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Introduction
United Airlines History
In 1926, Varney Airlines, America’s first commercial air transportation
company, got its start flying mail from Pasco, Washington to Elko, Nevada. In 1934,
Bill Boeing brought together a consortium of independent airlines including Varney,
National, Pacific, Boeing, and Pratt & Whitney. The companies merged to form
United Airlines Transportation Company. The company name was shortened to
United Airlines in 1943 (Simley p. 128).
Most of the companies Boeing brought together were in the airmail business
with two exceptions—Boeing and Pratt & Whitney. Boeing manufactured aircraft in
Seatle, and Pratt & Whitney manufactured aircraft engines. By joining forces the
group formed a vertical monopoly that planned to eliminate the competition.
However, 1934 was the same year Congress passed legislation outlawing vertical
monopolies. United was forced to divorce itself from Boeing and Pratt & Whitney.
Innovations
United is responsible for a large number of innovations in the airline industry.
It is credited with introducing air-to-ground radio, which greatly improved
communication and safety in the industry. A United exectutive also came up with the
idea of stewardesses. His reasoning was that no man could admit he was afraid of
flying if women were working on planes. The original eight stewardesses were all
registered nurses (Simley p. 128). In 1954, United became the first airline to use
flight simulators to train its pilots. It now operates the world’s largest, state of the art
training center valued at nearly $200 million (Student Resource Guide p. 9).
1
Expansion
In 1961, United acquired Capital Airlines. The purchase helped United
strengthen its presence in the eastern United States. In 1967, United became the first
airline to surpass $1 billion in annual revenues (Simley p. 129).
In 1978, the Airline Deregulation Act was passed. After the act became law,
the airlines were no longer required to get government approval before entering new
passenger markets. United was one of the first airlines to support deregulation;
however, after the act was passed, it was forced to scale down operations to remain
competitive (Standard & Poor p. 8).
Deregulation brought about the rapid growth of hub-and-spoke systems.
United Airlines now has four major hubs located in Washington Dulles, Chicago,
Denver, and San Francisco. The four hubs are perfectly positioned geographically to
cover the United States from east to west and north to south (Student Resource
Guide p. 5).
United purchased Pan Am’s Asian traffic rights for $715.5 million in 1985.
The agreement also included 18 jets, 2700 Pan Am employees, and all of Pan Am’s
facilities in Asia. It also added 30 destinations and 65,000 miles to United’s network
(Simley, p. 129).
During the late 1980s, some of the more financially distressed airlines started
selling routes to raise money. Instead of reacting the way TWA and Pan Am did,
United saw this as an opportunity to expand and become more global. When the
economy began to weaken in the 1990s, the entire airline industry was hurt by
reduced passenger traffic. The Persian Gulf Crisis also caused an increase in fuel
prices.
2
These factors lowered the income of all the major airlines, and United
suffered a net loss of $331.9 million in 1991. Of course, United also made some big
purchases in 1991. In the spring, United purchased 6 Pan Am routes to London for
$400 million, and later that same year, it acquired part of Pan Am’s Latin American
division for $135 million. Today, United continues to expand into Latin America and
Europe (Simley p. 130).
Size
United’s vast network includes 5 continents, 30 countries, and 2 United States
territories with service to 97 domestic and 38 international airports worldwide.
United Airlines employs close to 92,000 people including 9,281 pilots, 21,283 flight
attendants, 26,430 mechanics, and 34,785 management and salaried personnel.
Everyday United employees are responsible for 2,245 flights carrying approximately
230,580 passengers (Student Resource Guide p. 10).
Fleet
As of January 1, 1998, United Airline’s fleet consisted of 576 aircraft, and the
company has already placed orders for 75 additional aircraft. The airline’s passenger
fleet includes 727’s, 737’s, 747’s, 757’s, 767’s, 777’s, McDonnell Douglas DC-10s,
and Airbus 320s. The average age of United’s aircraft is 10.8 years. During 1998,
United took delivery of 41 new planes including 4 Boeing 777-200s, 4 Boeing 747-
400s, 10 Airbus 320-200s, 16 Airbus 319s, and 3 Boeing 757-200s (Student Resource
Guide p.4).
3
Revenue
In 1997, United Airlines was the largest domestic airline with carrier revenues
of $17.4 billion, which was equal to 19.3% of industry revenues. United’s closest
competitor was American Airlines with $16.9 billion. The United States airline
industry is estimated to have had $90 billion in 1997 revenues. Eighty-one billion
dollars of that total came from ticket sales, and the other $9 billion came from in-
flight sales and carrying mail and other cargo (Standard and Poor p. 8).
In-flight sales consist of alcoholic beverages, telephone, ATM, and fax
services, as well as, a variety of television and entertainment services. Freight
accounts for close to 75% of United’s cargo shipments, with mail making up the other
25%. United’s cargo revenues increased 15% from 1996 to 1997, and now make up
5% of the company’s overall revenues. With $892 million in cargo revenue, United
is the largest cargo-revenue-producing airline in the United States (1997 Annual
Report p. 19).
Unions and the Employee Stock Ownership Plan (ESOP)
In the past, United has had some trouble with its employee unions. In 1976,
the airline paid a million-dollar settlement in an anti-discrimination lawsuit filed by
female and minority employees. And in 1979, United lost $72 million due to a month
long strike (Simley p. 129).
To solve some of these problems, United underwent major changes in 1994.
Gerald Greenwald was elected the new company CEO. He oversaw the buyout of
United Airlines and its conversion into the largest employee owned corporation.
United’s pilots’ and machinists’ unions now own 60% of the company (Leonhardt p.
4
42). Under the employee stock ownership plan, employees forgo wage and benefit
increases in exchange for stock in United Airlines.
United also developed its own “airline-within-a-airline” in 1994. The
employees named the new airline Shuttle by United. Shuttle was developed for many
reasons including providing passengers with an alternative in the growing low-cost,
high frequency, and short-haul market up and down the West Coast, creating
additional jobs for United employees, and feeding United’s hubs. Shuttle provides
service to 20 West Coast cities and offers 466 daily departures (Student Resource
Guide p. 2)
The ESOP agreement was reviewed in 1996 to make sure employee wages
were comparable to the industry. In March of 1997, the unions reached an agreement
with United that increased wages 5% in July of 1997 and an additional 5% in July of
1998. The agreement also provided a provision to restore wages to pre-ESOP levels
in 2000 (1996 Annual Report p. 3).
