LUVSWOTand StrategicAnalysis

Southwest Airlines Co.

Southwest Airlines Co.- Financial and Strategic Analysis Review

Reference Code: GDTTL48167FSA

Southwest Airlines Co. - Financial and Strategic Analysis Review Publication Date: 13-Oct-2011


Company Snapshot Key InformationSouthwest Airlines Co., Key InformationWeb Address www.southwest.comFinancial year-end DecemberNumber of Employees 45,112NYSE LUVSource : GlobalData

Key RatiosSouthwest Airlines Co., Key Ratios

P/E 14.40

EV/EBITDA 7.34

Return on Equity (%) 7.36

Debt/Equity 54.19

Operating profit margin (%) 8.16

Dividend Yield NA

Note: Above ratios are based on share price as of 27-Oct-2011

Source : GlobalData

Share DataSouthwest Airlines Co., Share Data

Price (USD) as on 27-Oct-2011 8.85

EPS (USD) 0.61

Book value per share (USD) 8.34

Shares Outstanding (in million) 747

Source : GlobalData

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

Source : GlobalData

Company Overview Southwest Airlines Co. (Southwest Airlines) is a US-basedpassenger airline principally engaged in offering scheduledair transportation in the US. The company offers a supplychain of travel services to its passengers such as air, car,hotel, cruise and vacation packages. The other servicesoffered by the company include selling credits to variousbusiness partners that include credit card companies,hotels, telecommunication companies and car rentalagencies. It operates more than 3,400 flights a day. Thecompany’s 548 Boeing 737 aircraft serves over 69 cities in35 states throughout the US. Southwest Airlines isheadquartered in Dallas, Texas, the US.

SWOT Analysis Southwest Airlines Co., SWOT Analysis

Strengths Weaknesses Optimum Asset Utilization

Point-To-Point Services

Long Term ConsistentGrowth

Trade Account Receivables

Debt Obligations

Opportunities Threats Growing Global Air Freightand Logistics Sector

Acquisition of AirTranHoldings, Inc.

Positive Air Traffic Outlook

Stringent GovernmentRegulations

Overdependence onTechnology

Competitive Pressures

Source : GlobalData

Financial Performance The company reported revenues of (U.S. Dollars) USD12,104.00 million during the fiscal year ended December2010, an increase of 16.95% over 2009. The operatingprofit of the company was USD 988.00 million during thefiscal year 2010, an increase of 277.10% over 2009.The net profit of the company was USD 459.00 millionduring the fiscal year 2010, an increase of 363.64% over2009.




