Southwest Airlines Financial Analysis
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The strategy of Southwest Airlines (SWA) has remained the same, which is to give customers low-cost, point-to-point airfare, with excellent customer service. This simple strategy has resulted in SWA posting profits for 30 consecutive years. While other airlines are downsizing, SWA is showing slow steady growth. This performance is evident throughout their SEC Filings.
First we will look at SWA’s ROI and ROE compared to the rest of the industry. Two thousand and one and 2002 were difficult years for the airline industry. Most airlines showed negative ROIs and ROEs, however SWA posted an average ROI of 16.76% for the three years ending in 2002. Likewise, they also showed a substantial 12.87% growth in ROE, during the same period.
The good news did not stop there. If we look at P/E Ratios, Southwest Airlines also out performed the industry. P/E Ratios give an indication of the amount over the market price, that investors would be willing to purchase the stock. This has traditionally been a significant indicator for investors. SWA has shown numbers in the 29-46% percent range for the three-year period ending in 2002.
Two other economic indicators, which SWA exceeds the industry is dividend payout ratios, and dividend yields. With payout ratios of 2.7 to 18.1 and dividend yields of 0.44, Southwest Airlines should be at the top of the list for investors of airlines.
On top of all the excellent indicator information, SWA posted a $417,338,000 profits. How did they do this, when other airlines are losing money? SWA was posed with the burden of extra landing fees, security costs, and personnel cost; they were able to handle the costs through a few smart changes. They spent money to increase airport facilities, increase personnel, and increase technology. This led to an increased efficiency, which resulted in a profit for SWA.
Southwest Airlines looked good in 2000-2002, and are poised to continue to lead the industry in 2003 and beyond. They intend to do this by increasing the size of their fleet, retire older vehicles and replace them with new ones, cut down their dependence on leased planes, and continue to invest in new technologies. If SWA continues on its current strategy, and pushes into the future with a new preparedness, they will continue to out-pace the industry, and be a smart investment choice.
Southwest Airlines financial highlights
Southwest airline is a low-fare airline with high customer satisfaction. The airline primarily serves short haul city pairs, providing single class air transportation, which targets the business commuters as well as leisure travelers. The company, incorporated in Texas, commenced customer service in 1971, with only three Boeing aircrafts. Today, Southwest operates 375 Boeing aircrafts and provides service to 59 airports in 30 states throughout the nation. The reason for this rapid rate of growth is mainly strong financial status of the company.
In 2002, Southwest posted a profit for the 30th consecutive year. While the company’s 2002 profitability fell short of its historical standards, Southwest was the only company in the industry to report a profitable year. The year 2002 was not a productive year for airline industry. It was the year that included dramatic increases in aviation insurance cost; increased passenger security costs rising energy prices, and a recession in airline revenues. Many of major airlines were forced to downsize in order to lower their costs. On the other hand, Southwest’s business strategy, which provides predominately short haul, high frequency, low fare, and low cost services, continued to be productive for the company. This strategy provides the company with a higher market share compare to other companies. Furthermore, Southwest has managed to keep its operating cost lower than any other major airline. Southwest’s costs are low for a variety of reasons such as single aircraft type; efficient, high-utilization point-to point rout structure; satisfied and hard working employees.
As mentioned before, many airline companies were forced to downsize in 2002. Southwest, in comparison, continued to grow. The growth rate slowed to just over five percent, in 2002. This was an attempt to keep the company’s debt under control. The company did not add any new cities in 2002, and has no plan to add any more for the year 2003. However, Southwest added new stops to some of the current routs and added non-stop flights to other routs. Southwest hired more employees to satisfy the new security demands in the airports. The company, also, purchased eight new aircrafts, in 2002.
Result of Operation
The company’s consolidated net income for 2002 was $241.0 million ($.30 per share, diluted), as compared to 2001 net income of $511.1 million ($.63 per share, diluted), a decrease of $270.1 million or 52.9%. Operating income for 2002 was $417.3 million, or 33.9% compared to 2001. Consolidated results for 2002 and 2001 included $48 million and $235 million in gains the company recognized from grants under the Air Transportation Safety and System Stabilization Act. Consolidated results for 2002 also included $36 million in additional passenger revenue from reduction in estimated refunds and exchanges. In 2002, the company had a total cash flow of $603.1 million, which was $394.7 less than the year 2001. The company purchased 23 new aircraft in the past two years.