CEO
On March 25, 1999, the Board of Directors of UAL Corporation elected
James E. Goodwin to succeed Gerald Greenwald as chairman and chief executive
officer. Goodwin has been the president and chief operating officer of United since
September of 1998. He will assume his new duties in July of 1999 (UAL Board, p. 1)
Goodwin is a 32-year veteran of United Airlines. His previous positions with
the company include running the North American and overseas operations and the
San Francisco maintenance center. Labor officials have praised the board’s decision
5
because of Goodwin’s knowledge of the company and his ability to make
subordinates feel involved in decision-making (Leonhardt p. 44).
The biggest challenge facing the new CEO will be labor negotiations. By
April 2000, United and its two employee unions must decide whether or not to renew
the 1994 employee stock ownership plan (ESOP). Approving the plan means
employees will give up higher wages in return for stock. A majority of the pilots
want to renew the plan because of United’s five-year stock performance. However,
the machinists are not as happy with ESOP 2. If talks do not go well, United could
face the same kind of labor problems that have plagued American and Northwest
Airlines.
6
Environment Analysis
Macroeconomic Analysis
Sales of industries, such as airlines or luxury consumption goods, critically
depend on macroconditions: sales rise when the economic conditions improve and
decline when economic conditions deteriorate (Benningga, p. 140). Since airline
industry is both labor and capital intensive, its yield can be expressed as a function of
leading economic indicators such as the ∆% in labor rate, the ∆% of fuel price per
gallon and the ∆% of interest rate. The historical date for the years 1988 – 1997 is
gathered and then converted to constant index at 1997 = 100 with is showed below:
Nominal
Yield CPI Labor Fuel Interest Percentage Change (%)
Year (per emp
(cents) 97=100 per year) (per gal.) (%) Labor Fuel Interest
1988 11.88 44,915.2 53.4 9.67 2.95% -4.54% 3.47%
1989 12.43 46,581.7 60.2 10.46 3.58% 11.32% 7.57%
1990 12.76 47,384.0 77.8 10.11 1.69% 22.58% -3.54%
1991 12.74 50,268.0 70.0 8.56 5.74% -11.17% -18.04%
1992 12.50 52,789.5 65.5 8.34 4.78% -6.84% -2.63%
1993 13.06 55,692.3 60.2 8.54 5.21% -8.73% 2.35%
1994 12.60 57,901.6 54.8 9.22 3.82% -9.83% 7.38%
1995 12.87 60,633.0 55.8 9.83 4.50% 1.70% 6.21%
1996 13.10 62,040.0 65.2 9.14 2.27% 14.42% -7.57%
1997 13.13 63,437.0 63.1 7.58 2.20% -3.33% -20.57%
Real
1988 21.10 56.3 79,778.4 94.9 17.18 -6.30% -14.51% -5.74%
1989 19.98 62.2 74,890.2 96.8 16.82 -6.53% 2.02% -2.12%
1990 18.47 69.1 68,573.2 112.6 14.62 -9.21% 13.99% -15.03%
1991 17.03 74.8 67,203.2 93.6 11.45 -2.04% -20.34% -27.78%
1992 15.78 79.2 66,653.4 82.7 10.53 -0.82% -13.13% -8.67%
1993 15.66 83.4 66,777.4 72.2 10.24 0.19% -14.50% -2.83%
1994 14.43 87.3 66,324.9 62.8 10.56 -0.68% -14.96% 3.05%
1995 14.05 91.6 66,193.2 60.9 10.74 -0.20% -3.14% 1.59%
1996 13.60 96.3 64,423.7 67.7 9.49 -2.75% 10.03% -13.09%
1997 13.13 100 63,437.0 63.1 7.58 -1.56% -7.30% -25.20%
7
Yield – measure revenue of the industry. In this case yield is measured in
cents and is indexed at 1997 = 100.
Labor – the industry’s largest cost item. Labor cost absorbs about 30% of the
average carrier’s revenues. Therefore, the change in labor cost has significant effect
on their income. In this case the labor cost per employee is indexed at 1997 = 100
Fuel – the second largest cost item. Fuel cost absorbs about 10%-15% of the
average carrier’s revenues. In this case the average price/gallon of jet fuel is indexed
at 1997 = 100
Interest – most carriers are highly leveraged. Therefore, the change in interest
rate has directly effect on their CF and NPV. In this case the interest rate is indexed
at 1997 = 100
From the information above, regression model for airline industry’s real yield
is:
Yield = 12.98 – 99.71(∆%L) – 15.57(∆%F) +6.27(∆%I)
Yield - airline industry revenue per passenger mile
∆%L - percentage change in labor cost per employee
∆%F - percentage change in fuel price per gallon
∆%I - percentage change in interest rate
R2 = 85.56% - the change in fuel price (%), the change in labor cost (%)
and the change in interest rate (%) explain 85.56% of yield.
F Value = 18.885 > 4.76 - at 5% level of significance the F Value is
greater than the critical F. Therefore, this model is a “good fit”.
Significance F = 0.001850657 < .05 – at 95% confidential level, this model
is significance.
8
Industry Analysis
The U.S. airlines industry took in estimated revenues of $90 billion in 1997,
of which some $81 billion (90%) was derived from passenger fare. In addition to
passenger fares, the industry obtained another $9 billion by carrying mail and cargo
and from in-flight sales. In comparison, revenues totaled $86.2 billion in 1996, with
$76.6 billion (89%) in passenger fares. Domestic travel accounted for 78% of
passenger revenues in 1997; international travel accounted for 22% (Standard p.8).
Airlines derive their revenues primarily from the fares they charge to transport
passengers. They also earn revenues by transporting mail and cargo and by selling
in-flight services and alcoholic beverages.
The airline industry has transformed the commercial world into one big
market place. Consequently, many business people use air travel to make sales trips,
visit far-flung factories, and attend industry conventions. In its latest survey of air
travel (1995), the Travel Industry Association (TIA) found that 41% of air trips were
made for business purposes.
The business traveler is the industry’s principal moneymaker. A United
Airlines survey in 1997 determined that just 9% of its passengers (in business class)
were contributing 44% of its revenues. Business travelers generate high yields for
airlines because they typically book flights at the last minute, when fares are highest.
Because their firms pick up the tab, they tend to be relatively price-insensitive
(Standard p.16).
9
Industry Structure
The airline industry is an imperfect oligopoly. A few major carriers; UAL,
AMR, DAL and NW dominate long-haul passenger traffic, while several dozen small
carriers compete for short-haul flights (Standard, p. 16).
1997 Market Share
(Based on revenue passenger-miles)
UAL
20%
Others
34%
AMR
18%
NW
12% DAL
16%
Source: Airlines Industry Survey, May 14, 1998
10
Airline size categories
According to Airlines Industry Survey, the Department of Transportation
(DOT) classifies airlines as following; major, national, or regional carriers, according
to the size of their revenue base.
