United Slips to Underperform

Last week, we downgraded our long-term recommendation on United Continental Holdings Inc. ( UAL - Analyst Report ) from Outperform to Underperform based on concerns over travel demand and pricing, which is expected to result in weak traffic in the third quarter. The largest U.S. airline retains a Zacks # 5 (Strong Sell) Rank for the short term (1–3 months).

The company delivered lackluster performance in the second quarter, with earnings per share missing the Zacks Consensus Estimate and below the year-ago earnings. The shift to a single passenger service system and the new procedures related to Continental merger actions took a toll on the demand for United Continental’s services in the second quarter, ensuing in higher costs and revenue loss.

Despite the company’s aggressive actions to improve profitability, we believe surging fuel prices and the threat of recession in Europe pose downside risks to the stock. Additionally, high non-fuel costs related to fleet optimization and product initiatives, high unionization, new regulations related to advertising, competitive threats from major rivals - Delta Air Lines Inc. ( DAL - Analyst Report ) and Southwest Airlines Co. ( LUV - Analyst Report ) , and risks pertaining to the successful Continental integration could hurt the company’s profitability going forward.

Further, the airline industry has been struggling with rising fuel costs and economic uncertainties. In fact, the deepening European debt crisis has affected almost all the key global economies. In addition, weak travel demand is leading to lower traffic and profits for the air carriers. As a result, the earnings estimates for United have been trending downward over the last three months on the back of numerous macroeconomic headwinds.

The Zacks Consensus estimates for United went down by more than 50% to $1.45 for the third quarter and $2.35 for 2012 in the last three months. Notably, the Zacks Consensus Estimates for the third quarter and the fiscal year were $2.72 and $4.53, respectively, three months back.