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					Airlines

David Chan
Maggie Han
Franky Yuen
Sean Li
       Categories of Airlines
• International

• National

• Regional

• Cargo
    Large issues about airlines
• Weather

• Fuel Cost - typically, 14-16% of total cost is
  from fuel cost.

• Labor - Estimated to be 40% of the total airline
  expenses
Regulatory Government Agency
• The Department of Transportation (DOT)
• The Federal Aviation Administration
  (“FAA”)
• President of the United States
• The Transportation Security Administration
• The Department of Justice (“DOJ”)
• The United States Environmental
  Protection Agency (“EPA”)
                  Regulations
 International Air Transportation Competition Act
 U.S. Transportation Code
 Federal Air Regulations
 Occupational Safety and Health Administration (OSHA)
  regulations
 Food and Drug Administration (FDA)regulations
 Aviation and Transportation Security Act
 The Airport Noise and Capacity Act of 1990
  Influence of Regulatory Changes
• Enaction of Aviation and Transportation Security
  Act

• TSA assumed the aviation security functions and
  assumed passenger screening contracts at U.S.

• Cost on reducing the number of waiting lines
   Special Regulatory risk for Delta

• Periodic renewal of certain route authority is required

• Success in renewal is not guaranteed
Risk Factors of Airlines
Pressures to airline companies
• Threat of New Entrants

• Power of Suppliers

• Power of Buyers

• Competitive Rivalry
Risk Participating Stock Drops
             Strategy Risk
• Strategic risks are defined by business
  design choices and how these interact
  with various external factors
   -Challenge from a new form of
  competition,
   -Shifts in customer preference
   -Industry consolidation
      Strategic Risk Mitigation
• Conserve cash during the boom times and
  invest in the tough
• Selection of an appropriate business
  design itself
• Traditional responses
  – Creating a culture focused on the customer
  – Developing a rigorous strategic planning process
  – Maintaining an independent board of directors
 Strategy Risk Mitigation by Southwest

• Selection of the business design
  -Attract customers in good times and in
  bad
  - Use of secondary airports
  - Low debt levels reduce the exposure to
  interest rate fluctuations.
  -Profit sharing and a fun culture reduce the
  chance of labor difficulties
            Financial Risk
• Financial risks involve the management of
  capital and cash, including exogenous
• factors that affect the variability and
  predictability of revenue and cash flow
• (e.g., general economic conditions or
  foreign exchange rates).
      Hedging Financial Risk
• Design and placement of financial
  transactions
   -Structured finance
   -Derivatives
   -Insurance
   -Contingent financing
   -Debt/equity offerings
Operating Income of Fuel Hedging
 New Financial Risk Management
• Guarantees for credit card transactions.
          Operational Risk
• Operational risks arise from the more
  tactical aspects of running the business
  day-to-day, such as crew scheduling,
  accounting and information systems, and
  e-commerce activities.
   Operational Risk Mitigation
• Organizational solutions
  - Process redesign
  - Organization structural changes
  - Improved communication
  - Contingency planning
  - Performance measurement
  - Reward systems
  - Capital allocation and pricing
   Operational Risk Mitigation
• Working with the government to shape
  industry regulation
Delta Airline
                  Business


• “We are a major air carrier that provides
  scheduled air transportation for passengers
  and cargo throughout the United States and
  around the world”
          Corporate Information
• Headquarters: Atlanta, Georgia
• Subsidiaries: Atlantic Southeast Airlines,
  Comair
• Destinations: 497 cities in 88 countries
• SkyTeam Alliance
• Daily flights+partners: 7,697
             Stock Price
• NYSE Symbol: DAL
Route Map
Goals


        • Cost Reduction
    [Bankruptcy or restructure]
                  Risks
• Fuel Price

• Currency

• Interest Rate

• Others
                Fuel Price

• Fuel price structure




• Average fuel price up by 20% from
  2000-2003
            Fuel Price Risks
• Solution: Hedging
• Problem: No jet fuel market
• Hedge contracts – up to 36 months, hedge
  up to 80% of expected fuel requirement on
  a 12 month rolling basis
• Dec 31, 2003, hedged 32% of aircraft fuel
  requirement for 2004 at an average
  76.46¢
         Fuel Price Risks Continue
• In February 2004, all of our fuel hedge contracts
  are settled prior to their scheduled settlement
  dates; received $83 million in cash

• SFAS 133, gains of $82 million will be recorded
  in accumulated other comprehensive loss until
  the related fuel purchase, which were being
  hedged, are consumed and recognized in
  expense during 2004
Fuel Price Risks Continue
Fuel Price Risks Continue
         Fuel Price Risks Continue




