a day out of Newark. "We can run it as a connecting hub. Because of that, it's the best Atlantic gateway of any hub in the country. It's a big local market, but you can also feed a lot of traffic. If you are JFK, because of capacity restrictions, even if you try to fly out of JFK, you can't have an operation that feeds a lot of connecting traffic into it. But in Newark, we can. And Newark can and should be the premier gateway across the Atlantic in New York."

As Scott noted, prior to the merger, Continental had a 30% market share in New York. That number has now slipped to 26%. According to him, there is no reason the airline could not be grabbing a bigger percentage of that market.

The most profitable hubs in the country have the highest percentage of connecting revenues. But, as Scott pointed out, Newark has not been set up as a connecting hub. Rather, it's set up more like a rolling hub. That, according to Scott, is going to change. He then explained why this type of hub system will actually work better – even with the constraints that are natural to the operation of Newark.

Scott then explained why United's current scheduling into competitors' hubs is opposite of what it should be. Thank you Scott. Maybe this means I'll get to fly more mainline flights on United out of Dallas occasionally.

As he put it, "I'm commuting between Dallas and Chicago right now, and – until I buy a house up here. And half the time I'm flying on a regional jet, which is just incredible to me that I'm flying on a regional jet between two big cities like that. The first flight of the day, I can't get to Chicago on United until 10 a.m. I've got several other options on our competitors to get here earlier. So if I'm a commuting business traveler, United really isn't an option for me. And so fixing that is another huge opportunity for us, and it's a theme that plays out across all the hubs we're going to talk about."

This means we can expect to see improved local schedules for O&D passengers, and upgauging between major markets.

Chicago – Scott talked about cachement areas the airline does not serve out of Chicago, and how United is not banking its schedules in Chicago. Coming up at ORD? Omni-directional banks.

"The reality is, if you're going from Green Bay, we ought to be able to get you easily to the West Coast or to the East Coast. A whole bunch of cities like that. And again, that's all the kinds of places that you are feeding high-yield revenue into the hub. So doing similar things in Chicago as we are doing in Newark are a real opportunity with both the bank structure and the local schedules as well."

He sees no reason why American can offer more connectivity out of Chicago, while operating fewer flights. That – is going to change.

Denver – Who knew that Denver is United's most profitable hub? For two reasons. It doesn't hurt that "the airport has done a great job at driving costs down." But it also has the highest percentage of connecting revenues. Look for even more connectivity to be added.

Houston – Houston has been challenged between Latin American weakness and the energy market weakness. Look for a re-banking, but with a fewer number than the current 11 banks a day. This will increase connectivity, but with no need for more capacity.

San Francisco – According to Scott, "San Francisco is the best Pacific gateway of anyone in the country." He added, "We are best positioned of anyone to continue to serve Asia, and we will continue to grow with those markets."

Los Angeles – Very fragmented market. Talked about how the airline is challenged physically with its location at the airport. Talks going on now with the airport as to how this can be improved.

Washington/Dulles – Does "really well" internationally and with transcons. But it is a high-cost airport.

Scott stressed that all of this hub reworking will take time, and it won't happen overnight. But eventually he projects hub changes can generate some $600 million a year in improved EBITDA by 2020.

After a segment from Julia Haywood, CCO, in which she primarily described the new BE product, Scott returned for a discussion of numbers. Or as he put it, "Now it's time for those of us who think math is actually cool and sexy, which I admit I'm a nerd and I think that. And actually in this room, I think there's probably some other people who think that as well. So this is a good room for me to talk about yield management. But I do think this is an incredible opportunity for us. And whether you like all the detail or not, hopefully you can get the picture that it's an exciting opportunity that exists for United Airlines."

Revenue Management

The current revenue management system at United is Orion. It will be renamed Gemini, but according to Scott, it is still the same core system. Orion was built 20 years ago and "has some known shortcomings." A bit of an understatement.

"At its foundation, the problem with our yield management system – by the way, it's a problem with really every yield management system in the world – is an assumption of independence and demand. I'm going to talk about what that means and why it's a flawed assumption. But all of the mathematics that exist in yield management systems is built upon this assumption. And it was mostly true 20 years ago when there was a business fare and there was a leisure fare that had a Saturday night stay, and business customers didn't buy that fare. It's not true at all today."

Then there is the "numbers" problem. "Our system is an O&D yield management system. We are making a specific forecast that the 11 a.m. departure from Albany to Chicago connecting onto the 3 o'clock departure to Des Moines in T class is going to have X amount of demand. And our forecast – the median forecast for those O&Ds at that level of detail is pretty close to zero, something like 0.2."

He continued, "And so when you are forecasting such small numbers, you can see that you just have a huge dispersion, because customers don't show up in 0.2's. They show up at [0, 1, 2, 10]. And I look at this and this sort of says it all to me, this number – the standard deviation of our median forecast is actually 11 times higher than our actual mean result. And so if we are forecasting 0.3 passengers, the standard deviation is 3.3. That is meaningless data for anyone that tries to forecast something and use it, it's just meaningless data when you've got that kind of forecast error going into the forecast."

Essentially all of this has to be overriden manually.

Bottomline: "We don't have any forecast evaluation process."

Scott likened it to if analysts recommended stocks, but had no way to see if the stocks then went up or down. "We have no feedback loop in the system to tell us the forecast was good or bad."

