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United Continental Holdings Inc. (UAL - Analyst Report) – the largest U.S. airline – reported lackluster performance in the third quarter of 2012. Adjusted earnings of $1.35 per share slid 32.5% from the year-ago quarter and missed the Zacks Consensus Estimate of $1.45.

United’s revenue got badly hit during the quarter as customers opted for other airlines due to reduction in its operational efficiency. The company’s shift to a single passenger service system and the new procedures related to Continental merger actions took a toll on the demand for its services in the quarter, ensuing higher costs and revenue loss. Additionally, a huge accounting charge eradicated most of its profit.

Adjusted earnings in the reported quarter exclude $1.33 per share in special items pertaining to merger-related costs and other one-time charges. Considering these charges, earnings substantially dropped from the year-ago quarter to 2 cents.

Revenue

Total revenue inched down 2.6% year over year to $9.90 billion and marginally missed the Zacks Consensus Estimate of $9.98 billion. Airlines traffic, measured in revenue passenger miles, dropped 1.46% year over year. Capacity (or available seat miles) slid 1.35% year over year, while load factor (percentage of seats filled with passengers) plunged 10 basis points year over year to 85.2%.

On an annualized basis, Passenger and cargo revenues decreased 2.6% and 13.1%, respectively, while other revenue increased 1.1%. Consolidated passenger revenue per available seat miles (PRASM or unit revenue) decreased 1.3% year over year due to a 8.3% drop in Latin American PRASM, 4.5% slump in Atlantic PRASM, partially offset by 9.9% growth in Pacific PRASM.

Operating Expenses

Total operating expenses, excluding special items, rose 0.9% year over year to $9.2 billion in the reported quarter.

Consolidated unit cost or cost per available seat mile (CASM), excluding fuel, third-party business expense and special items, crept up 2.1% year over year. CASM, including fuel and special items, rose 6.6% from the year-ago quarter.

Liquidity

At the end of the quarter, the company had $7.2 billion in unrestricted liquidity including $6.7 billion in cash and short-term investments, and $500 million in undrawn revolving credit facilities.

United Continental generated operating cash flow of approximately $845 million and spent approximately $412 million in the reported quarter.

Our Take

The U.S. airline industry has been struggling with rising fuel costs and economic uncertainties. United’s future liquidity could be negatively impacted by declines in passenger and cargo demand associated with the global recession and deterioration of global financial systems and any future commitments for purchase of aircraft.

Fuel price volatility continues to be one of the significant challenges for United and its ability to pass on the increased costs of fuel to its customers is restricted as the company continues to face competition from rivals like Southwest Airlines Co. (LUV - Analyst Report) and Delta Air line Inc. (DAL - Analyst Report).

We maintain our long-term Underperform recommendation on United Continental Holdings Inc. The company also retains a Zacks #5 Rank, implying a short-term Strong Sell rating.

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