Airline Industry Ratios

ROE> CEC (21% vs. 12.5%) => P/B > 1
Southwest Airlines – Strategy Impacts




ROW: 21% Earnings Growth: Very High Assets Growth: 15.4 % Net Operating Profit Margin : 11% stable (highest in the market) Forecast:
Future Trends?

Passenger traffic on a steady increase since 2002 Airlines operating under cost cutting strategies A trend towards globalization Increased influence of alliances: Star, SkyTeam and One World



Industry Analysis
Threat of New Entrants (LOW) • High startup costs •Limited Hub Access •Post 911 environment
Bargaining Power of Buyers (MODERATE) • Price •Convenience •Service
Rivalry Among Existing Firms (HIGH) • Route Sharing • Hub Competition •‘No Frill’ Airlines
Bargaining Power of Suppliers (HIGH) • Boeing & Airbus •Bombardier& Embraer
Revenue Earnings Growth Predicted ROE
2002 30% 32% 23%
2003 30% 22% 23%
Delta Airlines
Founded in 1924 Highly competitive in domestic market; growing competition Low switching costs Unionized labour force Average asset growth

What does this all mean?

To maintain long term competitiveness and sustainability, an airline needs to have both global scale, strong presence and a cost efficient strategy.

Skywest – Strategy Impacts




ROE: 18% Earnings Growth: High (Long term Sustainability??) Assets Growth: 20.1% Net Operating Profit Margin: 9% (declining) Forecast:
Revenue Earnings Growth Predicted ROE
2001 loss -
2002 8% growth 8.50%
Skywest Airlines
Founded in 1972 Relationship with Delta Airlines & United Airlines – LT revenue High competition with regional airlines, low fare carriers & major airlines
services Many affiliated with longhaul carriers Low bargaining power Non-unionized ‘no frills’ airlines Technologically advanced Serve mainly domestic market


(Earnings/Equity)
If ROE < CEC then P/B decreases Assumption: CEC = 12.5% industry wide

Other Things to Consider
Company Strategy Operating Model Growth Plans Access to Capital Company & Industry Trends

Industry – Financial State
First cyclical downturn in 2001 Air travel demand declined & prices softened ROE had declined to 12% v.s. 25% P/B ratio declined to 2% v.s. 2.8% P/E ratio was negative
Delta Average Low Low to Average P/B ~ 1
Southwest High High High Sustained Growth
Skywest High High High Growth ?; P/B >> 1
Valuation Multiples
Airline A B C P/E 7.5 6.8 16.8 P/B 0.8 1.2 3.1 Our Guess

Valuation Multiples
Airline A B C P/E 7.5 6.8 16.8 P/B 0.8 1.2 3.1 Your Guess ? ? ?
D
26.8
4.9
?
Our findings
American ROE P/E P/B Low Low Low (ROE<CEC) (P/B<1)
Revenue Earnings Growth Predicted ROE 2001 11% 19% 17% 2002 12% 24% 18%
பைடு நூலகம்
Recall: Financial Theory
P/E increases as Earnings grow P/E decreases as CEC increases ROE is based on Dupont
Threat of Substitutes • Short Haul: (MODERATE-HIGH) • Long Haul: (LOW- MODERATE)
Airline Model Comparison
National
Long
Regional
Non-stop
haul domestic & international services Economies of scale (long flights) ‘Hub-and-spoke’ networks High fixed costs Low marginal costs Use alliances to strengthen international presence
short haul
Company Strategy & Current Performance

Company strategy drives

Earnings growth Growth in ROE Growth in equity


Financial Theory
P/E increases as Earnings grow P/E decreases as CEC increases ROE is based on Dupont
Valuation Ratios in the Airline Industry
Hari Stirbet Tammy Cheung Shelly Khindri Parmjit Marway
Agenda




Industry Overview Financial Theory American Airlines Skywest Delta Southwest Class Exercise Summary
Revenue Earnings Growth Predicted ROE 2001 loss 2002 increase 13%
Southwest Airlines
Flexible non-unionized workforce Use of same aircraft across routes Low cost airports No lock-in to standard banking services


(Earnings/Equity)

If ROE < CEC then P/B decreases
American Airlines
Very competitive domestic market Competition in long-haul, regional & cargo service Many other airlines on same routes Relatively new aircraft Unionized labour force
Industry - Overview
1978: deregulation of US Airline Industry Mid-2001