United Airlines Holdings, Inc. (NASDAQ:UAL) Morgan Stanley's 12th Annual Laguna Conference September 12, 2024 3:50 PM ET

Company Participants

Mike Leskinen - CFO

Conference Call Participants

Ravi Shanker - Morgan Stanley

Great. Hopefully everybody had a great lunch. And for dessert, we have a threefer of continuous airlines content for you, starting with United Airlines. And happy to welcome back to Laguna, CFO, Mike Leskinen. Mike, thanks so much for being here.

Mike Leskinen

Ravi, thanks for having me.

Question-and-Answer Session

Q - Ravi Shanker

So, unlike some of your peers, you didn't put out an update this morning, which in itself is somewhat of a good thing. I think. So maybe start off with just talking about what you're seeing out there. Obviously lots of puts and takes on demand and supply across the industry, particular focus on RASM. So how's 3Q shaping up for you?

Mike Leskinen

Yes. I appreciate that. Look, you saw a lot of updates from our competitors this week. You saw a couple last week. We talked very confidently on our second quarter call about how we expected a positive inflection in RASM and domestic and Atlantic in August. We saw that. We talked very proactively and positively about what was going to happen in September, a continuation of that trend. We're seeing that. I think there was some skepticism on the call. I think that's reasonable. But we've seen a lot of money losing capacity come out of this market in a very rational way, and you're seeing a very logical follow-on with some improvement in yields as a result. And that is absolutely to plan and to what we expected for the third quarter.

In addition to that, you've seen, and you can see it every day tracking oil prices. Oil prices have moderated a little bit, and so that's a nice small bonus.

Ravi Shanker

Got it. Would you say that positive RASM year-over-year is the kind of ultimate smoking gun, that enough capacity has come out and kind of. So if it flips back negative, do you think the industry kind of is like - is that the industry sort of North Star right now, but how much capacity to put it out there?

Mike Leskinen

I think the North Star for this industry, that has been cyclical, boom the bust, the North Star is that at least the leaders in the industry have returns on invested capital that are nicely above their cost of capital. And at United, we're well on that path as we've decommoditized the product, we've got more work to do. Our relative returns are really, really strong. We're very proud of the relative returns, but our absolute returns do need to march higher. I'd like to see and expect to see our margins move into the low double digit range in coming years, and that's consistent with United Next.

I would say since we announced United Next, the absolute returns have lagged a little - the relative returns, if anything, are better than what we had expected and modeled for. It's time for the absolute returns to catch up.

Ravi Shanker

Got it. I have a few questions on United Next in a second, but maybe just to round out the story on demand, can you share a little more color on what you're seeing out there? Obviously a lot of concerns around the consumer right now, but our surveys are showing us that travel intent still remains very, very robust. So if you can breakdown into domestic, international and corporate, are you seeing just continued momentum in all three of them? Any kinds of cracks anywhere?

Mike Leskinen

Well, as far as I can see from the releases you've seen from our competitors, the incremental news has been positive across the Board. We expected that, but it's nice to see it come to fruition. Corporate revenue for us is up 15%. Really proud of that. So strong corporate results, domestic results are inflecting very nicely. Positive, as I said, the inflection being in August for us, as we talked about in the second quarter call. International Atlantic, we expected maybe a little bit of a softening at the Atlantic, but the Atlantic's been actually very strong as well.

So if anything, if I wanted to differentiate, there is a little bit more weakness for the lower end consumer and a little bit more strength for the premium consumer. Those trends continue. There's nothing that we can see in the data that suggests those trends abate anytime soon.

United has been on a - we've been on a journey for 7 years preparing ourselves for that elevated demand for the premium product, both domestically and internationally. And so we've got a 7-year head start on those that haven't been on that journey and sure feels like the economy is set up in a way where premium is going to continue to lead.

Ravi Shanker

Just on that note, to your point, I think you and maybe one of your peers are kind of really leading the industry when it comes to the premiumization there. How do you think about what more you need to do to kind of satiate that demand and kind of keep that momentum going? And second, when you think of the ULCC carriers launching a business class product, right? I mean, is that good for the industry as a whole because it's a rising tide of premium for the entire industry, or does that mean the industry is kind of closing up and gets more competitive?

