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Valuation Ratios in the Airline Industry

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. Industry - Overview. 1978: deregulation of US Airline Industry Mid-2001

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Valuation Ratios in the Airline Industry

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  1. Valuation Ratios in the Airline Industry Hari Stirbet Tammy Cheung Shelly Khindri Parmjit Marway

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

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

  4. 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

  5. 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.

  6. 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

  7. 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- MODERATE)

  8. Airline Model Comparison

  9. Company Strategy & Current Performance • Company strategy drives • Earnings growth • Growth in ROE • Growth in equity

  10. 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

  11. 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

  12. 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:

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

  14. Skywest – Strategy Impacts • ROE: 18% • Earnings Growth: High (Long term Sustainability??) • Assets Growth: 20.1% • Net Operating Profit Margin: 9% (declining) • Forecast:

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

  16. 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:

  17. 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

  18. 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:

  19. 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

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

  21. Valuation Multiples

  22. Our findings

  23. Valuation Multiples

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

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