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United Continental Beat on Earnings — Yet Shares Sank

In this segment from the MarketFoolery podcast, host Mac Greer, Total Income's Ron Gross, and Million Dollar Portfolio's Matt Argersinger discuss the complicated earnings picture for United Continental (NYSE: UAL).

Hurricane-damaged Houston is one of the airline's major hubs, which gave it greater exposure to Harvey, and PRASM (they'll explain) is down. But for a whole host of reasons, the Fools are bullish on the company, and the sector.

A full transcript follows the video.

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This video was recorded on Oct. 19, 2017.

Mac Greer: Matt, this next story is for you, because you have been bullish on the airlines. So, I need you to sort this one out for me. We have United Continental reporting better-than-expected earnings despite all the hurricane-related events. So, that sounds good, right? But they lowered guidance back in September, so they kind of got a lowered bar, and shares down big on Thursday. What does it all mean for investors?

Matt Argersinger: I think there's definitely some short-term turbulence in the airlines markets.

Greer: Nice.

Argersinger: Especially for United Continental. You have to remember, one of their big hubs was Houston, which was devastated in September.

Greer: Home of the Astros. Go Astros.

Argersinger: I know.

Greer: Don't get me started.

Argersinger: But fuel prices are a little bit higher. I mentioned Houston, the hurricanes have hurt United more than the other airlines. So, you have some turbulence. They saw a 4% drop in passenger revenue per available seat mile, PRASM, that great airline metric.

Greer: What was that acronym?

Argersinger: PRASM, it's passenger revenue per available seat mile.

Greer: Oh my gosh. I'm going to just mix that into my after-dinner conversation tonight.

Argersinger: So, earlier in the year, they were guiding for growth in that metric over the full year. They've had negative numbers now, they're guiding for a negative number in the fourth quarter, so that has investors a little worried. I like United a lot. I like the airlines in general. I think United has some things going for it. It has Oscar Munoz, who came over from CSX a couple of years ago. It has some activist investors involved. They've done a lot. Their goal is essentially to try to catch Delta. Delta has superior margins in the industry. United, for years, has been about 5% below Delta in terms of operating margin, so that's their big goal, to catch up with that. And I think they're doing it. And you have a stock price here at United that's 8X earnings. And that goes for most of the airlines. They're in the single digit P/E multiples. And I just think, with the consolidation that's happening in the industry, you have four airlines controlling 80% of the seats, you have lower fuel prices over time, more efficient airplanes, I think there's going to be value here with these airlines. We know Warren Buffett has made a big investment with Berkshire Hathaway. So, if these companies can turn it around, if the margins keep going up, if you believe what American Airlines CEO recently said, that they're never going to lose money again, which I disagree with but could happen, then there's no reason why in a few years, United Continental and other airlines can't deserve at least a market multiple, vs. the really discounted market multiple they've been getting for years, rightfully so. If that's the case, you're looking at a double at most of these stock prices.

Ron Gross: This is more of a question. Southwest (NYSE: LUV) seems to have pulled away in terms of stock price lately. And certainly, it's valued higher, it's approaching 20X, vs. the others that are more like 10X. What are they doing? What accounts for that?

Argersinger: There's a cultural thing with Southwest, and that's ingrained in the market. Investors have always been willing to pay a higher multiple, but that's because Southwest has always been more efficient, operating margins have always been higher. They haven't had that huge expenses in terms of labor and fuel that the other airlines have had. They've been better at managing those things.

Gross: And they have a ticker symbol of LUV.

Greer: It's such a great ticker.

Argersinger: It is. So, to me, it's a matter of, can Delta, United, American Airlines, can the multiples of those companies catch up with something like Southwest and the market? I think so.

Greer: And my favorite stat, you mentioned United Continental CEO Oscar Munoz, Matt, he said, in this last quarter, there were 28 days in which United did not bump a passenger. And their previous record was 0 days.

Argersinger: That's a great quote.

Greer: So, they are changing.

Argersinger: Yeah. Again, airlines are never going to be, maybe except for Southwest, they don't have a lot of brand recognition. Passengers like us, we don't care, we just want the lowest price in general. But what's happened with the consolidation is, now, for example, Mac, if you want to fly back to Houston to see your family, you're pretty limited in the choices you can make. United is one of the few that goes direct.

Greer: Or for the World Series. Less of an issue.

Argersinger: Hopefully that happens, I don't know. Damn Yankees. But, this is just --

Gross: [laughs] Send your emails to Matt Argersinger --

Argersinger: I know, I know. But, the industry has changed a lot, and I think for the better. And I think at some point -- Warren Buffett has been early on this -- there's going to be some love back to the airlines.

Greer: Now, here's what I don't get, and I know they've done the math here. If you fly Frontier, they nickel and dime you and everything. They have a carry-on item, which is different from a personal item, and you pay and pay and pay -- why don't you just bake that in? Southwest takes more of the bake that in. Because, even if I end up paying Southwest a little bit more, there's something about the psychology of feeling like you're charging me to go to the bathroom.

Gross: I agree. But then they're just copying Southwest. They're trying to differentiate themselves.

Greer: Copy Southwest. I would copy Southwest.

Gross: How about Spirit Airlines? The website ... I'm not smart enough to figure out the website.

Greer: Is that right? They're always so much cheaper, but I don't trust it.

Gross: I just don't get it.

Greer: They basically pay me to fly to Houston. I'm like, this can't be right, there has to be a catch.

Mac Greer has no position in any of the stocks mentioned. Matthew Argersinger owns shares of Berkshire Hathaway (B shares). Ron Gross owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends CSX and Spirit Airlines. The Motley Fool has a disclosure policy.