Major airlines – carriers whose revenues exceed $1.0 billion. They typically
operate jet aircraft with 150 to 400 seats on an average stage (or flight) length of
about 1,000 miles. The large aircraft used for international flights can travel
5,000 miles before refueling.
National airlines – carriers whose revenues fall between $100 million and $1
billion. Despite their designation, some of these carriers may limit their service to
regional markets, while others may offer international service. Their aircraft may
have somewhat smaller seating capacity than the major’, about 100 to 150 seats.
Additionally, national carriers may operate more short-haul flights and typically
specialize in point-to-point service.
Regional airlines - carriers whose receive revenues of less than $100 million.
This category contains two distinct types: commuter lines and the start-up carrier.
Commuter lines – primarily serve low-density, short-haul markets.
Start-up carriers – classified as regional because of their revenue base, may
initially serve a single region; however, their goal is to offer broad coverage.
11
Competition Analysis
Airlines confront a variety of competitors. In some markets, major airlines
face competition from other majors and from national and regional airlines as well.
All airlines compete with other transportation modes, such as automobiles, railroads,
and buses.
Following deregulation in 1978, competition in the airline industry intensified.
As regulatory barriers to entry were dismantled and risk capital poured in, established
carriers faced an unending parade of aggressive start-up airlines that targeted larger
carriers’ high-margin business. In recent years, competitive pressures have eased as
capacity has tightened and carriers have limited their geographic reach.
The automobile is the airline industry’s chief competitor. Airline travel is
neither practicable nor economical for short traps. According to the Travel Industry
Association, some 70% of auto trips were under 600 miles in 1995 (latest available),
compared with only 11% of airlines trips. For long distances, air travel is preferred.
Some 75% of airline trips exceed 1,000 miles, while only 13% of auto trips exceed
that distance.
Airlines also face competition from intercity railroads, specifically Amtrak,
whose fares are partly subsidized by the U.S. government. While Amtrak operates
some long-distance routes, its passengers use it for an average journey length of about
280 miles. Intercity bus travel, although much more popular than railroads, rarely
competes directly with air travel because the typical bus journey is just 140 miles.
Airlines compete with each other on other service and price. For business
travelers, flight frequency and reliability are critical, while cuisine and frequent-flyer
12
programs also are influential. Small airlines that cannot obtain gate space during
peak travel periods are unable to attract business travelers.
Service information is disseminated by the U.S. Department of
Transportation’s (DOT) Office of Consumer Affairs, which each month reports the
on-time performance for the larger airlines. The DOT also collects and disseminates
information about airlines’ performance in baggage handling and overall complaint
record. These statistics can influence business travelers’ carrier selection. Leisure
travelers are less affected by such reports; aside from the few first-class nonbusiness
passengers, price is the leisure traveler’s biggest concern.
In differentiating themselves from their competitors, airlines may strive to
build brand loyalty through frequent-flyer programs. Targeted mainly to business
travelers, frequent-flyer programs let travelers chalk up bonus miles by taking flights
or by conducted business with other organizations that have tie-ins with the airlines.
These bonus miles can be redeemed for free air tickets. Frequent-flyer programs are
desinged to promote repeat business for an airline; members tend not to defect to
another airline to reap minor price savings.
13
Price Competition
Price competition is a fundamental weapon that carriers commonly use to win
a greater share of the leisure market. Fare differentials of just a few dollars can
persuade leisure travelers to select one airline over another or to make their journey
by a different mode. In contrast, business fares are rarely discounted and do not
change as often.
However, since airlines view their seats as a perishable inventory. Once a
plane is aloft, its empty seats can no longer be sold. To prevent such loss of
inventory, the industry has developed sophisticated computer programs to help
determine how much demand there will be for each route at different times of the day,
days of the week, and seasons of the year.
Airlines also attempt to calculate how much of a flight should be booked by a
given point in time through a process known as yield management. Yield
management alerts the carrier to abnormal booking patterns, to which it can react by
either cutting or raising fares well before a flight departs.
Furthermore, to attract leisure travelers, airlines advertise deeper discounted
fare. But most passengers do not get these fares because, by law, carriers do not have
to offer more than 10% of the seats on a flight at the discounted rate. On a given
flight, passengers who are flying coach may have booked fares at as many as dozen
different prices. Carriers offer different level of fares according to the length of time
in advance that the flight is booked. Walk-up fares, paid by passengers at the airport
gate at departure time, are the highest.
14
On the other hand, since deregulation, the airline industry has been prone to
periodic bursts of destructive fare wars. Some of the blame lies in the aggressive
pricing tactics of start-up carriers, which operate with substantially lower costs than
the major airlines.
Generally, the industry is susceptible to fare wares when the level of capacity
is fare in excess of the level of demand. Because airlines have high fixed costs (for
equipment and terminal facilities) relative to their marginal costs (the cost of flying
one additional passenger), fare wars can reach extremes before order is restored.
15
Traffic Analysis
Revenue passenger miles (RPMs)
RPMs is an indicator measures the total number of passengers carried by the
industry’s 10 largest airlines multiplied by the number of miles flown. Since the 10
largest carriers account for some 94% of total U.S. traffic, RPMs is a great indicator
to measure how much the industry has grown in the past years (Standard p. 21).
According to the table and graph below, in the past five years (1998-1997),
RPMs has been growing at an average rate of 3.92%. Using that geometric means,
next year RPMs can be predicted to be 605.43 billions RPMs.
RMPs RMPs RMPs (Billions)
Year (Billions) Growth
650
1988 423.30 4.45%
600
1989 432.71 2.18%
1990 457.93 5.51% 550
1991 447.95 -2.23%
500
1992 478.55 6.39%
1993 489.65 2.27% 450
1994 519.38 5.72%
1995 540.66 3.94% 400
1988 1989 1990 1992 1993 1994 1995 1997 1998
1996 578.66 6.57%
1997 605.43 4.42% RMPs 423.30432.71 457.93478.55 489.65519.38 540.66605.43 629.17
1998 (F) 629.17 3.92%
16
Operating Cost Analysis
Labor
According to Airlines Industry Survey, labor is the industry’s largest cost
item, absorbing about 30% of the average carrier’s revenues (Standard p.19), it is a
factor to be watched closely. Although some airlines spend as little as 22%, some
others spend as much as 36% of their revenues on labor. Such disparities depend on
the carrier’s efficiency and the labor intensiveness of their routes. For example,
airlines that serve meals require more flight attendants and cleaning personnel than
airlines that do not. In addition, outsourcing certain tasks such as maintenance or
reservation services both reduces labor costs as a percentage of total costs and cuts
total costs as well (Standard p24).
According to the regression model:
Yield = 12.98 – 99.71(∆%L) – 15.57(∆%F) +6.27(∆%I)
If the labor cost (L) change by 1% and all other variables holding constant, the
yield should change 86.73 cents.