The payment for these aircrafts was recorded through the consolidation of a special purpose trust. Four of mentioned aircrafts were paid off before December 31, 2002. The payment for 11 aircrafts was recorded in the Statement of Cash Flows of 2001, and the rest was recorded on the Statement of Cash Flows of 2002. Net cash used in financing activities was for repayment of the company’s $475 million revolving credit facility and the payment of new aircrafts. The total cash used in these activities was $381.7 million, which was offset by $385 million cash generated in the year 2002. The company borrowed $475 million in 2001, and had a long-term loan of $614.3 million. These borrowings were offset by the redemption of $100 million unsecured noted in 2001. The company’s cash on hand at December 31, 2002, was $1.82 billion, which included internally generated funds and a $575 million band revolving line of credit. Southwest Airline has outstanding shelf registrations for the issuance of up to $1.0 billion in public debt securities and Pass-Through Certificates, which it may utilize for aircraft financings in the future.
Competitive Trend Analysis
Return on Investment
Investing is an art as well as a science. The Science of investing is cutting through the information to get to the heart of what makes a company great. Which ones are good investments, and which ones should we avoid. Many times people look at the revenues, while others look at percentage of growth. The problem with these methods is that companies are not all working with the same amount of capital, and their stocks are not at par with one another. The best way to compare these companies is to look at what they do with what they have. Two ways to accomplish this is to look at the return on investment (ROI) and the return on equity (ROE).
The return on investment is the amount of revenue that the company realizes for every dollar invested in the operations of the company. This is important to determine the profitability of a company. A small company, who only see net income of $100,000.00, may be a smarter investment than a company who realizes one billion dollars, if the percentage of return is higher for the small company. That is, if the smaller company only spent one thousand dollars to make its profit, vs. the larger company spending 2 billion dollars, the smaller company has received a better ROI. In the case of Southwest Airlines (SWA), Delta, and JetBlue (JB), the ROI were compared. SWA showed an average of 16.76% ROI for the three year period ending in 2002. Delta showed an average of -3.58% ROI for the same period. JetBlue did not enter the market until 2002, however in the two years since its inception it posted a 5.51% ROI. From this evaluation SWA appears to have a better handle on their business. From this these companies can look at their margin and turnover ratio to determine if the profitability is to blame or if it could be their efficiency. The ROI is a good place to start when evaluating a company’s value; however there is more needed research to be done.
Return on Equity
Another area of analysis to consider is the return on equity. ROE is demonstrates a company’s use of the equity that it posses, and the revenues that are realized from the use of the equity. If we assess the ROE for the three companies again, we come up with the following evaluation: SWA showed an average of 12.87% ROE. Delta showed an average of -25.38% ROE. JetBlue showed an average of -45.5%. This data gives another insight into a company’s worth. From this evaluation, SWA again comes out on top.
The ROI and ROE of a company is only the tip of the iceberg. These are two evaluations to start to get a picture of a company’s worth. From these two evaluations, we show that SWA was better positioned for the future in the airline industry. We will need to look further into these three companies, and intend on looking at other methods throughout this evaluation.
Southwest and Delta had negative changes in Average Day’s Sales from 2000 to 2002, with the biggest changes occurring between 2000 and 2001. Southwest’s rate of change for average day’s sales has been -$175,053 per year over the three-year period. Delta changed at a rate of -$9,413,699 per year over the same period. JetBlue has had positive changes in average day’s sales from 2000 to 2002; also, the rate of change for JetBlue has been approximately $1,596,937 per year. In contrast to Delta and JetBlue, Southwest has a much more stable average day’s sales over the period.
The number of day’s sales in accounts receivable shows Southwest and JetBlue having the greatest changes over the three years while Delta remained stable. Between 2000 and 2001 Southwest and Delta only had less than a day’s shift in the number of day’s sales in accounts receivable (Southwest was negative and Delta was positive); however, there is not data available for JetBlue during that period. Between 2001 and 2002 Delta had a negative shift of just over a day; thus, the total trend for Delta was almost flat for the three years. Southwest more than doubled its value, and JetBlue cut its number of days in half between 2001 and 2002. Out of the three companies, Southwest appears to be having the most problems with receiving prompt payments with the upward trend. JetBlue has the best trend over the short-run with the best rate of improvement and the lowest number of days.
Accounts receivable turnover shows all three companies are currently near the same ratio of about 40. This is the first year where data is available to calculate the ratio for JetBlue. Delta has remained fairly flat over the three-year period with a slight upward curve over all. Southwest has increasingly shown decreasing improvements over the same time; in short, Delta has increased (improved) its ratio by about 0.5 per year, and Southwest has decreased (worsened) its ratio by about 10.9 per year. This trend indicates that Southwest is having issues in this area, and it will likely be lagging behind Delta and possibly JetBlue for 2003.
