United Continental (NYSE: UAL) President Scott Kirby is playing with fire. Since taking the No. 2 job at United a year ago, Kirby has overseen a stark strategy change. The company has significantly increased its growth rate in the domestic market while becoming aggressive about matching or even beating competitors' prices.
These moves ultimately stem from Kirby's belief that United Airlines' willingness to cut or downsize underperforming routes has harmed its financial performance in recent years. Serving more domestic routes with more nonstop flight options is critical to success as a network carrier, according to this logic. Kirby also believes that it's important to match every competitor's prices in order to avoid losing customers to cheaper rivals.
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However, the result is that United is simultaneously picking fights with the likes of Alaska Air (NYSE: ALK), Hawaiian Holdings (NASDAQ: HA), Spirit Airlines (NASDAQ: SAVE), and Frontier Airlines. This doesn't bode well for United's profitability in the next few quarters.
Taking the fight to Alaska Air
Since buying smaller rival Virgin America for $2.6 billion last year, Alaska Air hasn't been shy about its plans to grow in California -- especially the Bay Area. That would obviously pose a challenge to United Continental, which dominates the San Francisco air travel market.
United has responded with a strategy of pre-emptive growth. In late February, it announced that it would add new routes from San Francisco to several key cities, including Cincinnati, Detroit, and Hartford. For the most part, these capacity additions make sense, as these are large markets that warrant nonstop service from a major hub like San Francisco.
Shortly after United's announcement, Alaska Air unveiled plans to add nine new routes from San Francisco starting in the fall. In total, it is set to launch 13 new routes from San Francisco during 2017, most of which are currently United Airlines monopolies.
United Continental responded by increasing capacity in many of these markets -- dramatically in some cases. This may help the carrier retain market share, but it will almost certainly lead to steep unit revenue declines.
Picking a fight with two no-frills budget carriers
The battle between United Continental and Alaska Air is just starting to heat up. Nevertheless, United recently decided to pick a fight with Spirit Airlines and Frontier Airlines: America's two largest ultra-low cost carriers.
Spirit Airlines indicated last month that price competition has become much more intense in Chicago, Newark, Houston, and Denver recently. It's not a coincidence that all four are United Airlines hubs. United Continental is aggressively matching and even undercutting Spirit and Frontier on pricing, even though it has much higher unit costs. It's even cutting prices in markets where Spirit hasn't changed its footprint for years.
United faces a more direct threat from Frontier Airlines. Frontier recently announced a slew of new routes, with an increased focus on serving midsize cities from its Denver hub. Kirby indicated that United Continental will respond aggressively to this incursion.
United's desire to defend its position in Denver is understandable given that it is the carrier's most profitable hub. That said, United could torpedo its own unit revenue in Denver if it takes extreme measures to undercut Frontier Airlines there.
Challenging Hawaiian Airlines in Hawaii
United Continental also announced plans to challenge Hawaiian Holdings in its home market of Hawaii back in early June. In late December, it will increase service on 11 routes to Hawaii. Some of the routes getting extra flights link Chicago and Denver to Hawaii. Hawaiian Airlines doesn't serve either of those markets. However, United will also add at least seven daily flights from San Francisco and Los Angeles to secondary airports in Hawaii (i.e. not Honolulu).
United is adding these routes just as Hawaiian Airlines is ready to ramp up a long-planned initiative to grow its service to secondary airports in Hawaii. The carrier recently upgraded its seasonal Los Angeles-Lihue route to year-round service and it plans to launch year-round Los Angeles-Kona flights in March.
More routes overlapping with United's recent service additions are likely to be announced in the next year or so, as Hawaiian's A321neo fleet expands. Hawaiian Airlines earns a revenue premium in all of its domestic markets, so United's moves to add capacity to Hawaii could easily backfire once Hawaiian Airlines responds.
At war with the world
A targeted price-matching campaign against a single fast-growing competitor is often effective in the airline industry. While it inevitably causes some short-term unit revenue pressure, the payoff is that it may hurt the rival even more, forcing it to scale back growth.
By contrast, United is taking on numerous smaller rivals -- including Alaska Air, Spirit Airlines, Frontier Airlines, and Hawaiian Holdings -- at the same time. This is an extremely rash strategy that could lead to unit revenue declines and margin erosion starting later this year.
United Continental already experienced significant margin pressure in the first half of 2017. Its current guidance calls for unit revenue growth to stall out entirely in the third quarter. With United's competitive battles set to ramp up further over the next year, the outlook for Q4 and 2018 is quite bleak if the company sticks to its current plans.
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Adam Levine-Weinberg owns shares of Alaska Air Group, Hawaiian Holdings, and Spirit Airlines and is long August 2017 $46 calls on Hawaiian Holdings and short October 2017 $50 puts on Hawaiian Holdings. The Motley Fool recommends Spirit Airlines. The Motley Fool has a disclosure policy.