Based on most conventional metrics, United Airlines Holdings Inc. (UAL, Financial) is a cheap stock. Shares trade at a forward price-earnings ratio of 5 and a forward enterprise value/Ebitda ratio of 3.80. Comparably, the S&P 500 trades at roughly 22 times forward earnings.
The stock has a GF Value of roughly $67 per share, which represents a 37% premium to the share price at the time of writing. However, it may be cheap for a reason and further analysis is required.
A highly competitive, capital-intensive and cyclical business with low returns on capital
The airline business is highly competitive. United competes with other U.S. airlines, including American Airlines (AAL, Financial), Southwest Airlines (LUV, Financial), Delta Airlines (DAL, Financial), Alaska Air (ALK, Financial), JetBlue (JBLU, Financial) and Spirit Airlines (SAVE, Financial). The company also competes with foreign carries on international routes. The result is that the airline business tends to be a very low-margin business.
Air travel demand is highly cyclical and tends to be driven by economic trends. The high degree of cyclicality is especially challenging for airlines due to the high fixed-cost structure required to operate.
The airline business is a very capital-intensive as well since the companies are forced to invest substantial capital to maintain and operate fleets of airplanes. For 2023, United reported adjusted capital expenditures of roughly $7.90 billion, which represents approximately 15% of annual revenue.
The result of these factors is that United and other airlines have historically struggled to generate solid returns on invested capital.
Highly levered balance sheet
United currently has adjusted net debt of roughly $24 billion and a net leverage ratio of 2.90 based on 2023 adjusted Ebitdar. This level of leverage is fairly high for any company, but is especially high for an extremely cyclical company.
The company is rated below investment grade, but was recently upgraded to BB- by Fitch and S&P. In its ratings upgrade, Fitch noted the company's credit metrics improved significantly during 2023.
Despite an improving credit profile, United remains highly levered. Its high degree of leverage has the potential to be problematic in the event of a serious economic downturn that results in a challenging operating environment. Additionally, United's high degree of leverage means it is exposed to potential increases in interest rates, which would require debt to be refinanced at higher levels.
Attractive valuation versus peers
United currently trades at a moderate discount to peers. It has a forward enterprise value/Ebitda ratio of 3.80. Comparably, Delta, American Airlines and Southwest have respective forward EV/Ebitda ratios of 5.10, 4.80 and 5.40. JetBlue and Spirit Airlines, two smaller carriers which have been struggling of late, trade at forward EV/Ebitda ratios of 8.40 and 6.40.
On a forward price-earnings ratio basis, United trades at just 5 times forward earnings per share. Comparably, Delta, American and Southwest respectively trade at 7.40 times, 6.20 times and 18.80 times forward earnings.
While the discount versus Southwest is warranted given it has a much healthier balance sheet, the discount versus Delta and American Airlines does not appear to be warranted, in my opinion.
United's net leverage ratio of roughly 2.90 is similar to Delta and better than American Airlines. In terms of revenue and earnings growth, the company is expected to deliver similar results to these two companies and faces similar risks. Additionally, United, Delta and American Airlines all have large frequent-flyer businesses, which represent a key source of value. For these reasons, I do not believe United's valuation discount in comparison to Delta and American is warranted.
Potential monetization of MileagePlus is an upside catalyst
One of the most valuable parts of United is its MileagePlus business. The way this business works is the company sells miles to credit card companies and other third-party partners while also purchasing some miles itself to offset member miles earned via flights.
In 2020, United used the MileagePlus business as collateral to help raise debt needed to allow it to navigate the Covid-19 pandemic's disruption. At that time, the business was valued at 12 times Ebitda, or nearly $22 billion, and produced roughly 34% Ebitda margins. It is a high-quality business due to its stable free cash flow generation and strong Ebitda margins.
In 2022, United explored selling part of its MileagePlus business to raise cash, but did not complete a transaction. At Citi's Global Industrial Tech & Mobility Conference, Chief Financial Officer Mike Leskinen suggested that monetization of the MileagePlus business is still possible:
"We have an incredible high-margin, asset-light growth business within United Airlines. And 2 of our competitors have similar businesses. And right now, those businesses are deeply, deeply undervalued. And if I cannot through disclosure help the capital markets recognize the value of Mileage Plus, we have other levers we can press to create shareholder value. But it is a compelling business and it is -- and you're going to have to stay tuned for our May 1 Investor Day. But there is -- there are even some more growth opportunities to this business that are unappreciated.
So we're going to try to educate the Street on those opportunities. We're going to show you results. We're going to segment out over time. So you can see the high-margin nature of the business and the growth trajectory of that business. And I think that will accrue to shareholders. If it doesn't, we'll do something more aggressive."
While it is difficult to predict what more aggressive actions the company may be contemplating, I think two potential options include a minority sale stake to a private equity investor or a spinoff of the MileagePlus business in which United maintains majority control. Such a transaction does not come without precedent as Air Canada spun off its mileage business via a 2005 initial public offering. However, Air Canada ultimately repurchased the business in 2019.
I would view a spinoff or minority stake sale in the MileagePlus business as a major positive for shareholders as it represents a way for the company to unlock value.
Key risks to consider
One key risk to consider is that United faces is potential regulations following a series of safety-related issues. CEO Scott Kirby has already sent a memo to customers reassuring them that safety is the airline's top prioritym but regulators remain concerned. The Federal Aviation Administration is said to be considering implementing restrictions, such as limiting United from adding new routes or restricting the company's ability to fly passengers on newly delivered aircraft.
Additionally, United Airlines has heavy exposure to the Boeing (BA, Financial) 737 MAX aircraft. It is the largest operator of the 737 MAX planes, which account for 8% of its total capacity. In addition to this, the company also has a significant amount of 737 MAX orders which have already been placed. The company is expected to take delivery of 100 737 MAX planes in 2024 and an additional 201 737 MAX planes after 2024.
Flights of the aircraft have recently resumed after being grounded following a recent door plug blowout incident on Alaska Airlines (ALK, Financial). Any future problems with Boeing's planes have the potential to pose a risk to United Airlines given the company's dependance on them.
Conclusion
I believe United Airlines should trade at a significant discount to the broader market given the challenging nature of the airline industry due to a mix of high competition, significant cyclicality, high fixed costs, high capital requirements and low historical returns on invested capital. However, I believe the current discount to the broader market is too large and United is undervalued at current levels.
The stock currently trades at a roughly 36% discount to the average valuation of close peers Delta and American Airlines based on forward price-earnings ratios. I do not find this discount to be warranted given the fact that United is fairly similar to Delta and American Airlines. All three airlines have similar near-term earnings growth prospects and are faced with the same industry challenges, along with highly levered balance sheets.
While it is possible that United becomes subject to potential regulatory restrictions, I think the impact of such restrictions will be limited and is unlikely to impact the company's long-term earnings potential.
Additionally, I view the recent comments by United's CFO regarding a potential monetization of MileagePlus as a key positive for the stock and a potential upside catalyst. Thus, I currently view United as moderately undervalued and an attractive investment opportunity relative to its peers.
