SOUTHWEST AIRLINES CO. ANNUAL REPORT PROJECT MICHAEL HSUN BUS A.

Transcription

1 SOUTHWEST AIRLINES CO. ANNUAL REPORT PROJECT MICHAEL HSUN BUS A

2 Introduction CEO: Gary C. Kelly Headquarters: Dallas, TX Ending date of latest fiscal year: 30, 2012 Dec Southwest Airlines provides scheduled air transportation services in the United States. It is the third largest airline in the United States by passenger carriage and operates using a low cost, point-to-point transit model. 97 destinations across 41 states, and six international Central American countries.

3 Audit Report Independent Auditors: Ernst & Young LLP of Dallas, Texas The financial statements presented fairly the consolidated financial position, results of operations, and cash flows of Southwest Airlines Co. in conformity with US generally accepted accounting principles.

4 Stock Market Information Most recent closing price: $ week range: $8.45 to $14.56 Dividend per share (last quarter): $0.04 As of June 18, 2013

5 Stock Market Information Recommendation: HOLD Significant cost creep: Unit costs 30% higher than low fare competitor-leader Allegiant Industry high labor costs Revenue growth lagging behind peers Missed 15% ROIC target for 2012 Long term outlook seeks cost synergies from AirTran acquisition and development of new, ancillary revenue streams (i.e. checked baggage fees) Strong capacity growth (more than doubled since 2000)

6 Income Statement (In Millions) Gross profit 8,438 7,792 Income from operations Net income The above format is in a single-step format While revenues and corresponding net income are increasing strongly, a fall in operations income suggests that the company s operational costs are increasing

7 Balance Sheet (In Millions) Assets = Liabilities + Stockholders Equity ,596 11,604 6, ,068 11,191 6,877 Assets grew primarily through an increase in flight equipment (aircraft) Liabilities grew by approximately the same amount through an increase in air traffic liability. Stockholders equity decreased slightly to remain approximately the same

8 Statement of Cash Flows (In Millions) Operating Activities 2,064 1,356 Investing Activities (833) (1,022) Financing Activities (947) (766) Cash flows from operations are significantly higher than net income The company is growing through investing activities, especially through recent purchases of new flight equipment (aircraft) The company s two primary sources of financing are proceeds from employee stock plans and proceeds from the termination of interest rate derivative instrument Cash has increased by approximately $2 billion in the last two years

9 Accounting Policies Revenue recognition: Tickets sold are initially deferred as Air traffic liability. Passenger revenue is recognized when transportation is provided. The Company estimates the amount of tickets that expire unused and recognizes such amounts in Passenger Accounts and other receivables: Accounts and other receivables are carried at cost. They primarily consist of amounts due from credit card companies associated with sales of tickets for future travel, amounts due from business partners in the Company s frequent flyer programs, and amounts due from counterparties associated with fuel derivative instruments that have settled.

10 Accounting Policies Inventories: Inventories consist primarily of aircraft fuel, flight equipment expendable parts, materials, and supplies. All of these items are carried at average cost, less an allowance for obsolescence. These items are generally charged to expense when issued for use. Short-term and noncurrent investments: Short-term investments consist of investments with original maturities of greater than three months but less than twelve months when purchased. These are primarily short-term securities issued by the U.S. Government and certificates of deposit issued by domestic banks. All of these investments are classified as available-for-sale securities and are stated at fair value, which approximates cost. Property and equipment: Property and equipment is stated at cost. Depreciation is provided by the straight-line method to estimated residual values over periods generally ranging from 23 to 25 years for flight equipment and 5 to 30 years for ground property and equipment once the asset is placed in service.

11 Topics of Notes to Financial Statements Cash and cash equivalents Short-term and noncurrent investments Accounts and other receivables Inventories Property and equipment Aircraft and engine maintenance Goodwill and intangible assets Revenue recognition Frequent flyer programs Advertising Share-based Employee compensation Financial derivative instruments Software capitalization Income taxes Concentration risk

12 Financial Analysis Liquidity Ratios Liquidity Ratio Formula Working capital CA CL 4,227 4,650 = (423) Current ratio CA/CL 4,227/4,650 = 0.92 Receivables turnover Average days sales uncollected Inventory turnover Net Sales/Averag e AR Days/Receiv ables turnover COGS/Avera ge Inv. 17,088/[( )/2] = ,345 4,533 = (188) 4,345/4,533 = ,658/[( )/2] = /54.2 = /63.4 = ,399/[( )/2] = ,237/[( )/2] = 38.0