17
Fuel
Airlines are energy-intensive operations. Fuel consumption rates are greatly
influenced by the age of a carrier’s aircraft; newer planes are more fuel-efficient than
older ones.
Fuel prices are expected to fall in 1998. Jet fuel, which averaged 64.7 cents
per gallon in 1997 (a 1% rise over 1996) is expected to average about 52 cents, or
20% less in 1998. The reduced demand from Asia, and continued disarray within
OPEC have driven jet fuel prices to four-year lows. Iraq’s return to the oil markets
has also helped to depress fuel prices. Airlines, which consume about 18 billion
gallons annually, could save as much as $2 billion in fuel costs in 1998 (Standard
p24).
According to the regression model:
Yield = 12.98 – 99.71(∆%L) – 15.57(∆%F) +6.27(∆%I)
If the price of fuel per gallon (F) change by 1% and all other variable holding
constant, the airlines industry’s yield should change by 2.59.
18
Industry Outlook
In 1998, the airlines industry is expected to grow 3.92% to post the record
high at 629.16 billion revenue passenger miles (RPMs), up 23.73 billion RPMs
posted in 1997. The 1997’s gain is a bit slower than the 4.8% average growth rate the
industry registered between 1986 and 1996 because of the higher fares have prompted
curtailment of travel, and Asian travel has plummeted in some markets. However,
according to Airlines Industry Survey, over the long run, air travel is expected to
continue to grow at approximately two times the rate of increase for real GDP.
Year GDP ($B) GDP g RMPs (B) RMPs g
1987 5,750.57 404.47
1988 5,952.83 3.40% 423.30 4.45%
1989 6,093.51 2.31% 432.71 2.18%
1990 6,078.96 -0.24% 457.93 5.51%
1991 6,105.25 0.43% 447.95 -2.23%
1992 6,327.12 3.51% 478.55 6.39%
1993 6,476.86 2.31% 489.65 2.27%
1994 6,688.61 3.17% 519.38 5.72%
1995 6,825.80 2.01% 540.66 3.94%
1996 7,093.12 3.77% 578.66 6.57%
1997 7,364.63 3.69% 605.43 4.42%
1998 Growth 2.43% 3.92%
Business travel, which accounts for 40% of passengers, may be flat in 1998,
given that corporate profits are expected to grow a meager 0.3% before taxes in 1998,
following a robust 8.3% gain in 1997. Meanwhile, airlines keep ratcheting up
business fares. American Express’s Business Fare Index rose 16% in 1997.
Corporations have reacted to the higher fares by encouraging their executives to fly
19
cheaper coach class and even to stretch their trip to include a Saturday stay to qualify
for deeply discounted leisure class rates. If this trend become pervasive, airlines will
face a squeeze on margins.
The outlook for vacation and personal travel in 1998 (both international and
domestic) appears positive. Leisure travel, which accounts for about 60% of
enplanements, is being buoyed by strong consumer sentiment and strong dollar.
Unemployment is expected to average 4.7% in 1998 – the lowest level in 30 years.
Stadard & Poor’s projects that disposable personal income will advance 5.4% in
1998, after seeing a 4.9% increase in 1997.
The strength in consumer sector is reflected in the sentiment consumer sector
is reflected in the sentiment readings calculated by the Conference Board, a private
research firm. In February 1998, consumer sentiment reached a 30-year high at
147.4, up sharply from the 47.3 nadir recorded in early 1992. With consumers in fine
spirits, more dollars will be allocated for leisure and traveling.
International travel, which accounts for 26% of RPMs, will lag the overall
growth anticipated in domestic markets. Still, it will climb a respectable 3.5% in
1998, down from 5.3% in crease recorded in 1996. A strong dollar, while helping
make vacations to Europe affordable, is hurting travelers coming to the U.S.
Additionally, traffic in most of Asia has deteriorated, reflected the region’s currency
and economic crises (Standard p.
20
Growth Projection
Under the assumption that UAL’s sales appreciates at the rate of inflation, the
constant-dollar sales of UAL can be estimated by adjusting the reported annual sales
to changes in the consumer price index (CPI). The conversion of UAL’s sales as
reported in its financial statements for the year 1988 – 1998 to Sales figure expressed
in 1997 dollars is presented in the following table and graph.
Nominal Real
Year UAL Sales Growth CPI UAL Sales Growth
($M) (%) 97=100 ($M) (%)
1987 8,292.790 51.4 16,133.83
1988 8,981.74 7.67% 56.3 15,953.36 -1.13%
1989 9,793.64 8.29% 62.2 15,745.39 -1.32%
1990 11,037.48 11.27% 69.1 15,973.19 1.43%
1991 11,662.58 5.36% 74.8 15,591.68 -2.45%
1992 12,889.70 9.52% 79.2 16,274.87 4.20%
1993 14,511.00 11.17% 83.4 17,399.28 6.46%
1994 13,950.00 -4.02% 87.3 15,979.38 -8.89%
1995 14,943.00 6.65% 91.6 16,313.32 2.05%
1996 16,362.00 8.67% 96.3 16,990.65 3.99%
1997 17,378.00 5.85% 100 17,378.00 2.23%
1998 Growth 5.66% 1998 Growth 1.17%
UAL's Sales in Nominal vs. Real
18,000
17,000
16,000
15,000
14,000
(millions)
13,000
12,000
11,000
10,000
9,000
8,000
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Nominal 8,981.74 9,793.64 11,037.48 11,662.58 12,889.70 14,511.00 13,950.00 14,943.00 16,362.00 17,378.00
Real 15,953.36 15,745.39 15,973.19 15,591.68 16,274.87 17,399.28 15,979.38 16,313.32 16,990.65 17,378.00
21
Ratio Analysis
Liquidity Ratios
UAL UAL UAL UAL UAL UAL
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LIQUIDITY
Current ratio 0.56 0.54 0.69 0.65 0.76 0.64
Quick Ratio 0.36 0.33 0.47 0.49 0.60 0.45
Working Capital per Share -40.13 -39.46 -27.41 -34.45 -12.04 -30.70
Cash flow per Share 29.34 22.78 21.73 16.12 7.9 19.57
AMR AMR AMR AMR AMR AMR
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LIQUDITY
Current Ratio 0.90 0.80 0.67 0.63 0.61 0.72
Quick Ratio 0.68 0.57 0.44 0.40 0.34 0.49
Working Capital per Share -3.15 -6.02 -10.18 -11.83 -11.39 -8.51
Cash Flow per Share 12.87 12.69 9.52 9.76 6.73 10.31
DELTA DELTA DELTA DELTA DELTA DELTA
AIRL AIRL AIRL AIRL AIRL AIRL
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LIQUIDITY
Current Ratio 0.70 0.90 0.88 0.91 0.95 0.87
Quick Ratio 0.52 0.72 0.73 0.73 0.75 0.69
Working Capital per Share -16.50 -5.25 -8.40 -6.20 -3.01 -7.87
Cash Flow per Share 21.22 11.66 18.03 6.3 6.73 12.79
USAIR USAIR USAIR USAIR USAIR USAIR
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LIQUIDITY
Current Ratio 1.1 0.81 0.64 0.49 0.53 0.71
Quick Ratio 0.9 0.68 0.49 0.34 0.33 0.55
Working capital per Share 2.72 -8.37 -14.21 -18.72 -17.88 -11.29
Cash Flow per Share 14.61 9.01 7.43 -5.49 -0.52 5.01
22
Current Ratio
A firm’s current ratio indicates its ability to meet short-term obligations. It is
measured by dividing current assets by current liabilities. The current ratio is the
single best indicator of a company’s ability to convert assets into cash and pay off
short-term liabilities. This ratio is an adequate measure of the financial strength of a
company in the short-term and can be used to compare similar companies in the same
industry. A high current ratio could mean that the company has a lot of money tied
up in nonproductive assets, such as cash, or marketable securities or in inventory. But
for UAL, it is not the case.
