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

All right. We are coming up to the top of the hour. So I want to welcome you all to Bernstein's 40th Annual Strategic Decisions Conference. We are delighted today to be joined by Scott Kirby, United Airlines, and the Investor Relations team. We are going to get started here in just a minute. We're going to start off with some of the forward-looking disclaimers that we normally do. I'd remind you all that we will take some questions from the audience through the pigeonhole application. If you want to go ahead and put anything through there or promote or demote any of the questions that might be in there, that's kind of our new index card methodology for collecting audience questions. And with that, I will turn it over to you for the forward-looking.

Thanks, Dave. Information in today's release and the remarks made during this conference may contain forward-looking statements, which represent the company's current expectations or beliefs concerning future events and financial performance. All forward-looking statements are based upon information currently available to the company, and please refer to our SEC filings for any further detail.

All right. Now that you have all been appropriately forewarned, we can kick it off.

Scott, thank you so much for making time for us in supporting the conference. I'd like to welcome you back. And maybe you can kick us off with some early remarks about the state of United Airlines and maybe whether or not it's all over?

Well, thanks for having me. It's good to be back here again. I want to start by welcoming my son, Sean, who's joining me at another conference. He is sitting up here with me. I'm sure there's lots of smart people in the room, but I think Sean is probably the smartest in the room. So it's also great to travel with your 10 year-old son, everyone should do it. And I'm not saying that just because it would be good for airline revenues, it really does make business travel a lot better. At United, look, we'll get to Q&A, but we feel really, really good about how things are setting up the last 4 years. Like I think back to what we thought was going to happen in March of 2020, it has played out, both for United and for our -- each and every one of our competitors, almost exactly like we thought. And it's an industry now that there are 2 airlines that are probably going to be close to 100% of the profitability in the U.S. airline industry this year when all is said and done, that are different in ways that are structural, permanent and irreversible, and I'll look forward to talking about why all those things are true. It is a different industry. The pandemic was a once-in-history opportunity to change and restructure that happened. I'm really proud of the United team and what they're doing out there every day. This is no longer -- I've talked about it for the last 4 years, this is no longer hypothetical, this is now past tense. This has happened. You see it at the results, a lot of reasons to think that there's a lot of upside ahead for United and for the industry for that matter. But we feel really good about where we are and that things have shaken out almost exactly like we thought they would.

Okay. So one of the things that did come out in the last 24 hours is that one of your peers had noted weakness in the domestic markets. Is that also something you're seeing? Or are you guys not seeing that or are there some other offsets that are may be happening to help smooth that transition?

