UT Dallas CFA IRC Report - 2016 LUV [104644]

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Transcript of UT Dallas CFA IRC Report - 2016 LUV [104644]

  • CFA Institute Research Challenge

    Hosted by:

    CFA Societies Texas, Louisiana, New Mexico and Oklahoma

    Local Challenge- Southwest US

    The University of Texas at Dallas

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    Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16

    Share Price and Events

    S&P 500 Index Southwest Airlines Target Price

    S&P Indexed to LUV Share Price

    Pilots Picket AirTran Integration

    Completed

    Wright Amendment

    Repeal

    AirTran Acquisition

    Completed First International

    Flight

    737-800s First

    Introduction

    Market Profile (as of 02/04/2015)

    Closing Price: $37.54

    52-Week High-Low: $31.36 / $51.34

    Diluted Shares Out. : 679.55 M

    Average Volume (6M): 8.441 M

    Market Cap: $ 22.78 B

    LTM Dividend Yield: 0.76%

    Short Interest: $ 14.9 M

    Beta: 1.11

    EV/EBITDAR*: 5.0 x

    P/E*: 12.7 x

    Institutional Holdings: 82.94%

    Insider Holdings: 0.28%

    Key Financials FY 2015 FY 2016E FY 2017E

    Revenue: 19,647$ 20,460$ 21,009$

    Op. Margin*: 4,132 4,300 3,495

    Net Margin: 10.2% 11.6% 9.0%

    EPS: 3.26$ 3.76$ 3.20$

    ROA*: 8.5% 9.5% 7.4%

    ROE: 28.4% 31.0% 23.6%

    ROIC*: 20.3% 21.4% 16.7%

    Valuation Current Comparable Valuation

    Method Price Weights

    Comps $30.24 50%

    DCF $38.81 50%

    Target Price $34.53

    Upside/Downside -8.03%

    BBB+ Upgrade

    NYSE: LUV Recommendation: HOLD

    Industry: Airline Current Price: $37.54

    Sector: Transportation Target Price: $34.53 (8% Downside)

    *Denotes Glossary term

    # Denotes Appendix reference

    We Dont Believe in LUV at First Sight

    Investment Highlights We initiate our coverage on Southwest Airlines (LUV) with a cautious Hold

    recommendation derived from a price target of $34.53, representing potential

    downside of 8%. Our recommendation is primarily driven by the following:

    Past Maverick Personality Has Been Key to Success. Southwest has proven

    profitable over the last 43 years due to its ability to remain a low-cost leader. As

    the low cost airline who pioneered the Point-to-Point (P2P) system, Southwest set

    the airline industry standards through its low-cost, no-frill approach. In an

    industry where customer service has been ranked one of the worst, Southwests

    unique strategy, combined with a customer-oriented approach, has separated

    Southwest from the crowd.

    Safety Saves Sadness, Sufferingand Solvency. The conservative operating

    philosophy regarding capacity* expansion and capital structure has fared well for

    the low-cost leader. By not following in the footsteps of its rivals undisciplined

    capacity deployment, Southwest has been able to separate themselves from the

    cyclical nature shared by the industry. Managements commitment to maintain a

    low degree of financial leverage reduces insolvency risks by providing adequate

    liquidity in economic downturns.

    However Good Airlines Copy, Great Airlines Steal. The recent wave of

    bankruptcies have allowed competitors to reorganize their cost structures similar

    to Southwests. The financial success of Southwest attracted new carriers to enter

    the industry and adopt aggressive pricing policies. In the long-run, we believe

    Southwests ability to maintain its low cost advantage will diminish. We see

    convergence of interests among carriers to continue pressuring unit revenues,

    which will negatively impact margins.

    Labor: Southwests New Achilles Heel. Southwests decades of achievement

    and the record profits resulting from fuel tailwinds could revert back to the mean

    if the pressing labor issue is left unaddressed. The firms success has reached a

    crossroads in strategy, forcing an uneasy choice between remaining the low-cost

    leader or restoring its employee-first attitude. We see the burdensome impacts of

    the expected contracts as a shift in managements attitude, contributing to

    declining employees morale and mitigating the firms excess returns.

