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SW Presentation FINAL 4-24

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Rupert Pattisson
Rupert Pattisson

This document provides an overview of Southwest Airlines' business operations and financial performance. Some key points: - Southwest operates a fleet of 694 planes, employs 46,000 people, and serves 97 destinations in the US and nearby international markets. - It has adopted a low-cost business model and focuses on point-to-point routes rather than hubs. The acquisition of AirTran introduced some international flights and services at major airports. - Major competitors include American, Delta, United, and JetBlue. Southwest saw revenue of $17 billion in 2012 and carried over 134 million passengers as the fourth largest US airline. - Financial ratios show solid current ratio and times interest earned. Projections estimate 9

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By: Dennis Bayon, Rupert Pattisson Tolga Turgut, Shidan Wang 5440 Financial Management April 24, 2013
Introduction Fleet size: 694 comprising of 606 B-737s & B-717s Labor force: 46,000 employees Network: U.S. domestic & near-international markets Home base: Dallas Love Field, Ticker symbol LUV Honors: Only airline to make Fortune`s top 10 list of the World`s most admired companies. Passengers: $134 Million (fourth largest U.S. airline) Revenue: $ 17,088 Billion (2012)
Business Model & Services Leading low cost carrier (LCC) Provides point-point services mainly, no hub and spoke Air travel services within U.S. and near-international markets to serve 97 destinations in 41 states Leading domestic U.S. airline by number of passengers enplaned Slight shift of strategy with AirTran acquisition: introduction of international services, flights to primary airports, business class services
Primary Markets and Competition Atlanta, Baltimore, Chicago Midway, Dallas Love Field, Denver, Houston Hobby, Las Vegas, Los Angeles, Orlando (destinations with 100 + departures daily) Major competitors: American/US Airways, Delta Airlines, United, and Jet Blue. Limited international network and presence at major East Coast Airports.
Merger & International Strategy AirTran was acquired at$ 1.0 Billion net in cash &shares Full integration expected to be completed by 2017 Stock price declined 4% within the days of acquisition Operations to six foreign countries resumed as a result of AirTran acquisition $400M in annual pre-tax synergies targeted as a result of: Network optimization Fleet renewal Fleet commonality program
Selected Financial Ratios FY2011 FY2012 Peers Current Ratio 0.96 0.91 0.80 Times Interest Earned (TIE) 2.88 6.76 2.25 Return on Invested Capital (ROIC) 5.55 5.48 - Current Ratio: Remains above average even after acquisition of AirTran. Significant cash, liquid short-term investments, un-used credit facilities. TIE: Capital structure with low debt. ROIC: Currently below WACC of 8.9% is unsustainable.
DuPont Analysis FY2011 FY2012 Profit Margin 1.14 2.46 Asset TO 0.87 0.92 Equity Multiplier 2.63 2.66 = ROE 2.61 6.02 Anticipate ROE growth will be driven by: Profit Margin: Growth due to AirTran merger cost savings. Asset TO: Growth due to increased capacity of planes and load factors. Equity Multiplier: Anticipate no growth; SW targeting similar capital structure.
Revenue and Net Income Revenue FY12 revenue = $17 billion Average revenue growth = 12% over past 5 years Generated and combined four growth rate models Projected 9% annual revenue growth rate Industry only 5%. Net Income Average NI = $267 million over past 5 years Drastic drop after AirTran acquisition. Butstill positive Projected 29% annual NI growth rate Cost and operational efficiency driving increased profit margin
Free Cash Flows FCF projected using method outlined in Financial Management textbook Negative FCF in FY2011 and FY2012 not necessarily bad $1 billion investment over two years Should explore additional investments made possible by AirTran acquisition FREECASH FLOW PROJECTION FY2011 FY2012 FY2013 FY2014 FY2015 NOPAT 382 383 722 856 1,086 Operating Current Assets 1,767 2,124 2,382 2,736 3,153 Operating Current Liabilities 3,889 4,379 4,555 4,962 5,428 Net Operating Working Capital (2,122) (2,255) (2,173) (2,226) (2,274) Total Net Operating Capital 10,005 10,511 10,753 10,963 11,216 Net Investment in Op. Capital 439 506 242 210 253 NOPAT 382 383 722 856 1,086 Net Investment in Op. Capital 439 506 242 210 253 Free Cash Flow (57)$ (123)$ 480$ 646$ 833$ Growth -107.3% 115.6% -490% 35% 29%
