United Airlines Holdings, Inc. (UAL) Earnings Call Transcript & Summary

Hi, and good afternoon, everyone. My name is David Vernon. I am the airlines and transport analyst at Bernstein. We are pleased to have Michael Leskinen from United Airlines, Head of Corporate Development and Investor Relations, here to join us today for our second airline session in the -- this year's ODC. Mike is going to start us off with some prepared remarks. You should notice on your screen 2 things. On the left -- on one side is a pigeonhole question submission and promotion and demotion tool, where you can go ahead and offer up some suggestions for questions in the Q&A. And the second part of the screen has a link to a Procensus survey, which we can use to incorporate some real-time feedback into the session, which is useful not only for other investors, but also for us and for United in terms of kind of understanding engaging consumer sentiment. So please make use of both of those tools. With that, I will go ahead and hand the mic over to Mike, who's going to go ahead and walk us through a couple of slides, and then we will open it up for Q&A. And thanks again for joining us, and we'll hand it over to Mike.

Thanks, Dave. I really appreciate it. And I'm really excited to present at the first Bernstein conference that I have attended. I have attended as a participant, as a -- in the audience for 20, 20-plus conferences, and you guys do a great job. So thanks for -- thanks very much for inviting me. I've got a couple of slides. These are mainly just to drive some Q&A afterwards. But as Dave mentioned, I -- one of the divisions I manage is the corporate development division. And we're doing some really exciting things that are going to give us a competitive advantage as we see the other side of this crisis. And so let me share a couple of slides, and we'll jump into Q&A. Okay. Sharing slides. How's that?

Looks good.