Mike Leskinen

Segmentation has been a universal good for this industry. And so anytime we talk about additional segmentation at the industry level, I think that is a step in the right direction from the commodity product to a decommoditized product where we compete on the product and the service. And so I would applaud the efforts of some of our peers to do that. It takes a long time to put first class seats in. It takes a long time to put in seatback entertainment. It takes - I think sometimes it's impossible, frankly, to duplicate the club network that we have, to duplicate the loyalty network, the credit card network that we have.

We are constantly thinking about what we can do to continue to increase that competitive gap with premium products, from improving the food we serve on our planes, to improving our loyalty program, to improving our WiFi product, to improving particularly our Polaris product on international first class. We're out in front. We're running hard. We're not going to slow down. We've created a competitive gap. We're going to do everything to increase that competitive gap.

I do think that we and one other domestic competitor are increasing the portion of our planes dedicated to first class seats and premium products. And I think the demand for that, as far as we can see, is it's not insatiable. But the level of increase in supply is being metered in at a pace that I feel very comfortable we will continue to see supply that, or demand that is in excess of supply.

Ravi Shanker

Got it. Just a couple of more questions on 3Q itself. One is obviously we had the impact of the tech outage hurt everybody in the industry. How do we think about kind of how that impacted 3Q and has there been - I'm sure that was just a one-time thing and we moved on very quickly.

Mike Leskinen

I'm so proud of what we've done at United Airlines around setting guidance and then hitting that guidance. And I like to say that we set our guidance in a way that if there's an act of God that goes against us in a quarter or a period of time, one act to God, we prepare for that in the guidance, and then it's not going to cause us to deviate from the range. If that ever occurs, and there will be periods when we have two acts of God in a quarter, it's just too much. And in that case, we'll be out here quick to bring bad news.

I'm not going to sit on bad news, but at United, I'm also incredibly proud of the team because we have hubs that are in very expensive cities with very congested airspace, particularly the New York area. And Newark is one of our crown jewels. And weather hits, and weather hits in Chicago and San Francisco occasionally has weather issues as well. That creates irregular operations that we then need to quickly adapt to and recover the operation and do that while minimizing the impact on our customers.

We have become incredibly strong at that relative to our competitors. And so while we have some of the best digital technology assets in the business, we also faced some of the hurdles of CrowdStrike, just like our competitors. But just like we are faster at recovering from a storm, we are faster at recovering from an event like that. And I think it really differentiates United, and we should be really proud of that.

Ravi Shanker

Got it. And the other issue was, I think you and your peers would have to suspend flights to Israel. How do we think about dimensioning that? I think you said that in the past, but just given where the network is right now, how do we think of sizing the impact of that?

Mike Leskinen

Yes, Israel traffic represents about a little less than 1%, 0.8%, to be precise, of our capacity. We are tremendously proud of the franchise we have serving Israel from multiple hubs with more frequency than any other U.S. carrier. We are the first carrier to get back to Israel. We were the last to leave. And I sure hope that when the hostilities cease and we can safely return, we'll be the first U.S. carrier back to Israel. The big issue for us is, when you land there, we have to overnight our aircraft and our crews. And that was a risk we weren't comfortable with in the short-term. And so, hopefully this passes and you will see United return.

Ravi Shanker

Got it. Just kind of going back to the RASM dynamic, right. I mean, one of your peers this morning pointed out that, the fact that the industry is seeing positive RASM inflation, in a deflationary fuel environment is a very good significant. And kind of tells you that this industry has, basically needs to recover cost inflation in other areas in the form of price, right. Would do you agree with that view and kind of, how sustainable do you think that is?

Mike Leskinen

Yes, I love the question, and I've probably been one of the most vocal proponents of not hedging fuel. And not hedging fuel, because a healthy industry passes through increases, in their input costs to the consumer. And I think this is industry that is long overdue for that. Now, when I say that, that means that it's not a direct correlation, not causal rather, you see rising fuel prices.

And as a result of that, some of the incremental routes that weren't making money, are losing more money. And so, you see those carriers then cut that capacity, and as that capacity is cut, supply demand would dictate higher prices, and that's how it gets passed through, and the same in the reverse. But now we find ourselves in a spot, where the have-nots in the industry have margins that are, mid-teens losses, and you get a nice tailwind from lower fuel.

