Southwest Airlines Co.

Southwest Airlines Co. - Financial and Strategic Analysis Review

Publication Date: 13-Oct-2011 Reference Code: GDTTL48167FSA

Company Snapshot
Key Information
Southwest Airlines Co., Key Information Web Address www.southwest.com Financial year-end December Number of Employees 45,112 NYSE LUV
Source : GlobalData

Company Overview
Southwest Airlines Co. (Southwest Airlines) is a US-based passenger airline principally engaged in offering scheduled air transportation in the US. The company offers a supply chain of travel services to its passengers such as air, car, hotel, cruise and vacation packages. The other services offered by the company include selling credits to various business partners that include credit card companies, hotels, telecommunication companies and car rental agencies. It operates more than 3,400 flights a day. The companys 548 Boeing 737 aircraft serves over 69 cities in 35 states throughout the US. Southwest Airlines is headquartered in Dallas, Texas, the US.
14.40 7.34 7.36 54.19 8.16 NA Optimum Asset Utilization Point-To-Point Services Long Term Consistent Growth Trade Account Receivables Debt Obligations Southwest Airlines Co., SWOT Analysis Strengths Weaknesses

Key Ratios
Southwest Airlines Co., Key Ratios P/E EV/EBITDA Return on Equity (%) Debt/Equity Operating profit margin (%) Dividend Yield
Note: Above ratios are based on share price as of 27-Oct-2011 Source : GlobalData

SWOT Analysis

Share Data
Southwest Airlines Co., Share Data Price (USD) as on 27-Oct-2011 EPS (USD) Book value per share (USD) Shares Outstanding (in million)
Source : GlobalData

Opportunities 8.85 0.61 8.34 747 Positive Air Traffic Outlook Acquisition of AirTran Holdings, Inc. Growing Global Air Freight and Logistics Sector

Threats Stringent Government Regulations Overdependence on Technology Competitive Pressures

Performance Chart
Southwest Airlines Co., Performance Chart (2006 - 2010)

Source : GlobalData

Financial Performance
The company reported revenues of (U.S. Dollars) USD 12,104.00 million during the fiscal year ended December 2010, an increase of 16.95% over 2009. The operating profit of the company was USD 988.00 million during the fiscal year 2010, an increase of 277.10% over 2009. The net profit of the company was USD 459.00 million during the fiscal year 2010, an increase of 363.64% over 2009.

Source : GlobalData

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Southwest Airlines Co. Southwest Airlines Co. - SWOT Analysis