Very good. So big picture, corporate development, we were spending a ton of time. The focus is how do we make sure that United is more competitive on the other side of the crisis. And one of the biggest advantages we have is our Star Alliance partners. We've got the best partners around the world, and we'll talk about that shortly, about the revenue and the connectivity that we get out of the Star Alliance. And so we start with a foundation of strength, and the question is how do we make sure that those partnerships are more resilient than ever on the other side of the crisis. We've been spending a lot of time on that, a lot of time in Latin America, which has been messy. And a second area we're even spending a lot of time and is going to fundamentally have an impact on how we recover from this crisis domestically is the regional carriers and how we interact with our regional partners. And we've had a fairly complex strategy over the years, and we're working hard to simplify that and align our interests among the likes of SkyWest and Mesa and Wisconsin Air, et cetera. So we can talk about that a little bit. One area that I'm really excited about, that we have spent -- got a subgroup, spending a lot of time on, is becoming really important to some of our corporate customers, particularly in Europe, that is decarbonization of the airline and how do we make sure that our carbon footprint is reduced. Right now, we have a goal to reduce that to 50% of our -- 50% of the prior level. And so we'll talk about some of our -- some of the exciting ideas we're doing there. And we need to do it in a cost-efficient way. And we'll talk a little bit about pilot pipeline, not really an issue right now, but as the industry recovers, making sure that we have the best pilots and we have a commitment to safety and a pipeline to train up the best pilots in the industry, something that we think we've already built a competitive advantage here at United on doing. And then lastly, on this initial slide, I want to just touch on, in a crisis like this, you get kind of repurposed to do what is needed. And I was really excited to spend a lot of time on MileagePlus. When I was an analyst and portfolio manager on Wall Street, I always thought about the resiliency of the cash flows from our loyalty program and how, as an airline, we never really got credit for that. And there were talks of spin-offs and lots of failed spin-offs over the years and other ways to monetize that asset. And I think all of them fell flat because they created conflicts of interest between loyalty, the equity holders in the loyalty program and the equity holders in the airline. And so what we did was a really innovative transaction, first of its kind, to monetize the asset through the use of debt, keeping interests aligned for the equity holders. And I think something that was so successful that we saw many of our competitors already copy. And I think that's fantastic news for United Airlines. It's fantastic news for the industry, in that this will be a permanent source of financing for the foreseeable future. So really excited about what we're doing in corporate development. Crisis creates opportunity, and we're trying to make sure to emerge on the other side of this a stronger United Airlines. I'll touch briefly on what I said on the Star Alliance partners. And I think this doesn't get a lot of credit in an environment where international revenues are depressed. And international revenues are depressed more than domestic, and business revenues are depressed more than leisure revenues, to which I say, that's true. There's no question about it. And what that means though is that despite those headwinds, United has performed very admirably through the crisis. And if you think about the world in the lens of normalized earnings, which was the [ protagonist ] used as an investor, we have the most upside potential as international demand rebounds and business demand rebounds. And so we're really excited about that. And we're really confident that international and business demand will rebound, and it's just a matter of getting the vaccines that we know are even more effective than anybody hoped, to 90% with Pfizer and 94.5% with Moderna. Really, nobody was expecting that type of efficacy. And so hopefully, that pulls forward, how quickly the vaccines can get disseminated, and we can start a drive in international business travel again. But just a little refresher on Star Alliance. And I think I never spend enough time on this as an analyst. But far and away, the strongest alliance in the world, #1 by revenues, #1 by country served, #1 by airport served and #1 by daily seats. And really, nobody is close. And so what we need to work towards and what my team is spending a lot of time thinking about is how do we make sure that we keep the members that we have and how do we strengthen those partnerships, having strengthened them in a way that we further create connectivity between ourselves and ANA, between ourselves and Air Canada and Lufthansa. How do we make sure that the customer experience is as seamless as possible. How do we make sure that the frequent-flyer programs are lined up with one another. And so we've got some really good ideas on that front, even how do we make sure that for the customers that care about things like decarbonization, how do we make sure that [ we're laying ] on initiatives like that. And so spend a lot of time on this, and it's an exciting time to explore ways to kind of reset some of these relationships with the current pandemic. This slide, really, just teasing some of the ideas that we have in decarbonization. And we announced last fall that we're going to start to invest. We had targeted back then that we would invest $40 million per year in decarbonization and environmental investments around the world. And right now, to make big investments is something that -- capital is very dear. But we are -- we do know, now that post the MileagePlus transaction, post our recent WTC, one of the most creative WTCs in the history of the airline industry, that we're not questioning the survival of United Airlines. We -- there's -- we have built a foundation, and there's no question regardless of the timing of a vaccine and the return of demand, that United is here to stay. And the question is how do we maximize the earnings potential on the other side of this crisis. And one of the ways we expect to do that and then be customer-friendly and corporate-friendly in the decarbonization world is to make sure that we are offering our customers the most environmentally friendly options to fly on United Airlines. And so I think we've got a lot of aerospace investors on this call. Flying an airline, flying an aircraft, the energy it requires for an aircraft, it's incredibly energy-dense. And so when we think about battery technology, it worked great for Tesla. It might work great for shipping on the ground. For an aircraft, the technology with current battery technology is decades, if not further out. And so we're of the belief that jet fuel is the solution for the foreseeable future. And we'll try to get more and more efficient jet engines, for sure, and we'll work with Boeing and Airbus to do that. But we think that, that combined with a direct air capture and carbon sequestration initiative could get us to -- could help us reduce our carbon footprint and meet the targets that we've already set and hopefully, over time, set even more aggressive targets for the company. But really excited about this, carbon sequestration being a big part of the solution and a direct solution that impacts the carbon footprint of air travel versus just buying offsets. So excited about that, and if there are questions, we can dig into that a little bit more. I'll just briefly touch on this. But prior to the crisis, we were looking at an industry that used to create most of its pilots through the military. And the military created a lot of pilots. And when they retired from the military, they often came to United Airlines and Delta Airlines and American Airlines. But with the shrinking pilots in military, there's a real shortage. And that shortage is probably now 5 years out, not 2 or 3 years out. But retaining, attracting the best talent at United Airlines is really something we're focused on now. It takes 5 years to train up the pilot. So if you think the industry is going to be recovered by 2025, and we passionately think it will be recovered before that, we need to start to think about how to attract those pilots of the future today. And so, just last year, we acquired a flight training school in Phoenix, Arizona, and we'll start to run pilots through our training program. And once we run them through our program, we'll run them through a partner, Part 135 carriers, which is small package delivery, and we'll run them through then our express carriers, through the Air Wisconsins and Mesas of the world, and eventually to bring them to United Airlines. And so really excited about this. I think it will be a competitive advantage, as I said, in driving some of the best and brightest pilots and retain them at United Airlines. So with that, Dave, I would love to take questions, and we can take questions about corporate development initiatives, we can take questions about United broadly, but excited to be here today.

