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United Airlines Is Betting on International Growth

Adam Levine-Weinberg, The Motley Fool

A few years ago, United Airlines (NASDAQ: UAL) was the poster child for capacity discipline in the airline industry. The carrier deliberately did not try to grow, instead aiming to improve its profit margin by cutting underperforming routes and not attempting risky new routes. Indeed, United reduced its capacity by 1.4% in 2013 and increased its capacity just 0.3% and 1.6% in 2014 and 2015, respectively.

However, under the new leadership team assembled in 2015 and 2016, United Airlines has made growth a priority again. Company President Scott Kirby has been particularly adamant about the need to regain market share in order to attract high-value corporate customers.

So far, much of this growth has been focused on the domestic market. In each of the past three years, United has grown more than twice as fast in the domestic market as it has on international routes. But in recent weeks, it has announced a major international expansion effort, signaling that United's management now sees compelling growth opportunities in international markets.

New planes will support new long-haul routes

During the second half of 2019, United will add four new wide-body planes -- suitable for long-haul routes -- to its fleet: two Boeing (NYSE: BA) 777-300ERs and two 787 Dreamliners. Its long-haul fleet expansion will accelerate in 2020, when the carrier is scheduled to receive 17 more wide-bodies from Boeing: two 777-300ERS and 15 Dreamliners.

A United Airlines Boeing 787 flying over a coastline.

United Airlines will significantly expand its wide-body fleet over the next 18 months. Image source: United Airlines.

United Airlines' fleet currently includes 21 older Boeing 767s that were built between 1991 and 1993 and are near retirement age. However, the company plans to extend the lives of many of these planes, enabling it to use most of the new wide-body jets for growth.

Earlier this month, the Department of Transportation confirmed its decision to award United Airlines four more route authorities at Tokyo's Haneda Airport. In late March, United will begin new nonstop routes from Chicago; Los Angeles; Newark, New Jersey; and Washington, D.C. to Haneda. The Chicago and Washington, D.C. routes will replace existing service to Tokyo's less-convenient Narita Airport, but the Los Angeles and Newark routes will represent incremental capacity.

Last week, United announced an even more ambitious international expansion. Between March and May of 2020, it will launch new seasonal service from Newark to Nice, France, and Palermo, Italy; year-round service between Chicago and Zurich; and second daily frequencies from Newark to Amsterdam and Frankfurt, Germany. It will also convert its Denver-London route to year-round service this November. Finally, United confirmed the launch of new routes connecting Newark to Cape Town, South Africa, and San Francisco to New Delhi in December.

United is also making cutbacks -- but not many

The list of long-haul routes being dropped by United Airlines is far shorter than the list of new additions. Indeed, in last week's new route announcement, the airline noted that it will bring back all of its 2019 seasonal routes next year -- in many cases, for an extended season.

That said, United has decided to suspend its Chicago-Hong Kong route as of Sept. 8 and its Newark-Buenos Aires route as of Oct. 26. Neither decision is very surprising. Chicago-to-Asia travel demand has deteriorated in recent years, and the ongoing protests in Hong Kong have further sapped demand. Meanwhile, weak economic conditions in Argentina have weighed on the Buenos Aires route. Importantly, United Airlines will continue serving both Hong Kong and Buenos Aires from other hubs.

All of this growth will be expensive

United Airlines spent $2.5 billion on capital expenditures in the first half of 2019, and it has commitments to spend at least $2.2 billion on capex in the second half of the year. Capex will be even higher in 2020, due to the number of pricey Boeing 777s and Boeing 787s arriving next year to support United's growth. As of June 30, the company had $5.9 billion in committed capital expenditures for 2020.

At present, United's annual capex is set to decline gradually after next year. However, the carrier has about 120 wide-body jets that were built in 2002 or earlier -- all 767s or 777s -- and hundreds of narrow-bodies of the same vintage. Most (if not all) of these planes will need to be retired over the next decade.

Thus, United will need to place lots of additional orders with Boeing and Airbus to address its aging fleet. Growth plans would require even more new orders. As a result, capex is likely to remain elevated for the foreseeable future.

United Airlines produced $6.2 billion of operating cash flow in 2018. Even if its underlying profitability improves in the years ahead, the company probably won't generate much free cash flow due to its high capex requirements. As a result, United Airlines doesn't look like a great investment choice right now.

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Adam Levine-Weinberg has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

United Airlines Is Betting on International Growth was originally published by The Motley Fool