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Southwest Airlines Co.

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Introduction

Southwest Airlines Co. is one of the leading airline industries in the economy, and it has its headquarters in Texas. United States citizens have enjoyed the popularity and efficiency of the airline. Its operations are diversified across the globe and it undertakes approximately 3,200 flights each day; as per the company’s information on January 2011. The company’s profitability has manifested from its “low-cost carrier” that is provided in the aviation industry—this is attributed to its unique and effective business model. The airline’s business model provides that the company will only be flying a single aircraft, the Boeing 737, on regions characterized by high-density routes. In addition, Southwest Airline’s business model is also defined by the minimal airline services that the organization offers (Vasigh, 2010). Some of the services that the airline does not offer include airport lounges, audio/video programming, first class cabin, and reserved seat assignment. With reduction in the number of services offered, the company has reduced the prices for flights; thereby increasing the overall returns for the organization.

Consequently, Southwest airline is not only the largest international carrier but also a success in its domestic region. In 2009, it carried about 102 million passengers on approximately 1.2million flights. The company has also reduced the operating expenses; therefore saving close to $1.1 billion of miscellaneous costs in 2008. Though competition in the sector has been stiff, the company aims at achieving its strategic goals in the long run (Peterson and Fabozzi, 2012). The financial analysis for the company covers the financial period 2009, 2010 and 2011.

Financial analysis

Current ratio

Current ratio    = Current Assets/Current Liabilities

Years 2010-2011 2009-2010 2008-2009
Current Assets ($M) 4345 4279 3358
Current Liabilities ($M) 4533 3305 2695
Proportion 0.96 1.30 1.25

Current ratio is used to determine the company’s ability to meet its short term obligations with the available liquid assets. It is on the management’s discretion to ascertain liquid assets and also determine the current liabilities that can be offset by the current assets (Gibson, 2010). The aviation industry current ratio is at 2:1. In the financial year ending 2009, the Company had a quick ratio of 1.25. The ratio is lower than the ideal quick ratio for the industry. In the subsequent years, 2010 and 2011, the current ratio was 1.30 and 0.96 respectively. From this analysis, the company, in 2011, was not able to offset its short-term obligations with the available current assets. There is a critical problem in all scenarios as total short-term liabilities is higher—in the case of 2011—or slightly lower than the current assets. Generally, higher current ratio is better but it should not be excessively larger than 2.0. Investors analyze the trend in the company’s ability to offset its short-term obligations without relying on external aid.

Quick ratio

Quick ratio      = Liquid Assets/ Current Liabilities

Years 2010-2011 2009-2010 2008-2009
Liquid Assets ($M) 3944 4036 3137
Current Liabilities ($M) 4533 3305 2695
Proportion 0.87 1.22 1.16

Quick ratio measures the company’s liquidity status in the short-run. It shows the ability of the company to use the available current assets (marketable securities, cash and cash equivalents and accounts receivables etc) to meet its short term obligations (Gallagher, 2009). The aviation industry’s quick ratio is 1:1. The company’s quick ratio was 1.16, 1.22 and 0.87 for the financial period ending 2009, 2010 and 2011 respectively. In 2009 and 2010, the company had kept excess amount of cash in hand and it was also experiencing difficulties in collection of its accounts receivable. These increased the company’s liquid assets. However, in 2011, the company’s quick ratio was lower than the ideal industrial level of 1.0. It shows that the company had limited quick funds and, therefore, relied on short-term notes and borrowing from financial institutions to meet its short-term liabilities. Most of the investors would be interested in investing in a business organization having a quick ratio of 1.0 or higher than 1.0.

Stock Turnover

Stock Turnover           = Sales/Stock

Years 2010-2011 2009-2010 2008-2009
Sale ($M) 15658 12104 10350
Stock ($M) 401 243 221
Proportion 40days 50days 47days

Stock turnover is an efficiency ratio that measures number of times, an organization, can sell its inventory and replace it within a given financial period (Siddiqui, 2006). It is the number of days that the company can hold stock. As there is no ideal industrial level for stock turnover, high value of stock turnover shows the company’s efficiency in its performance while low value denotes that the company is overstocking (Gallagher, 2009). Overstocking may increase the company’s operating expenses in terms of inventory holding costs and also may create obsolescence risk. High stock turnover is normally experienced in business operations that trade in perishable commodities unlike those companies trading in durable commodities. Southwest airline recorded a stock turnover of 47 days, 50 days and 40 days in the period ending 2009, 2010 and 2011 respectively. Investors will analyze information of other firms within the industry and determine whether Southwest airline stock turnover ratio is higher or lower than that of other rival companies.