Well, I'm going to use this to talk more broadly about what has happened. One, I think, for them, that was just a forecast issue, not a weakness, it's a forecast issue. But when I say the industry has been restructured, I highlighted that -- let me tell you more what I mean, and I'll expand on some of the comments I made on the last earnings call. I'll start with saying, a pretty good way to think about the customers in the airline industry is in 3 groups, not perfect, but it's a good approximation. There are premium travelers. They typically fly international. They buy first class. That's a reasonable chunk of the market. They are what I call domestic road warriors. These are typically small business travelers, owners, who mostly fly domestically to see their customers and clients. They care a lot about flexibility. That's probably #1 on their list of concerns. And then there are price-sensitive customers, infrequent customers, typically leisure, but infrequent customers who travel not a lot. What has happened as we've come out of the pandemic is United had a moat around our business, but it was breached in 2 places, and we've now repaired those 2 breaches. And so now we have a solid moat around the business. And that moat is we have the best customer service, the best proposition for customers. And when I say it's permanent, it's structural and it's irreversible, we'll kind of go through each one of those segments and explain why. For premium, if you want to cater to premium, you got to have a big international network. You got to be able to fly to places like Tahiti, Cape Town, to [indiscernible], Paris to get customers places for the -- [indiscernible] the frequent flyer program. Infinitely better if you can get them to places like that instead of just to domestic destinations. It just makes our frequent flyer programs better. You combine it with clubs and lie-flat business class and all the other amenities we have, and that's what the moat around the business has always been, and that always appealed to premium customers. But the change has really been less about that. There's been that. We've dramatically improved in that. And there's 2 airlines that's sort of top of class in that regard. But that second group, domestic road warriors, that was always Southwest's bread and butter. And I already touched about what those customers care about is flexibility. And this is not a criticism of Southwest. They do a great job. They have, for 50 years, they do a great job. But the #1 advantage that Southwest had for those 50 years was no change fees. Nobody recognized or very [indiscernible] -- I guess I recognized it, but most people didn't recognize it, no one there recognized it. It is the biggest advantage that they have. And I can tell you stories of friends of mine back in the days at America West in the '90s that flew Southwest because of no change fees, business travelers that needed flexibility. I mean I've known it for a long time. It was the overwhelming factor that let them over-index on close-in travel for their whole career. And not [indiscernible] anything wrong, but when we got competitive with change fees and the rest of the industry got competitive with change fees, now all the other stuff mattered. And so now if you're a domestic road warrior, before you flew out Southwest because there are no change fees, but today, your choice, you have no change fees on any airline. So your choice then becomes about things like the frequent flyer program, the ability to upgrade to first class, the premium travel. That's why I say this is structural, it's permanent and it's irreversible. It's not a knock on Southwest, but we finally got competitive with that. And we have seen huge increase in close-in market share, in those kinds of markets as a result of eliminating change fees. So we repaired that breach in the moat. The second breach in the moat was price -- was around price-sensitive customers. And the ultra-low-cost carriers built a better mousetrap than us for customers that only cared about price, that were willing to have the price disaggregated and get low headline prices. And we had to do 2 things to repair that breach. One, we had to create a viable, competitive, basic economy product. But secondly, we had to upgauge. But the only way we can be profitable selling that basic economy product is we can do if it's [indiscernible] jets. We had to upgauge to bigger airplanes that we had seats to sell and could do so profitably. But because when we repaired those 2 breaches in our hubs, like no one can compete with us. Like we just are winning, and we're going to win in our hub. It is structural. It is permanent. It is irreversible in our 7 hubs that we have a structural advantage where we're going to win. And by the way, we aren't trying to go fight on turf where we don't have the high ground. We fight on turf, where we have the high ground, but we're not one to fly National to Orlando and try to compete where we don't have the advantage. But in our hubs, we have the winning hand, and we're going to play it. And that's why we're leading the industry in margins now. It's why our domestic RASM outperformance, that's the best metric to look at, has been so strong compared to everyone else. And that's only going to improve because it's structural. It's really is. That's a real point, this really is structural.

Okay. So you started off by saying that it wasn't that -- from your perspective, it wasn't so much of a market issue as much as a forecasting issue in terms of the revenue weakness that your competitors are experiencing. Have you seen any sort of change in corporate travel or share in the recent couple of months that is over and above what you'd normally expect based on what...

I guess that's really a question about the distribution strategy at American. And we think the distribution strategy chase at American has had an impact. It's pretty small. If you looked at kind of the margin gap between Delta, United on the one hand and American on the other, it's a single-digit percentage of that. If I list -- I'm not going to list the issues that I think are different that make a difference, but it wouldn't make the top 5 of the issues. Not that it's not an issue, but it would not make the top 5 issues. And we saw market share shifts happening in competitive markets with them. We've seen it for years happening. This is long term. This is -- it goes back a long way. We've seen it for years happening, but it's not unique to American. We've seen it happening versus Southwest. We see it happening versus the ULCCs. We've picked up market share really versus everyone. It's not about distribution. Or if it is, it's a small part of it.

Small piece, okay. And then maybe you think about the longer term, right? So I've been covering the airlines now since 2015, 2016, and that kind of came in at a point where people were getting very bullish on consolidation, that's becoming a better industry. We got the blessing from Omaha for a short period of time there before the pandemic. When you think about those bigger picture structural themes, read a lot of times that I'm talking to investors about airlines, they initially sort of the eyes roll into the back of the head and you're ready to like [indiscernible] supply-demand commodity market. I guess, do you think those issues around the industry dynamic being better are still intact kind of post-COVID or...