SWOT Analysis - Overview Southwest Airlines Co. (Southwest Airlines) offers scheduled air transportation in the US. The company leverages upon its unique point-to-point service and the long history of profitability. However, debt obligations and increasing trade accounts receivable remains as an area of concern for the company to look upon. The company at the same time faces major challenges in terms of strong competition in the industry and volatility in the fuel and oil prices. However, growing air traffic and consolidation in the industry could present the company with an opportunity to improve its business. Southwest Airlines Co. - Strengths Strength - Optimum Asset Utilization Southwest Airlines makes optimum utilization of its aircrafts. It aims to reduce the amount of time the aircrafts are on the ground. The strategy of the company to serve secondary or downtown airports which are less congested than other airlines hub airports enables it to achieve maximum asset utilization. The secondary airports served by the company include Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Burbank, Manchester, Oakland, San Jose, Providence, Ft. Lauderdale/Hollywood, and Long Island Islip airports. This strategy also reduces the number of aircraft and gate facilities that would otherwise be required. Thus by making optimum use of the assets the company is able to save on cost and provide low fares to its customers. Strength - Point-To-Point Services Southwest Airlines engages in providing point-to-point service contrary to the hub-and-spoke service provided by other major U.S. airlines. This service is provided using its homogenous fleet of 537 Boeing 737 aircraft. This service offers frequent direct flights over short distances, like from Los Angeles to Las Vegas. The point-to-point system adopted by the company provides direct nonstop routing and thereby minimizes connections, delays, and total trip time. As of December 31, 2010, the company served 460 nonstop city pairs. The average aircraft trip stage length of the company recorded an increase in 2010. The average aircraft trip stage length was 648 miles with an average duration of 1.8 hours in 2010, compared to 639 miles and an average duration of 1.8 hours in 2009. Point-To-Point service facilitates Southwest Airlines to provide conveniently timed flights at low fares. Strength - Long Term Consistent Growth The airline industry is influenced by large number of factors as the industry is cyclical, labor intensive, capital intensive, heavily regulated, energy intensive, heavily taxed and extremely competitive. The company started off its services on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities, namely, Dallas, Houston, and San Antonio. Presently,in 2010, the company operates with 548 Boeing 737 aircraft serving 69 cities in 35 states throughout the United States, and has plans to begin service in to two new states and three new cities in March 2011. The year-on-year growth in terms of expanding of its facilities indicates that the company has been very consistent in spite of the prevailing risks and competitive pressures in the industry and also as per the reports of the U.S. Department of Transportation, as on September 30, 2010, the Company was the largest domestic air carrier in the United States, measured by the number of originating passengers boarded. Strength - Increasing Margins and Returns Southwest Airlines reported 16.9% increase in total revenue in 2010 as compared to that in 2009. The revenue growth resulted in increased gross margin, which increased 21.08% in 2010 as compared to 18.12% during 2009. Revenue growth and increased gross margin was complimented by its controlled costs. The companys operating cost as a percentage of sales declined 91.84% in 2010 from 97.47% in 2009. Similarly, the company reported increased returns in 2010 as compared to those in previous years. The company's return on equity (ROE) was 7.36% at the end of fiscal year 2010, as compared to 1.82% in 2009. Its return on capital employed was 8.13% in fiscal year 2010, as compared to 2.26% in 2009. Also, its return on assets, return on fixed assets, and return on working capital were 2.97%, 8.83% and 101.44%, respectively, in 2010 as compared to 0.69%, 2.40% and 39.52% in 2009. Increasing profitability ratios indicate the companys sturdy performance and its ability to deliver returns expected by its shareholders. The decreased cost and increased returns led to overall growth of its operating margins. The companys operating margin increased 8.16% in 2010 from 2.53% in 2009. Its net profit margin also grew in 2010. Its net profit margin increased to 3.79% in 2010 from 0.96% in 2009. Such stable revenue and growth rate will allow the company to pursue strategic capital investment opportunities in the future. Southwest Airlines Co. - Weaknesses Weakness - Trade Account Receivables The companys increasing account receivables affects its competitive and profitability position. Southwest Airliness

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Southwest Airlines Co.

accounts receivables increased to $195m in 2010 from $169m in 2009, showing an increase of 15.4% over the period. The company under its operational process entered into several factoring agreements with trade debtors as per the trade settlements. Southwest Airliness accounts receivable principally consists of due from credit card companies associated with sales of tickets for future travel and amounts due from counterparties associated with fuel derivative instruments. Such increasing accounts receivable reflect the inefficient credit management by the company. In the backdrop of growing economic recession, the probability of defaults by any of creditors increased, which may impact the overall financial position as well as profitability of the company. Weakness - Debt Obligations Southwest Airlines reported highly leveraged capital structure, which may affect its expansion and growth plans. At the end of fiscal 2010, the company reported a debt obligation of $3,380m consisting of a total long-term debt component of $2,875m. In addition, the company reported a substantial high debt to equity ratio of 54.19% and a debt to capital ratio of 27.80% in the fiscal year ended December 2010. The company incurred this debt to meet its working capital and capital expenditure needs. If it fails to comply with any of the debt service requirements, the debt could become due and payable prior to its scheduled maturity. However, in 2010, the company reduced its long term debts with 13.5% as compared to previous year, with the payment of $155m interest amount. Any reduction in revenues and operating cash flows could hinder the companys ability to repay interest and principal, resulting in default. Thus, such huge debt increases the financial burden on the company, limiting the availability of cash for its growth. Southwest Airlines Co. - Opportunities Opportunity - Growing Global Air Freight and Logistics Sector Despite of the global economic slowdown, there has been a strong growth in the global air freight and logistics industry in the recent past. It is expected that, the total revenues generated by this industry would grow significantly. Also, it is estimated that the volume of the global air freight and logistics market would touch 228 billion freight ton kilometers (FTKs) by 2012, growing at a CAGR of 5.6% during 2007-2012. Growing demand in India and China could be the reason for this projected growth in the sector. The company could capitalize on this opportunity and improve its revenues and could thereby further enhance its market share. Further, the emerging markets of the world, particularly India and China have strong growth prospects for the economic development. These countries are witnessing stronger economic growth than many of its western counterparts. Subsequently, with the growth in economy, activities such as infrastructure and industrial development are on rise. In such scenario, it is expected that the logistics market would grow significantly in the region. Strong growth potential in the logistics market in the Asia-Pacific, particularly India and China could provide strong business growth to the company. Opportunity - Acquisition of AirTran Holdings, Inc. The company completed the acquisition of AirTran Holdings, Inc. on May 2, 2011. This acquisition represents a great opportunity to extend its network into key markets, such as Atlanta and Washington, D.C., through Ronald Reagan National Airport. It provides Southwest Airlines an opportunity to serve over 100 million customers in a year from more than 100 different airports in the US and near-international destinations, offering customers more low-fare destinations as it diversify and expand the well-known 'Southwest Effect' to hundreds of additional low-fare itineraries for the traveling public. The acquisition of AirTran also expands its presence in New York LaGuardia, Boston Logan, Milwaukee, and Baltimore/Washington, as well as extending its services to several smaller domestic cities with access to key near-international leisure markets in the Caribbean and Mexico. Opportunity - Positive Air Traffic Outlook The company may benefit from the long-term outlook for the global passenger traffic growth that looks positive. The traffic growth is clearly on the rise and shows that the markets are maturing and returning to the real growth as compared to the pre-crisis levels. The period is projected to witness annual passenger traffic growth of 7.1%, in January 2011. The growth of domestic passenger volume in North American region, the largest domestic market as compared to other geographies posted a rise of 1.7% in 2010 as compared to the 2009. Similarly, the Latin American region saw strongest expansion in domestic traffic posting a 9.2% rise. Since the company has its major operations in the American geography, Southwest Airlines can leverage this market opportunity, which would further grow its revenues and market share. Southwest Airlines Co. - Threats Threat - Stringent Government Regulations The company is subject to several regulations and policies, which could have an adverse effect on the overall operations of the company. The various regulating bodies of air transportation services include Transportation Security Administration (TSA), the U.S. Department of Transportation (DOT) and the Federal Aviation Administration (FAA). The various aspects regulated by DOT authority include economic aspects of air transportation, such as discriminatory pricing, non-competitive