Yes. So I've got a handful of questions kind of coming off of the presentation deck, which you shared earlier today. And then maybe we can step out a little bit and talk about some of the longer-term, bigger-picture issues around earnings power and things like that. But if we were to start with the ALPA arrangement, you noted in there that the changes you guys had made with ALPA were sort of industry-leading. Can you help us understand exactly what that means from a cost perspective on the way back up and then at a run rate level? Like what specifically has -- have you guys done with the pilots to help kind of manage through the crisis? And then what does that do to the long-term cost structure?

Sure. Happy to. Really excited about the deal we did. And pilots represent about 20% of the salary base of United Airlines. And so what we did is if you have to furlough a bunch of pilots, you have -- that's expensive. You get everyone at the top of the scale seniority-wise because everybody goes from a wide-body to a narrow-body and a narrow-body to a smaller narrow-body. And those all require training events. It's not good for morale, and it's not good for flexibility. So what we struck was a bargain where all of the pilots will be retained. We -- there will be no furloughs. And it allows us to flex the hours, keep people in the seats, captains, first officers in the seats that they're flying today, and reduce everyone's hours and do that in a way that if in May and June of next year, the virus is under control and we have strong demand, we can bring capacity up very quickly. And if there's a rebound in July, we can bring capacity back down even month-to-month. So it's not a matter of flexing up and down once in each direction. It gives us the ability to match supply/demand as finely as we want to, even 1 month to the next. And that's going to allow us to maximize revenue and minimize cash burn for the next 6 to 9 months or for however long it takes to get to the other side of this vaccine.

And do those freedoms around sort of lower hourly minimums, lower bid lines, all that kind of stuff, is that persistent after the recovery? Or does that come off after sort of hours reach a certain level or after demand reaches a certain level? Is this a permanent change in the way that the costs are going to move? Or is this just a stop-gap to help you avoid having to furlough and maintain the flexibility?

This creates flexibility that will get us to the other side of the crisis. We're confident in that. I won't speak to the specifics of the contract. That's a private matter between us and ALPA. I think that there probably are some documents out there in the public domain, but we want to respect ALPA and the privacy of that. But I think it does set up a framework, and it really -- what it emphasizes is just how strong our relationship is with the union, never been stronger. And so really excited about this, in that I think it's a win for everyone. We're all stronger for it.

Okay. And I guess as you think about the partnerships issue with the Star Alliance, is there going to be anything different about the way you manage those partnerships or look to make it easier for flyers to -- of one program to exercise their privilege or their status at another airline? Like are you looking at making changes to the way that works? Or are you just relying on the historical strength of the relationships?

No, absolutely. And we are looking to improve upon it. We have great partners, and we want to continue to refine and improve the contracts that we have to align interests where, a lot of times, is there some reason for them to fly their aircraft, or us to fly our metal, and we want to make this about maximizing the size of the customer base that we serve together. And there are pieces of that, and I alluded to some of them. I'm not going to get into the specifics because we want to announce deals when we have deals. But how do we make sure that our loyalty programs are better integrated with one another. How do we make sure that you can pick your seats out when you book from our website, and you're booking on Lufthansa or ANA. How do you make sure that everything is as seamless as possible when you connect through one of our partners and vice versa. And how do we make sure that the way we schedule our banks and the connectivity through our hubs and how we connect through the ANA hubs and the Lufthansa hubs, how do we make sure that, that is all set up in a very customer-focused way. And so we spend a lot of time on that, and you'll see us do more and more. And we're not doing it in an equity-heavy way just to differentiate a little bit versus what some of our peers have done. If, at times, it takes equity to solidify relationships, we're certainly open-minded to that. But this is about creating the best product, the most seamless network of a global airline has anywhere in the world. And the good news is that the one thing that you can't change easily is the partners that you have. Refining and improving the agreements you have with partners is something that we certainly can control. Starting with the second tier of partners is not something you can fix.