Other comprehensive loss
• Additional pension liability

2) Effective unrealized gain/loss of fuel hedging contracts

3) Effective unrealized gain/loss of market securities
            Interest Rate Risks
• Solution: Interest Rate Swap
• (1) $300 million principal amount of
  unsecured Series C Medium-Term Notes
  due March 15, 2004, which pay interest at
  a fixed rate of 6.65% per year and
• (2) $500 million principal amount of
  unsecured Notes due December 15, 2005,
  which pay interest at a fixed rate of 7.70%
  per year.
          Interest Rate Continue
• May 9, 2003, settled these interest rate swap
  agreements prior to their expiration. As a
  result, we received $27 million, including
  $7 million previously recognized as
  adjustments to interest expense under the
  terms of the swap agreements. The fair value
  adjustments to the previously underlying
  debt related to the interest rate swaps totaled
  $20 million.
         Exchange Rate Risk
• Solution: may enter into foreign
  currency options and forward contracts
  with maturities of up to 12 months. We
  did not have any foreign currency
  hedge contracts at December 31, 2003
  or 2002.
Fair value of derivatives
Fair value of derivatives
              Stock Options
• All stock options granted had an exercise
  price equal to the fair value of the
  underlying common stock on the grant
  date.
Stock Options
              Stock Options
Four Stock Option Plans:
- Broad-based Employee Stock Option Plan
- Delta 2000 Performance Compensation Plan
- Non-Employee Directors’ Stock Option
  Plan(1998)
- Non-Employee Directors’ Stock Option
  Plan(1995)
               Stock Options
Broad-based Employee Stock Option Plan
-Broad-based pilot and non-pilot plans
-Granted eligible employees non-qualified stock
  options to purchase a total of 49.4 million
  shares of common stock in three
  approximately equal installments on
  October 30, 1996, 1997 and 1998.
                Stock Options
Delta 2000 Performance Compensation Plan
-Authorizes the grant of stock options and a
  limited number of other stock awards.
- Restates the prior plan
- No awards will be granted under the prior plan
  on or after this date
                Stock Options
Non-Employee Directors’ Stock Option Plan(1998)

- Each non-employee director may receive an
  annual grant of non-qualified stock option
                Stock Options
Non-Employee Directors’ Stock Option Plan(1995)

- A portion of each non-employee director’s
  compensation will be paid in shares of common
  stock
Stock Options
              Stock Options
Stock Option Exchange Program
- Commenced on May 28, 2003
- Eligible employees
  - Broad-based Stock Option Plans
  - Delta 2000 Performance Compensation Plan.
- Board of Directors(CEO) not eligible
            Stock Options
-canceled approximately 32 million
outstanding stock options on June 25,
2003
-issued approximately 12 million
replacement options on December 26,
2003. The exercise price of the
replacement options is $11.60, the closing
price of our common stock on the grant
date.
            Stock Options
-canceled approximately 32 million
outstanding stock options on June 25,
2003
-issued approximately 12 million
replacement options on December 26,
2003. The exercise price of the
replacement options is $11.60, the closing
price of our common stock on the grant
date.
Stock Options
Stock Options
               Stock Options
-Earnings Per Share (EPS)
Southwest Airline
           Company Background

• Southwest Airline is incorporated in Texas in 1971
      - only 3 Boeing 737 aircraft
      - serving three Texas cities
        (Dallas, Houston, and San Antonio)

• In 2003, Number ONE carrier in terms of domestic
  boarding in the U.S.

• “ LUV “ --- Stock Exchange Symbol
                  Southwest Airline
•Southwest operated 388 Boeing 737
aircraft
•Provided service to 59 airports in 58
cities in 30 states throughout the
United States
•The “largest carrier” in the United States
(based on originating domestic passengers boarded and scheduled
domestic departures)
Market Share of Southwest
     Southwest Airline Characteristics
•   Short-haul
•   High-frequency
•   Point-to-point
•   Low-fare
         Competitive Strengths:

• low operating costs
• the lowest costs among the major airlines
• focus principally on point-to-point service,
  rather than hub-and-spoke
         Major Competitors


• American Airline
• Jet Blue Airway
• Delta Airline
      Major competitors comparison:
                               LUV          AMR          DAL          JBLU       Industry

Market Cap:                     11.13B         1.40B     625.05M        1.97B          684.11M
Employ-ees:                     31,011        92,100       70,600       5,956            5.96K
Rev. Growth (ttm):              10.00%        0.80%        0.00%       26.80%          13.50%
Revenue (ttm):                   6.53B       18.65B       14.97B        1.27B            1.46B
Gross Margin (ttm):             29.83%       18.91%        4.61%       34.57%          19.69%
EBITDA (ttm):                  986.00M         1.15B     -208.00M     189.48M          119.37M
Oper. Margins (ttm):            8.50%        -0.77%       -9.71%        8.92%           3.65%

