southwest investorrelations taofeng

8/11/2019 Southwest InvestorRelations TaoFeng

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Investor Relations Plan

Southwest Airlines (NYSE: LUV)

Investor Relations

Professor: William. B. Powell

Tao Feng

[email protected]

New York University
mailto:[email protected]:[email protected]:[email protected]


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Company Overview

Southwest Airlines Co. (NYSE: LUV) is a passenger airline that provides

scheduled air transportation in the United States. Headquartered in Dallas, Southwest

is the nations largest carrier in terms of originating domestic passengers boarded.

Today, Southwest operates the largest fleet of Boeing aircraft in the world to serve 96

destinations in 41 states. The company ranks as the fourth largest airline in U.S. based

on total revenue passenger miles (RPMs).

Started up as a low-cost carrier with only 4 planes, Southwest has now become

the most innovative and trendsetting companies in the airline industry. On May 2,

2011, the Company acquired AirTran Holdings, Inc. (AirTran) and kept expanding its

market. In 2013, the company added 11 new destinations in 8 states: Pensacola,

Florida; Wichita, Kansas; Portland, Maine; Flint, Grand Rapids, Michigan; Branson

Missouri; Rochester, New York; Charlotte, North Carolina; San Juan, Puerto Rico;

Memphis, Tennessee and Richmond, Virginia. The companys stock is at historical

high at $18.5 per share.

Business Model and Strategy

Short-Distance Point-to-Point Domestic Service

Southwestsbusiness strategy was to avoid the traditional hub and spoke

model that large airlines operated by, and instead offer passengers inexpensive,

point-to-point flights over short distances. In addition, the company serves downtown

airports, which include Dallas Love Field, Houston Hobby, Chicago Midway,


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Baltimore-Washington International, Burbank, Manchester, Oakland, San Jose,

Providence, Ft. Lauderdale/Hollywood, and Long Island Islip airports. These airports

are less congested than other airlines' hub airports. This operating strategy allows

Southwest Airlines to achieve high asset utilization and reliable on-time performance,

which in turn helps the company to increase its revenues and to tap profitable

markets.

Five Strategic Initiatives

From 2011, the company started five strategic initiatives to optimize its airline

operation, manage its current network and capacity. Among the five programs, the

Rapid Rewards Program, the Fleet Modernization and the Plane Placement are the

most successful ones that have significant impacts on its performance.

The Rapid Rewards Program set a new standard in frequent flyer programs and

offered enhanced Member benefits while providing the opportunity to generate

significant revenues. In Q3 2013, Southwest recognized approximately $13 million in

incremental revenues from this program.

For the Fleet Modernization and the New Plane Placement, Southwest has

taken delivery of nine of the 18 planned 737-800 orders and two leased 700 aircraft

by Q3 2013. The new 800 planes have higher fuel efficiency and bigger capacity than

the current 700 planes. The purchase of the 800 can effectively lower the CASM and

help to control fuel expenses. Southwest converted its 737-700 planes to new 143


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seats evolve configuration. This again, will lower the cost per unit and create higher

revenue per turnaround.

Fuel Hedging

Southwest's key to financial success was its fuel hedging where the company

agreed to future fuel contracts that secure a particular price. Southwest hedged more

oil than any other airline, which had ensured the lowest prices on jet fuel during

significant oil spikes. Southwest hedged around 70% of its fuel needs, while most

other major airlines had only between 20% and 30% of their fuel hedged.

In the 3Q 2013, Southwest spent 22 million in hedging the fuel price. They

successfully controlled their furl price in a $3.05 to $3.10 range, which was much

lower than the estimated price range of $3.25 to $3.30 per gallon. The lower fuel price

was one of the main reasons for their strong performance in these few years. They

always plan ahead for their fuel price.