Liquidity Ratios
Current Ratio
1.5
1
0.5
0
1993 1994 1995 1996 1997
Year
UAL AMR DAL USAir
Average Current Ratio
1
0.9
0.8
0.7 UAL
0.6 AMR
Ratio
0.5 DAL
0.4 USAir
0.3 AVERAGE
0.2
0.1
0
23
Quick Ratio
A firms’s quick ratio is measured by current assets minus inventories divided
by current liabilities. As it is seen from the current ratio, UAL’s quick ratio is also a
little lower than the industry average. This indicates UAL’s assets are less liquid than
its comparables. UAL’s quick ratio is low compared to the industry. Since UAL’s
average collection period is low, accounts receivable can be collected and the
company should be able to pay off its current liabilities.
Liquidity Ratios
1
Quick Ratio
0.8
0.6
0.4
0.2
0
1993 1994 1995 1996 1997
Years
UAL AMR DAL USAir
Average Quick Ratio
0.8
0.6
Ratio
0.4
0.2
0
UAL AMR DAL USAir Average Comparables
24
Cash Flow per Share
Cash flow per share is defined as the cash flow from operations minus
preferred stock dividends divided by the number of the number of common shares
outstanding. From 1993 to 1997 UAL’s cash flows have increased. During this
period sales increased 20%. UAL also has fewer shares of stock outstanding
compared to the rest of the industry and UAL does not pay dividends.
LIQUIDITY
40
CASH FLOW PER
30
SHARE
20
10
0
-10 1993 1994 1995 1996 1997
YEARS
UAL AMR DAL USAIR
Average Cash Flow per Share
25
20 UAL
15 AMR
Ratio
DAL
10
USAir
5 Comparables Average
0
25
Working Capital per Share
Working capital per share is measured by current assets minus current
liabilities divided by number of shares of outstanding. Generally, the working capital
ratio should be positive. A positive ratio indicates a company has sufficient resources
to cover its current liabilities. However, our calculations indicate UAL and its
comparables all have negative working capital per share, and UAL has the worst
ratio.
LIQUIDITY
10
CAPITAL PER
0
WORKING
SHARE
-10 1993 1994 1995 1996 1997
-20
-30
-40
-50
YEARS
UAL AMR DAL USAIR
Average Working Capital per Share
0.00
-10.00
Ratio
-20.00
-30.00
-40.00
UAL AMR DAL USAir Average Comparables
26
Activity Ratios
UAL UAL UAL UAL UAL UAL CORP
CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
ACTIVITY
Inventory Turnover 42.53 43.42 45.93 44.96 44.63 44.29
Receivables 17.27 17.11 16.24 13.88 12.89 15.48
Turnover
Total Asset 1.22 1.35 1.28 1.13 1.16 1.23
Turnover
Average Collection 21 21 22 26 28 23.60
per Days
Days to Sell 8 8 8 8 8 8
Inventory
Operating Cycle 29 29 30 34 36 31.60
AMR AMR AMR AMR AMR AMR
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
ACTIVITY
Inventory Turnover 24.37 24.03 22.26 19.91 20.35 22.18
Receivables 13.50 14.01 14.34 15.25 16.91 14.80
Turnover
Total Asset 0.90 0.89 0.87 0.83 0.83 0.86
Turnover
Average Collection 27 26 25 24 21 24.60
per Days
Days to Sell 15 15 16 18 18 16.40
Inventory
Operating Cycle 42 41 41 42 39 41.00
DELTA DELTA DELTA DELTA DELTA DELTA
AIRL AIRL AIRL AIRL AIRL AIRL
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
ACTIVITY
Inventory Turnover 309.53 149.35 161.64 146.62 131.11 179.65
Receivables 14.22 14.46 14.86 12.74 10.39 13.33
Turnover
Total Asset 1.09 1.02 1.01 1.04 1.09 1.05
Turnover
Average Collection 25 25 24 28 35 27.40
per Days
27
Days to Sell 1 2 2 2 3 2.00
Inventory
Operating Cycle 26 27 26 31 37 29.40
USAIR USAIR USAIR USAIR USAIR USAIR
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
ACTIVITY
Inventory Turnover 31.19 29.86 26.85 22.18 18.27 25.67
Receivables 26.72 24.71 23.12 20.32 26.07 24.19
Turnover
Total Asset 1.07 1.12 1.09 1.02 1.05 1.07
Turnover
Average Collection 13 15 16 18 14 15.20
per Days
Days to Sell 12 12 13 16 20 14.60
Inventory
Operating Cycle 25 27 29 34 34 29.80
28
Total Assets Turnover
Total assets turnover measures the turnover of all the firm’s assets. It is
defined as sales divided by total assets. If the firm’s ratio is lower than the industry,
sales should be increased, some assets should be sold or a combination of these things
should be done. UAL’s total assets turnover ratio has been relatively flat over the
past five years, this is also true of its competitors. However, UAL’s ratio is above the
industry average indicating it is handling its assets in an efficient manner.
Total Assets Turnover
1.5
1
Ratio
0.5
0
1993 1994 1995 1996 1997
Years
UAL AMR DAL USAir
Average Total Assets Turnover
1.40
1.20
UAL
1.00
AMR
0.80
DAL
0.60
USAir
0.40
Comparables Average
0.20
0.00
29
Average Collection Period
Average collection period is used to appraise accounts receivable, and it is
calculated by dividing accounts receivable by average daily sales to find the amount
of sales that are tied up in receivables. Over the past 5 years, UAL’s collection period
has been declining which means UAL has more cash on hand. UAL can use this cash
to retire debt or invest in assets. Even though UAL’s average collection period is
above the industry average, the recent decline in its collection period is a positive sign
for the future.