And as you think about the priority and the focus as everybody is trying to kind of get their way over the finish line, is there something that we should be looking for, more material changes kind of down the road? Or is there something that -- stuff that you're working on kind of today that's going to help you kind of accelerate the recovery?

Yes. I think we are constantly looking at opportunities in this area. And I think I'll just leave it at that.

Okay. And then regionally, I guess, as you look at the partnerships that you have, not every airline has been fortunate to be in a country where the government has stepped in to provide financing. There's going to be some shakeout here and there. Do you see any potential for consolidation across the partner ecosystem, not for you to be participating in it, but in terms of like a regional focus of 3 or 4 smaller airlines, say, in Latin America, deciding that maybe we should just be one airline? Are you keeping -- or like how do you think that COVID's going to shift the global landscape a little bit from a partnership standpoint?

Yes, this is a cyclical industry, and we get reminded of that periodically. And nothing healthier for a cyclical industry than to go through a downturn and see some consolidation as a result of it. And I think it is inevitable that you will see consolidation internationally. It's inevitable. It's a question of pacing, and we'll have to see what the recovery looks like and what the shape of the recovery is. But this has been a long time coming. I think the commercial aerospace cycle was in its 12th year of an upturn. So certainly, nobody envisioned a crisis of this magnitude, but we will see consolidation. And one thing that I think is outside of the consensus, Dave, that I think is going to be really consequential on the other side is you'll see more consolidation in the international lanes than I think you'll see in the domestic market. And listen, if the crisis persists through 2021 and dips its tail into 2022, maybe you'll even see some consolidation domestically, certainly among the second- and third-tier airlines in the U.S., but internationally, inevitable. And I would -- you didn't ask this, but I want to highlight it. If you think about the number of wide-body aircraft that have been permanently grounded around the world and what that means to the supply response when demand comes back to those international lanes, you can see a setup for a real nice industry structure for several years.

Interesting. So MileagePlus, I did want to congratulate you because I think when Paul Jacobson at Delta called you guys out, complimentary, it was the first time that I've seen an executive at one airline compliment an executive in another airline in my couple of years covering this space. So as you think about that program, you mentioned this is going to be a permanent part of the capital structure. So this isn't like a temporary move, you're going to do it and then remove the financing when we're better, right?

Well, look, Pam Hendry, our Treasurer, is the best in the business. But what I would tell you, what we're always doing is we're optimizing our capital structure to minimize the cost of capital. And that stream of income coming off of MileagePlus is absolutely resilient. It's like a consumer staple stream of income. And that's really the heart of lots of pieces, and it took us many months to refine the program in a way that was successful when we launched it as it was. And we'll find some ways to improve it. This was the first time it was ever done. But that underlying stream of cash flow has and will continue to give investors a lot of confidence in the return of their capital and their principal. And so we would expect that it will be even lower cost on the other side of the crisis. We got -- in the worst crisis in aviation history, we received investment grades from all the rating agencies that rated the transaction. And so on the other side of this, we think it will compete really attractively with EETC financing and being more permanent. And so we would expect it. Now whether it is a line of credit or it's actual debt that is sitting on the balance sheet that we use against the asset, we're definitely going to maintain the capability.

And that would be -- that could actually help you then accelerate the repayment and restructuring some of the other liabilities that have been taken out to help fund the crisis, right? I would imagine you would get better financing terms on that program when demand is better.

No question about it. No question about it. And our focus is going to be deleveraging this balance sheet as quickly as we can as we return to profits.