SWOT Analysis

Strengths

Firm Operating Strategy

Modernized Fleets Fuel Hedging

Weaknesses

Heavy Dependence on Passenger

Revenue No International Flights

Opportunities

Growth in Air Passenger Travel in

the US

Poised to be Benefit from the

Acquisition of AirTran Holdings

Growing Global Air Freight market

Threats

Intense Competition due to Industry

Consolidation

Unstable Fuel Prices Could Strain

Margins

Stringent Government Regulation

could Increase Operating Costs


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Strengths

Firm operating strategy

Southwest Airlines focuses mainly on point-to-point service. This service allows for

direct nonstop routing by minimizing connections, delays and total trip time. As a

result, approximately 71% of Southwest Airlines' customers flew nonstop in 2012.

During the year, the company's average aircraft trip stage length was 664 miles with

an average duration of approximately 1.8 hours. This service enables the company to

provide its markets with frequent, conveniently timed flights and low fares.

Modernized Fleets

Southwest started the Fleet Modernization and the Plane Placement in 2011. By

purchasing the new 737-800 planes and retiring the fifteen 717 planes that acquired

from AirTran, they standardized and unified their fleet with only aircraft type- Boeing

737. At the same time, Southwest started to convert its 737-700 planes into new 143

seats, which increase their capacity by 4.3%. These processes have largely reduced

the fuel consumption and improved the revenue per unit.

Weaknesses

Heavy dependence on passenger revenues

Southwest Airlines is highly dependent on passenger revenues. The company derived

revenues of $160 million (1% of total revenues) from its freight operations and


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$16,093 million (94.1%) from passenger segment in 2012. The company has not yet

completely leveraged its strong domestic network towards increasing its cargo

revenues, which may lend more stability to its revenues. The cargo business has lower

demand elasticity than the passenger business and serves as a natural hedge against

higher jet fuel prices. Therefore, a low level of cargo/freight operations exposes the

company's dependence on passenger revenues, which increases its risks of operating

in an environment characterized by rising fuel costs.

No International Flights

Southwest is always focusing on the U.S. market. Till 2012, 100% of its revenue is

generated from the domestic market. Southwest has been proud of its domestic

performances, however, the instability of the regional market in the U.S may strain its

future development.

Opportunities

Growth in air passenger travel in the US

The US air passenger travel industry has witnessed fluctuating growth rates in the

recent past. However, the industry is expected to grow strongly in the coming years.

According to The Federal Aviation Administration (FAA), the airline passenger travel

would nearly double in the next 20 years. FAA estimates that RPMs (revenue

passenger miles) would nearly double from 815 billion in 2011 to 1.57 trillion in 2032,

with an average increase of 3.2% per year. The number of commercial operations at


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FAA and contract towers is expected to increase by more than 45% from current

levels. Thus, a growing end market auger well for Southwest Airlines as it is well

positioned to benefit from the growing air passenger travel in the US and generate

additional revenues.

Poised to benefit from the acquisition of AirTran Holdings

Southwest Airlines pursues acquisitions that supplement its existing businesses. The

acquisition provides Southwest Airlines an opportunity to grow its presence in key

markets it didn't yet served. It would allow the company to expand its presence in

slot-controlled markets where the company currently has little (New York LaGuardia)

or no service (Washington D.C Reagan); expand its service in other key domestic

markets, including Boston and Baltimore and to add destinations to its route system;

and provide access to near-international leisure markets in the Caribbean and Mexico,

as well as smaller cities. The complete combined company would serve more than

100 million customers annually from more than 100 different destinations in the US

and near-international destinations.

Growing global air freight market

The global airfreight sector has recovered from the global economic downturn in

2008 and 2009. It produced moderate growth from 2010 to 2012, which is forecast to

continue through to the end of the forecast period in 2016. According to Forrester

Research, the global airfreight sector is forecast to have a value of $159,426.9 million

in 2016, an increase of 27.9% since 2011. Southwest Airlines offers a range of freight


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and mail services onboard its passenger fleet. Thus, sustained growth in the

company's key end markets would translate into higher top line growth and enable the

company to record further steady revenue growth in coming years.

