FCF valuation of Southwest Airlines

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FCF valuation of Southwest Airlines Powered By Docstoc
					Southwest Airlines
Financial Statements
source: www.moneycentral.com

October 23, 2001

Comments:
I put together this valuation template for use on Southwest Airlines. This is a cut-down version of my original.
On the FCF forecasts tab, I have undertaken a cash flow forecast for Southwest Airlines
            I have followed the definitions on page 382-3 of Damodaran, 2ed. You should note that he advocates (and I agree) that
              cash changes should not be included in working capital changes, except insofar as cash is essential to operations.
              I have excluded all of cash changes from working capital.

            You must decide how you are going to forecast each item making up cash flow. Also, you must decide
              how you want to divide the future. I have divided the forecast into (a) the next two years, which are special, with
              specific assumptions, (b) a three-year supernormal growth rate after that, and (c) a period in which the growth
              rate declines to the final growth rate (4% in my forecast).
            In the full version (not shown here)I have determined historical percentages to carry forward as assumptions.
              In special places, I have made special assumptions reflecting the special circumstances of LUV at the time.
            Note that the method of forecasting each item should reflect its normal relation to other key variables.

On the Valuation tab, I have determined costs of capital for Southwest and used those to discount the forecast cash flows.

This exercise leaves huge amounts of room for imagination, flexibility, and - yes - error.

-- John S
Southwest Airlines
October 23, 2001
Note: Blue numbers indicate numerical input by user

Forecast of Free Cash Flows for Southwest Airlines
                                             Short run
First 4 columns are reversed from the FCFF-FCFE spreadsheet                  Intermediate high growth period            Declining growth period

Parameters used in forecast                            2001      2002          2003             2004          2005          2006            2007            2008              2009        2010         2011         2012         2013
                                                Revenues depressed in 01, partial recovery in '02, abnormal growth specified after that for 10 years, lower growth after.
Growth rate of revenues                                -15%       20%          20%              20%            20%          18%              16%             14%              12%         10%           8%           6%           4%

Free cash flows to the firm (FCFF) *                     2001        2002        2003           2004             2005         2006          2007            2008              2009        2010         2011         2012         2013

Revenue Forecasts                                   4,802.16     8,135.42     ######       11,715.01      14,058.01     16,588.45     19,242.61       21,936.57        24,568.96     27,025.86    29,187.93    30,939.20    32,176.77
Cost of sales                                       2,305.04     3,010.11     ######        4,100.25       4,920.30      5,805.96      6,734.91        7,677.80         8,599.14      9,459.05    10,215.77    10,828.72    11,261.87
SG&A expenses                                       2,304.40     3,335.52     ######        5,271.75       6,326.11      7,464.80      8,659.17        9,871.46        11,056.03     12,161.64    13,134.57    13,922.64    14,479.55
Other income                                           48.02        81.35      97.63          117.15         140.58        165.88        192.43          219.37           245.69        270.26       291.88       309.39       321.77
Depreciation and amortization                         349.18       406.23     547.38          656.86         788.23        930.11      1,078.93        1,229.98         1,377.58      1,515.34     1,636.57     1,734.76     1,804.15
EBIT                                                  -108.44     1,464.92   1,502.74        1,803.29       2,163.95      2,553.46      2,962.01        3,376.70         3,781.90      4,160.09     4,492.90     4,762.47     4,952.97


EBIT                                                  (108.44)   1,464.92      ######       1,803.29       2,163.95      2,553.46       2,962.01        3,376.70        3,781.90      4,160.09     4,492.90     4,762.47     4,952.97
EBIT(1-t)                                              (84.58)   1,142.63      ######       1,406.57       1,687.88      1,991.70       2,310.37        2,633.82        2,949.88      3,244.87     3,504.46     3,714.73     3,863.32
Add depreciation and amoritization                     349.18      406.23      547.38         656.86         788.23        930.11       1,078.93        1,229.98        1,377.58      1,515.34     1,636.57     1,734.76     1,804.15
After-tax EBITDA                                       264.60    1,548.87      ######       2,063.43       2,476.11      2,921.81       3,389.30        3,863.81        4,327.46      4,760.21     5,141.03     5,449.49     5,667.47


Change in net working capital
 Current assets less cash                             216.10      366.09       439.31         527.18           632.61      746.48        865.92           987.15        1,105.60      1,216.16     1,313.46     1,392.26     1,447.95
 Prior year C.A. less cash                            308.50      216.10       366.09         439.31           527.18      632.61        746.48           865.92          987.15      1,105.60     1,216.16     1,313.46     1,392.26
  Change in current assets less cash                  (92.40)     150.00        73.22          87.86           105.44      113.87        119.44           121.23          118.46        110.56        97.29        78.81        55.69

 Current liabilities                                  103.73      135.45       153.76         184.51           221.41      261.27        303.07           345.50            386.96     425.66       459.71       487.29       506.78
 Prior year C.L.                                    1,298.40      103.73       135.45         153.76           184.51      221.41        261.27           303.07            345.50     386.96       425.66       459.71       487.29
  Change in current liabilities                    (1,194.67)      31.73        18.30          30.75            36.90       39.85         41.80            42.43             41.46      38.70        34.05        27.58        19.49
    Change in non-cash W.C.                         1,102.27      118.27        54.91          57.11            68.53       74.02         77.63            78.80             77.00      71.86        63.24        51.22        36.20

