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Low Fares Here to Stay, Chairman of UAL Says

Times Staff Writer

The head of United Airlines’ holding company is known in the business for the accuracy of his predictions, having told securities analysts last fall that the airlines’ competitive fare wars would lead to a “blood bath"--which is currently taking place.

And now, Richard J. Ferris, chairman of UAL Inc., says U.S. air carriers are going to have to live with lower fares as “a permanent way of life.”

According to Airline Economics, a consulting firm, the 13 major U.S. carriers--those with revenue topping $1 billion--had a collective operating loss during this year’s first quarter of $554 million. Only two--American Airlines and Continental Airlines--were in the black.

Ferris’ UAL was a big loser. The corporation, which, in addition to the airline, owns the Hertz auto rental company and Westin Hotels & Resorts, had a whopping net loss of $103 million for the first quarter of 1986, compared to a loss of $661,000 in the same period last year.

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United Airlines is the non-communist world’s largest air carrier, operating a fleet of 343 aircraft serving 173 cities in all 50 states and 13 nations in North America and the Pacific. By itself, it had an operating loss of $61.1 million in the first quarter, compared to last year’s first-quarter operating earnings of $18.7 million.

The airline’s total loss (including such things as interest, taxes and returns from sale of aircraft) was $107.3 million in the period, compared to a $3.9-million loss in the previous year.

In an interview here recently, Ferris recalled: “I said (in November) that capacity was outstripping the growth in the industry. Excess capacity leads to competition to fill seats, and that leads to fare wars. What happened is what we predicted would happen.”

And what happened was that the airlines lowered their prices--drastically. According to the Air Transport Assn., an industry trade group, 85.3% of all passengers flew at a discount last year.

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And the number is still rising. Currently, 88% of all passengers are flying at discounts averaging nearly 60%.

Such fierce competition cut deeply into airline revenue. For example, United’s yield (the amount of revenue per passenger mile) dropped to 10.56 cents in the first quarter of 1986 from 11.35 cents in the final quarter of 1985.

To put that in perspective, each penny is worth $600 million in annual revenue for United. For the major airlines as a whole, the yield dropped from 12.48 cents for all of last year to 11.56 cents in February.

New Fact of Life

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Now, Ferris has gazed into his crystal ball once more to see what’s in store for both the industry and UAL. Depressed ticket prices, he predicted in the interview, are going to remain a fact of airline life.

Although fares might “moderate” a bit, he said, “you aren’t going to have this swing back to the high levels that we knew historically.”

Thus, he said, it is mandatory that the major airlines remain competitive with the new carriers that were created or those that greatly expanded after the government deregulated the airlines in 1978.

Some carriers failed to lower their overhead costs and have been forced to merge with competitors. Others, United among them, have accepted strikes to bring down their labor costs, which average about 36% of an airline’s overhead.

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“We’re a strong survivor,” Ferris said. “We now have salary rates that, on the average, are competitive in all employee classifications with the newcomers. To the best of our ability, we are competitive dollar for dollar. And we can do a lot of things better and cheaper because of our size.”

Two-Tier Pay Scale

United now has a two-tier pay scale. New employees are paid according to the lower of the two rates--a scale that is even lower than that of some of the newer carriers.

For example, a starting pilot at United gets $1,854 a month, compared to the $2,333 starting wage of a People Express pilot.

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Despite Ferris’ optimism, there are some legitimate questions about UAL’s future:

- Will it be able to profitably integrate Hertz, Westin and the airline?

- How quickly will it mesh Pan American World Airways’ Pacific division, which it purchased earlier this year, into its airline system?

- How will it come out in the fierce competition (Ferris calls it “suicidal”) with Continental and Frontier airlines in Denver? A significant share of United’s total business--14%--is in the Denver market, where United has a 40% share of the passenger traffic.

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“For UAL Inc., 1986 appears to be a rebuilding year, and uncertainties abound,” said airline analyst Timothy Pettee of the stock brokerage of L. F. Rothschild, Unterberg, Towbin.

Skeptics believe that there is not much chance of a dramatic turnabout for UAL this year. “With a poor first quarter and an improving second quarter, a strong second half is necessary for UAL to achieve modest annual profitability from operations,” said Mark E. Daugherty, first vice president of the Dean Witter Reynolds brokerage. “Unless they really get a boom in the third quarter, it is going to be a pretty difficult year for them.”

United Airlines, for example, is just now returning to full operation after a shutdown caused by a pilots’ strike last year.

Some Optimistic

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Since the strike, United has undertaken an expansion program that has required extensive training of new pilots and retraining of old pilots. All told, United has trained 2,700 pilots since June, 1985, compared to 1,800 trained in the 17 months before the strike.