Threats

Intense competition due to industry consolidation

The US airline industry is characterized by intense price competition, especially in

domestic markets. Southwest faces increasing and significant competition from

marketing/operational alliances formed by its competitors. In recent years, the

domestic market share held by low-cost carriers has increased significantly. This

increase has lowered the price structure and diminished the profit margin of domestic

carriers. Moreover, there have been numerous mergers and acquisitions and changes

in industry alliances. In 2008, Delta Air Lines acquired Northwest Airlines; in 2010,

United Airlines merged with Continental Airlines; in 2014, US Airways will merger

with American Airlines. The increased competition in these international markets,

particularly due to consolidation in the airline industry, may have a material adverse

impact on Southwest Airlines' results of operations, financial condition and liquidity.

Unstable fuel prices could strain margins

Fuel prices and availability are subject to wide price fluctuations based on

geopolitical issues and supply and demand, which can neither be controlled nor

accurately predicted. According to IATA (International Air Transport Association),


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the estimates jet fuel prices would be $124.6 in 2013. Jet fuel and oil consumed for

2011 and 2012 represented approximately 38% and 37% of Southwest Airlines' total

operating expenses, respectively. Although the fuel price remains flat in 2012-2013,

changes in fuel prices can still have a considerable effect on the company's result. The

increase in global and regional oil prices exposes the company to extreme fluctuations

in earnings, which is likely to have an adverse consequence on its growth initiatives.

Thus, any inability to obtain jet fuel at competitive prices would materially have an

impact on Southwest Airlines' results of operation and financial condition. Below are

Brent oil price for the near five years and the airline net profit in the same period, it

clearly reflects the fuel prices impacts on airline companies profit margins.

Government regulation could increase operating costs

Airlines are subject to extensive regulatory and legal compliance requirements that

result in significant costs. The Federal Aviation Administration (FAA) regularly

issues directives and other regulations relating to the maintenance and operation of

aircraft that necessitate significant expenditures. The Aviation and Transportation

Security Act, which became law in 2001, mandates the federalization of certain


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airport security procedures and imposes additional security requirements on airports

and airlines, most of which are funded by a per ticket tax on passengers and a tax on

airlines. The federal government has on several occasions proposed a significant

increase in the per ticket tax. The proposed ticket tax increase, if implemented, could

negatively impact the company's revenues.

Southwests Financial Performance

Southwest recorded revenues of $17,100 million during the financial year

ended December 2012, an increase of 3% over 2011. The operating profit of the

company was $623 million during 2012, a decrease of 10.1% as compared to 2011.

The net profit was $421 million in 2012, an increase of 136.5% from 2011. Its RPMs

(Revenue Passenger Miles) increased by 5% from 97.6 million to 102,9 million.

Southwest has the healthiest balance sheet among the major U.S. airlines, with an

adjusted debt to capital ratio of about 29% compared in to the industry average of

72.91%. Its return on equity is 6.06, five times higher than 1.00 industry average.

Southwests P/E ratio is 21.21, higher than the industry average of 17.54. Till 2012,

Southwest was profitable for the 40th consecutive year. From the second quarter of

2012, the company raised its dividend from 0.0045 to 0.01 per share. Later in second

quarter 2013, Southwest increased it dividend again from 0.01 to 0.04. The increase

of dividend creates higher value for its investors.


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As you can see the charts, Southwests stock is traded at its historical high at an

average of 18.59 dollars per share in Dec 2013. For the last 52 weeks, Southwests

stock was up 95.1%. During the 12 months ending on 9/30/2013, its earnings per

share totaled $0.86 per share. These 12-month earnings are greater than the earnings

per share achieved during the calendar year ending last December. The company has

just created the best third quarter performance in 2013, which is a 162% growth year

over year. The estimate earning in Q4 is 0.26 per share, almost three times higher than

the same period last year. The market expects Southwest continue to grow in the


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coming year as it smoothly gone through the merger process. For 2014, the estimated

EPS is 1.23, a 17% increase from 2013.

