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Global Airlines

Global Airlines

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Global Airlines

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  1. Global Airlines James Bolegoh Mauro Horie Richard Konings Zhe Liu Robbie Lydon

  2. Agenda • Introduction • Southwest airlines • Singapore airlines

  3. Airline Products • Provides fast passenger transportation, both nationally and internationally • Freight can also be transported quickly • Substitutes: • Car or bus • Train • Boat

  4. Industry Characteristics • Cyclical in nature, with over expansion during upturns, and large cutbacks during downturns • Only marginally profitable • A special case due to: • Defense • Economic • Flag

  5. Revenue Structure • The two main sources of revenue for Airlines are from: • Passenger fares • Cargo

  6. Cost Structure

  7. World Airline Profits 1992-2002

  8. Adverse Industry Effects • 9/11, SARS, and Iraq war • The industry was already entering a down period prior to this catastrophic event • Increasing fuel costs began late 2000 • Huge losses and layoffs were announced shortly afterwards • Large decline in the number of passengers

  9. Industry Outlook • Recovery from industry shocks • Expansion into developing markets • Increased use of Alliances

  10. Strategic Alliances • Sharing of resources • Seamless global network • Competitive advantage

  11. International Air Transport Association Market Share

  12. Regulatory Environment • Two key organizations that affect the international airlines are: • International Civil Aviation Organization • Composed of representatives from member countries • International Air Transport Association • Comprised of International Airlines

  13. US Regulatory Impact • Airline Deregulation Act (1978) • To encourage a competitive air transportation system • International Air Transport Competition Act (1979) • 3 goals • Open Skies Agreements

  14. Airline Risk Factors • Financial risk • Variability of revenue and costs • Strategic risk • Business design choices • Operational risk • Tactical aspects of running the business • Hazard risk • Safety of physical assets

  15. What Risks are Hedged? • Fuel Costs • Foreign Exchange Risk • Interest Rates • Credit Card Guarantees

  16. Southwest Airlines

  17. Section Overview • Company background • Major risks and risk management • Stock options

  18. Company Background • Founded in 1971 with flights between Dallas, Houston and San Antonio • Has become the forth largest major airline in the United States in terms of revenues as of Dec.2002 • Has been the number one carrier in terms of domestic boardings in the U.S. since May 2003 • Transports more than 64 million passengers per year to more than 58 cities in 30 states

  19. Southwest Route Map

  20. Fact Sheet Daily Departures: 2,800 flights per day Employees: 33,000 throughout the system Common Stock: Traded under the symbol LUV at NYSE 2003 Financial Statistics: • Net Income: $442 million • Total Passengers Carried: $65.7 million • Total RPMs: $47.9 million • Total Operating Revenue: $5.9 billion • Passenger Load Factor: 66.8%

  21. Company Fleet Profile • Southwest operated 388 Boeing 737 Jets (as of Dec, 2003) • Company fleet has an average age of 9.5 years

  22. LUV Financial Position

  23. LUV Financial Position

  24. 5-Year Stock Price Evolution 9/11 SARS

  25. Revenue Source

  26. Growth • For the five years ended 2001, the average annual capacity growth was 10% • 2002 - over 5% • After 2002, the estimated annualized growth rate over the next 10 years is roughly 8%

  27. Cost Structure Interest expenses1.7% 2.1% 1.4%

  28. Major Types of Risk Market risk • Fuel price risk • Financial market risk • Interest rate risk • Credit risk • Liquidity and financing risk

  29. Fuel Price Risk • Fuel price risk • Estimated 1.2B gallons of jet fuel for 2004. A change of $0.01 in fuel prices would impact fuel expenses by $12M • Makes cash flow and earnings unpredictable • Southwest solution - fuel hedging • Not for trading purposes • Effective commodities - crude oil and heating oil • Short-term and long-term • Mixture of call options, collar structures, and fixed price swap agreements • Hedged 80% of 2004 fuel requirement, 60% of 2005, and portions of 2006-2007 as of Dec. 31, 2003

  30. Fuel Price Risk Fuel hedging results • Recognized gains of $171M in fuel expense (Table 1) and unrealized gains of $123M, net of tax • A net asset of $251M at the end of 2003 (Table 2) • Sensitivity analysis: 10% change in commodity prices would change fair value of derivative instruments by approximately $125M and more or less than $125M of changes in cash flows (as of Dec. 31, 2003)

