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Global Airlines

Global Airlines. James Bolegoh Mauro Horie Richard Konings Zhe Liu Robbie Lydon. Agenda. Introduction Southwest airlines Singapore airlines. Airline Products. Provides fast passenger transportation, both nationally and internationally Freight can also be transported quickly

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Global Airlines

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  1. Global Airlines James Bolegoh Mauro Horie Richard Konings Zhe Liu Robbie Lydon

  2. Agenda • Introduction • Southwest airlines • Singapore airlines

  3. Airline Products • Provides fast passenger transportation, both nationally and internationally • Freight can also be transported quickly • Substitutes: • Car or bus • Train • Boat

  4. Industry Characteristics • Cyclical in nature, with over expansion during upturns, and large cutbacks during downturns • Only marginally profitable • A special case due to: • Defense • Economic • Flag

  5. Revenue Structure • The two main sources of revenue for Airlines are from: • Passenger fares • Cargo

  6. Cost Structure

  7. World Airline Profits 1992-2002

  8. Adverse Industry Effects • 9/11, SARS, and Iraq war • The industry was already entering a down period prior to this catastrophic event • Increasing fuel costs began late 2000 • Huge losses and layoffs were announced shortly afterwards • Large decline in the number of passengers

  9. Industry Outlook • Recovery from industry shocks • Expansion into developing markets • Increased use of Alliances

  10. Strategic Alliances • Sharing of resources • Seamless global network • Competitive advantage

  11. International Air Transport Association Market Share

  12. Regulatory Environment • Two key organizations that affect the international airlines are: • International Civil Aviation Organization • Composed of representatives from member countries • International Air Transport Association • Comprised of International Airlines

  13. US Regulatory Impact • Airline Deregulation Act (1978) • To encourage a competitive air transportation system • International Air Transport Competition Act (1979) • 3 goals • Open Skies Agreements

  14. Airline Risk Factors • Financial risk • Variability of revenue and costs • Strategic risk • Business design choices • Operational risk • Tactical aspects of running the business • Hazard risk • Safety of physical assets

  15. What Risks are Hedged? • Fuel Costs • Foreign Exchange Risk • Interest Rates • Credit Card Guarantees

  16. Southwest Airlines

  17. Section Overview • Company background • Major risks and risk management • Stock options

  18. Company Background • Founded in 1971 with flights between Dallas, Houston and San Antonio • Has become the forth largest major airline in the United States in terms of revenues as of Dec.2002 • Has been the number one carrier in terms of domestic boardings in the U.S. since May 2003 • Transports more than 64 million passengers per year to more than 58 cities in 30 states

  19. Southwest Route Map

  20. Fact Sheet Daily Departures: 2,800 flights per day Employees: 33,000 throughout the system Common Stock: Traded under the symbol LUV at NYSE 2003 Financial Statistics: • Net Income: $442 million • Total Passengers Carried: $65.7 million • Total RPMs: $47.9 million • Total Operating Revenue: $5.9 billion • Passenger Load Factor: 66.8%

  21. Company Fleet Profile • Southwest operated 388 Boeing 737 Jets (as of Dec, 2003) • Company fleet has an average age of 9.5 years

  22. LUV Financial Position

  23. LUV Financial Position

  24. 5-Year Stock Price Evolution 9/11 SARS

  25. Revenue Source

  26. Growth • For the five years ended 2001, the average annual capacity growth was 10% • 2002 - over 5% • After 2002, the estimated annualized growth rate over the next 10 years is roughly 8%

  27. Cost Structure Interest expenses1.7% 2.1% 1.4%

  28. Major Types of Risk Market risk • Fuel price risk • Financial market risk • Interest rate risk • Credit risk • Liquidity and financing risk

  29. Fuel Price Risk • Fuel price risk • Estimated 1.2B gallons of jet fuel for 2004. A change of $0.01 in fuel prices would impact fuel expenses by $12M • Makes cash flow and earnings unpredictable • Southwest solution - fuel hedging • Not for trading purposes • Effective commodities - crude oil and heating oil • Short-term and long-term • Mixture of call options, collar structures, and fixed price swap agreements • Hedged 80% of 2004 fuel requirement, 60% of 2005, and portions of 2006-2007 as of Dec. 31, 2003