The final activity measure is fixed assets turnover; in other words, turnover for buildings, machines, equipment, and land. Again, there was not enough data to plot a trend for JetBlue; however, the JetBlue’s datum for 2002 is very close to Delta and near Southwest’s value for the same period. Delta and Southwest have decreasing negative plots over time that parallels each other. Delta tends to remain about 0.2 higher than Southwest over the entire period. The two companies are improving this ratio; however, it is likely that the improvements for 2003 will be less than 2002 because of the decreasing rate of change. Southwest appears to be leading this group in fixed assets turnover.
The financial leverage of a firm refers to the debt of that firm. Firms borrow money with fixed interest rate to invest and produce more profit than the expense of the loan. While this is a healthy and common business practice, investors must be aware of the risks involved with this practice. For this reason it is important for the firms to keep tract of their debts. The ration of total liabilities to owners’ equity is called debt ratio, and debt/equity ratio is the ratio of total liabilities to total liabilities and owners’ equity. In addition, times interest earned ratio demonstrates the relation of operating income to interest expenses.
According to these numbers, Southwest airline has decreased the amount of its debts substantially since 2000. The debt ratio of 27.3% is decreased to 14.8% in 2002. Also, the debt/equity ratio was dropped to 17.3% from 37.6% in 2000. The reason for this, as discussed earlier, is the extra expenses for higher prices of gas and security issues from the events in the previous year. However, in 2002 the times interest earned ratio is only 3.7 times, which is significantly below the average for the company. The reason for this, as discussed earlier, is the extra expenses for higher prices of gas and security issues from the events in the previous year.
The airline industry is a risky and unstable business. For this reason, Southwest airline tries to keep its debts in a manageable amount, and have enough cash on hand for at least six months of operating expenses. At the end of 2002, Southwest showed $1.8 billion in cash on hand; a fully available bank revolving credit facility of $575 million; un-mortgaged assets of approximately $5 billion; and debt to total of almost 40%, including aircraft leases as debt. The table below shows company’s contractual obligation for the next five years.
Payments due by period (in thousands)
Contractual obligations 2003 2004-2005 2006-2007 Beyond 2007 Total
Long-term debt $120,797 $320,320 $637,588 $516,980 $1,595,685
Capital lease commitments 17,751 41,160 26,758 52,016 137,685
Operating lease commitments 281,042 496,371 365,403 1,459,961 2,602,777
Aircraft purchase commitments 597,097 1,394,569 1,139,891 104,924 3,236,481
Total contractual cash obligations $1,016,687 $2,252,420 $2,169,640 $2,133,881 $7,572,628
Table 1. Contractual Obligations and Commitments
The price/earnings ratio is “a ratio that is used extensively by investors to evaluate the market price of the company’s common stock relative to that of other companies and relative to the market as a whole.” (Marshall, D., et al, 2002, p. 284) The price/earnings ratio is a measure, which informs managers how much investors would be willing to pay above or below the current market price. The ratio is measured as market price per share divided by diluted earnings per share. (p. 284) In the years 2000, 2001, and 2002, analysis shows that investors are willing to pay a considerably higher amount to acquire shares of Southwest Airlines than they would for their competitors, Delta and JetBlue. In 2000, investors were willing to pay 44 times earnings for Southwest Airlines in contrast to only paying 8 times earnings for Delta. No price/earnings ratio comparison was available for JetBlue for 2000 or 2001, because they did not go public with their stock until 2002.
2001 brought a bit of a decline in the amount investors were willing to pay for the airline companies. A major factor causing the decline was the tragedy of the 9/11/2001 terrorist attacks. Many potential investors lost some of the confidence they had in the airline industry, and they did not feel comfortable that they would be able to produce gains for them on their investment. Although the overall airline industry saw a decrease in the price/earnings ratio in 2001, Southwest Airlines was still able to achieve a ratio of 29.3% over Delta’s -2.9%. Investors were willing to pay 29.3% times earnings for Southwest, whereas they figured they would lose money on their investment in Delta.