Debtors Collection period

= Debtors/Sales *365

Years 2010-2011 2009-2010 2008-2009
Debtors*365 562 409 460
Sales 15658 12104 10350
Proportion 14days 13days 17days

Debtor’s collection period ratio is vital in determining a company’s performance in the economy. The ratio measures the effectiveness of the company in collecting trade debts (Chandra, 2008). In addition, the ratio also denotes the frequency of converting trade receivables into liquid cash. As such, it shows the liquidity status of an organization, and how it can effectively convert its trade debts. In 2009, the company collected debts after every 17 days while in 2010 and 2011; the company’s collection period was 13 days and 14 days respectively. Business entities would desire to realize their debts within a short period in order to effectively manage its credit. However, it is vital for the company to increase its revenue through interest charged on delayed payments made by debtors. Ideally, an organization that reports low debtor’s turnover ratio would need to increase its working capital requirements; thereby necessitating higher interest cost. This will reduce the company’s profits in the long run.

Creditor’s payment period

=Creditors/Cost of sales *365

Years 2010-2011 2009-2010 2008-2009
Creditors*365 2053 1602 1461
Cost of Sales 7866 5358 4667
Proportion 96days 110days 115days

The ratio is quite similar to debtor’s collection period ratio as creditor’s payment period is also used in determining the company’s overall performance in the economy. The ratio measures the effectiveness of the company in paying its trade creditors. Its effectiveness in the payment of trade credit will necessitate investors or lenders to provide the company with the required trade credit. As such, it also shows the liquidity status of an organization, and how it can effectively pay its trade creditors. In 2009, the company was able to pay creditors after every 115 days while in 2010 and 2011; the company’s creditor’s payment period was 110days and 96 days respectively. The Company’s reputation is determined by the creditor’s payment period. Where the company records a low creditor’s payment ratio, it denotes the effectiveness in the company’s management to pay the creditors when it falls due. With low creditor’s payment period, the investors are assured of the company’s credit worthiness. However, in the case where the ratio is much lower, it shows that the company is not utilizing credit facilities that are provided by the creditors.

Gearing Ratio

= (Short term liability & overdrafts + Long term Liabilities)*100/Shareholders

Years 2010-2011 2009-2010 2008-2009
Short term lib.& overdrafts+ Long Term Lib. *100 11191 9226 8815
Shareholder funds 6877 6237 5454
Proportion 163 148 162

Gearing ratio measures the organization’s ability to finance its obligations with the shareholder’s equity. It is significant for every business entity in order to ascertain its performance during a given financial period (Debarshi, 2011). In the period ending 2009, Southwest airline recorded a gearing ratio of 162. This was significantly high as compared to other periods. In 2010 and 2011, the company posted a gearing ratio of 148 and 163 respectively. From the above information, it is clear that the company is performing well in terms of its efficiency in meeting both the short-term and long-term financial obligations. With this trend, the company will attract new investors thereby increasing its revenue outlay and profitability.  For an investor to make an effective investment decision; there is need to compare between various rival companies in the aviation industry.

Fixed Asset Turnover

= Sales/Fixed Assets

Years 2010-2011 2009-2010 2008-2009
Sales 15658 12104 10350
Fixed Assets 13723 11184 10911
Proportion 1.14 1.08 0.95

Fixed asset turnover is an efficiency ratio that measures number of times that an organization can utilize its fixed assets in realization of sales revenue. As there is no ideal industrial level for fixed asset turnover, high value of fixed asset turnover shows the company’s efficiency in its performance and demonstrates its ability to utilize the available fixed assets in a positive way. However, low value denotes that the company is not fully utilizing its fixed assets. From the above information, Southwest airline reported an increasing value of its fixed asset turnover over the past three years. In the period ending 2009, the fixed asset turnover ratio was 0.95, which increased to 1.08 and 1.14 in the year ending 2010 and 2011 respectively. Investors normally rely on fixed asset turnover ratio in order to ascertain whether major purchases in terms of PP&E increased the overall output for the organization.

