United Continental could use fuel-cost savings to pay down debt

By Paul Deckelman

New York, Jan. 22 – United Continental Holdings, Inc. – the corporate parent of United Airlines, the No. 3 U.S.-flag airline carrier – paid down debt during 2014, including most of its remaining outstanding convertible notes, and the company said Thursday that it might use savings generated from lower fuel costs to pay down some more debt or else return it to shareholders via accelerated stock repurchases.

“We continued to take steps to strengthen our balance sheet,” the Chicago-based company’s executive vice president and chief financial officer, John D. Rainey, told analysts on its conference call following the release of results for the 2014 fourth quarter and fiscal year ended Dec. 31.

During the year, he said, the company prepaid more than $1.5 billion of debt, including $248 million of its 6% convertible debt due 2030, a transaction that took place during the fourth quarter. Over the course of 2014, it eliminated a total of $310 million of convertible debt.

Rainey said that earlier this month, “the last of our remaining convertible debt matured,” so that in total, the company has eliminated $1.9 billion of convertible debt since the 2010 merger between United Airlines and sector peer Continental Airlines.

‘Record-low’ financing costs

Rainey also said that during the year, the company had continued to finance its purchase of new aircraft “at very low rates, including our most recent EETC [enhanced equipment trust certificate] transaction, which had a blended interest rate of 3.9%.” That July 28 deal included $823 million of 3.75% class A certificates with a final expected distribution date of Sept. 3, 2026 and $238.4 million of 4.625% class B certificates with a final expected distribution date of Sept. 3, 2022. Both tranches were sold at par.

United Continental’s chairman, president and chief executive officer, Jeffery A. Smisek, went a step further, saying that the company had been able to finance its aircraft purchases “at record-low interest rates”; meanwhile, he said, “we paid down expensive debt.”

Other capital market transactions during 2014 besides the July certificate sale and the 6% convertibles prepayment included a $949 million two-part equipment certificate sale in March, an incremental $500 million term loan facility that the company entered into in September, while at the same time increasing the lending commitments under its revolving credit facility by $350 million to $1.35 billion, and its redemption in September of its $800 million of outstanding Continental Airlines 6¾% senior secured notes that otherwise would have come due this coming September. The company funded the latter transaction with the proceeds from its new term loan plus cash on hand.

Rainey said that as a result of these transactions, United Continental’s 2014 interest expense was about $50 million less, year-over-year: $735 million in 2014 versus $783 million in 2013. Fourth-quarter interest expense came in at $176 million, down from $193 million in the year-earlier fourth quarter.

United Continental said that it ended the fourth quarter with $5.7 billion of unrestricted liquidity, including $1.35 billion of undrawn commitments under its revolver, and that it had made debt and capital lease principal payments of $534 million in the fourth quarter, including the $248 million convertible notes prepayment.

However, the company did not follow the customary corporate practice of including balance sheet data such as cash and debt levels as part of its fourth-quarter earnings announcement. According to its most recent 10-Q filing with the Securities and Exchange Commission, covering the third quarter ended Sept. 30, long-term debt minus current portion as of that date stood at $9.89 billion, with an additional $1.34 billion as current portion. Those figures were down from their levels at the end of fiscal 2013 on Dec. 31 of that year – $10.02 billion of long-term debt plus $1.37 billion of current portion debt.

The company had $3.11 billion of unrestricted cash as of the end of the third quarter plus $284 million of restricted cash.

Fuel costs create opportunity

During the call, Rainey and Smisek spent some time discussing recently lower oil prices and the impact these had on the company’s finances and likely would continue to have going forward.

United Continental saw its consolidated average fuel costs for both its mainline operations and its smaller regional operations fall to $2.58 per gallon of jet fuel during the fourth quarter, a 17% plunge from $3.11 per gallon in the year-earlier quarter, while its consolidated average fuel cost for the full year slid by 5.1% to $2.97 per gallon from $3.13 in 2013. However, the company – like all large airlines, which are huge consumers of fuel – had hedge contracts in place to protect it against unexpected rises in fuel prices; when the prices plummeted, the company had to book losses on the cost of those hedge contracts, eating into the savings it had realized on paper.

Figuring in the hedge losses, United Continental’s consolidated average fourth-quarter fuel costs were $2.83 per gallon, including 25 cents related to the hedges, an 8.1% decline from $3.08 per gallon a year earlier, while its full-year fuel costs on that basis were $3.03 per gallon, down 2.9% from $3.12 in 2013.

Rainey said that the company’s fourth-quarter results included a $237 million hedge loss, which includes about $80 million from 2015 hedge positions that it closed out in the fourth quarter.

Since the start of the year, he continued, United Continental had closed out virtually the entire remaining portion of its first-quarter hedge positions and now expects to incur $190 million in hedge losses for the current 2015 first quarter. The company is projecting an average fuel price per gallon to be between $1.96 and $2.01, including the impact of the settled hedges.

He also said that while the company’s current full-year hedge position “allows us to participate in 84% of any future declines in the price of oil, based on the Jan. 15 forward curve, our existing open 2015 hedges, beyond the [closed-out] first quarter, are in a loss position of approximately $680 million.”

However, Rainey and Smisek anticipate that beyond those potential hedge-position losses, the sharply lower average cost that United Continental will be paying to gas up its more than 1,250 aircraft – 691 big jets in its mainline fleet as of Dec. 31 and 566 smaller aircraft in its regional fleet –will greatly improve the company’s financial measures, including its cash flow.

Smisek declared that the company would be “opportunistic with our use of the additional cash we expect to generate as a result of lower fuel prices. We will use this cash to accelerate our path toward longer-term goals we’ve previously identified, including reducing our financial leverage and continuing to return cash to shareholders through our share repurchase program.”

Rainey said that “it’s reasonable to assume that we could accelerate our share buyback if cash flows turn out to be better than what we originally expected at the inception of this program. We will also continue to de-lever and at a pace that will allow us to achieve some of our capital structure goals more quickly than previously planned.”

During the question-and-answer portion of the conference call following the formal presentations by Rainey, Smisek and two other United Continental executives who participated – Gregory L. Hart, the company’s executive vice president and chief operating officer, and James E. Compton, its vice chairman and chief revenue officer – an analyst asked Rainey how much of the debt the company might be willing to prepay using the anticipated extra cash from the fuel-cost savings.

The CFO said that “we’ve got quite a bit that we can take advantage of” – but added that the interest rates on some of the debt that could be prepaid “are pretty attractive right now. So one thing that we could look at is actually using cash to purchase airplanes as well.”

Smisek clarified the point, saying that “at some level, you’re prepaying debt that has an interest rate that’s so attractive that you wouldn’t want to prepay, so another use of the cash would be to use the cash to purchase aircraft – as opposed to financing those aircraft – which has the effect of reducing the debt that otherwise would be on your balance sheet.”

The CEO also said that even though the lower oil prices will give the company a lot of extra cash – which in theory could be used to buy or lease more aircraft and expand its operations, which currently run well behind larger rivals American Airlines and Delta Airlines in terms of passengers carried and market share – United Continental is not going to go that route.

“We will only grow the airline as demand dictates,” he asserted. “The U.S. airline industry has transformed itself over the last several years through consolidation and capacity discipline, matching capacity with demand – and United will continue its discipline, growing its capacity less than GDP, regardless of the price of oil.”

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