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Southwest Airlines Co.

practices, interlocking relations and cooperative agreements. It also lays down regulations for the import and export of cargo. The companys operations are also subjected to micro monitoring and high-security checks for passengers. Failure to comply with these regulations could impact the overall operations of the company. Threat - Overdependence on Technology The company is increasingly being dependent on the use of complex technology and systems to carry out its ongoing operations. The company has implemented a new SAP Enterprise Resource Planning application, which replaces several of the company's back office legacy systems including the general ledger, accounts payable, accounts receivable, payroll, benefits, cash management, and fixed asset systems. The company also has invested its financial resource in making significant technological changes necessary to support its new Rapid Rewards frequent flyer program, enhanced southwest.com website, and WiFi implementation. Integration of complex systems and technology presents significant challenges in terms of costs, human resources, and development of effective internal controls and also introduces a risk of operational or security inadequacy or interruption, which could materially affect the company's ability to operate its business. The technological implementation associates itself with a major factor of continuous modifications and refinements and any failure in doing so, will adversely affect the companys operations. Threat - Competitive Pressures The aviation industry is highly competitive. Southwest Airlines faces stiff competition from national and, international airways services providers, and particularly from low cost airlines. Southwest Airlines competes with American Airlines, Continental Airlines, Delta Air Lines Inc, JetBlue Airways, United Airlines and US Airways Group. The company could face challenges in pricing, quality, services, and related issues. Although the low cost structure of the company has been one of its primary competitive advantages due to offer of low fares, drive traffic volume, and growth in market share, has limited control, however, over increases in many of its other costs. The companys failure to maintain and enhance its competitive position could adversely affect its business and prospects. Competitive pressure could lead to a decline in revenues and margins of the company. Threat - Fuel Price Volatility Southwest Airlines faces significant challenges due to the extremely volatility in fuel prices. The Jet fuel and oil consumed by the company for the fiscal year ended December 31, 2010 and 2009 accounted to about 33% and 30% of the operating expenses, respectively, and also constituted the second largest expense incurred by the company. The fuel price fluctuations have directly caused an influence on the company as, the cost of fuel has been historically high over last few years and the price change is unpredictable. Also, the company is dependent on energy and any change in the market fuel prices will adversely affect the profitability figures. Since, the company also relies on the foreign imports of crude oil, any conflicts in the oil producing areas or changes in the governmental policies on fuel production, transportation and marketing will hamper the companys strategy of cost cutting.

NOTE: * Sector average represents top companies within the specified sector The above strategic analysis is based on in-house research and reflects the publishers opinion only

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