Scenario Analysis FREECASH FLOW - WORSTCASE FY2011 FY2012 FY2013 FY2014 FY2015 NOPAT 382 383 304 253 294 Net Operating Working Capital (2,122) (2,255) (1,878) (1,756) (1,799) Total Net Operating Capital 10,005 10,511 10,959 11,337 11,308 Net Investment in Op. Capital 439 506 448 378 (29) NOPAT 382 383 304 253 294 Net Investment in Op. Capital 439 506 448 378 (29) Free Cash Flow (57)$ (123)$ (143)$ (125)$ 324$ FREECASH FLOW - BESTCASE FY2011 FY2012 FY2013 FY2014 FY2015 NOPAT 382 383 979 1,096 1,317 Net Operating Working Capital (2,122) (2,255) (2,329) (2,537) (2,751) Total Net Operating Capital 10,005 10,511 10,847 11,062 11,281 Net Investment in Op. Capital 439 506 336 215 219 NOPAT 382 383 979 1,096 1,317 Net Investment in Op. Capital 439 506 336 215 219 Free Cash Flow (57)$ (123)$ 643$ 881$ 1,098$
Historical Stock Price
Stock Prices & Analyst Opinions Our 2013 FYE target price is $14.69; currently $13.34 Projected 18.7 PE ratio Projected 43% FY2013 stock price return Projected 9.2% from now until 2013 FYE Analyst target price range is $14.30 $15.00 Split between Hold and Buy recommendations We recommend to buy on weakness
The Cost of Capital Rs = 10.5% Average CAPM (10.3%) and DGM (10.6%) Current WACC = 8.9% 19.5% Debt, 81.5% Equity Low debt Assumptions Total debt = MV bonds plus leases Weighted Average YTM Beta based on 5 year monthly data (1.14) Matched higher published betas
Optimal WACC = 8.5% Excel model, taking rs from CAPM Will company increase debt? Replacement debt only $700m maturing debt in 2016 with improving earnings 8.20% 8.30% 8.40% 8.50% 8.60% 8.70% 8.80% 8.90% 9.00% 9.10% 10% 15% 20% 25% 30% 35% 40% Optimal WACC is 8.51% at 30% Debt
Dividend and Capital Structure 2012 Dividend? Capital Structure High Operating Leverage High business risk Aversion to debt? Credit rating constraints 400 578 22 $ Million Share buyback Debt repayment Dividend 81.50% 18.50% Equit y
Corporate Governance Executive remuneration - 80% is shareholder value related (2012 Proxy Statement) An independent and experienced board Duality of CEO and COB New 2013 claw back rule Performance: A well run business? yes but Copycat competitors ROIC lower than WACC! 27% 38% 30% 5% 2009 Salary Bonus Equity Other 15% 25% 55% 5% 2012 Salary Bonus Equity Other
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SW Presentation FINAL 4-24

  • 1. By: Dennis Bayon, Rupert Pattisson Tolga Turgut, Shidan Wang 5440 Financial Management April 24, 2013
  • 2. Introduction Fleet size: 694 comprising of 606 B-737s & B-717s Labor force: 46,000 employees Network: U.S. domestic & near-international markets Home base: Dallas Love Field, Ticker symbol LUV Honors: Only airline to make Fortune`s top 10 list of the World`s most admired companies. Passengers: $134 Million (fourth largest U.S. airline) Revenue: $ 17,088 Billion (2012)
  • 3. Business Model & Services Leading low cost carrier (LCC) Provides point-point services mainly, no hub and spoke Air travel services within U.S. and near-international markets to serve 97 destinations in 41 states Leading domestic U.S. airline by number of passengers enplaned Slight shift of strategy with AirTran acquisition: introduction of international services, flights to primary airports, business class services
  • 4. Primary Markets and Competition Atlanta, Baltimore, Chicago Midway, Dallas Love Field, Denver, Houston Hobby, Las Vegas, Los Angeles, Orlando (destinations with 100 + departures daily) Major competitors: American/US Airways, Delta Airlines, United, and Jet Blue. Limited international network and presence at major East Coast Airports.
  • 5. Merger & International Strategy AirTran was acquired at$ 1.0 Billion net in cash &shares Full integration expected to be completed by 2017 Stock price declined 4% within the days of acquisition Operations to six foreign countries resumed as a result of AirTran acquisition $400M in annual pre-tax synergies targeted as a result of: Network optimization Fleet renewal Fleet commonality program
  • 6. Selected Financial Ratios FY2011 FY2012 Peers Current Ratio 0.96 0.91 0.80 Times Interest Earned (TIE) 2.88 6.76 2.25 Return on Invested Capital (ROIC) 5.55 5.48 - Current Ratio: Remains above average even after acquisition of AirTran. Significant cash, liquid short-term investments, un-used credit facilities. TIE: Capital structure with low debt. ROIC: Currently below WACC of 8.9% is unsustainable.
