Valuation Ratios in the Airline Industry

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Valuation Ratios in the Airline Industry

• Hari Stirbet
• Tammy Cheung
• Shelly Khindri
• Parmjit Marway

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Agenda

• Industry Overview
• Financial Theory
• American Airlines
• Skywest
• Delta
• Southwest
• Class Exercise
• Summary

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Industry - Overview

• 1978 deregulation of US Airline Industry
• Mid-2001
• industry dominated by long-haul small carriers
• Many non-stop regional commuter carriers

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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

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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.

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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

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Industry Analysis

• Threat of New Entrants (LOW)
• High startup costs
• Limited Hub Access
• Post 911 environment

• Rivalry Among Existing Firms (HIGH)
• Route Sharing
• Hub Competition
• No Frill Airlines

• Bargaining Power of Buyers (MODERATE)
• Price
• Convenience
• Service

• Bargaining Power of Suppliers (HIGH)
• Boeing Airbus
• Bombardier Embraer

• Threat of Substitutes
• Short Haul (MODERATE-HIGH)
• Long Haul (LOW- MODERATE)

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Airline Model Comparison
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Company Strategy Current Performance

• Company strategy drives
• Earnings growth
• Growth in ROE
• Growth in equity

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Financial Theory

• P/E increases as Earnings grow
• P/E decreases as CEC increases
• ROE is based on Dupont
• (Earnings/Equity)
• If ROE

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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

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American Airlines Strategy Impacts

• ROE 12 - (declining from 21)
• Earnings Growth Loss (slow growth)
• Assets Growth 6
• Net Operating Profit Margin 5 - (declining
  from 8)
• Forecast

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Skywest Airlines

• Founded in 1972
• Relationship with Delta Airlines United
  Airlines LT revenue
• High competition with regional airlines low fare
  carriers major airlines

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Skywest Strategy Impacts

• ROE 18
• Earnings Growth High (Long term
  Sustainability)
• Assets Growth 20.1
• Net Operating Profit Margin 9 (declining)
• Forecast

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Delta Airlines

• Founded in 1924
• Highly competitive in domestic market growing
  competition
• Low switching costs
• Unionized labour force
• Average asset growth

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Delta Airlines Strategy Impacts

• ROE Fluctuates between 17 - 30
• Most recent 8
• Assets Growth 12.4
• Net Operating Profit Margin 6 (declined from
  9)
• Forecast

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Southwest Airlines

• Flexible non-unionized workforce
• Use of same aircraft across routes
• Low cost airports
• No lock-in to standard banking services
• ROE CEC (21 vs. 12.5) P/B 1

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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

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Recall Financial Theory

• P/E increases as Earnings grow
• P/E decreases as CEC increases
• ROE is based on Dupont
• (Earnings/Equity)
• If ROE
• Assumption CEC 12.5 industry wide

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Other Things to Consider

• Company Strategy
• Operating Model
• Growth Plans
• Access to Capital
• Company Industry Trends

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Valuation Multiples
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Our findings
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Valuation Multiples
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Summary

• Difference in performance/strategy can affect the
  valuation multiples
• Rank companies based on strategy analysis
• Value of the company is NOT only numbers