The company missed expectation ONCE in the 2Q of 2011. It reported 2Q 2011

earnings of $0.15 per share on 8/4/11. This missed the $0.20 consensus of the 14

analysts covering the company. The underperformance is probably due to the

significant raise of fuel price and the upfront input into the acquisition process. Its

stock price dropped from $11.45 to $8.06 in two months. Southwest come back with a

positive surprise in the coming quarter of $0.15 EPS and beat the census earning of

$0.14 per share. But it still took Southwest half an year to get back to the original

price.

Competitor Analysis

In domestic market, Southwestsbiggest competitors in the airline industry are:

US Airways Group, Inc., AMR Corporation, Delta Air Lines Inc. and JetBlue

Airways Corporation.

Company Sales in

billion

Sales

Growth

P/E P/S Main Market

Southwest 17.088 9.1% 21.21 0.76 The United States

(100%)US Airways 13.831 5.9% 8.1 0.33 The United States


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(74.8%)

AMR

Corporation

24.855 3.7% 9.4 0.16 Domestic (57.5%)

Delta Airlines 36.670 4.4% 11.98 0.68 North America

(65.0%)

JetBlue

Airways

4.780 10.6% 21.83 0.36 The United States and

the Caribbean (100%)

Company Comparisons (Fiscal Year ending 2012)

In 2012, Southwest and JetBlue have higher sales increases than three other

companies. While Southwest and JetBlue enjoyed a sales increase of 9.1% and 10.6%,

the other companies saw smaller increases: US Airways Group, Inc. sales were up

5.9%, AMR Corporation increased 3.7%, and Delta Air Lines Inc. experienced

growth of 4.4%.

Southwests 21.21times P/E ratio is the second highest among the five

companies, slightly lower than JetBlues 21.81. For P/S ratio, Southwest is currently

trading at 0.76 times sales. This is a higher ratio than all other companies, which are

trading between 0.16 and 0.68 times sales.

While AMR still struggling to come back from bankruptcy; US Airways and

Delta have smaller growths and see lower expectation; JetBlue suffer from its

financial performances by missing expectations twice this year, Southwest is the most

competitive companies among the five.

Analyst Coverage


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There are 16 analysts covering Southwest. The number remains stable in the past 6

months. According to the analysts, the current Price Target for LUV is $19.12. The

market still expects its growth.

The estimate EPS for 2013 is $1.05 ($0.26 for 4Q 2013). Analysts expect the earning

for the next year will be $1.23 per share, a growth of 17% from 2013. The mean

recommendation for the company is 2.63, suggesting a hold or a weak buy.

According to the report of S&P, Southwest are ranked in the most undervalued stocks.

Its price is undervalued by $11.44 or 66.7%. Deutsche Bank sets a high target price

for Southwest at $21 per share. They also expect Southwest to have estimated EPS of

$1.25-1.27 in the coming year, higher than the consensus of $1.23. They expect the

company to significantly grow in the coming year. Barclays Capital overweighed the

stock for its outstanding performance in the 3Q 2013, they believe the market

underestimates efforts to re-allocate flying and suggested sentiment and stock

performance had made for an attractive entry point for investors.

Some institutions have different opinions, analyst from J.P Morgan suggested the

more-congested market that Southwest is developing would slow Southwests aircraft


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Since 82% of its float held by institutional and mutual fund investors, LUV is not a

retail stock. s

Companys Investor Relations Performances

IR Website

Although LUV is not a retail stock, its investor relations website is fully loaded and

informative.

There are four main sections (corporate governance, news & events, financials,

investor resource) on their IR website, providing comprehensive information for

different stakeholders. Investors can find Southwestsfinancial statement, annual &


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quarterly reports, company reports and SEC filings easily through the website.

