Source: Forbes
Author: Mark Tatge

United Airlines parent UAL will leave bankruptcy a smaller airline, heavily leveraged, and should lose $250 million next year, according to a Forbes.com analysis of the documents filed Wednesday with the federal bankruptcy court.

The losses are predicated on crude oil prices remaining above $60 per barrel, a likely scenario given forecasts calling for a shortage of jet-fuel refining capacity for the next three to five years, well after the shockwaves of Hurricane Katrina fade. United could spend $4 billion next year on fuel--$600 million more than anticipated--wiping out the any profits the carrier might generate.

Filings show CEO Glenn Tilton has trimmed billions in costs, mostly by shrinking the airline. Annual salary and pension costs were trimmed $3.2 billion annually. Aircraft rents were reduced nearly $190 million. Tilton slashed United’s capacity or available seat miles by 20% since 2000, with passenger revenue only taking an 8% haircut.

United now has among the lowest operating costs of the major legacy carriers, estimated to be at 7.56 cents per available seat mile (9.98 cents with fuel), giving United a major advantage over AMR’s American Airlines, Delta Air Lines, Northwest Airlines and Continental.

But Tilton also faces major challenges. The three biggest: putting the brakes on fuel costs, boosting revenue and repaying debt.

Here’s the outlook for the airline based on an analysis of its long-awaited plan of bankruptcy reorganization, which has yet to be approved by the court.

Debt. United will be heavily leveraged once it leaves bankruptcy. Only 14% of UAL’s capital structure will be equity. And that figure hinges on raising $1.9 billion in new common equity. The rest is bank and aircraft debt totaling more than $9 billion. Interest payments will run some $500 million per year.

Fuel. United uses $45 to $50 per barrel crude oil to forecast profits through 2010, or about $1.55 for a gallon of jet fuel.

But prices should remain above $60 for West Texas Intermediate at least through 2007, says Vaughn Cordle, chief analyst with Airline Forecasts, an economic forecasting firm.

Jet fuel should run $1.89 per gallon next year, or 34 cents more per gallon than what United forecasts. At 2.2 billion gallons annually, that comes to an additional $748 million for fuel.

Cordle says the gap between a barrel of crude and jet fuel refined from that crude has only widened in recent weeks. Crude hit $70 per barrel, but jet fuel prices were running $100 per barrel. This difference isn’t expected to change given shortages in refining capacity. The spread between the crude oil and jet fuel is three times higher than it was 1990 to 2004.

Revenue. Next year, United forecasts 2.6% growth in core passenger revenue per available seat mile, or about half 2005’s increase. Much of the growth has come from shifting traffic overseas.

But the industry is raising prices to cover fuel costs. Higher ticket prices could result in more empty seats per mile flown as customers curtail flying. United forecasts mainline passenger revenue growing from $13.1 billion in 2006 to $14.4 billion in 2010.

Profits. United projects a profit, excluding special items from the bankruptcy reorganization, of $349 million next year.

But the airline could easily end up paying $400 to $600 million for fuel next year.

Viewed another way, higher fuel prices would consume more out half of the $916 million operating profit the airline forecasts. Profits are expected to grow to $1.5 billion on a pre-tax basis by 2010.

United, however, forecasts its fuel bill to be $3.4 billion, falling from this year’s $3.75 billion.

But that presumes a moderation in fuel prices. If fuel prices don’t drop, they could jeopardize United’s ability to repay its debt, forcing yet another restructuring.

Taxes. The airline has $7.5 billion in tax losses that can be used to reduce future tax liabilities. But these losses are worthless to United if the airline doesn’t produce a profit.

But they could prove valuable to investors. Hedge funds or other private equity investors may want to take control of United to take advantage of these losses, in an effort to offset taxable income. The filing estimates United’s enterprise value at $10.3 billion.

The UAL Corporate Restructuring Information documents can be viewed at http://www.pd-ual.com/.