Okay. And then kind of moving down the -- through the topics on the slides, the issue around sort of the pilot training and pilot training school. I guess as you look at the industry, there was a lot of talk kind of pre-COVID around pilot shortage, potential for pilot shortages. Obviously, we're going to see a bunch of older pilots move out of the active workforce as a result of early buyouts and stuff like that across the industry. I mean how do you think about the prevalence of that issue of pilot shortages kind of on the other side of this? Is this something where you feel like with a pretty big snap -- quick snapback in demand, we could be right back into that situation? Or do you think it will take some time for the industry to absorb the available labor that's out there?

Yes, you have to ask yourself a couple of questions. Some will kind of go to like Econ 101 on supply and demand for pilots. Pilots take many years to train, so that supply is relatively inelastic. And I'll tell you, going through a crisis like this, if anything, discourages young people from taking on that profession, right? And so, if anything, supply of pilots has been diminished a little bit as we look forward 5 years from now. The demand for pilots, we got to think about this, right? Do we see a rebound like we did post 9/11 and demand for air travel? How many people stopped taking leisure trips because once we're on the other side of this and it's safe and nobody is concerned about COVID, do people stop traveling to the Caribbean and stop going to see friends and family? We're believers that they won't. When you think about business demand, is some business demand inevitably offset by Zoom and products like this? I mean this is okay. It's not great. I would rather be seeing you in person and the audience in person today. But there will probably be some business travel that you can substitute Zoom for. We're all a lot more comfortable with it. We think maybe offsetting some of that though will be folks that if they don't have to be in the office so much, maybe they actually live -- maybe they live in Breckenridge and they commute to the office 1 week a month. And so there's a little extra demand on that side. It's hard to know. But our guess is -- our best guess is that demand for air travel rebounds, and it might take 2 or 3 years to fully rebound, but it rebounds to 2019 levels. And then the growth rate, the secular growth rate and the desire to travel returns to the same trend line it was on, albeit we'll have a few years of lost growth. And so in international, by the way, it was growing faster secularly than domestic. And so we would also expect international demand to return to that secular pattern of faster growth than domestic demand. So with that backdrop, we think demand is going to look pretty similar to what it was for pilots, and we think the supply is going to be constrained, if not constrained a little bit more. And so while that shortage of pilots that we thought might have been a 2023 or 2024 event, maybe it's a 2025 or a 2026 event, but there's no question that as we look out towards the future, that if we don't do things as an industry to help generate this very long-tailed asset of pilots, that there's going to be a shortage. And we're going to make sure that United is sitting in a position where we're ready to stand out from the crowd when that shortage presents itself.

Okay. And then on the environmental side, I'm curious if you have talked to the revenue team about how impactful United's efforts on the carbon front have are on the demand side. Right? Is this something where you're trying to help manage the perception for the masses? Or is this something where you're specifically getting asked about it in the corporate sale process? Or is this something where you just want to make sure that you can appeal from an institutional investment standpoint to investors that increasingly are looking at environmental issues? We're -- in our research, we're certainly seeing this groundswell of demand, but I'm just wondering what your perspective is on the ESG front.

Yes. We've got to be careful to not let the tail wag the dog, right? So investors, I think, number one, and you can correct me, but number one, and they should, they have a fiduciary duty, number one, should be focused on the cash flows. And so that's how we think about it at United. We're not doing this for investors. It will be a byproduct bonus because there are increasingly, certainly on the European front, investors that can't invest in you if you don't have the right carbon footprint and carbon strategy. That said, what we're seeing on the leisure front, it's going to be harder and it's harder to tell when is a customer willing to spend $5 or $10 more to buy an air ticket that has a carbon-neutral footprint versus one that does not right now. When you think about going on to Expedia or some other channel, the leisure travelers that are not showing loyalty to one carrier, $10, and you're booking the cheaper ticket. Now I think some of us that are road warriors don't think about it that way because we understand the difference in the product. So that's a tough lift. But what I'll tell you, Dave, is talking to some of our biggest corporate travelers, the big consulting firms out there, the big pharma companies out there, the big banks out there, they care. Big technology, they care a lot and increasingly so and increasingly are willing to point their travel towards the airline that's going to take care and be a responsible corporate citizen. And so we're making sure that we need to do it in a cost-effective way. This is a hypercompetitive business. And so this is not something where we can go out and pay $80 for fuel instead of $40 for fuel. But if we can figure out a path to incentivize the right technologies, and that's really what we're doing through investments, to incentivize the right technologies, that puts us on a footing to decarbonize United and eventually decarbonize the industry, that's going to set us apart from competitors and it will drive greater cash flows to United Airlines and to our investors because of that preferred airline that we will be for some of these corporates that increasingly care about it. And we think those trends are secular. So the number of corporates that care about it today, they're going to double in a couple of years and quadruple a couple of years from that. And so we're making sure to stay out in front of it.