  31. Fuel Price Risk Fuel hedging results - Table 1

  32. Fuel Price Risk Fuel hedging results - Table 2

  33. Financial Market Risk • Financial market risk • Interest Rate Risk • Credit Risk • Liquidity and Financing Risk • Southwest strategy • Capitalize conservatively • Grow capacity steadily and profitably • Strong B/S and modest financial leverage • High credit rating - “A” with S&P’s rating; “Baa1” with Moody’s rating on senior unsecured fixed-rate debt

  34. Interest Rate Risk • Debt • Short-term investment • Leasing

  35. Interest Rate Risk • Interest rate risk (debt) • Changes in interest rate affect I/S and cash flow; may result in insolvency and bankruptcy • Southwest solution • Low debt strategy • Total debt - $1.55B; low D/E ratio:0.30 (AMR:12.86, DAL:16.33, JBLU:1.65) • Market sensitive instruments • Fixed rates and modest financial leverage ($475M) • Interest rate swaps ($760M) • Prepayment, redemption or termination for floating-rate debt ($222M)

  36. Interest Rate Risk • Interest rate swap agreements (2003) • Agreement 1: pay LIBOR + a margin every 6 month and receive 6.5% every 6 month on $385M senior unsecured notes; due Mar-2012 • Agreement 2: pay LIBOR + a margin every 6 month and receive 5.496% every 6 month on $375M, 5.496% pass-through certificates; due Nov-2006

  37. Interest Rate Risk • Interest rate risk (short-term investment) • Total cash and cash equivalents of $1.87B as of Dec. 31, 2003 • Parallel closely with floating interest rates • Affects earnings and cash flow • Southwest solution • Invests in certificates of deposit, highly rated money markets, and investment grade commercial paper • No additional actions to cover interest rate market risk and other material market interest rate risk management activities

  38. Interest Rate Risk • Interest rate risk (leasing) • Total PV of leasing payments (2004 after): • Capital leasing - $91M • Operating leasing - $2.5B • Aircraft leases can be renewed at the end of the lease term for one to five years • However, leases are not considered market sensitive financial instruments and not included in the interest rate sensitivity analysis

  39. Interest Rate Risk • Results • No significant exposure to changing interest rates on fixed-rate debt • A liability of $18M - interest rate swap • Sensitivity analysis: 10% percent change would affect net earnings and cash flows by less than $1M (floating-rate debt, invested cash, and short-term investments) • An increase in rates has a net positive effect

  40. Credit Risk • Credit risk • Nonperfomance by the counterparties associated with outstanding financial derivative instruments • Results in credit loss • Southwest solution • Selects and periodically reviews counterparties based on credit ratings • Limits the exposure to a single counterparty • Monitors the market position • Agreements with seven counterparties (early termination rights, bilateral collateral provisions, security requirements) • Results • No counterparties fail to meet their obligations

  41. Liquidity and Financing Risk • Liquidity and financing risk • Agreements with financial institutions (credit card transactions) • Credit facility • Outstanding debt agreements • May reduce the availability of cash or increase the costs to keep the agreements • Southwest responsibility • Maintaining minimum credit ratings • Maintaining minimum assets fair values • Achieving minimum covenant ratios for available or outstanding debt agreements • Results • The company met or exceeded the minimum standards set forth in the agreements

  42. Risk Management Governance • No specific committee or RMO for Southwest’s risk management.

  43. Other Potential Risks and Uncertainties • War risk • Competitive factors • General economic conditions • Factors to control costs • Operational disruptions

  44. Stock Options • Stock-Based Employee Compensation covers: • Majority of employee groups • Board of directors • Plans related to certain contracts with certain executive officers of the company

  45. Stock Options • Two classes of employee stock plans: • Collective bargaining plans • Subjective to collective bargaining agreements • Granted at or above pair value • Normally have terms ranging from 6 to 12 years • No executive nor member of the Board of Directors are eligible to participate in this plan • Not required to be approved by Shareholders

  46. Stock Options • Other employee plans • Not subjective to collective bargaining agreements • Granted at fair market value • Have 10-year terms and become fully exercisable after three, five or ten years • Need to be approved by shareholders

  47. Stock Options

  48. Stock Options Shares Outstanding: 790 million Stock Price: $14.33

  49. Singapore Airlines