Southwest Airlines weathered the storm of the 2001 tragedy and was able to come back strong in 2002. Investors regained their confidence in the airline industry to a point where Southwest, Delta, and JetBlue all showed improvements in their price/earnings ratios. Southwest achieved the largest price/earnings ratio at 46.3%. JetBlue’s first year after going public on the stock market was able to achieve a favorable price earnings ratio of 32.14%. Although Delta showed signs of improvement from their 2001 ratio of -2.9%, they still were only able to achieve a 2002 price/earnings ratio of -1.20%. Out of all three airlines, Southwest has been able to sustain their strength over the past three years. Investors are confident that they will gain from their investment in Southwest, and they are willing to pay 46.3 times earnings to achieve those gains.
Dividend Payout Ratios
The competitive dividend payout ratio describes the dividend policy of a company. (Marshall, D., et al, 2002, p. 287) In 2000, Southwest was paying out 18% dividends on their earnings, largely contrasting to Delta’s 1.5% dividend payout. JetBlue was a relatively new company that was just recently established, and had not paid out dividends yet.
Even though the airline industry struggled throughout the fourth quarter of 2001, Southwest Airlines was able to pay investors dividends of 2.7%. Unfortunately, Delta was unable to achieve the same level of earnings, but they still paid dividends to their investors. Delta showed negative earnings per share, yet they still paid out 1% dividends
As the 2002-year ended, Southwest was able to see an improvement in earnings and was able to pay out 5.8% dividends. This was a commendable comeback from the unfortunate occurrences of 2001. Delta was still reporting negative earnings per share in 2002 as they tried to recoup from the unfortunate circumstances of 2001. They were able to maintain a stable 1% dividend to their investors. Sustaining the ability to pay dividends while reporting negative earnings will keep their investors loyal to them in the long run as they continue to see improvements.
As previously discussed, JetBlue Airlines had not issued dividends yet through the 2002 through 2002 time period, because their stock just went public in 2002. In 2000, Southwest had a dividend of .44 versus Delta’s dividend yield of .2. In contrast, Delta’s dividend yields were greater than Southwest’s in both 2001 and 2002. Southwest’s lower divided yields in 2001 and 2002 inform investors that they began to take more of their earnings and reinvest them into improving the company instead of paying higher dividends. Southwest made the wise decision to reinvest in order to continue to make improvements to their company, so they could stay healthy and successful over the long-run.
Southwest Airlines Cash Flows
The statement of cash flow of a firm is designed to provide information about cash receipts and cash payment of that firm during a period (Marshall, D., et al, 2001 229). Through the following discussion below, an in-depth analysis of the statement of cash flows for Southwest Airlines will be carried out. From completing the analysis business decision makers and potential investors will be able to obtain a much better idea of where the firm’s cash inflows and outflows originate from, and where potential adjustments may need to be made to ensure the greatest profit maximization possible.
Cash flows from operating activities
Southwest Airlines (SWA) focuses on short-haul, point-to-point, high frequency, and low fair flights. Their vehicle of choice is the Boeing 737. According to their form 10K submitted to their stockholders, they had operating revenue of 5.5 billion dollars, with an operating income of 417 million dollars. The following is an assessment of their cash flow from operating activities for 2002.
Operating Revenues $5,521,771,000
Operating Expenses $5,104,433,000
Operating Income $417,338,000
Even though 2002 was a bitter year, Southwest Airlines was able to make some very good changes in their operating activities to make a profit when all other airlines were just trying to stay in the black. Very few were able to accomplish this feet, and none as successful as SWA. In 2002, because of higher insurance premiums, and higher operating costs, directly related to the terrorist bombing on September 11, 2001, SWA burdened higher overhead. In addition, SWA was forced to increase staff to check-in baggage and customer service, pay for added airport security and extra landing fees, because of increased percentage traffic provided by SWA. To combat these unexpected expenses, some dramatic changes needed to be made. These changes included lowering their distribution costs, and implementing cost reduction measures, while increasing customer service. Some examples of cost reduction measures included addition of new technologies, increase in personnel, and addition of airport facilities.
In addition to the changes in procedures, which led SWA to a financial win in 2002, they would like to have the following reconciliation considered, which will help make up the differences between 2002 and 2001. These items are not expected to reoccur.
If we look at the foresight of SWA, we can see that they are ready for the task at hand. They are always looking for areas to improve customer service, reduce costs, and increase profits. The operating revenues reflect this commitment, and should serve SWA well into the next year.
Cash flows from investing activities
Cash flow from investing is one the major sections of this statement. This section offers information about the investments that the firm makes in order to expand. Investing activities could be done in form of debts or use of stocks, but mostly the firms use cash for these types of activities. In either way, it is important for management and stockholders to be aware of the trends of these activities.