That's interesting. We're definitely seeing that across the freight transports anyway, where that's becoming much more a part of the buying criteria. So it's encouraging to hear that's happening on the corporate side as well.

I mean the good news is with the right technology, which we're working to stimulate, with the right technology, we don't think it has to cost more.

So if we step back for a second and think about the issue you brought up before on normalized earnings power, right, you mentioned that, that United has the longest sort of -- the lowest amount of headroom in terms of normalized earnings power. What should we be thinking about the amount of that headroom if we were to think about it in the context of 2019 margin levels? Or like how would you guide me in talking to investors about that issue?

Yes. Look, I don't think -- I was an investor for 20 years, right? I don't think a lot has changed structurally. The question you have to ask yourself is, is there a little extra consolidation on the other side of this, in which case, structurally, maybe we're even a little bit better than we were going into the crisis, if you see that consolidation. Now a little early to say if we're going to see it or not. I think, certainly, international channels, you'll see it. Domestically, a little too early to say. But if you see that consolidation, I think then you argue for higher margins. But it was clear to me, going into this crisis, that margins were on a march higher at the industry level. We were pricing in a way that we were pricing for the value we brought to our customer. Our loyalty programs were stronger than they ever were as an industry. We were focused on creating connectivity in the hubs that we were all strongest in. I mean think about what we were doing in O'Hare and in Denver and in Houston and the opportunity to make margins in those hubs look a lot more similar to the margins in Atlanta and in Charlotte and Dallas. So all of those -- that trajectory that we entered the crisis, the reason that you haven't seen a major U.S. carrier file bankruptcy, is because we came into the crisis stronger than ever before. There are stronger players and weaker players, but we came in stronger than ever. And so I would expect margins to -- if nothing happens consolidation-wise, we should resume that path towards a march higher to the low double-digit level, maybe better than that, on the other side of this crisis. It's a matter of pacing. And if we see consolidation, maybe even better than that.

How do you think the industry's higher debt service level is going to affect that level of earnings power? Do you think the industry is going to price to that cost? Or do we think we're going to be trying to compete and take share to drive leverage against that cost? Like how do you feel about like balancing that tension in this market?

Yes. I think in the short term, this is a competitive business. And so we'll probably going to have little fistfights here and there on school playgrounds, right? That's just the reality of the industry we're in. But medium term, what you saw prior to the crisis was that when fuel prices spiked, ticket prices followed [ with that ], and really, it's a highly statistically significant level. What you saw when you saw higher labor rates, you saw that pass-through to ticket prices in a highly statistically significant manner. And so higher debt burdens, I strongly feel, will be thought of the same way. And for United Airlines, in United Airlines' case, nothing will be a higher priority than to deleverage our balance sheet and put ourselves back into a strong balance between equity and debt.

And so while we're touching on the edges of an area that I wanted to also get your perspective on around competition, right, your rating in the Journal about Southwest as being predatory and opportunistic, you're seeing a demand environment where, frankly, there will be some pockets of demand, whether it's Cleveland or Fort Lauderdale or whatever nonstop place you normally wouldn't necessarily fly. But as we think about a company like a Southwest kind of creeping into Houston, creeping into Chicago, how do you think that changes the dynamic a little bit near term, long term? Do you think those changes are persistent? How do you feel like that -- how do you feel like those actions kind of fit into the narrative around competition right now?