Well, I think they're different. I think when I talk about the structurally better industry, what I mean is -- I'll take one step back. Airlines can't fly places that they lose money. At our last Board meeting -- there's great data for airlines so we can go do the route network P&Ls for everyone. They can do them for us, too, we're plus or minus 1 margin point kind of by route. And I look at everyone that's not Delta or United, and they have large chunks of their route network that lose money. I know where, I know how much. They can do the same for us. We make money in all 7 of our hubs. We're pretty unique at that. Less than some, more in others, but we make them across the board. And that is a mathematical and economic inevitability that they're ultimately going to stop flying in places that lose money, like they're not going to do it in the short term. I don't know what the catalyst is going to be, but they're going to. The airlines don't keep flying places. They try to do it for a long time. People think strategic flying. I mean I don't really get it. But people think about strategic flying, they fly, but they eventually -- economic reality triumphs over hope. And that's what's going to drive the change. And in the past cycles, you had everyone doing poorly. And so everyone moves in a similar boat and would shrink and things would rise and fall on the tide. There's one airline that wasn't, which is Southwest, and they outperformed dramatically during that time. The situation now, the analogy is it's Delta and United that are dramatically outperforming, that are above the tide. And everyone else has loss-making operations, and they're going to have to close the loss-making operation. That's going to happen. I don't know when. I'm not predicting it tomorrow. I'm not even predicting it in the medium term, but it is going to happen. And that is going to be a much better industry for everyone, including them when they do it, but for United as well.

And is that just a function of the fact that you have more defensible territory to kind of reinvest it and improve the profitability of or like what's really changed in that competitive dynamic, though, because one could say like if an airline is falling out of [indiscernible] lose money today, they could eventually get the product right and get the equipment right and maybe improve that.

That's why I said this is irreversible. So take the product. Well, 8 years ago, American Airlines is putting -- I'll just it use an example. I'm not a criticism of American Airlines. I was President of American. We're putting seat-back entertainment system on every one of our airplanes. Everyone in America thought that was a stupid idea. The day after I left, they reversed it and they spent money to take it off the airplanes because you would say fuel burn, reduced weight, say fuel burn. We put it on at United. We're putting on every single airplane at United, big screens, Bluetooth. I flew on one yesterday. As I always do when I fly on one, I walk from back to front, 2/3 of the customers on the airplane are watching movies. Our NPS scores on those airplanes are dramatically higher than others, not only our NPS scores for in-flight entertainment, but the food is better. The flight attendants are better. The gate agents are better. The TSA screening is better when you fly with seat-back entertainment. It's something that customers care about. We believe that air travel at United is not a commodity, and we've invested in it, and we've won large market share in those competitive markets. Size of airplanes, like we got rid of 300 regionals jets yes and replaced them with 200 mainline jets. That's what customers prefer. Like those are decisions that would take you a decade to change. And then there's dozens, hundreds of others that are similar, that are smaller in size and scale. It's not changeable, it's not reversible. This is done. This took 8 years to get here. It has been happening, but it's over now.

Okay. And I guess within the backdrop, one of the things that has talked a lot about is this idea of premiumization or decommoditizing travel, however you want to think about it, breaking up the fair ladder into different buckets, adding attributes, all that kind of stuff. How has that changed competition between airlines? And how does that change your relationships with your customers?

So like I said, I'd go back to the moat. Like we always had a product -- and we -- the product is a lot better at United today than it was pre-pandemic. The biggest thing, by the way, is our people, and they do a great job. And I hear it from customers all the time. I see it on airplanes. Our flight attendants are the face of United. They do a wonderful job. By the way, United, I think there's only one still doing this. We still give out the little towels, wipes that you can use. We don't do that because people are worried about the pandemic anymore. We do it because it creates a one-on-one, eye-to-eye contact with customers to get on there. That's why we do it. And those things, matter. Our flight attendants do a great job. They like that they're people, people. They like that, and they do a great job. Now I forgot the question as I get to bragging about flight attendants.

So the question is really around like segmenting the cabin, and really the change in marketing.