Maybe that's two or three points of profitability, current magnitude. And so, you're losing 15% now you're losing 12%. You're not going to add more capacity, because of that. And therefore, I don't think that the path to lower fares is as clear, as it has been in the past. So there's probably some areas around the margin where that is true, where maybe there's a flight that was going to be cut, that doesn't get cut.

There's nothing in the fourth quarter, certainly not in the third quarter, nothing in the fourth quarter that I see around the schedule change that, would lead the lower - that would lead to higher supply, because of the move in fuel and therefore lower prices. I still don't think even in Q1, maybe by Q2, if fuel prices stay at this lower level, we could see a little bit of a degradation, all else equal. But there are much more tailwinds for yield right now than headwinds to yield.

Ravi Shanker

So you, do you believe, are you hoping that there is something like a two or three quarter lag between, passing through jet fuel on the way down? Is that - what you would hope to be the industry standard going forward?

Mike Leskinen

I think that it is directly related to what the margins in the industry are.

Ravi Shanker

Okay. Got it.

Mike Leskinen

And if you have a player that is sitting around its cost of capital margin, I don't know, 7%, 8%, 9%, then there's going to be some marginal routes that shift depending on the fuel price.

Ravi Shanker

Yes.

Mike Leskinen

But right now you have the halves with premium product that have margins that are above that and moving higher, and the have-nots that have margins that are so low that I think that the movement in fuel become somewhat irrelevant. So, I do think that in a more normal environment, when this industry right sizes, when the money losing routes are curtailed, so that the margins for even the have-nots have improved, that the relationship with fuel will reassert itself. And I think that bag can be anywhere from 90 days to 180 days. And it depends on how tight the supply demand balances.

Ravi Shanker

Got it. Last question on this topic. Scott Kirby was the first CEO in the industry to evocally point out that some players have like fantasy growth plans. And it's almost 18 months ago that he said that, or maybe even longer. Do you think that enough capacity has come out of the 4Q schedule, that we are in a sustainable place right now, or do you think more needs to come out?

Mike Leskinen

I think, we've seen the capacity we expected to be curtailed, because it was losing so much money has been curtailed, and it's happened faster maybe than even we expected. But I do think that there is more to come as we roll into 2025. But I think it is very, very, very encouraging, the pace at which these decisions have been made. There's been some very rational decisions.

And I think having activists involved in the space, more and more carriers talking about capital discipline, more and more carriers talking about return on invested capital, not just margin, is a critical step in gentrifying this industry is. We have historically been too quick, to manage to margin and not consider the long-term returns on capital necessary, to invest in growth in this business.

And so, I think it's a very, very healthy dynamic, and I'm optimistic it's going to lead to several years, of a much more robust and stable industry, which, by the way, is going to benefit all the stakeholders. And it's going to benefit our customers, because you're going to have more stability. It's going to benefit our employees, and I think it will benefit all of our financial stakeholders, both creditors and equity shareholders.

Ravi Shanker

Gentrifying the industry is a great phrase. I may steal that from my note, if you don't mind?

Mike Leskinen

The neighborhood matters and our neighborhood has been under attack, and we can have a really, really nice house and a bad neighborhood and nobody's going to pay full price for the house. And so, we want our neighbors to have nice homes, too, and increases the value of ours.

Ravi Shanker

Getting a Starbucks there first, and then everything follows. Do you want to shift gears a little bit and talk about United next? Obviously, when you guys came out with those 2026 targets in 2021, I think people were like, what are they talking about? Five years visibility in the airline space, especially in 2021, was crazy. You guys are, to your point, kind of maybe getting there in a different way than you thought, because obviously a lot has changed. Can you just talk about how you see those 2026 targets today, where you sit in '24?

Mike Leskinen

I don't think it's that different. I think that there's been a bit of a delay, and the mixture of cost and revenue is different. But that is different for every company in this country, because inflation has been higher. And inflation has definitely impacted the airline industry, maybe even a little bit disproportionately. But the path, we started this journey, we had an unfair advantage.