Average Collection Period
40
35
30
25
Days
20
15
10
5
0
1993 1994 1995 1996 1997
Years
UAL AMR DAL USAir
Average Collection Period
30.00
25.00
UAL
20.00 AMR
Days
15.00 DAL
10.00 USAir
Average Comparables
5.00
0.00
30
Profitability Ratios
UAL UAL UAL UAL UAL UAL
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
PROFITABILITY
Net Profit Margin 5.51 3.67 2.53 0.55 -0.21 2.41
Return on Assets 5.57 4.26 2.79 0.15 -0.50 2.45
Return on Equity 37.70 54.27 -135.98 -5.70 -5.46 -11.03
Return on Investment 14.19 13.13 8.71 0.54 -1.34 7.05
AMR AMR AMR AMR AMR AMR
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
PROFITABILITY
Net Profit Margin 5.30 6.22 1.16 1.41 -0.61 2.70
Return on Assets 4.71 5.39 0.98 0.88 -4.42 1.51
Return on Equity 15.85 19.50 5.24 5.21 -4.88 8.18
Return on Investment 9.75 10.82 1.77 1.53 -1.36 4.50
DELTA DELTA DELTA DELTA DELTA DELTA
AIRL AIRL AIRL AIRL AIRL AIRL
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
PROFITABILITY
Net Profit Margin 6.28 1.25 2.41 -3.31 -3.46 0.63
Return on Assets 6.63 0.61 1.7 -4.36 -4.42 0.03
Return on Equity 28.1 2.91 11.28 -35.38 -27.45 -4.11
Return on Investment 17.04 1.52 4.06 -10.82 -9.19 0.52
USAIR USAIR USAIR USAIR USAIR USAIR
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
PROFITABILITY
Net Profit Margin 12.04 3.23 1.6 -9.79 -4.93 0.43
Return on Assets 11.48 2.32 0.49 -11.21 -6.15 -0.61
Return on Equity 132.56 -21.89 -3.28 68.23 99.36 55.00
31
Net Profit Margin
Net profit margin is calculated by dividing net income by sales. UAL’s net
profit margin is above the industry average due to its efforts to hold costs down. Low
costs generally indicate efficient operations. If two firms have identical operations --
their sales, operating costs, and EBIT are the same, but one firm uses more debt than
the other, then that firm will have to a higher interest expense.
The firm paying higher interest charges will have a lower net income, and if
sales are constant, this will result in a lower profit margin. Since the airline industry
is highly leveraged net profit margins are generally lower than in other industries.
UAL’s net income has been improving for several reasons: fuel prices have
decreased, load factors have increased, travel agent commissions have decreased, and
debt has decreased.
PROFITABILITY
15
10
NET PROFIT
MARGIN
5
0
-5 1993 1994 1995 1996 1997
-10
-15
YEARS
UAL AMR DAL USAIR
32
Average Net Profit Margin
3
2.5
UAL
2
AMR
1.5 DAL
USAir
1
Average Comparables
0.5
0
Return on Assets
Return on assets is measured by dividing net income by total assets. This is a
widely used measure of profitability and higher percentages tend to indicate more
profitable companies. UAL’s return on assets is a result of its increase in sales and
more efficient use of assets.
PROFITABILITY
15
RETURN ON ASSETS
10
5
0
-5 1993 1994 1995 1996 1997
-10
-15
YEARS
UAL AMR DAL USAIR
33
Average Return on Assets
3
2.5
2
UAL
1.5 AMR
Ratio
1 DAL
0.5 USAir
Average Comparables
0
-0.5
-1
Return on Equity
Return on equity is the rate of return on stockholders’ investment. It is
calculated by net income divided by common equity. Return on investment indicates
how well common stockholders’ money is being used. The decrease in UAL’s return
on equity in 1995 is due to the retirement and replacement of 94 aircraft. The new
aircraft are more efficient and require less fuel and maintenance this accounts for the
increase in return on equity after 1995.
PROFITABILITY
200.00
RETURN ON
100.00
EQUITY
0.00
-100.00 1993 1994 1995 1996 1997
-200.00
YEARS
UAL AMR DAL USAIR
34
Average Return on Equity
60
50
40 UAL
30 AMR
20 DAL
10 USAir
0 Average Comparables
-10
-20
35
Leverage Ratios
UAL UAL UAL UAL UAL UAL
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LEVERAGE
Total Debt/Invested Cap. (%) 68.9 82.28 109.88 129.73 84.96 95.15
Total Debt/Total Assets (%) 27.07 26.7 35.24 36.94 31.54 31.50
Total Assets/Common Equity 6.76 12.74 -48.71 -37.23 10.95 -11.10
(%)
Long-Term Debt/Shrhldr 165.68 310.35 N/A N/A 293.35
Equity (%)
AMR AMR AMR AMR AMR AMR
CORP CORP CORP CORP CORP CORP
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LEVERAGE
Total Debt/Invested Cap. (%) 43.75 49.91 68.72 76.35 66.48 61.04
Total Debt/Total Assets (%) 21.14 24.86 37.85 44.11 40.69 33.73
Total Assets/Common Equity 3.36 3.62 5.37 5.9 6.05 4.86
(%)
Long Term Debt/Shrhldr 62.56 80.13 189.57 233.08 176.66 148.40
Equity (%)
DELTA DELTA DELTA DELTA DELTA DELTA
AIRL AIRL AIRL AIRL AIRL AIRL
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LEVERAGE
Total Debt/Invested Cap. (%) 42.24 46.84 65.77 72.25 65.89 58.60
Total Debt/Total Assets (%) 16.44 18.59 27.45 29.14 31.71 24.67
Total Assets/Common Equity 4.24 4.81 6.65 8.11 6.21 6.00
(%)
Long Term Debt/Shrhldr 56.81 81.22 160.3 205.74 186.26 138.066
Equity (%)
USAIR USAIR USAIR USAIR USAIR USAIR
Dec-97 Dec-96 Dec-95 Dec-94 Dec-93 Average
LEVERAGE
Total Debt/Invested Cap. (%) 74.42 96.77 108.98 108.11 84.67 94.59
Total Debt/Total Assets (%) 31.19 35.85 40.23 43.79 36.81 37.57
Total Assets/Common Equity 11.54 -9.44 -6.63 -6.13 -16.16 -5.36
(%)
Long Term Debt/Shrhldr 223.93 447.50
Equity (%) N/A N/A N/A
36
Total Debt to Total Assets
The numbers from Compustat are actually the long-term debt to total assets.
