John Paul Clarke - isr.umd.edu · PDF fileJohn-Paul Clarke, Alex Lee, Bruno Miller ... Best...
Transcript of John Paul Clarke - isr.umd.edu · PDF fileJohn-Paul Clarke, Alex Lee, Bruno Miller ... Best...
M I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o nM I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o n
MIT MIT ICAT ICAT
Is air transportation financially sustainable?
John-Paul Clarke, Alex Lee, Bruno MillerDepartment of Aeronautics and Astronautics
Massachusetts Institute of Technology
MIT MIT ICAT ICAT Measuring Financial Health (1)
There are three common methods to measure the financial health (or bankruptcy risk) of a firm
Managerial Performance ModelsSubjective model based on analyst’s judgment of the overall managerial, financial and trading position of the firm
Best known model is the Argenti “A” score modelAnalysts assign scores under 3 major headings
DefectMajor mistakesSymptoms
Scores based on a point system
MIT MIT ICAT ICAT Measuring Financial Health (2)
Univariate Financial Ratio AnalysisAnalyzes firms’ financial ratios both on a cross-sectional basis and on a time-series basis
Ratios commonly used include: Profitability ratiosLeverage ratiosActivity ratiosInvestment ratios
Analyst examines each ratio separatelyRatios could be contradictoryRelies on analyst’s interpretation of the ratios
MIT MIT ICAT ICAT Measuring Financial Health (3)
Multiple Discriminant Analysis (MDA)Altman developed MDA in response to shortcomings of the univariate financial ratio analysis
Based on objective statistical data rather than on the subjective interpretation of a financial analystResearchers have developed industry-specific MDA models
MDA models developed in the following steps:Establish two mutually exclusive groups, namely those firms which have failed and those which are still continuing to trade successfullyCollect financial ratios for both of these groupsIdentify the financial ratios which best discriminate between groupsEstablish z-score based on these ratios
Sensitive to changes in accounting practices
MIT MIT ICAT ICAT Altman Z-score model
The most commonly used MDA model to predict bankruptcy is the Altman Z-score model
Gritta (1982) applied Altman’s model to the airline industry and correctly predicted Braniff’s bankruptcy
Chow, Gritta, and Leung (1991) developed the first industry specific bankruptcy prediction model for the airline industry, called the AIRSCORE model (based on Altman’s Z-score model)
Authors indicate that these models are good for predicting bankruptcies two years into the future, but are not good for longer term predictions
This is partly due to the static nature of the model, not taking into account cycles in demand
MIT MIT ICAT ICAT AIRSCORE Model
The AIRSCORE model by Chow, et.al. is:z-score = a * (interest expenses/total liabilities) +
b * (operating revenues/miles flown) + c * (shareholder’s equity/total liabilities)
The coefficients they estimated were:a = -0.34140 b = 0.00003 c = 0.36134
Z-score boundaries:Carriers above 0.03 are healthy
Carriers below -0.095 are in trouble
MIT MIT ICAT ICAT AIRSCORE for "Failed" Airlines
-0.2
-0.1
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PA - System Wide EA - System Wide Healthy In-Trouble
AIRSCORE for Failed Airlines
MIT MIT ICAT ICAT
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-0.1
0
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1978
AIRSCORE: 1978-2003 (1)
MIT MIT ICAT ICAT AIRSCORE: 1978-2003 (2)
-0.2
-0.1
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1978
MIT MIT ICAT ICAT AIRSCORE: 1998-2003 (1)
-0.1
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1998 1999 2000 2001 2002 2003
AAUADLNWCOHealthy
MIT MIT ICAT ICAT AIRSCORE: 1998-2003 (2)
-0.1
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1998 1999 2000 2001 2002 2003
USWNHPASTWHealthy
MIT MIT ICAT ICAT AIRSCORE: Observations (1)
AlaskaSafely in the healthy range
America WestGot into trouble during the recession in the early 90s
Restructured and emerged from bankruptcy in the mid-90s (as seen by the significant improvement in their z-score) and continues to be healthy
AmericanCurrently below the healthy level for the first time since deregulation
MIT MIT ICAT ICAT AIRSCORE: Observations (2)
Continental Low z-scores (and 2 bankruptcies) in the 80s and early 90s
Z-score improving since 1995 (arrival of Gordon Bethune)
DeltaCurrently below the healthy level for the first time since deregulation
NorthwestIn the healthy range but consistently declining
SouthwestVery healthy and consistently has the highest score
MIT MIT ICAT ICAT AIRSCORE: Observations (3)
TWADid not improve their z-score to the healthy range when they emerged from their first bankruptcy
Forced to file for a second bankruptcy shortly thereafter and isnow dead
UnitedCurrently well below the healthy level
US AirwaysStill below the "safe" line even after recent bankruptcy
MIT MIT ICAT ICAT Key Questions
What are the factors that drive the economics and viability of airlines?
Crew costs
Fuel costs
What could happen to the these factors?Crew costs in regional carriers could become aligned with the crew costs of mainline carriers
Fuel costs could vary significantly given volatility in fuel prices
What would the impact of these changes be?
MIT MIT ICAT ICAT Crew Cost (Mainline v. Regional)
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50 100 150 200 250No. of Seats
MIT MIT ICAT ICAT Impact of Salary Scale on RJ DOC
MIT MIT ICAT ICAT Fuel Burn
MIT MIT ICAT ICAT Impact of Fuel Cost on DOC
MIT MIT ICAT ICAT
Sensitivity of Earnings Per Share (EPS) to Fuel Price
80%$0.07$0.60Southwest
40%$0.25$1.60LanChile
40%$0.08$0.90JetBlue
10%$1.05- $0.50Continental
5%$1.85$0.30AMR
28%$0.15$0.75AirTran
% of 2004 fuelthat was hedged
Sensitivity to 10% fuel price increase
2004 EPSAirline
Source: Merrill Lynch
MIT MIT ICAT ICAT History and Model of Fuel Prices
Long-term average: $0.71/gallonSpeed of reversion: 0.17/yearVolatility: $0.0591/year
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20
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1980
1982
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2000
2002
Fuel
pric
e (c
ents
/gal
lon)
MIT MIT ICAT ICAT 2004 EPS (95% Confidence Limits)
$0.70$0.50$0.60Southwest
$1.98$1.22$1.60LanChile
$1.02$0.78$0.90JetBlue
$1.10- $2.10- $0.50Continental
$3.14- $2.54$0.30AMR
$0.97$0.53$0.75AirTran
Upper LimitLower Limit2004 EPSAirline
MIT MIT ICAT ICAT Conclusions
Most airlines are in bad shapeUnited is in very poor shape but have not yet emerged from bankruptcy so the future is unclear
US Airways is not in the healthy range even after bankruptcy
Significant potential impact on airline direct operating cost and on measures of airline financial performance
Future of economic drivers uncertain
Impact of changes could be significant