Is It Time to Buy United Continental Holdings Inc. Stock?

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United Continental  issues preliminary monthly progress reports that help analysts calculate quarterly revenue and earnings ahead of the official quarterly report. Predicting earnings is difficult, but the harder part is figuring out a proper valuation based on earnings predictions.

First, why even consider United?
An investment in United is in a way an investment against oil. United's number one operating cost by a wide margin is its fuel costs. Increased domestic oil production and a strong dollar are currently helping to clobber the cost of this commodity.

Since United doesn't hedge the vast majority of its fuel costs, as the price of oil drops its operating costs drop and its profits go up.  At the same time the company is working to accelerate revenue. An example cited in the last conference call was offering flights directly to Asia from West Coast hubs instead of first stopping at Tokyo. United plans to accelerate its capacity for trips to China. 


Cost control
In recent years and quarters, United Continental's revenue growth is pretty consistent from flat-ish to up a bit. United is well aware of this, so it is focusing on cost control, which over the long term will drive revenue since ticket cost is the No. 1 factor for many consumers in choosing an airline. Reduce costs and pass a portion of the savings to customers, and revenue will take care of itself.

United Continental is conducting an internal campaign dubbed "Project Quality." The goal by 2017 is to take $2 billion in annual costs out of the system without sacrificing revenue. According to the most recent earnings conference call, about $500 million of this has been achieved for this year.

Analysts expect the airline to bring in about $1.94 billion in adjusted net income for 2014. If that extra $1.5 billion in savings was already in place, and using a 33% tax rate (for simplicity on rough hypothetical numbers), it would add $1 billion to the adjusted bottom line, or $2.94 billion in total. This would put earnings at $7.42 per share for the year.

Increasing the size of the pie slices
United in July announced a $1 billion share buyback program that it plans to execute over the next three years. Who knows where the stock price will go during that time, but let's use $50 per share as a nice round number to work with.

With an average buyback of $50 per share, the $1 billion would effectively reduce the outstanding share count by 20 million, or 5.1%, to 376 million diluted shares. The reduced share count would boost the $7.42 in hypothetical per-share earnings up to $7.82.

In other words, using the $4.91 per share analyst estimate for the year, United Continental initiatives, if successful and all other things being equal, would have the leverage to boost earnings by 59% to $7.82 per share, assuming flat revenue.

Does EPS of $7.82 in three years make it a buy?
A $44 share price (about where it stood at the time of this writing) puts the P/E ratio at 5.6, which in itself is cheap in just about any industry that is seeing expanding revenue and profits.

Let's use Delta Air Lines as an example with similar revenue expectations for fiscal year ending Dec. 2015 -- $42 billion compared to United's $40 billion. Delta trades with a P/E of about 8 based on a share price of $31 and the average analyst estimate of $3.89 EPS for the fiscal year ending Dec. 2015.

If United traded at a similar valuation to Delta, it would translate into a stock price of $66 for United. That doesn't even include any revenue growth and additional earnings over the next three years.

With a current stock price under $44, a $66 share price would come out to 50% upside within three years. Actually realizing that stock boost assumes management can carry out its plans and meet its goals -- and that the market warms up to the stock.

Overall, I like the odds: The cost savings and buybacks add a layer of protection and opportunity that doesn't seem priced into the stock. 

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The article Is It Time to Buy United Continental Holdings Inc. Stock? originally appeared on Fool.com.

Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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