We hired the leaders from the airline industry who had built the strongest, connecting, most profitable hubs in the industry. And we had the D&A at United with hubs that were under-capacitized, that didn't have the connectivity, that were surviving on the profitability of our crown jewel, which is our international franchise. But the domestic franchise wasn't carrying its weight, and that was obvious.

It wasn't obvious to Wall Street, for sure, but it was obvious to the leadership we hired in, Andrew Nocella and Scott Kirby and Patrick Quayle. And so, we sat on that mission. And so, it seems strange this audience to say, well hi, we're planning five years out, but we knew it was going to take five years to fix that. And so, we're marching along that journey.

And what that has done, is it has created a competitive moat around our business relative to the ultra-low cost carriers, just as we expected it would. The premium product, just another degree of segmentation, is it strengthened that competitive moat. And that has led to relative margins that, are 20 plus points higher than those low margin airlines that, we're competing with.

Now, what is different is that we thought that, maybe they would not allow their margins to fall so deep, deeply negative. And in that industry dynamic, if their margins were a little bit higher than ours would be - in the double-digits sooner. But I think, and I'm incredibly optimistic, that as we enter '25 with some wind in our sails, that we're firmly on that path.

I'm not going to hazard a guess, or change guidance today to talk about the specific timing. But I feel as confident as ever that, we are on that path to low double-digit margins at United Airlines. And that's going to create, that's going to create a much nicer neighborhood, and shareholders are going to be richly rewarded.

Ravi Shanker

Got it. A central pillar of that plan was obviously capacity growth. Not capacity growth, but fleet renewal, right kind of - a bunch of new narrowbody aircraft. Do you have the confidence that you will have those tools to deploy that plan?

Mike Leskinen

Yes, I mean, we talked about, in the first quarter of this year, we talked about level loading CapEx at $7 billion to $9 billion over the next three years. And I've got various tools, regardless of OEM delays and other issues around the supply chain that, I think will keep us in that range of CapEx. And with a CapEx like that, I think with reasonable expectations for profitability, free cash is going to start to grow pretty meaningfully - to grow pretty meaningfully at United.

So from that standpoint, feel very, very strongly like and operationally, because we're now going to very deliberately level load the growth. I think it'll be a smoother ramp in, ramp in capacity from here as well. And we've been doing that and I kind of, I would have actually sat in the audience and not even believed it, but we've been doing that, adding capacity to aggressive clip.

And you would think that would depress our yields, and that RASM at United would be lower than the industry. But quarter-after-quarter-after-quarter, because of this, because of the segmentation, because of what we're doing with the connectivity, we have outperformed the RASM on elevated growth that is a special recipe. And that says to me, and it should say to all of you, that the strategy is working.

Ravi Shanker

Got it. Are you confident you can get the planes?

Mike Leskinen

Yes. Let me - expand on that, because we haven't always been able to get the planes. Boeing is doing much better, particularly on 737s. Their delivery rates have stabilized. We have growing confidence there is the risk of the strike. I'm not going to opine on that. That would certainly be a speed bump. But we're very encouraged by the recent narrowbody deliveries from Boeing.

And I think they're encouraged, frankly, by the new leadership. Kelly was a great leader at Rockwell Collins. I got to know him when he was a CEO there, and I think he is the right leader to fix Boeing, and put them on the right track. And Boeing is an incredible partner for United. There's a little bit more concern around ramp rates on 787 with supply chain. I'm a little bit concerned about seats.

And so, I'm not going to run away from those. If there are some constraints in capacity. By that factor, I think United will still get more than our share. For Airbus, Airbus the - A321 is a really spectacular aircraft, and we're thrilled to have the number of aircraft we have in the fleet. I was excited to lease a few more 321 aircraft. The constraint there is the engine, and with GTF engine supply constraints, I think that's going to persist for some time.

But aircraft's very good with the LEAP engine as well. So, there could be a little bit more slowness for the 321. But in aggregate, I feel very good, very good about United delivering about 100 or taking delivery about 100 narrowbodies a year in each of the next three years.