So this is -- so what we've done is -- we always had that. So we were always would have been the most compelling -- from a product perspective, we were the most compelling opportunity. But we had the 2 breaches. If you care about flexibility, we had change fees and one of our competitors didn't. If you care about price, others had lower prices. And so we had to get competitive on those. So it's less -- it's more about we got -- we think we repaired those 2 breaches. That's really what happened. We always had the high ground on the product and the service and the experience, but we had to repair those 2 breaches before we could win in those categories. And so now we can win in every category. And you can't just be one category and be successful. And in our hubs, we still aren't -- like we don't win in Dallas. We're not going to win in Atlanta. We're not going to win in Nashville against Southwest. But in our hubs, we just have the winning hand now across the board.

And I guess as you think about deploying capital going forward then, is it more about expanding your coverage area or monetizing the scaled network that you have?

Well, so for deploying capital, you went to a different place, I thought you would. For deploying capital, for us, we said on our last earnings call, we're going to do $7 billion to $9 billion of CapEx. By the way, we're doing that. I think that's the most that we -- I think this is the right level. It's about 100 narrowbodies a year. It's going to be about half Airbus, half Boeing. That's the amount of aircraft, I think, that we can -- that consistency is important. It's hard when you're ramping up and ramping down, makes it hard on the operation, particularly makes it hard on pilot training. And we're going to be at that approximately 100 airplanes a year of narrowbody. That means $7 billion to $9 billion of CapEx. That means, by the way, that certainly on the current forecast, we're generating a lot of free cash flow even while we're doing that CapEx investment. And we're going to have a -- we have a several year accelerated growth phase, but that's going to stop. We're going to get our hubs to maturity, and that's going to stop. And then there's going to be really big cash flow at United. But even in the near term, and we'll say more about this when we do at Investor Day. But even in the near term, we essentially, we have our balance sheet back to pre-pandemic levels. Our adjusted net debt is back to where it was pre-pandemic. Our net leverage is basically back to where it was pre-pandemic. We do still have one piece of high-cost debt, $1.8 billion of pandemic debt that's high cost. That becomes prepayable next month, so we will prepay that. But at that point, talking about capital allocation is a reasonable thing to do. Our priorities for capital allocation are invest in the business, but we're doing that. That $7 billion to $9 billion, that's the most we can invest practically speaking, and we're going to continue to do it, but it's not going to go above that. Second is prepay, get our balance sheet into position to particularly pay off high-cost debt. We'll have done that in June. And then that leaves you options for number 3, once you've done those 2 things.

Well, I was just sort of thinking about it more -- I appreciate the balance sheet rundown, but I was thinking about more of the context of like, okay, what are we going to do next year? Are we going to go ahead and take more share from somebody in another market? Or are we going to figure out a way to enhance the experience within our existing footprint to extract more economic rent from this [indiscernible] we have?

Well, I'm definitely not going to use that word. But we -- well, this is not the way I think about it. We're not trying -- we're not like out trying to take market share from someone. We're trying to create a great airline for customers, that results in market share, but we're trying to create a great airline for customers. And primarily, we do that. But I actually think I have the easiest job of anyone at United because I think of it as my only responsibility is to create an airline that our employees are proud of. Because if our employees are proud of the airline, they're going to want you to feel the same way when you fly and they're going to take care of you. By the way, creating an airline they're proud of, means doing things like investing in seat-back entertainment because they're proud to have that system on. Customers tell them they like it, they're proud of it. It means investing in the app because they like being on an airplane. And when the inevitable happens and there's weather like there was yesterday around the country and flights are delayed, the customers have so much information at their fingertips. And they tell our flight attendants, this is so much better than other airlines. That makes them feel proud. And doing things that make them proud, deliver -- they deliver for customers. And so what we're trying to do is constantly make a better airline for customers, and that manifested higher market share and higher profitability. But it's not -- market share is not the goal, better customer experience is the goal.