Gross capital expenditures
 Net P&E                                            6,770.52     8,688.63      ######      12,511.63      14,763.72     17,125.92     19,523.55       21,866.38        24,053.01     25,977.25    27,535.89    28,637.33    29,782.82
 Prior year Net P&E                                 5,819.70     6,770.52      ######      10,426.36      12,511.63     14,763.72     17,125.92       19,523.55        21,866.38     24,053.01    25,977.25    27,535.89    28,637.33
  Change in Net P&E                                   950.82     1,918.11      ######       2,085.27       2,252.09      2,362.20      2,397.63        2,342.83         2,186.64      1,924.24     1,558.64     1,101.44     1,145.49
 Add depreciation                                     349.18       406.23      547.38         656.86         788.23        930.11      1,078.93        1,229.98         1,377.58      1,515.34     1,636.57     1,734.76     1,804.15
  Gross capital expenditures                        1,300.00     2,324.35      ######       2,742.13       3,040.33      3,292.31      3,476.56        3,572.81         3,564.22      3,439.58     3,195.20     2,836.20     2,949.64

FCFF                                               (2,137.67)     (893.75)    (620.50)       (735.82)       (632.75)       (444.51)      (164.89)         212.20            686.25    1,248.77     1,882.58     2,562.07     2,681.62

Free cash flows to equity (FCFE)**                      2001         2002        2003           2004           2005          2006           2007            2008            2009          2010         2011         2012         2013
FCFF                                               (2,137.67)     (893.75)    (620.50)       (735.82)       (632.75)      (444.51)       (164.89)         212.20          686.25      1,248.77     1,882.58     2,562.07     2,681.62
Debt and other non-current liabilities              1,676.77     2,185.87      ######       3,169.62       3,749.78      4,358.83       4,977.65        5,583.06        6,148.96      6,647.99     7,053.46     7,341.62     7,637.05
Prior year debt and other non-current liab.         1,163.50     1,676.77      ######       2,634.03       3,169.62      3,749.78       4,358.83        4,977.65        5,583.06      6,148.96     6,647.99     7,053.46     7,341.62
   Net increase (add)                                 513.27       509.10      448.16         535.60         580.16        609.05         618.82          605.41          565.91        499.03       405.47       288.17       295.42
Interest before tax                                    67.07        87.43      105.36         126.78         149.99        174.35         199.11          223.32          245.96        265.92       282.14       293.66       305.48
Subtract after-tax interest expense                    41.25        53.77       64.80          77.97          92.24        107.23         122.45          137.34          151.26        163.54       173.52       180.60       187.87
                            FCFE                   (1,665.65)     (438.43)    (237.14)       (278.19)       (144.83)        57.31         331.47          680.26        1,100.89      1,584.25     2,114.54     2,669.63     2,789.18

*(p 383 of Damodoran 2ed): FCFF = EBIT(1-t) + depreciation - capital expenditures - change in working capital
**(p 382 of Damodoran 2ed):
             FCFE = FCFF - Interest Exp (1-t) - Principal repayments + new debt issues - preferred dividends
             (note I have rearranged the equation to solve for FCFE
Southwest Airlines
October 23, 2001
Note: Blue numbers indicate numerical input by user


Valuation
Date of valuation                         10/23/2001

Capital costs                             Assigned      Reported     Source for reported figure
Current 20-year T-bond rate                   5.24%         5.24%    source: Wall Street Journal for market of 10-29-01: yield on 20-year T-bond due November '21
Equity risk premium                            7.8%         7.80%    source: Ibbotson Associates 2001 yearbook, page 174: Arithmetic large co. less T-bond
Southwest stock beta                            1.05          1.05   source: Value Line
Southwest current ke                          13.4%
Southwest current kd                          7.80%         7.80% source: best guess using Southwest annual report, footnote 5 to the financial statements
Effective tax rate                            38.5%         38.5% source: 2000 income taxes divided by pre-tax income
Southwest after-tax kd                         4.8%

Debt value estimate: book value (000s)      306,761       306,761 source: 2000 balance sheet: long term debt plus other long-term liabilities
Current market value of Southwest
 Number of shares outstanding (000s)        763,400       763,400 source: moneycentral.com
 Price                                       $15.74          15.74 source: quote 10-30-2001, moneycentral.com
Equity value (000s)                      12,015,916
Total value                              12,322,677
Debt ratio                                    2.49%
WACC                                         13.22%                  Formula: WACC = (D/V)kd(1-t) + (E/V)ke, where V=D+E. Market values should be used.

Forecasts
                                                2001         2002         2003       2004       2005       2006        2007       2008     2009     2010     2011     2012     2013
FCFF                                       (2,137.67)     (893.75)     (620.50)   (735.82)   (632.75)   (444.51)    (164.89)    212.20   686.25 1,248.77 1,882.58 2,562.07 2,681.62
FCFE                                       (1,665.65)     (438.43)     (237.14)   (278.19)   (144.83)     57.31      331.47     680.26 1,100.89 1,584.25 2,114.54 2,669.63 2,789.18
Valuation
Date of first CF forecast                 12/31/2001
Days until first cash flow                        69
Terminal growth rate assumption                   4%
                                           FCFF          FCFE
Cost of capital                              13.22%         13.4%    Brought down from above
Cash flow in 2013                          2,681.62      2,789.18
Terminal value at 2013                      $30,264       $30,761    Constant growth model: V = CF(1+g)/(k-g)
Present value of Terminal Value              $6,666        $6,621    Cash flows are discounted to 2000 + 10/12 of a year (i.e., to November 1, 2001)
Present value of intermediate CF              (2,018)      (2,053)   Ditto
Total                                        $4,648        $4,568
Add Cash                                         523          523
Subtract value of debt                           307
Equity value                                 $4,865        $5,091
Shares outstanding                           763.40
Value per share                                $6.37        $6.67
Current Price                                $15.74

				
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