Cash is used in investing activities such as buying new equipment. Southwest Airlines is not an exception to this rule. The company used cash for purchasing new aircrafts. In fact, the only investing activity in the year 2001 and 2002 was purchasing new 737-700 aircrafts. In year 2001, the company purchased eleven new aircrafts through the consolidation of a special purpose trust. In addition to this purchase, the company bought another four aircrafts, and used cash to pay for this investment. The total cash flows used in investing activities during that year were $997.8 million. During the next year, the company invested in more aircrafts. This time the company purchased only eight aircrafts, and paid for this transaction through consolidation of the trust. In year 2002, Southwest Airline used only a total cash flow of $603.1 million in its investing activities. This amount was $394.7 million less than the year before. Southwest Airlines plans to purchase additional aircrafts in the future. The transaction of these investing activities will be recorded on the statement of cash flows of that fiscal year.
Cash flows from financing activities
Southwest Airlines experienced negative cash flows from financing activities as of December 31, 2002. Three financing areas provided positive cash flows, while four other areas provided negative cash flows. The issuance of long-term debt obtained $385,000,000 in cash flows. Proceeds from trust arrangement obtained an additional $119,142,000, and Proceeds from Employee stock plans accounted for $56,757,000–a total of $560,899,000. Payments of long-term debt and capital lease obligations accounted for negative cash flows of $64,568,000 and Payments of trust arrangement were -$385,195,000. An even larger negative cash flow came from payments of revolving credit facility totaling $475,000,000. Cash dividends cost the organization $13,872,000, and other obligations cost $3,922,000. The total cash outflows from financing activities were $942,557,000; thus, the much larger negative cash flows compared to the smaller volume of positive cash inflows accounts. Overall, the cash flow results for 2002 were negative $381,658,000, an outflow of cash that was greater than their inflows. It is interesting to note that cash flows from financing in 2001 were a positive $1,270,101,000, which is a huge difference.
Results from this analysis are very supportive with Southwest Airline’s managers’ discussion for 2002. For example, management claims that the company has made profits for the past 30 years, and that 2002 was no different. Analysis of the financial data shows that Southwest has made a profit in a year in which Delta and JetBlue had difficulties making profit; also, Southwest proved to have very good ROI and ROE–further supporting management’s claim to Southwest having the ability to make money during troubled times for the industry. Management indicated that this was a very bad year financially, and this analysis shows Southwest had less operating income, net income, and cash flows for 2002 compared to 2001 and 2000. Analysis also supports that this was an industry wide trend because JetBlue and Delta had similar results. The results of 911 are claimed to be the catalyst for many negative trends in the industry according to management, and despite the events from 911, Southwest is claimed to have been able to escape some of the negative “fall-out” of the terrorist attacks. Interpretation of Southwest’s 2002 10K–Southwest has been able to avoid several downfalls 911 has brought to the airline industry and do something very special–make a profit.
Future Outlook of Southwest Airlines
After thorough analysis of Southwest, Delta, and JetBlue Airlines, it is quite clear to determine that Southwest is an airline that has maintained financial health and stability through both good times as well as through turmoil. Throughout the 2000 to 2002 time period, Southwest has been able to sustain very reputable return on investment and return on equity over their two competitors. Southwest has been able to wisely invest their earnings at the right levels and the right times to create the most profitable revenues on those investments. In addition, they have been able to favorably use the equity that they built up to create a greater level of revenues for the company.
Southwest may have had to cut back on dividends a bit in the past two years, but this was a wise decision on their part. Through both the economic highs and lows, Southwest has been able to maintain their strength and success level through well-managed inflows and outflows of cash through their organization. Southwest has “weathered the storm” and has established themselves in the airline industry as truly strong competitors of the future. Investing in their stock at this point in time would be a wise choice of a potential investor. Southwest has their feet solidly on the ground of the airline industry. They have the fundamentals, ethics and corporate drive, which will allow them to continue to grow and prosper into a very solid and financially healthy airline that will consistently produce positive returns for their investors.
Delta Airlines 2000-2002 10K financial report retrieved October 17, 2003 from
Historical stock price data retrieved October 31, 2003 from http://bigcharts.marketwatch.com
JetBlue Airways 2000-2002 10K financial report retrieved October 31, 2003 from
Marshall, D., et al, 2002, Accounting: What the numbers mean [5th edition].
San Francisco: Irwin/McGraw Hill
Southwest Airlines 2002-2001 10K financial report retrieved October 31, 2003 from
Southwest Airlines 2000-2001 10K financial report retrieved October 31, 2003