Okay. Excellent. And you mentioned before about this cycle being kind of different, right? What -- from an outsider looking in perspective, it does feel like the lower-cost carriers are having a lot more problems than the legacy airlines. Typically, end of cycle, you would normally see the highest cost capacity having to recapitalize and move out. That's kind of been the history prior to 2015 or so. We're hearing now that a lot of the USCs are having to change their strategy and move into different markets and trying to get out of the way. What's the driver of that change in industry dynamic from your perspective?

It's a fundamentally flawed business model. It's a tiny market niche for customers that are willing to accept that product. And it worked as long as the big airlines were crappy. But once we got to be good, it doesn't work. I can give you a longer answer, but I don't want to. But anyway, the business model just doesn't work. It does not work against a competent competitor. It works against an incompetent competitor, and we are now competent.

And has the development of that basic economy product kind of meeting that same customer that maybe wanted that price point value of that, has that been a big shift?

Sure. We had to do that to be competitive for that customer. But we also had to upgauge. We couldn't have basic economy on a 50-seat regional jet. We did big airplanes where we could afford to sell the seat and still be profitable at those kinds of prices, and we created that.

Okay. Let's talk a little bit about the revenue and the loyalty part of the airline investment case, right? Obviously, it's become a much more higher contribution component of it. How does that change how you think about running the airline?

I don't know the change. We've always had it. Making sure -- there's a lot of -- first, there's a lot of opportunity in loyalty. At our Investor Day, we'll talk more about it. It goes way beyond just the traditional loyalty program. I mean if anybody wants to be [indiscernible], you can think around what United is doing. There are other companies that are doing what we're doing. But we have probably the best premium customer database, probably of anyone in the world. And so doing good stuff with that is important. But the loyalty program continues to be a huge attribute for us. It's great for our customers. They aspire to earn miles and take the family on the dream vacation to tape down, and we can uniquely offer them that. It's good for customers, it's good for us. It's a huge part of what we do.

If you put that into some economic terms that investors can kind of understand, like what kind of contribution are you getting out of the loyalty program today? Where has it been in the past and that runway going forward?

So we will share more of this at Investor Day, so I'm not going to do it today. I think we're going to -- I think we'll also start at some point breaking out the financials and reporting them. We're figuring out how to do that and what to say exactly, which will be good for investors, but I'm not going to predate it. But the goal that I gave to the team is -- which I think we are on track to achieve and I think we'll achieve, is to double the -- it's already a good business with high EBITDA, double the EBITDA between 2019 and 2026. And I think we're going to do that.

Double the EBITDA dollar contribution?

Yes.

Okay. And as you think about the contribution of the loyalty program and the contribution you get from premium revenue tickets and stuff like that, like how do you distinguish that? Like how do you think about the buy up on the ticket price versus what you're getting out of the rewards part because you're kind of balancing that -- the 2 sources of revenue.

I guess I don't think of them as in conflict I have to balance. I mean, again, it just goes back to -- let me make things simple, like create an airline that customers want to fly. That means create a great frequent flyer program. That means create and have a great premium product. That all goes together. I don't ever really think of things as being in conflict with each other, as really creating an airline that customers want to fly. And if we do that, I think the rest of it is taking care of itself.

Okay. And then if you think about the runway you have to add sort of premium real estate inside the cabin, can you give us a sense of where you are in terms of maximizing the real estate footage that you might have on...

I don't think we're going to change any of -- we're already way ahead of the industry. One, we're in more premium markets. The largest -- we have hubs in the largest premium markets in the world. So we should have more premium because we got hubs in Newark, Dallas, Chicago, San Francisco, LA. Like we're in the big premium markets and so we've always had more. We've got unique products like the high-J 767 that flies here out of Newark to London. Over half of the real estate is business class, WiFi business class seats. But we already have that. So mostly, I think our premium growth is going to be -- just as we take new aircraft. The new aircraft have more premium on them. But it's not a seismic change coming because we spent a lot of years preparing for it. We've been, since sort of 2017, putting more premium on airplanes. And that's just like snap your fingers, they may have more premium on airplanes. That's a multiyear, and we started it back in 2017. It's now bearing, now realizing the benefits of it. But we've been on this journey for a long time.