    *Multiples adjusted for Operating Leases

    This report is published for education purposes only

    by students competing in the CFA Institute Research

    Challenge

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    Industry

    Others

    SAVE

    FRNT

    UAL

    ALGT

    AA

    DAL

    ALK

    LUV

    JBLU

    Exhibit 1: LUV's high customer service satisfaction

    23.7%

    76.3%

    Exhibit 2: 2015 Market Share by Traffic Demand

    LUV Domestic

    Scorecard Standards

    Strategic Initiatives (25%) Metric Wt. Payout Pct

    Airtran Integration 5.0% 150.0%

    International 5.0% 150.0%

    The 737-800's 5.0% 150.0%

    Fleet Modernization 5.0% 150.0%

    New Reservation System 5.0% 150.0%

    Most Loved (16.7%)

    Net Promoter Score 8.3% 11.1%

    Employee Satisfaction 8.3% 50.0%

    Most Flown (8.3%)

    Ontime Performance 8.3% 16.5%

    Most Profitable (50%)

    Total Operating Revenue 16.7% 150.0%

    CASM Ex. Fuel & Profitsharing 16.7% 106.5%

    15% ROIC 16.7% 150.0%

    Total Executive Payout 111.7%

    Name Title Tenure

    Gary C Kelly Chairman/President/CEO 7.7

    Tammy Romo CFO 3.3

    "Mike" G Van De Ven COO 7.7

    Jeff Lamb Executive VP 0.5

    Robert E Jordan Executive VP 4.3

    Thomas M Nealon Executive VP 0.1

    Source: Companys Proxy Statement

    Source: Bloomberg, Team Research

    Source: American Customer Satisfaction Index

    Source: Companys Data

    Business Description Southwest Airlines (LUV) is headquartered in Dallas, Texas at Love Field Airport. The

    company operated their first flight on June 18, 1971. With 49,600 employees,

    Southwest transports more than 100 million passengers annually to 97 destinations in

    40 states and 7 additional countries. As the nations largest domestic carrier,

    Southwest operates 3,900 flights daily with a uniform fleet of 704 Boeing 737 aircraft.

    In 2014, the company fully integrated AirTran Airways into their operations,

    providing Southwest access to the Hartsfield-Jackson International Airport in Atlanta

    and increasing capacity by 25%. The company offers several products such as Business

    Select, Fly by Priority Lanes, and SWABIZ*. Southwest created the Transfarency*

    philosophy, which ensures customers are treated fairly and provided with the lowest

    possible fares. Southwest is the only major carrier to offer bags fly free and no change

    fees. The firm has established a leading network that serves 24 of the top 25 U.S metro

    areas. The company provides Point-to-Point (P2P) rather than Hub-and-Spoke

    service14, allowing the company to offer more short-haul routes and avoid congested

    airports. Coupled with fleet efficiencies, Southwest has reduced aircraft turnaround

    times and carries 23.7% of all domestic traffic.

    Company Strategies

    Fleet Modernization - As of 1/21/2015, Southwest announced an accelerated

    fleet modernization program to achieve greater range, new markets and fuel

    efficiency by adding the Boeing 737 MAX.

    2017 New Integrated Reservation System - The Amadeus system provides

    Southwest with a single platform to schedule both domestic and international

    flights, leading to higher load factors and capacity utilization.

    Networks Under Development LUV is expanding 5 key airports to increase

    flight frequencies in demanding markets (Dallas, Fort Lauderdale, Chicago

    Midway, Los Angeles, and New Orleans).

    Prudent International Expansion - With the crowd domestic market,

    Southwest is looking to expand into Latin America, the Caribbean, Central

    America, and Mexico to fuel future growth. International networks account

    for ~2% of the firms total capacity.

    Management & Culture

    The Southwest Airlines executive council has provided unusual stability for

    Southwest within an industry known for its cyclicality. Gary Kelly, the CEO, been

    recognized by his peers for numerous Executive of the Year awards. The company has

    posted 43 consecutive years of profitability while also never furloughing employees.

    With 83% of its employees unionized, a strong relationship with its employees is

    essential to maintaining a positive culture. This resonates through all levels of the

    organization, with employees rating Southwest

    as one of the top companies in America to work

    for.

    The Corporate Governance structure is

    composed of 10 directors that bring experience

    from a diverse range of backgrounds. They range from former corporate executives of

    Fortune 500 companies to university professors. This creates an experienced board

    that is able to guide management effectively and with a purposeful direction. In order

    to retain executive talent, managements pay scales are based on progress made

    towards short and long term goals. These are linked to vested equity shares and stock

    options that mature over time based on company performance.

    Our vision is to become the

    worlds most loved, most flown, and

    most profitable airline.

    CEO Gary Kelly

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    BargainingPower ofSuppliers

    BargainingPower of

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    Threat of NewEntrants

    Thre