Total Asset Turnover

= Sales/Total Assets

Years 2010-2011 2009-2010 2008-2009
Sales 15658 12104 10350
Total Assets 18068 15463 14269
Proportion 0.87 0.78 0.73

Total asset turnover is quite similar to fixed asset turnover as it measures the company’s efficiency in utilizing its total assets in order to increase its sales outlay. Like fixed asset turnover, there is no ideal industrial level for total asset turnover. A high value of fixed asset turnover shows the company’s efficiency in its performance and demonstrates its ability to utilize the available assets in a positive way. However, low value denotes that the company is not fully utilizing its total assets. From the above information, Southwest airline reported an increasing value of its total asset turnover over the past three years. In the period ending 2009, the total asset turnover ratio was 0.73, which increased to 0.78 and 0.87 in the year ending 2010 and 2011 respectively. Investors normally rely on total asset turnover ratio in order to ascertain whether major purchases in terms of the company’s assets increased the overall output for the organization.

Return on Capital Employed

=PBIT *100/ (Long Term Liabilities + Share Capital)

Years 2010-2011 2009-2010 2008-2009
P.B.I.T or (L.I.B.T)*100 505 894 329
Long Term Liabilities+ Share Capital 13535 12158 11574
Proportion 3.73 7.35 2.84

Return on Capital Employed (ROCE) measures the company’s profitability. The financial ‘health’ of an organization is determined by its profitability (Baker and Powell, 2009). Investors may find it difficult to make a decision on their investment unless they compare the financial information of Southwest Airline with other companies within the Aviation industry. In 2009, the company’s ROCE was 2.84, which was much lower than the subsequent years. The ROCE was 7.35 and 3.73 in the year ending 2010 and 2011 respectively.

Net Profit (%)

= (Gross profit *100)/Sales

Years 2010-2011 2009-2010 2008-2009
Gross Profit*100% 7792 6746 5683
Sales 15658 12104 10350
Proportion 49.76% 55.73% 54.91%

The Company’s net profit is a crucial component in determining the investors’ decision. Most of the organization aims at increasing the net sales and proportionately decreasing operating expenses in order to realize high net profit margin. Investors will only invest on business operations that reports high proportion of net profit. The company reported a net profit margin of 54.91% in 2009, which increased to 55.73% in 2010, and subsequent decrease to 49.76% in 2011. This shows that the company’s operations are not stable, and its revenue outlay tends to fluctuate with changes in economic conditions (Brigham and Daves, 2012). Business organizations should have a coherent plan and model that deals with changes in economic conditions across the globe. Investors are unlikely to invest on business organizations that do not have a clear and coherent strategy that will enhance mitigation of adverse effects of changes in economic conditions (Chandra, 2008). Though the company reported a promising proportion of Net profits, it should ensure that its net profit is constant, if not increasing.

Marginal ratio

= Net Profit (Loss)/Sales

Years 2010-2011 2009-2010 2008-2009
Net Profit/(Loss) 693 988 262
Sales 15658 12104 10350
Proportion 0.04 0.08 0.03

Marginal ratio shows the margin of Southwest airline in terms of its net profit. Ideally, for a profitable business operation, marginal ratio should be positive or, in the case of economic recession, it should be increasing. However, small changes in the operations and activities of a business entity will always impact marginal ratio—it is very flexible. In the financial year ending 2008, the company recorded a marginal ratio of 0.03. The ratio increased to 0.08 in the financial year ending 2010, and decreased in 2011 to 0.04. It shows that the marginal ratio fluctuates with minimal change in the sales value and economic endowments in the economy. Though it can be argued that in the financial year ending 2009, the net profit was lower than the subsequent years, its net profit for the entire three years were proportionate to the sales volume. Increase in sales is attributed to expansion of operations and loyalty of consumers due to the “low cost” business model employed by Southwest Airline Company.

Asset Cover

=Total Assets/Long Term Debt

Years 2010-2011 2009-2010 2008-2009
Total Assets 18068 15463 14269
Long Term Debt 3107 2875 3325
Proportion 5.82 5.38 4.29

The Asset Cover ratio of Southwest Airline Co. is increasing over the past 3 years. The ratio shows the ability of the company to meet its obligations with the available assets. The ratio denotes the amount of the assets that the company will use to offset its long-term obligations. In the year ending 2009, the company recorded Asset cover of 4.29 and it has increased to 5.38 and 5.82 in the year ending 2010 and 2011 respectively. This is a good sign for a company in a competitive economy. It should not only rely on external financing, for instance loans and debts, but on the assets of the company. Normally, the investors analyze the trend in the company’s ability to meet its long-term obligations (Brigham and Daves, 2012). Therefore, in order to be competitive and enhance long-term survival in the current-changing economy, the company should ensure that its total assets are sufficient to meet the current and changing economic demands.