  30. Fuel Price Risk Fuel hedging results • Recognized gains of $171M in fuel expense (Table 1) and unrealized gains of $123M, net of tax • A net asset of $251M at the end of 2003 (Table 2) • Sensitivity analysis: 10% change in commodity prices would change fair value of derivative instruments by approximately $125M and more or less than $125M of changes in cash flows (as of Dec. 31, 2003)

  31. Fuel Price Risk Fuel hedging results - Table 1

  32. Fuel Price Risk Fuel hedging results - Table 2

  33. Financial Market Risk • Financial market risk • Interest Rate Risk • Credit Risk • Liquidity and Financing Risk • Southwest strategy • Capitalize conservatively • Grow capacity steadily and profitably • Strong B/S and modest financial leverage • High credit rating - “A” with S&P’s rating; “Baa1” with Moody’s rating on senior unsecured fixed-rate debt

  34. Interest Rate Risk • Debt • Short-term investment • Leasing

  35. Interest Rate Risk • Interest rate risk (debt) • Changes in interest rate affect I/S and cash flow; may result in insolvency and bankruptcy • Southwest solution • Low debt strategy • Total debt - $1.55B; low D/E ratio:0.30 (AMR:12.86, DAL:16.33, JBLU:1.65) • Market sensitive instruments • Fixed rates and modest financial leverage ($475M) • Interest rate swaps ($760M) • Prepayment, redemption or termination for floating-rate debt ($222M)

  36. Interest Rate Risk • Interest rate swap agreements (2003) • Agreement 1: pay LIBOR + a margin every 6 month and receive 6.5% every 6 month on $385M senior unsecured notes; due Mar-2012 • Agreement 2: pay LIBOR + a margin every 6 month and receive 5.496% every 6 month on $375M, 5.496% pass-through certificates; due Nov-2006

  37. Interest Rate Risk • Interest rate risk (short-term investment) • Total cash and cash equivalents of $1.87B as of Dec. 31, 2003 • Parallel closely with floating interest rates • Affects earnings and cash flow • Southwest solution • Invests in certificates of deposit, highly rated money markets, and investment grade commercial paper • No additional actions to cover interest rate market risk and other material market interest rate risk management activities

  38. Interest Rate Risk • Interest rate risk (leasing) • Total PV of leasing payments (2004 after): • Capital leasing - $91M • Operating leasing - $2.5B • Aircraft leases can be renewed at the end of the lease term for one to five years • However, leases are not considered market sensitive financial instruments and not included in the interest rate sensitivity analysis

  39. Interest Rate Risk • Results • No significant exposure to changing interest rates on fixed-rate debt • A liability of $18M - interest rate swap • Sensitivity analysis: 10% percent change would affect net earnings and cash flows by less than $1M (floating-rate debt, invested cash, and short-term investments) • An increase in rates has a net positive effect

  40. Credit Risk • Credit risk • Nonperfomance by the counterparties associated with outstanding financial derivative instruments • Results in credit loss • Southwest solution • Selects and periodically reviews counterparties based on credit ratings • Limits the exposure to a single counterparty • Monitors the market position • Agreements with seven counterparties (early termination rights, bilateral collateral provisions, security requirements) • Results • No counterparties fail to meet their obligations

  41. Liquidity and Financing Risk • Liquidity and financing risk • Agreements with financial institutions (credit card transactions) • Credit facility • Outstanding debt agreements • May reduce the availability of cash or increase the costs to keep the agreements • Southwest responsibility • Maintaining minimum credit ratings • Maintaining minimum assets fair values • Achieving minimum covenant ratios for available or outstanding debt agreements • Results • The company met or exceeded the minimum standards set forth in the agreements

  42. Risk Management Governance • No specific committee or RMO for Southwest’s risk management.

  43. Other Potential Risks and Uncertainties • War risk • Competitive factors • General economic conditions • Factors to control costs • Operational disruptions

  44. Stock Options • Stock-Based Employee Compensation covers: • Majority of employee groups • Board of directors • Plans related to certain contracts with certain executive officers of the company

  45. Stock Options • Two classes of employee stock plans: • 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

  46. Stock Options • 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

  47. Stock Options

  48. Stock Options Shares Outstanding: 790 million Stock Price: $14.33

  49. Singapore Airlines

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