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The largest U.S. airline United Continental Holdings Inc. (UAL) has reported third quarter adjusted earnings of $2.00 per share, missing the Zacks Consensus Estimate of $2.06. Rising fuel prices and merger related expenses were responsible for the lower-than-expected earnings.

Adjusted earnings exclude $120 million of special items pertaining to merger-related costs and other one-time charges. Including these charges, earnings per share dropped 21.8% year over year to $1.69.

Revenue

Total revenue climbed 8.7% year over year to $10.17 billion in the reported quarter, and outpaced the Zacks Consensus Estimate of $10.1 billion. On an annualized basis, Passenger and Other revenues increased 9.2% and 7.7%, respectively, while Cargo revenue decreased 2.4%.

Airlines traffic, measured in revenue passenger miles, dipped 1.5% year over year and capacity or available seat miles inched down 0.8%. Load factor (percentage of seats filled with passengers) fell 60 basis points year over year to 85.3%. Consolidated passenger revenue per available seat miles or unit revenue rose 10.1% from the year-ago quarter.

Operating Expenses

Total operating expenses, excluding special items, nudged up 1% year over year to $5.6 million in the reported quarter. Steeper expenses were largely due to a 41.3% year-over-year rise in fuel price, excluding the impact of hedges.

Consolidated unit cost or cost per available seat mile (NASDAQ:CASM), excluding fuel and special items, crawled up 1.5% year over year. CASM, including fuel and special items, rose 12.5% from the year-ago quarter.

Liquidity

The company ended the third quarter with cash equivalents including short-term investments of $8.4 billion. United Continental generated operating cash flow of approximately $385 million and spent approximately $196 million.

Our Analysis

Though we remain concerned about escalating fuel prices, United Continental has so long been able to pass on higher costs to its customers in the form of fare hikes and capacity cuts. We believe the improving demand for air travel, reduced capacity, unit revenue growth, fleet and network optimization, as well as merger benefits from Continental Airlines bode well for United Continental’s future growth.

In addition, United Continental hedges its fuel position that restricts its losses and provides increased profitability. The company has hedged 56% of its expected consolidated fuel consumption for the remainder of the year.

However, high unionization, competitive threats from its peers Delta Air Lines Inc. (NYSE:DAL) and AMR Corporation (AMR), and the successful integration of Continental Airlines with United might pose major risks to the company’s profitability going forward.

A month ago, we had downgraded our long-term recommendation on the stock to Neutral from Outperform. However, for the short term, the stock retains a Zacks #2 (Buy) Rank.

Source: United Continental Profit Falls As Costs Rise