Operating Ratio

=Operating Expenses/Net sales

Years 2010-2011 2009-2010 2008-2009
Operating Expenses 7099 5758 5421
Net Sales 15658 12104 10350
Proportion 0.45 0.48 0.52

Operating ratio shows the efficiency of an organization. Most of the companies, operating in aviation industry, rely on operating ration in order to convince the shareholders and/or investors on the need to invest in their operation. In the financial year ending 2009, the company’s ratio was 0.52which decreased to 0.48 and 0.45 in the year ending 2010 and 2011 respectively. Decline in operating ratio is not a good sign on the future of the company. The competitors may take advantage of the situation, and prioritize on increasing their proportion of operating ratio in an attempt to attract investors. It is clear that the company has not invested in new and emergent markets; thereby recording low level of net sales. The company’s business model allows minimization of operating expenses (Baker and Powell, 2009). Other organizations, in the aviation industry, have focused on increasing the revenue outlay without much focus on operating expenses. They have increased the number of services they offer, which has expanded their revenue base.

Conclusion

From the above ratio analysis, it critical to note that Southwest Airline is performing well, and investors will be guaranteed long term growth in the business activities of the company. Though the company has focused on offering minimal services to its customers, most of the clients are loyal to the company, which is denoted by the annual increase in revenue outlay and proportionate reduction of operating expense. Therefore, it will be prudent for the investment bank to invest in the operations of Southwest Airline.

 

References

Baker, K. & Powell, G. 2009. Understanding Financial Management: A Practical Guide, London: John Wiley & Sons.

Brigham, E. & Daves, P. 2012. Intermediate Financial Management, London: Cengage Learning.

Brigham, E. & Ehrhardt, M. 2011. Financial Management: Theory and Practice, London: Cengage Learning.

Chandra, P. 2008. Financial Management, London: McGraw-Hill Education.

Debarshi, B. 2011. Financial statement analysis: For University of Calcutta, New Delhi: Pearson Education India.

Gallagher, A. 2009. Financial management: Principles and practice, London: Routledge.

Gibson, C. 201). Financial Reporting and Analysis: Using Financial Accounting Information, London: Cengage Learning.

Peterson, P. & Fabozzi, F. 2012. Analysis of Financial Statements, London: John Wiley & Sons.

Siddiqui, S. 2006. Managerial Economics and Financial analysis, New York: New Age International.

Vasigh, B. 2010. Foundations of Airline Finance: Methodology and Practice, London: Ashgate Publishing Ltd.

 

 

 

 

Appendix 1

Performance of the Company in NYSE

www.bloomberg.com

 

 

 

 

 

 

 

Appendix 2

Competitors

Direct Competition Comparison

LUV AAMRQ DAL JBLU Industry
Market Cap. 8.30B 502.91M 11.73B 1.77B 1.68B
Employees 46,048 80,100 76,626 11,797 11.80K
Qtrly Rev Growth (yoy): 0.00 0.01 0.01 0.10 0.20
Revenue (ttm): 17.02B 24.87B 36.47B 4.93B 3.62B
Gross Margin (ttm): 0.22 0.22 0.22 0.29 0.26
EBITDA (ttm): 1.70B 1.45B 4.67B 651.00M 377.90M
Operating Margin (ttm): 0.05 0.02 0.09 0.08 0.11
Net Income (ttm): 495.00M -3.23B 1.43B 150.00M N/A
EPS (ttm): 0.65 -9.64 1.68 0.47 0.65
P/E (ttm): 17.30 N/A 8.25 13.34 13.76
PEG (5 yr expected): 0.96 -0.62 0.22 0.40 0.40
P/S (ttm): 0.48 0.02 0.32 0.34 0.47

LUV – Southwest Airline

AAMRQ – AMR Corporation

DAL – Delta Air Lines Inc.

JBLU – JetBlue Airways Corporation

Industry – Regional Airlines

 

Appendix 3

Airlines Ranked by Revenue Passenger Miles

Company Symbol Price Change Market Cap P/E
AMR Corporation AAMRQ 1.50 0.01 502.91M N/A
United Continental Holdings, Inc. UAL 26.00 0.00 8.64B N/A
Air France-KLM S.A. Private
Delta Air Lines Inc. DAL 13.86 0.02 11.73B 8.25
British Airways Plc Private
Deutsche Lufthansa AG Private
Japan Airlines Co., Ltd. Private
Southwest Airlines Co. LUV 11.25 0.01 8.30B 17.30
Continental Airlines, Inc. Private

 

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