Net Income (ttm):              314.00M      -760.00M       -3.34B      47.47M          12.00M
EPS (ttm):                       0.386        -4.731      -26.757       0.429             0.35
PE (ttm):                        36.79            N/A          N/A      43.92            12.77
PEG (ttm):                           1.81         N/A          N/A       3.19             1.52
PS (ttm):                            1.66         0.07         0.04      1.48   0.38


 AMR = AMR Corp
 DAL = Delta Air Lines Inc
 JBLU = JetBlue Airways Corp
 Industry = Airline
Above average industry performance




 "Southwest is the only airline that has
made money since 1973 with stock value
   up more than 500% since 1990"
General Airline Cost Structure
Southwest Airline Cost Structure
Southwest 5 Years Performance
Southwest Vs. Airline Industry




                                 Industry
                Potential Risks

•   Political risk
•   Economic risk
•   Competition risk
•   Fuel risk
•   Weather risk
•   Air Traffic Constraint
                 Political Risk

•   War risk
•   Military Actions
•   Terrorist attack risk (eg. 911 event)
•   Regulation changes
                   Insurance

Purpose of Insurance:
• protect the Company and its property
• comply both with federal regulations and certain
of the Company’s credit and lease agreements.

General Coverage:
•public and passenger liability, property damage,
cargo and baggage liability, loss or damage to
aircraft, engines, and spare parts, and workers’
compensation.
                 Insurance

Following the terrorist attacks

• Insurance premiums increase significantly
  – Increase operating expenses


• Reduced war-risk coverage for commercial
  carriers
              Competition Risk

•   Fare sales
•   Decisions by competitors
•   Changes in competitors' flight schedules
•   Mergers and acquisitions
•   Codesharing programs
             Economic Risk

• General economic conditions
• Demand for travel
• Consumer ticket purchasing habit
                  Fuel Risk

• Jet fuel – 2nd largest expenditure
• Jet fuel Consumption
  •2003  15.2% of operating expense
  •2002  14.9% of operating expense
  •2001  15.6% of operating expense

•Large fluctuation in fuel price
• Hedging fuel prices is required
Average cost of jet fuel, net of hedging
    gains, over the past five years
Income Statement
               Fuel Hedging

• Risk of increasing jet fuel prices
• Derivative instruments not for trading purposes
• No reliable forward market for jet fuel
• Company must estimate the future prices of jet
  fuel
• Observe similar commodities (such as crude oil
  and heating oil)
                Fuel Hedging
December 31, 2003
Use call options, collar structures, and fixed price swap
agreements hedge the jet fuel
        82% of its 2004 total anticipated jet fuel requirements
        60% of 2005 total anticipated jet fuel requirements

• First quarter 2004 hedges are effectively heating oil-based
  positions in the form of option contracts
• Remaining hedge positions are crude oil-based positions.
Fuel Risk
               Fuel Hedging

• consume 1.2 billion gallons of jet fuel in
  2005
• A change in jet fuel prices of one cent per
  gallon would impact the Company’s “Fuel
  and oil expense” by approximately $12
  million per year.
 Stock-based Employee Compensation

Stock-based compensation plans covers:

• Company's Board of Directors
• Employment contracts with CEOs
• Majority of employee
              Employee Stock Plan

•   Two classes of employee stock plans:
    1) 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
Stock-based Employee Compensation

2) 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
Stock-based Employee Compensation
Stock-based employee compensation
              Financial Risk

• SW capitalize conservatively and grow
  capacity steadily and profitably.
• financial leverage

• An "A" credit rating on its senior
  unsecured fixed-rate debt with Standard &
  Poor’s and Fitch ratings agencies
• A "Baa1" credit rating with Moody's rating
  agency.
                    Credit Risk

• Default of counterparties to the financial derivative
  instruments agreements
• Solution :
• Review credit rating statuses of counterparties
• Spread exposure among several counterparties
• Monitor market position of the program and
  relative market position with each counterparty.
Result: No default of counterparties
Interest Rate Risk
    Floating Rate Debt Obligation

• Floating-rate financing arrangements

• Interest rate swaps
 Objective of interest rate swaps

– Reduce the volatility of net interest
  income

– Take advantage of market conditions
Interest Rate Swap
           Fixed Rate Debt

– Pass-through certificates

– Senior unsecured notes
        Hedge of Interest Rate Risk

• Use Short-term investment cover part of floating
  interest rate debt
   – Certificates of deposit
   – Highly rated money markets
   – Investment grade commercial paper
   – Other highly rated financial instruments.
   Influence of Change in Interest Rate

• a hypothetical ten percent change in interest
  rate results in:

• --No material effect on fair value of fixed rate
  debt

• --Less than $2million change in net earnings and
  cash flows

				
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posted:12/26/2011
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