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United Continental Holdings Inc. (UAL - Analyst Report) expects higher fuel prices and a slow moving U.S. economy to have an adverse impact on the first quarter results.

Fuel prices are estimated at $3.35 per gallon for the first quarter that is higher than $320.4 per gallon in the last quarter. Consolidated unit cost or cost per available seat mile (CASM) is expected to rise 8.0–8.7% year over year. Excluding fuel and special items, CASM would increase 1.5–2.5% in the first quarter, up from the last quarter’s increase of 1.3%.

The increase in non-fuel expense is expected to reduce cargo and other revenue to $1.07–$1.11 billion compared with $1.11 billion in the fourth quarter of 2012.

The largest U.S. airline expects passenger revenue per available seat miles (unit revenue) to grow 4–5% in the first quarter. This growth is lower than the 8.2% increase in the last quarter.

Overall airline traffic, measured in revenue passenger miles implying one mile flown by one passenger, is expected to drop 0.9% or remain flat year over year for the first quarter. However, this is better than the last quarter’s 3.2% decline as the company is adding new and improved features to its services, which are enhancing its value and profitability.

United Continental is taking profitable actions to endure surging fuel prices and the ongoing market turmoil. The company is successfully passing the increased fuel costs to customers in the form of fare hikes. Additionally, United Continental has a risk management strategy to hedge a portion of its expected jet fuel requirements.

The company has hedged 48% of the first quarter fuel consumption at $3.24 per gallon using a combination of calls, swaps and collars. United Continental has also hedged 37%, 36% and 25% of fuel consumption in the second, third and fourth quarters, respectively.

Besides, United Continental is planning cautiously and expects to keep capacity (consolidated per available seat mile) down 0.5–1.5% this year. For the first quarter, the company expects domestic capacity to decline 2.5% while international capacity to increase 3.5% year over year, leading to a slight 0.1% increase on a consolidated basis.

The Zacks Consensus Estimate projects loss per share of 68 cents for the first quarter, representing a substantial decline of 66.83% annually.

Further, United Continental, which competes strongly with Delta Air Lines Inc. (DAL - Analyst Report) and Southwest Airlines Co. (LUV - Analyst Report), continues to have a healthy balance sheet. The company expects to exit the year with cash equivalents, including short-term investments of $7.7 billion.

As a result, we are downgrading our long-term recommendation to Underperform on United Continental. For the short term (1-3 months), the stock retains a Zacks #5 (Strong Sell) Rank.

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