Ravi Shanker

Got it. Maybe shifting gears a little bit. Obviously, a lot of the focus so far has been on the demand environment, the supply environment, but you guys have also really idiosyncratically focused on the cost side of the house, and if you did it during the pandemic. You were the first one to put a cost cutting target out there, and kind of in your tenure as CFO, kind of you have been very vocal about continuously targeting cost takeout opportunities kind of over time. So can you just help us dimension how big, is that opportunity pipeline and kind of how quickly you can tackle that?

Mike Leskinen

Let me start with setting the table. CASM-ex has been under pressure with inflation, labor in particular. And as we roll the table into '25, we have some headwinds from our own labor agreements. I think probably two to three points. I think that's a headwind the industry. I know that's a headwind the industry also faces. So, we have a headwind in that.

We also though, and you know, I would, well it was not so many years ago, I was sitting in the audience. And so I think, well, how do you measure an airline CFO? And I said, well CASM-ex discipline, my view on that has evolved. We need to have the best CASM-ex in competitively better CASM-ex, versus the rest of the industry. But as we segment this business, making sure we invest in the product, is going to further de-commoditize it.

And so, Andrew and I talk about investing in food. And look, nobody cares about the food. Our customers care about the food. Investing in clubs. Our customers incredibly care about the clubs. Seats internationally, customers care about that a lot. And so, we are going to continue to widen the moat, by thoughtfully investing in the business that will create, I don't know, a point of CASM-ex headwind.

As we invest thoughtfully in making the product, a superior product. But we're going to more than make up for that on the revenue side. Now, let me end on the CASM-ex side where I'm excited though. As we roll into '26 and '27, United has this unique opportunity to up-gauge our aircraft. And we've been talking about this for some time. In '25, we will be up-gauging the mainline fleet.

In '26 and '27, we're up-gauging the mainline fleet a lot. In '25 though, we are going to be flying more regional aircraft and we're going to be flying them harder. And so that will mute the CASM-ex goodness of up gauging in 2025. But in '26 and '27, we get a couple of point advantage that will be idiosyncratic to United that I think we'll be having superior revenue in those years. But I think also we should have industry leading CASM-ex performance in those years as well. So, it was a really good story and unique to United because we had been uniquely undergaged historically.

Ravi Shanker

Got it. Any questions from the room? Conor?

Unidentified Analyst

Thank you. I think you mentioned that you had anticipated the Atlantic demand growth might be a little bit weaker, but it turned out to be quite strong. Just wondering why you thought it might be and what kind of surprise you in that regard.

Mike Leskinen

Well, look, the team did an incredible job in COVID. When COVID hit, we realized, wait a second, air traffic is going to kind of grind to a halt. And we curtailed expenses and prepared for that storm faster than any other global airline. And so that was a real key strategic decision. But probably even more important than that decision was realizing when everyone else in the world was saying that air traffic is never going to rebound, that it would rebound and it would rebound with a vengeance. And when it did, international travel would be a pretty exciting place. If you hadn't taken a lot of vacations, you probably want to go to Paris instead of to visit your relatives in Ohio. And so we spent some extra money through the pandemic to prepare to be spring loaded to grow into some of those international lanes, particularly the Atlantic. And so we gained a step on the competition.

And so if you look at the growth rates coming out of the pandemic for the Atlantic, they were very elevated for several years. And so I'm just a Chief Financial Officer being the pessimist. I'm supposed to be saying, trees don't grow to the sky. It's going to - at some point, it's going to bite. And so I had a little bit more pessimism around that. And thank goodness Andrew didn't listen to me, because we prepared and grew the capacity, the right amount and yields held in.

Ravi Shanker

Any further questions?

Unidentified Analyst

Thanks for taking my question. Earlier this year, you had postponed the Investor Day, and I'm just curious if you had any update there on timing.

Mike Leskinen

Yes, it's a great question. I appreciate you asking. I'm so excited to have an Investor Day. We have so much - so many special initiatives at United from updating you on where we are in United Next to updating you on MileagePlus and [Connective], our loyalty program and a fulsome, fulsome update on capital allocation. So we're excited to get that out there.