13 Financial Analysis Liquidity Ratios Liquidity Ratio Formula Average days inventory on hand Operating cycle Payables turnover Average days payables Days/Inventory turnover Days inventory + Days sales Days payable COGS/Average AP Days/Payables turnover 366/30.8 = /38.0 = = ,399/[( )/2] = = ,237/[( )/2] = /12.4 = /13.6 = 26.8

14 Financial Analysis Liquidity Ratios Although working capital and the current ratio is declining, Southwest has over $1B in cash which decreases the risk of nonpayment to creditors Operating cycle increased significantly, but Southwest is still self-financing Overall liquidity remains strong, bolstered particularly by a strong cash position

15 Financial Analysis Profitability Ratios (In Millions) Formula Profit margin Asset turnover Return on assets Return on equity Net income/reven ue Revenue/Aver age Total Assets Net Income/Avera ge Total Assets Net Income/Avera ge Total SHE 421/17,088 = 2.46% 17,088/[(18, ,068)/2] = /[(18, ,068)/2] = 2.30% 421/[(6, ,887)/2] = 6.07% 178/15,658= 1.14% 15,658/[(18, ,463)/2] = /[(18, ,463)/2] = 1.06% 178/[(6, ,237)/2] = 2.71%

16 Financial Analysis Profitability Ratios Profit margin improved slightly, marking 40 consecutive years of profits an outlier in the airline industry Asset turnover, a measure of revenue generation efficiency, remained flat, but high compared to its competitors ROA and ROE improved significantly, helped by ongoing AirTran acquisition synergies

17 Financial Analysis Market Strength Ratios (In Millions) Formula Price/earnings per share Dividend yield Price per share/eps Annual dividends per share/pps 10.24/0.56 = /10.24 =.337% 8.56/0.23 = /8.56 =.210%

18 Financial Analysis Market Strength Ratios P/E Ratio has declined significantly; no longer overvalued Southwest nearly doubled its dividend in 2012 on the back of improved profitability and operating metrics Dividend growth is expected to continue, as demonstrated with the recent 2013 announcement of a quadrupling the regular quarterly dividend to $0.04

19 Financial Analysis Solvency Ratios (In Millions) Formula Debt to equity Financing gap Total Liabilities/Total Equity Operating Cycle > Days Payable 11,604/6,992 = < 29.5 = Self-financing 11,191/6,887 = < 26.8 = Self-financing

20 Financial Analysis Solvency Ratios A debt to equity ratio greater than one indicates that creditors control the company Low interest rates in recent years have allowed Southwest to increase its debt to equity ratio without jeopardizing the company s financial health Southwest is self-financing; no financing gap exists

21 Industry & Company Plans In the last decade, the US airline industry has undergone an unprecedented period of restructuring and consolidation. Today, airlines are returning to profitability and the industry has stabilized into a sustainable one. ( Among the four legacy carriers that remain (United, Delta, American, and Southwest), Southwest is extremely well positioned to capture market share and demand for low-cost travel.

22 Industry & Company Plans Southwest is currently in the process of acquiring AirTran Airways which will make it the biggest low-cost carrier in North America when complete. The scale and network of the combined carriers will solidify its position as the world s third largest airline by passenger carriage. In addition, Southwest is beginning to foray into international markets. International passenger growth of 4.7% versus 3.1% for domestic passengers last year signal widespread opportunities for future growth in international markets. (FAA Aerospace Forecast Fiscal Years )

23 Industry & Company Plans Southwest has indicated that in light of industry consolidation, it no longer aims to offer the lowest fares, but rather become the dominant carrier on the routes it serves. The industry as a whole is limiting passenger carriage growth in favor of stronger yields and sustainable airfares. est-airlines-were-not-really-about-cheapflights-anymore/

24 Executive Summary The airline industry has witnessed a remarkable structural shift in the last decade. Consolidation has led to sustainable pricing, greater efficiency, and stronger route optimization. Southwest has benefited, and will continue benefit strongly from these developments. Its consistently profitable business model and strong management practices will continue to uphold and strengthen its competitiveness.

25 Executive Summary Southwest is highly efficient at managing capital. Extra cash is used to buyback shares and expand capacity while taking advantage of favorable fuel hedging contracts and attractively-priced acquisitions (most notably, the AirTran acquisition). Airline bankruptcies in the last decade have allowed legacy carriers to renegotiate labor contracts and lower labor costs. But Southwest has not had the opportunity to renegotiate and restructure its labor contracts, whose costs are now among the highest in the industry.

26 Executive Summary In addition, Southwest has been slow to expand into international markets where competitors such as JetBlue have thrived. After missing its 15% ROIC target for 2012, a conservative management has largely failed in efforts to keep Southwest a formidable competitor. Despite these concerns, Southwest s strong financial position will allow it to grow and invest in a restructured industry.