Southwest Airlines Co. - SWOT Analysis SWOT Analysis - OverviewSouthwest Airlines Co. (Southwest Airlines) offers scheduled air transportation in the US. The company leverages upon itsunique point-to-point service and the long history of profitability. However, debt obligations and increasing trade accountsreceivable remains as an area of concern for the company to look upon. The company at the same time faces majorchallenges in terms of strong competition in the industry and volatility in the fuel and oil prices. However, growing air trafficand consolidation in the industry could present the company with an opportunity to improve its business. Southwest Airlines Co. - StrengthsStrength - Optimum Asset UtilizationSouthwest Airlines makes optimum utilization of its aircrafts. It aims to reduce the amount of time the aircrafts are on theground. 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 DallasLove Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Burbank, Manchester, Oakland, SanJose, Providence, Ft. Lauderdale/Hollywood, and Long Island Islip airports. This strategy also reduces the number ofaircraft and gate facilities that would otherwise be required. Thus by making optimum use of the assets the company is ableto save on cost and provide low fares to its customers. Strength - Point-To-Point ServicesSouthwest Airlines engages in providing point-to-point service contrary to the hub-and-spoke service provided by othermajor U.S. airlines. This service is provided using its homogenous fleet of 537 Boeing 737 aircraft. This service offersfrequent direct flights over short distances, like from Los Angeles to Las Vegas. The point-to-point system adopted by thecompany provides direct nonstop routing and thereby minimizes connections, delays, and total trip time. As of December31, 2010, the company served 460 nonstop city pairs. The average aircraft trip stage length of the company recorded anincrease 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 Airlinesto provide conveniently timed flights at low fares. Strength - Long Term Consistent GrowthThe 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 June18, 1971, with three Boeing 737 aircraft serving three Texas cities, namely, Dallas, Houston, and San Antonio. Presently,in2010, the company operates with 548 Boeing 737 aircraft serving 69 cities in 35 states throughout the United States, andhas plans to begin service in to two new states and three new cities in March 2011. The year-on-year growth in terms ofexpanding of its facilities indicates that the company has been very consistent in spite of the prevailing risks andcompetitive pressures in the industry and also as per the reports of the U.S. Department of Transportation, as onSeptember 30, 2010, the Company was the largest domestic air carrier in the United States, measured by the number oforiginating passengers boarded. Strength - Increasing Margins and ReturnsSouthwest Airlines reported 16.9% increase in total revenue in 2010 as compared to that in 2009. The revenue growthresulted in increased gross margin, which increased 21.08% in 2010 as compared to 18.12% during 2009. Revenue growthand increased gross margin was complimented by its controlled costs. The company’s operating cost as a percentage ofsales declined 91.84% in 2010 from 97.47% in 2009. Similarly, the company reported increased returns in 2010 ascompared to those in previous years. The company's return on equity (ROE) was 7.36% at the end of fiscal year 2010, ascompared 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 company’s sturdy performance and its ability to deliver returns expected by itsshareholders. The decreased cost and increased returns led to overall growth of its operating margins. The company’soperating margin increased 8.16% in 2010 from 2.53% in 2009. Its net profit margin also grew in 2010. Its net profit marginincreased to 3.79% in 2010 from 0.96% in 2009. Such stable revenue and growth rate will allow the company to pursuestrategic capital investment opportunities in the future. Southwest Airlines Co. - WeaknessesWeakness - Trade Account ReceivablesThe company’s increasing account receivables affects its competitive and profitability position. Southwest Airlines’s




accounts receivables increased to $195m in 2010 from $169m in 2009, showing an increase of 15.4% over the period. Thecompany under its operational process entered into several factoring agreements with trade debtors as per the tradesettlements. Southwest Airlines’s accounts receivable principally consists of due from credit card companies associatedwith sales of tickets for future travel and amounts due from counterparties associated with fuel derivative instruments. Suchincreasing accounts receivable reflect the inefficient credit management by the company. In the backdrop of growingeconomic recession, the probability of defaults by any of creditors increased, which may impact the overall financialposition as well as profitability of the company. Weakness - Debt ObligationsSouthwest Airlines reported highly leveraged capital structure, which may affect its expansion and growth plans. At the endof 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 of27.80% in the fiscal year ended December 2010. The company incurred this debt to meet its working capital and capitalexpenditure needs. If it fails to comply with any of the debt service requirements, the debt could become due and payableprior to its scheduled maturity. However, in 2010, the company reduced its long term debts with 13.5% as compared toprevious year, with the payment of $155m interest amount. Any reduction in revenues and operating cash flows couldhinder the company’s ability to repay interest and principal, resulting in default. Thus, such huge debt increases thefinancial burden on the company, limiting the availability of cash for its growth. Southwest Airlines Co. - OpportunitiesOpportunity - Growing Global Air Freight and Logistics SectorDespite of the global economic slowdown, there has been a strong growth in the global air freight and logistics industry inthe recent past. It is expected that, the total revenues generated by this industry would grow significantly. Also, it isestimated 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 thisprojected growth in the sector. The company could capitalize on this opportunity and improve its revenues and couldthereby further enhance its market share. Further, the emerging markets of the world, particularly India and China have strong growth prospects for the economicdevelopment. 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 suchscenario, it is expected that the logistics market would grow significantly in the region. Strong growth potential in thelogistics 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 greatopportunity to extend its network into key markets, such as Atlanta and Washington, D.C., through Ronald Reagan NationalAirport. It provides Southwest Airlines an opportunity to serve over 100 million customers in a year from more than 100different airports in the US and near-international destinations, offering customers more low-fare destinations as it diversifyand expand the well-known 'Southwest Effect' to hundreds of additional low-fare itineraries for the traveling public. Theacquisition of AirTran also expands its presence in New York LaGuardia, Boston Logan, Milwaukee, andBaltimore/Washington, as well as extending its services to several smaller domestic cities with access to keynear-international leisure markets in the Caribbean and Mexico. Opportunity - Positive Air Traffic OutlookThe company may benefit from the long-term outlook for the global passenger traffic growth that looks positive. The trafficgrowth is clearly on the rise and shows that the markets are maturing and returning to the real growth as compared to thepre-crisis levels. The period is projected to witness annual passenger traffic growth of 7.1%, in January 2011. The growth ofdomestic passenger volume in North American region, the largest domestic market as compared to other geographiesposted a rise of 1.7% in 2010 as compared to the 2009. Similarly, the Latin American region saw strongest expansion indomestic traffic posting a 9.2% rise. Since the company has its major operations in the American geography, SouthwestAirlines can leverage this market opportunity, which would further grow its revenues and market share. Southwest Airlines Co. - ThreatsThreat - Stringent Government RegulationsThe company is subject to several regulations and policies, which could have an adverse effect on the overall operations ofthe 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 aspectsregulated by DOT authority include economic aspects of air transportation, such as discriminatory pricing, non-competitive