However, and we've been talking about this theme throughout the day. Right now, this industry is in a bit of a storm. We have players that are negative mid-teens margins, and then we have two players that are premium carriers at the top of the leagues with margins still absolute sense aren't adequate. And I will continue to share what we think the future holds, which is a very bright future. But while that plays out, and I think, make no mistake, I think that plays out through the remainder of this quarter Q4, probably a little bit into Q1 as this industry goes through that transformation.

I don't know that this audience is going to be the most receptive to a major Investor Day talking about how bright the world's going to look in 2027. I think that there may be a lot more receptivity for that type of event in the springtime when the storm has passed. And you can see that we have delivered some higher margins that you've seen yield in a positive way for a few quarters. And so we have not made a final decision. But there is a lot of thinking that we will want to push the Investor Day into the spring.

Ravi Shanker

Until then, if I can touch on both of those things. So MileagePlus, obviously big, big asset for you guys, you led the industry in kind of monetizing it during the pandemic. You since paid down that debt. How do you think about - again, not to take away thunder from the Investor Day, but just what can that entity do over time? Is it just a case of educating Wall Street about how good it is or do you still have plans for a huge amount of growth there?

Mike Leskinen

No. Educating Wall Street should be the last thing on my mind. I wanted to educate - we needed to educate Wall Street during the pandemic because we needed to raise capital to save the business and to save the industry. And everybody copied us in the structure to save the industry. But what we need to do is, and it was one of the first things I did as CFO, is think about how we allocate capital, think about how we allocate operating expenses to grow the business.

And we have a business, we have a segment of our business that is high margin, low capital, high growth, is nicely exposed to inflation. The more inflationary world, the more people spend on our credit card. And we've underinvested in that business over time and over invested slightly in aircraft. And so I believe it's uniquely my job to shift that balance, not moving the dial from a ten to a five, but to move it from a ten to a nine on aircraft and to move it from an eight up to a ten on investing in the loyalty program.

And through so doing, we'll be able to increase - I think we'll be able to greatly increase the cardholder base, and that will drive more loyalty to United, but also more loyalty revenue through our P&L, but also the relationship we have with our customers and how we can monetize that data and through advertisements and, well, mechanisms that I'm not quite ready to share with you today, but do require investment, do require new leadership.

And so the most important thing is not communicating to all you. The most important thing is to allocate the resources so that business becomes supercharged and you start to see earnings and cash flow being spun out in accelerated rate. And I think we're on the cusp of that. I think there's some big news for you very, very soon, that's going to form the foundation of - part of the foundation of accelerating that growth. And I think it will - talking about when the Investor Day timing, I think that by the time we roll forward to the spring, we'll have even more results to share versus just promises.

Ravi Shanker

And just very quickly, so you've been very clear about your CapEx plans on aircraft investing in the loyalty program. How are you thinking about cash return and potentially kind of when and how that happens?

Mike Leskinen

Wow. Near and dear to my heart. This industry needs to get better at returning cash to shareholders. We need to have more regular returns of cash to shareholders. Now, I passionately believe that those returns, when you're trading at four and five times earnings, should be the form of buyback, not dividend. I think dividend, you need to - a dividend is great and attracts different types of shareholders when you've already trading at 10 or 12 times, four or five times it's so opportunistic to buy back shares.

But listen, we had to invest in the strategy of United Next first because that's the foundation of making this business sustainable. We had to invest in our people. We've done both of those. Post-pandemic we needed to improve our balance sheet. Our balance sheet now is in a great spot. I talked on the Q2 call of a couple of pieces of debt that we had to repay. We have repaid those pieces of debt. Now my incremental debt cost is 125% to 5.25%. There's no more expensive debt to repay. I've got some debt that I can prepay next year, but right now there's a prepayment penalty, which leaves two things to do with cash, further deleveraging and share buyback.

I do want to get United on a path to two times net debt to EBITDAR. I think that's the right level of leverage longer term. But the pace at which we get to that level of leverage will be consistent, will be paced by what our equity multiple is. And at four times, I think that pace to two times leverage will be a little bit slower. So you need to stay tuned on a shareholder capital allocation. But we have checked off all the boxes that are priorities before we were to announce a buyback.

Ravi Shanker

Got it. That would be out of time. Mike, thanks for the time.

Mike Leskinen

Thanks, Ravi.

Ravi Shanker

Thank you.