Such training is expensive for an airline because it moves pilots from flying, which produces revenue, into classes, which do not.

Not everyone thinks that United’s situation is grim. Indeed, recent world events--lower oil prices and the terrorism and radiation scares in Europe--might play a role in any improvement of the company’s fortunes this year by increasing the likelihood of stepped-up domestic tourism.

“In the case of United Airlines,” said Candace Browning, airline analyst at the Oppenheimer & Co. brokerage, “returning to full production levels is a critical component of (its) projected return to profitability. United Airlines . . . should (also) benefit from strong domestic travel this summer and declining fuel prices. . . . Hertz and Westin, which account for about 23% of UAL’s total revenue, also should benefit from strong domestic travel this summer.”

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Some analysts say UAL is not following a correct acquisition strategy, adding that the company should be concentrating on enlarging the airline, which contributes almost 80% of the holding company’s revenue.

Last summer, UAL purchased Hertz for $587.5 million, a move criticized by some experts. One airline analyst, who asked that his name not be used, said the acquisition of the nation’s largest auto rental company (a fleet of 350,000 vehicles available through more than 4,700 company owned and licensed locations in 120 countries) was unwise.

“It is not classical business-school thinking to merge with a company that has the same characteristics of your company that you consider undesirable,” he said. “For UAL and Hertz, these overlapping characteristics are competition, capital intensivity and cyclicality.”

Ferris scoffs at such charges.

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“I don’t know of a business that isn’t competitive,” he says. “I guess if I could find a business where I was the monopoly, it would be great.”

He conceded that each of the company’s businesses is capital intensive, but he added that he could decrease capital intensity at Hertz quickly by cutting off the flow of new cars into the corporation and selling used cars more rapidly.

Likes New Mix

“I can shrink the capital base of Hertz very rapidly to respond to a change in the business climate,” he said. “You can’t do that with planes, and you can’t just fold up a hotel.”

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On the cyclical nature of UAL’s businesses, he argued that every business is affected by a downturn in the economy. “It’s just that in the travel business, we lead it in and we lead it out.”

And he likes the holding company’s new mix of travel-related businesses.

Hertz, he said, “fits like a glove” with United and Westin. “It’s a business we know, and it is growing a little faster than the airline.” The auto rental company was purchased to stabilize the profitability of the corporation, he said, “so that the peaks and valleys aren’t so great.”

Hertz added $496.5 million to the parent firm’s revenue and contributed $3.8 million to its net earnings in 1985. Analysts expect revenue for the car rental firm to reach $1.6 billion this year (an anticipated 17% of UAL’s total) with an operating profit of $279 million.

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Revenue for Westin--which operates 56 hotels and resorts in the United States and in 10 other countries--is expected to rise 5% this year to $57 million, about 6% of the parent company’s total revenue.

Though Ferris declined to predict this year’s profit for UAL, saying only that the second quarter would be better than the first, he said 1986 revenue should reach $10 billion.

United also expects big things from its $750-million acquisition of Pan Am’s Pacific division.

More Travel to Orient

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Helane Becker, airline analyst with the investment house of Drexel Burnham Lambert, predicts that travel on U.S. airlines will increase 8% during the next five years and that popular destinations will include the Pacific Northwest and the Pacific Rim countries of East Asia.

“With the purchase of Pan Am’s Pacific division,” she said, “United Airlines is now in a greater position to benefit from this growth.” For example, United will be able to capitalize on its domestic strength to feed its new Pacific routes.

Ferris said United has already expanded the Far Eastern operations by 30% since the deal with Pan Am was completed in February, having added non-stop service from San Francisco to Osaka, Japan, and to Taipei, Taiwan, and service from Honolulu to Hong Kong.

“We integrated a billion-dollar business into our system overnight,” he said. “We will be profitable within our first year of operation.”

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Can more acquisition activity be expected from United?

“You know, of course, we’re going to do other things. This is an aggressive company,” the UAL chairman said. But, “right now our plate is full. We’re digesting that which we have.”

UAL INC. AT A GLANCE The Chicago-based holding company has three primary operating subsidiaries, United Airlines, Westin Hotels and Hertz Corp.

1985 1984 1983 1982 1981 Operating revenues (Billions of dollars) 6.38 6.97 6.02 5.32 5.14 Net income (loss) (Millions of dollars) (48.7) 282.4 142.0 30.8 (70.5)

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Assets: $7.87 billion

Employees: 76,000

Shares outstanding: 45.14 million

12-month price range (NYSE): $45.00 - $64.75

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Friday’s close: $59.75, down $2.12 1/2


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