Okay. So within the -- back to the topic of sort of the loyalty programs and credit card and the co-brand cards, there is some push from a regulatory standpoint to [indiscernible] junk fees or whether it's the efforts to regulate the card transaction processing stuff. How do you think about the risks to those revenue streams from some of those...

So first, I think it would be bad policy, and it's -- with well -- I'm sure with well intention, but it's misinformed. 84% of consumers have a loyalty card of some sort in their wallets and use them. And they love them. People like getting their miles and taking a trip to Cape Town or getting their miles and getting a free sandwich or a free meal at Chipotle or whatever they do, whatever loyalty program they use. And those bills would eliminate loyalty program -- would eliminate the credit card loyalty programs to eliminate. So it's just -- it's a bad policy. It also targets the wrong target. If you look at small businesses that are paying high fees on interchange fees. The vast majority of their fees, 60% to 70% of the fees, are typically the intermediaries in between the credit card companies and the networks and the small merchants. So what they're doing is they're paying some company to install the readers and things. And those companies are charging 400 or 500 basis points just to provide the service, whereas the credit card company, the Visas, the MasterCard, the networks are charging 200 basis points. But for that 200 basis points, they give you security. Just think about it, how many trillions of dollars of expenses are going through those networks. And we don't hear about cyber issues, like the security is amazing that those companies give you -- they're giving you. When there's a fraudulent activity on your card, someone steals your card and purchases, you get your money back. And like they're providing a huge service for that. And so I don't think the bills will become law because they're -- while maybe well intentioned to buy some, there are pushing the them. They're bad policy. It's not what the consumers in the country want and so I don't think they're likely to pass.

Okay. And if we talk a little bit about supply constraints, I think you were really vocal kind of through the pandemic around the pilot shortage and made a lot of investments around pilot training. Where are we, kind of as an industry, as United, in terms of staffing the airline and dealing with some of those higher challenges?

Well, at United, we never had an issue with staffing. We're at the top of the food chain. So pilots, it's remarkable. Actually, I got to the TK, where we do a pilot training in Denver every month and I talked to the new hire classes and I asked where they came from, how many came from other big airlines. But we don't have a challenge hiring pilots. But I think, largely, the staff, the pilot shortage is mostly in the rearview mirror. There's still a lot of churn at smaller airlines, so they still get a higher lot because they churn out. But people can hire. There's other constraints. The air traffic control systems constraint, the vendors constraint. But frankly, the biggest constraint is being able to make money with new routes. I mean like a lot of airlines that are unable to get aircraft right now, it's the best thing going for them, like they need more loss-making routes like they need another hole in the head. It's the best thing that happened to them is that they don't have airplanes they have to fly. It goes back to what I said earlier, like every airline that's not Delta or United has a big chunk of their network that loses money. In that world, you don't want more airplanes, you want less. And the constraint, there's still plenty of supply constraints right now. But the constraint, ultimately, even if those supply constraints went away, the constraint is economics now. Can't buy planes or you'll lose money.

So as you think about some of the supply constraints that aren't related to pilots, give me your top 3 in order of importance.

Boeing.

Boeing and [indiscernible].

The GTF issue is probably worse than Boeing.

Yes.

Those are easy. But through that whole supply chain is there's challenges everywhere.

You didn't mention air traffic control.

You said supply. So I didn't [indiscernible]. Air traffic control is the biggest constraint.

For the industry?

I think.

Okay.

They're working on it. I'm not trying to criticize them like they're trying to come out of the pandemic and hire and the new FA realization bill is going to be good, but it's the biggest constraint.

And what should investors be thinking about in relation to that being a big constraint, specifically for United?

I don't think about it as investor. It's been top of my list, things to think about, to be honest with you. I think it's going to ultimately get resolved. I think the DOT and FAA are committed to working to get it resolved. I think the issue is the -- I think the industry is going to -- is moving towards a world where it [indiscernible] around everyone flying places where they can be profitable. That's what's going to be a much better industry.

Okay. And you mentioned a second ago that you thought the geared turbofan was a bigger issue than some of the issues coming out of Boeing. Can you elaborate?