Southwest also shares non-financial information including corporate governance

information, press releases, events, and available IR contacts. The website also

provides companys history performances, dividend information to give investors an

outlook of Southwests overallperformances.

Its website is user friendly and easy to navigate. Investors can get to critical

information without too many clicks. In addition, it provides various formats of

information, including HTML, PDF, XBRL, and audio recordings. Investors can also

use email alerts or RSS news feeds to access the above information. This website give

investors a good understanding of the company.

Communications

During the 2Q13 and 3Q13 earnings call, the management team talked about the

companys strategiesand future plans. They emphasized their effort in controlling the

fuel costs, unifying their airplanes and integrating new networks. They also stress on

their progress in hitting the 15% pretax ROIC target. They gave analysts enough

information in terms of their operation system, network management and fleet

modernization. The earnings call nicely positioned Southwest as a growing company

that expects to fully optimize their network by using effective strategies.

The companys IR presentation clearly interpreted the companys general goals and

overall business strategies. It well communicated about the acquisition process and

fleet management. It also provided specific information about the companys market


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expansions, revenue plans, cost structure and employee management. The whole

presentation is thorough and well structured.

Investor Relations Objectives

Southwest is going to complete the merger process in 2014. By 2013, they have

successfully adopted 85% of AirTrans network and expanded their destinations by

20%. They also successfully lowered the cost by implementing the fleet

modernization initiative and hedging against the fuel price. Southwest announced that

there wouldnt be any new destinations in the coming year; instead, they will try to

fully optimize the current network after the acquisition and seeking for a new growth.

Southwest has a good price right now and they have done good jobs to maintain the

momentum (outstanding financial and IR performances). They are also doing well to

enhance their shareholders values (increasing dividends).

However, many analysts consider Southwest has entered into its mature growth phase

and will have slower growths. They also concern that Southwest will stray from its

traditional business mode as they merger with AirTran and enter into new markets. In

addition, the unpredictable fuel price and the instable domestic environment still

lower the marketsconfidence on LUV and the airline industry. Under this situation,

Southwest need to enhance the markets confidence in buying in the companys stock.

Here are some suggestions for the company to improve their stock price.

Strengthen Southwestsimage as a growing company


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Distinguish Southwest from other major airlines as it continue to grow

Demonstrate Southwests effort to minimize the unpredictable effects

Tactics:

Timely provide information regarding the merger process, convince investors

that Southwest will continue to grow by fully optimizing the new network and by

seeing more opportunities in a bigger market

Clear and re-emphasis Southwest business strategies and operating management

as it finishing the acquisition and opening new markets, showing investors that it

can continue the strong performance under clear and firm operation

Proactively communicate Southwestsinitiatives progress, which helps them

effectively minimize the cost of the fuel price and increase the revenue per unit

Timely provide information regarding Southwestsnew network system

including flights schedule, operating management and airport resources

Conclusion

I will buy this companys stock because its steady, moving upward and making

progresses. Compared to other airlines, Southwest is less vulnerable to fuel prices,

healthier in liability-asset ratio, and more advanced in terms of the management and

operation. In domestic scale, Southwest will definitely has a much bigger potential

market post-merger. In a relatively stable economic environment, Southwests

revenue is expected to grow year-over-year.


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Southwests P/E ratio in the past 12 months was 20.2x, much higher than the industry

average of 17.1x. Market expects a continual growth of its earning. Its stock price is

also the most stable one in the industry

Following the strong performance these two years, then company has raised its

quarterly dividend from $0.01 per share to $0.04 per share; the company also

frequently repurchases their stock from the market. From investors point, it means

higher revenue and a higher value of the stock.

LUV is the most stable stock in airline industry. This is a good choice for investors

who seek for long-term investments and opportunities for a value increase.

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