Valuation Ratios in the Airline Industry

Hari Stirbet Tammy Cheung Shelly Khindri Parmjit Marway

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

Industry .Overview 1978: deregulation of US Airline Industry  Mid-2001  industry dominated by long-haul small carriers  Many non-stop regional & commuter carriers  .

2. 25%  P/B ratio declined to 2% v.8%  P/E ratio was negative  .s.s.Industry – Financial State First cyclical downturn in 2001  Air travel demand declined & prices softened  ROE had declined to 12% v.

strong presence and a cost efficient strategy. an airline needs to have both global scale. .What does this all mean?  To maintain long term competitiveness and sustainability.

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    .

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

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 services Many affiliated with longhaul carriers Low bargaining power Non-unionized ‘no frills’ airlines Technologically advanced Serve mainly domestic market 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   (Earnings/Equity)  If ROE < CEC then P/B decreases .

regional & cargo service  Many other airlines on same routes  Relatively new aircraft  Unionized labour force  .American Airlines Very competitive domestic market  Competition in long-haul.

(declining from 21%) Earnings Growth: Loss – (slow growth) Assets Growth: 6 % Net Operating Profit Margin : 5% (declining from 8%) Forecast: Revenue Earnings Growth Predicted ROE 2001 loss - 2002 8% growth 8.American Airlines – Strategy Impacts      ROE: 12% .50% .

low fare carriers & major airlines  .Skywest Airlines Founded in 1972  Relationship with Delta Airlines & United Airlines – LT revenue  High competition with regional airlines.

1% Net Operating Profit Margin: 9% (declining) Forecast: Revenue Earnings Growth Predicted ROE 2002 30% 32% 23% 2003 30% 22% 23% .Skywest – Strategy Impacts      ROE: 18% Earnings Growth: High (Long term Sustainability??) Assets Growth: 20.

Delta Airlines Founded in 1924  Highly competitive in domestic market. growing competition  Low switching costs  Unionized labour force  Average asset growth  .

30%  Most recent 8% Assets Growth: 12.Delta Airlines – Strategy Impacts     ROE: Fluctuates between 17% .4 % Net Operating Profit Margin : 6% (declined from 9%) Forecast: 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   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: Revenue Earnings Growth Predicted ROE 2001 11% 19% 17% 2002 12% 24% 18% .

Recall: Financial Theory P/E increases as Earnings grow  P/E decreases as CEC increases  ROE is based on Dupont   (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  .

Valuation Multiples Airline A B P/E 7.8 P/B 0.9 ? ? .8 1.5 6.1 4.2 Your Guess ? ? C D 16.8 26.8 3.

P/B >> 1 .Our findings American ROE P/E P/B Low Low Low Delta Average Low Low to Average P/B ~ 1 Southwest High High High Skywest High High High (ROE<CEC) (P/B<1) Sustained Growth Growth ?.

8 P/B 0.8 1.Valuation Multiples Airline A B C D P/E 7.2 3.8 26.1 4.5 6.9 Our Guess .8 16.

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