practices, interlocking relations and cooperative agreements. It also lays down regulations for the import and export ofcargo. The company’s operations are also subjected to micro monitoring and high-security checks for passengers. Failureto comply with these regulations could impact the overall operations of the company. Threat - Overdependence on TechnologyThe company is increasingly being dependent on the use of complex technology and systems to carry out its ongoingoperations. The company has implemented a new SAP Enterprise Resource Planning application, which replaces severalof 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 makingsignificant technological changes necessary to support its new Rapid Rewards frequent flyer program, enhancedsouthwest.com website, and WiFi implementation. Integration of complex systems and technology presents significantchallenges in terms of costs, human resources, and development of effective internal controls and also introduces a risk ofoperational or security inadequacy or interruption, which could materially affect the company's ability to operate itsbusiness. The technological implementation associates itself with a major factor of continuous modifications andrefinements and any failure in doing so, will adversely affect the company’s operations. Threat - Competitive PressuresThe aviation industry is highly competitive. Southwest Airlines faces stiff competition from national and, internationalairways 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 facechallenges in pricing, quality, services, and related issues. Although the low cost structure of the company has been one ofits primary competitive advantages due to offer of low fares, drive traffic volume, and growth in market share, has limitedcontrol, however, over increases in many of its other costs. The company’s failure to maintain and enhance its competitiveposition could adversely affect its business and prospects. Competitive pressure could lead to a decline in revenues andmargins of the company. Threat - Fuel Price VolatilitySouthwest Airlines faces significant challenges due to the extremely volatility in fuel prices. The Jet fuel and oil consumedby the company for the fiscal year ended December 31, 2010 and 2009 accounted to about 33% and 30% of the operatingexpenses, respectively, and also constituted the second largest expense incurred by the company. The fuel pricefluctuations have directly caused an influence on the company as, the cost of fuel has been historically high over last fewyears and the price change is unpredictable. Also, the company is dependent on energy and any change in the market fuelprices will adversely affect the profitability figures. Since, the company also relies on the foreign imports of crude oil, anyconflicts in the oil producing areas or changes in the governmental policies on fuel production, transportation and marketingwill hamper the company’s strategy of cost cutting. NOTE:* Sector average represents top companies within the specified sectorThe above strategic analysis is based on in-house research and reflects the publishers opinion only

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