Another problem: Limited history. The program has only a few years of history that is available. For example, there is no way United can go back and see what happened the last time Christmas took place on a Sunday.

The airline is currently in phase one of updating the system. Scott believes this overhaul will eventually be worth between 2-4 points in revenue. How much money are we talking about? "We have just taken the midpoint of that at 3 points and getting us up to $900 million of revenue by 2020 that leads to an impressive $3.8 billion of incremental improvement – on really the commercial side of the business. A big number, but I think indicative of what we think are the opportunity areas."

Revenue Premium

Later, in the question and answer session, Scott made a good point about RASM and revenue premium as he noted that, depending on how you work the numbers, any of the big three airlines can claim to have a "revenue premium." And they do. He thinks this is a useless, and flat-out wrong metric to tout.

Instead, he said, the "right metric should be improving your relative PRASM and closing the margin gap. "I just hate that metric. I want us to improve our year-over-year PRASM relative to the industry every year, and improve our margin performance every year. And if we're doing those things, who cares if it's a PRASM premium or not?"

When all is said and done, here is a summary of the airline's comments and a chart showing how it intends to "close the margin gap."

*Capacity will be up between 1-2% in 2017.

*The impact of revenue management initiatives is expected to deliver $400 million by 2018 and $900 million by 2020. These improvements will come from changing the system the airline currently uses to monitor inventories and by reducing its forecasting errors.

*CASM-ex is expected to increase 3.5-4.5% year-over-year in 2017. Despite reducing the forecasted benefits from cost initiatives, United expects less than 1% CASM-ex growth in 2018.

*United now expects Capex of $4.2-4.4B in 2017 and $3.3-3.5B in 2018 for a total of ~$7.7B over the next two years.



Wrap-Up

There was much more to the call, including presentations from Linda Jojo, EVP, CIO; Greg Hart, EVP, COO, Andrew Levy, EVP, CFO; Julia Haywood ,EVP, CCO; and there was even a shout-out to Gerry Laderman., SVP Finance, Procurement and Treasurer.

But the important piece of the day was the revenue piece. And Scott did not disappoint. I think he was successful in presenting the argument for how United can "close the revenue gap."

I must admit, I did not include the more detailed number discussion re: yield management. But take my word for it, it made even me appreciate math.

Below you'll find two links of interest. One is a .PDF of the deck that was distributed with the Investor Day presentation. The second is a recent profile of Oscar Munoz (you can skip the video at the top of the page if you wish) by Shawn Tully at Fortune. I thought Shawn did a great job with the piece. I recommend you give it a read.

Links You Might Like

United Airlines PowerPoint Deck for the Investor Day Presentation

Fortune article: "How United's Oscar Munoz Bounced Back After A Heart Transplant"
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Old 11-23-2016, 09:47 AM   #2  
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By Holly Hegeman
and that's where you lost me.
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Old 11-23-2016, 09:54 AM   #3  
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and that's where you lost me.
With exception of her recent bad call that we would close IAD and LAX, she's been right far more then wrong the last twenty or so years on the industry.

Anyway not much of her opinions in this piece and mostly a detailed recap of UAL's investor day.
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Old 11-23-2016, 12:21 PM   #4  
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Interesting read, from a "This is how Wall Street Analysts think" perspective.
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Old 11-23-2016, 07:02 PM   #5  
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I wish I could have heard it in person. I can't tell by reading if SK is the smartest guy in the room, or a BS artist.

It did seem like he was full of himself, so I am leaning toward the latter.

Last edited by UAL T38 Phlyer; 11-24-2016 at 04:59 AM.
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Old 11-23-2016, 07:50 PM   #6  
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Rono Dutta used to dazzle the room with similar presentations loaded with seemingly analytical thought.
Give the new guy a chance, sure, but beware of salesmen selling snake oil.
Third oldest profession, I think....
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Old 11-24-2016, 08:42 PM   #7  
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Interesting read, from a "This is how Wall Street Analysts think" perspective.
Except she's not an analyst, she's the closer to a Wall Street gossip columnist.
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Old 11-25-2016, 05:21 AM   #8  
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Except she's not an analyst, she's the closer to a Wall Street gossip columnist.
Ahhh. Well, that is disappointing.

Still, something is going on...price is pushing $70 a share; had stagnated in the 50s for nearly two years.

Whether that translates to an advantage for pilots or investors (or both?) still remains to be seen.
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Old 11-25-2016, 06:16 AM   #9  
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Except she's not an analyst, she's the closer to a Wall Street gossip columnist.
What do you base this on? She has a large following of those within the industry and many from the investment community. She is far more pro labor (within reason) then most in that community.

Obviously you have some issues with her. I've read her newsletter for years and while sometimes I strongly disagree with her take, she has by far and as a whole the most comprehensive an accurate detailed industry weekly read.
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Old 11-25-2016, 12:58 PM   #10  
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What do you base this on? She has a large following of those within the industry and many from the investment community. She is far more pro labor (within reason) then most in that community.

Obviously you have some issues with her. I've read her newsletter for years and while sometimes I strongly disagree with her take, she has by far and as a whole the most comprehensive an accurate detailed industry weekly read.
Have you ever heard her ask questions on an earnings call? Why do you think that is?
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