  • 7. DuPont Analysis FY2011 FY2012 Profit Margin 1.14 2.46 Asset TO 0.87 0.92 Equity Multiplier 2.63 2.66 = ROE 2.61 6.02 Anticipate ROE growth will be driven by: Profit Margin: Growth due to AirTran merger cost savings. Asset TO: Growth due to increased capacity of planes and load factors. Equity Multiplier: Anticipate no growth; SW targeting similar capital structure.
  • 8. Revenue and Net Income Revenue FY12 revenue = $17 billion Average revenue growth = 12% over past 5 years Generated and combined four growth rate models Projected 9% annual revenue growth rate Industry only 5%. Net Income Average NI = $267 million over past 5 years Drastic drop after AirTran acquisition. Butstill positive Projected 29% annual NI growth rate Cost and operational efficiency driving increased profit margin
  • 9. Free Cash Flows FCF projected using method outlined in Financial Management textbook Negative FCF in FY2011 and FY2012 not necessarily bad $1 billion investment over two years Should explore additional investments made possible by AirTran acquisition FREECASH FLOW PROJECTION FY2011 FY2012 FY2013 FY2014 FY2015 NOPAT 382 383 722 856 1,086 Operating Current Assets 1,767 2,124 2,382 2,736 3,153 Operating Current Liabilities 3,889 4,379 4,555 4,962 5,428 Net Operating Working Capital (2,122) (2,255) (2,173) (2,226) (2,274) Total Net Operating Capital 10,005 10,511 10,753 10,963 11,216 Net Investment in Op. Capital 439 506 242 210 253 NOPAT 382 383 722 856 1,086 Net Investment in Op. Capital 439 506 242 210 253 Free Cash Flow (57)$ (123)$ 480$ 646$ 833$ Growth -107.3% 115.6% -490% 35% 29%
  • 10. Scenario Analysis FREECASH FLOW - WORSTCASE FY2011 FY2012 FY2013 FY2014 FY2015 NOPAT 382 383 304 253 294 Net Operating Working Capital (2,122) (2,255) (1,878) (1,756) (1,799) Total Net Operating Capital 10,005 10,511 10,959 11,337 11,308 Net Investment in Op. Capital 439 506 448 378 (29) NOPAT 382 383 304 253 294 Net Investment in Op. Capital 439 506 448 378 (29) Free Cash Flow (57)$ (123)$ (143)$ (125)$ 324$ FREECASH FLOW - BESTCASE FY2011 FY2012 FY2013 FY2014 FY2015 NOPAT 382 383 979 1,096 1,317 Net Operating Working Capital (2,122) (2,255) (2,329) (2,537) (2,751) Total Net Operating Capital 10,005 10,511 10,847 11,062 11,281 Net Investment in Op. Capital 439 506 336 215 219 NOPAT 382 383 979 1,096 1,317 Net Investment in Op. Capital 439 506 336 215 219 Free Cash Flow (57)$ (123)$ 643$ 881$ 1,098$
  • 12. Stock Prices & Analyst Opinions Our 2013 FYE target price is $14.69; currently $13.34 Projected 18.7 PE ratio Projected 43% FY2013 stock price return Projected 9.2% from now until 2013 FYE Analyst target price range is $14.30 $15.00 Split between Hold and Buy recommendations We recommend to buy on weakness
  • 13. The Cost of Capital Rs = 10.5% Average CAPM (10.3%) and DGM (10.6%) Current WACC = 8.9% 19.5% Debt, 81.5% Equity Low debt Assumptions Total debt = MV bonds plus leases Weighted Average YTM Beta based on 5 year monthly data (1.14) Matched higher published betas
  • 14. Optimal WACC = 8.5% Excel model, taking rs from CAPM Will company increase debt? Replacement debt only $700m maturing debt in 2016 with improving earnings 8.20% 8.30% 8.40% 8.50% 8.60% 8.70% 8.80% 8.90% 9.00% 9.10% 10% 15% 20% 25% 30% 35% 40% Optimal WACC is 8.51% at 30% Debt
  • 15. Dividend and Capital Structure 2012 Dividend? Capital Structure High Operating Leverage High business risk Aversion to debt? Credit rating constraints 400 578 22 $ Million Share buyback Debt repayment Dividend 81.50% 18.50% Equit y
  • 16. Corporate Governance Executive remuneration - 80% is shareholder value related (2012 Proxy Statement) An independent and experienced board Duality of CEO and COB New 2013 claw back rule Performance: A well run business? yes but Copycat competitors ROIC lower than WACC! 27% 38% 30% 5% 2009 Salary Bonus Equity Other 15% 25% 55% 5% 2012 Salary Bonus Equity Other