This ratio measures the percentage of funds provided by creditors. Creditors prefer
low debt ratios because the lower the ratio, the greater their protection against losses
in the event of bankruptcy.
UAL is highly levered because it operates in a mature industry, with intense
competition, and a very low growth rate. Since assets = total liabilities + total equity,
this figure will range from 0-100%. The higher the level of debt the more important
it is for a company to have positive earnings and steady cash flow. Debt in and of
itself is not bad, but since it requires the timely payment of interest to debt holders. It
is important to analyze whether or not a company will have adequate resources to
meet its obligations in the future.
Average Total Debt to Total Assets
40
UAL
30
AMR
Ratio
20 DAL
USAR
10
AVERAGE
0
LEVERAGE
50
ASSETS in %
DEBT/TOTAL
40
TOTAL
30
20
10
0
1993 1994 1995 1996 1997
YEARS
UAL AMR DAL USAIR
37
Cash Flow Valuation
Free Cash Flow (FCF)
Free cash flow is the amount of cash that is readily available for distribution to
shareholders. It is expressed as:
FCF = PAT + Depreciation ± ∆ Current Assets and Current Liabilities
+ Interest Expense ± ∆ Fixed Assets
As seen from the FCF table and bar graph, UAL has done very well. It has
increased its FCF from negative $929 million in 1995 to a positive $226 million in
1997.
Reasons for UAL’s better FCF:
1. From 1995 to 1997, UAL increased its sales by 20%. This increase in sales
directly affected or resulted in an increase in FCF.
2. UAL’s acquisition of fixed assets decreased. This resulted in higher net profit
after taxes. Higher net profit after taxes causes higher free cash flows.
3. Interest expense decreased. This means less interest expense was deducted or
charged against profits; this will result in higher profits after taxes. All other
things equal, higher profits after taxes equals higher free cash flows.
38
Free Cash Flow
3000 1997 1996 1995
2000
1000
0
-1000
-2000
-3000
-4000
UAL AMR DAL US UAL AMR DAL US UAL AMR DAL US
PAT 950 985 854 319 600 1105 156 263 378 196 294 119
Depreciation 724 1244 710 311 740 1204 634 316 724 1259 622 352
Change in WC -21 -550 860 -788 209 -460 -71 -788 -622 -240 304 -242
Acct. CFO 1653 1679 2424 -158 1549 1849 719 -209 480 1215 1220 229
Interest Exp. 291 399 207 256 295 499 269 267 399 684 292 303
Finance CFO 1944 2078 2631 98 1844 2348 988 58 879 1899 1512 532
Chg. in Fixed Asset -1718 -1456 -3104 -368 -2163 -1349 -1016 715 -1808 -373 -1486 3
FCF 226 622 -473 -270 -319 999 -28 773 -929 1526 26 535
Free Cash Flow (millions)
2000
1997 1996 1995
1500
1000
500
0
-500
-1000
UAL AMR DAL US UAL AMR DAL US UAL AMR DAL US
FCF 226 622 -473 -270 -319 999 -28 773 -929 1526 26 535
39
WACC Calculation
Risk Free Rate (Rf )= 3.8%
Required Return for Small Firm Common Stock (Rm) = 12.7%
1997
Equity 2,337
Debt 8,218
Corporate Tax Rate (t) = 39%
Weight of Equity (W1) = 48%
Weight of Debt (W2) = 52%
Beta of Stock () = 1.25
Kr = Rf + (Rm – Rf) = 3.8% + 1.25(12.7% - 3.8%) = 14.93%
WACC = W1(Kr) + W2(Int*(1-t)) = 9.49%
Residual Cash Flow (RCF)
Residual cash flow (RCF) is expressed as finance cash flow from operations
minus weighted average cost of capital (WACC) multiplied by average total assets.
RCF = Finance CFO – WACC (Average Total Assets)
Residual cash flow measures the residual amount of finance cash flow from
operations after deducting its cost of financing assets. As seen in the 1997 residual
cash flow bar chart below, United’s performance is better than the industry average.
Among the comparables, only Delta Airlines outperformed United Airlines. There
are several reasons why UAL had a better residual free cash flow. All other things
40
equal, UAL’s consistent increase in finance cash flow from operations over the past
four years accounted for a consistent increase in residual cash flow. When computing
either residual cash flow or cash flow return on investment, some of the same
variables are used; therefore, an increase in cash flow return on investment generally
results in an increase in residual cash flow.
CFO WACC Avg. Asset
UAL 1944 0.0949 14240
US 98 0.1038 7952
AMR 2078 0.11 20706
DAL 2631 0.11 12484
1997 RCF (millions)
2000
1000
0
-1000
IND. AVG. UAL US AMR DAL
RCF 230.83 592.62 -727.42 -199.66 1257.76
Economic Value Added (EVA)
Economic Value Added (EVA) is expressed as profit after taxes (PAT) minus
the weighted average cost of capital (WACC) multiplied by average total assets.
41
EVA = PAT – WACC (Average Total Assets)
EVA
0
-500
-1000
-1500
-2000
-2500
Ind.
UAL US AMR DAL
Avg.
Dec-97 -678 -401 -505 -1293 -854
Dec-96 -831 -554 -489 -1098 -1184
Dec-95 -1077 -733 -595 -1951 -1028
Dec-94 -1653 -1090 -1395 -1907 -2218
Economic value added measures how profitable a business entity. The higher
a firm’s economic value added the better its performance. As shown in the economic
value added table and bar graph above, UAL’s three-year performance is better than
the industry average. Furthermore, UAL outperformed the other three comparable
airlines (US Airways, American and Delta Airlines).
Reasons for UAL’s better EVA
According to the April 19, 1999 issue of BusinessWeek UAL’s executives are
among the highest paid in the airline industry. For example, the ex-Chairman and
42
CEO G. Greenwald received $1.502 million in salary and bonuses last year. J.E.
Goodwin, the company’s president and COO, received $620,000 in compensation
(Executive p. 91). The point we want to make is that UAL’s executives are paid well
because under their leadership UAL’s economic value added improved from negative
$1,090 million in 1994 to negative $401 million in 1997.
A sales increase of 20% from 1995 to 1997 also contributed to the
improvement of UAL’s economic value added. We learned from classroom lectures
that when sales increase, profit after taxes (PAT) also increase, and all other being
things equal, economic value added will also increase.
Cash Flow Return on Investment (CFROI)
Cash flow return on investment (CFROI) is expressed as finance cash flow
from operations (CFO) divided by average total assets.
43
CFROI = Finance CFO/ Average Total Assets
CFROI
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
Ind. Avg. UAL US AMR DAL
Dec-97 13.36% 13.10% 9.31% 10.04% 21.00%
Dec-96 8.11% 14.12% -0.41% 11.28% 7.44%
Dec-95 8.50% 12.13% 6.50% 2.55% 12.80%
Cash flow return on investment measures the relationship between cash flow
generated from financial operations and average total assets. All other things being
equal, a higher percentage indicates the effective use of financial resources. As
depicted in the cash flow return on investment tables and bar graph above, UAL’s
three-year performance is above the industry average. This indicates UAL is doing
well compared to the competition.
Reasons for UAL’s better CFROI
As shown in statement of free cash flows, UAL’s finance cash flow from
operations over the three-year period increased consistently. They were $879, $1844
and $1944 for the years 1995, 1996 and 1997 respectively. Increases in the finance
44
cash flow from operations brought about increases in the cash flow return of
investment.
Pro-forma Statements
The pro-forma statements shown below are based on the historical financial
statements of United Airlines over the past ten years. When building the pro-forma
statements for United, great care was taken to incorporate many of the ‘Model One’
assumptions mentioned by the authors of our textbook, Corporate Finance A
Valuation Approach, by Simon Benning and Oded Sarrig. The assumptions made
when building the United Airlines pro-forma statements included the following:
1. It is assumed that UAL finances its activities through debt. That is borrowed cash
is used to defray or pay down company debts. Therefore, Debt is the ‘plug’ for
the pro-forma balance sheet.
2. For this project it is assumed that UAL’s growth rate includes inflation, so it is a
nominal growth rate. Hence, a nominal required return is used to maintain
consistency.
3. Another assumption is that nearly all the items found in the pro-forma statements
are expressed as a percentage of sales.
4. The constant sales growth rate of 4.6 percent is based on the arithmetic average of
sales figures over the past ten years.
5. It is assumed that all cash flows are derived at yearend.
45
Financial Statement Items as a Percentage of Sales
Sales Growth 4.6%
Initial Sales $17,378,000,000
Fixed Assets / Sales 73.97%
Current Assets / Sales 16.96%
Current Liab. / Sales 30.20%
Cost of Goods Sold / Sales 88.59%
Tax Rate 39%
Depreciation Rate 33%
Pro-forma Income Statement (in millions of $)
Year
Profit/Loss 1997 1998 1999 2000 2001 2002 2003
Sales 17,378 18,177 19,014 19,888 20,803 21,760 22,761
COGS 15,395 16,358 17,110 17,897 18,721 19,582 20,483
Gross Profit 1,983 1,820 1,903 1,991 2,082 2,178 2,278
Int. Exp. 291 304 318 333 348 364 381
Dep. Exp. 724 757 792 829 867 907 948
Other Rev. 1,132 1,184 1,239 1,296 1,355 1,417 1,483
Non-op. Exp. 188 197 206 215 225 235 246
Special Items 378 395 414 433 452 473 495
Pretax Income 1,534 1,350 1,412 1,477 1,545 1,616 1,690
Total Income Tax 561 526 551 576 603 630 659
Profit After Tax 973 823 861 901 942 986 1,031
Other adj. 101 106 111 116 121 126 132
Adj. Net Inc. 872 718 751 785 821 859 899
46
Pro-forma Balance Sheet (in millions of $)
1997 1998 1999 2000 2001 2002 2003
Assets
Cash&Equivalents 845 1,052 1,100 1,151 1,204 1,259 1,317
Net Receivables 1,051 1,308 1,369 1,431 1,497 1,566 1,638
Inventories 355 442 462 484 506 529 553
Other Current Assets 697 868 908 949 993 1,039 1,087
Total Current Assets 2,948 3,670 3,839 4,015 4,200 4,393 4,595
Fixed Assets
Plant&Equipment 16,833 17,789 18,800 19,867 20,996 22,188 23,449
Depreciation 5,741 6,018 6,308 6,612 6,930 7,265 7,615
Investments 223 226 229 233 236 239 243
Other Assets 1,540 1,690 1,855 2,036 2,234 2,452 2,690
Total Assets 15,803 17,358 18,415 19,539 20,735 22,008 23,362
Liabilities
Account Payable 1,030 1,232 1,474 1,763 2,109 2,523 3,019
Accrued Expenses 2,545 3,333 4,365 5,717 7,488 9,807 12,844
Other Current Liabilities 1,673 2,014 2,424 2,917 3,511 4,225 5,086
L-term Debt 8,218 8,335 7,595 6,467 4,830 2,526 -647
Equity
Capital Surplus 2,700 2,824 2,954 3,090 3,232 3,381 3,536
Retained Earnings 300 314 328 343 359 376 393
Treasury Stock 663 693 725 759 794 830 868
Total Liab.&Equity 15,803 17,358 18,415 19,539 20,735 22,008 23,362
Pro-forma Free Cash Flow
1997 1998 1999 2000 2001 2002
Profit After Taxes 973 1,018 1,065 1,114 1,165 1,218
Depreciation 724 757 792 829 867 907
Chg. Current Assets (266) (278) (291) (304) (318) (333)
Chg. Current Liab. 245 256 268 280 293 307
Acct CFO 1,676 1,753 1,834 1,918 2,006 2,099
Interest Expense 291 304 318 333 348 364
Finance CFO 1,967 2,057 2,152 2,251 2,355 2,463
Chg. In Fixed Asset 956 1,000 1,046 1,094 1,144 1,197
Free Cash Flow 1,011 1,058 1,106 1,157 1,210 1,266
47
Terminal Value
The terminal value for UAL is the assigned value at the end of our
projections. Below is a free cash flow stream for UAL from 1998 through 2002. As
our pro-forma balance sheet shows, from the year 2002 onward, all UAL’s debts will
be paid off. To find UAL’s terminal value, we discounted UAL’s free cash flow from
1998 through 2002. The constant growth rate, as indicated earlier, was 4.6 %. The
discount rate is 12.7 %.
Cash Flow Stream
1998 1999 2000 2001 2002
$1,058 $1,106 $1,157 $1,210 $1,266
Valuation Exercise
Year 1998 1999 2000 2001 2002
Discounted FCF 1,058 1,011 1,011 1,010 1,010
We calculated UAL’s value to be $5,053 million.
Computation of Stock Price per Share
Stock price per Share = Value of firm / Total Common Shares Outstanding
= $5,053 / 58.364
= $86.58
48
Conclusion
The market price per share for UAL’s stock as of April 30, 1999 was $80.25.
Since our projected stock price per share for UAL is $86.58 and the market price is
$80.25, we believe that UAL’s stock is undervalued. Therefore, potential investors,
as well as stockholders, should buy UAL’s stock.
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