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Global Airlines. James Bolegoh Mauro Horie Richard Konings Zhe Liu Robbie Lydon. Agenda. Introduction Southwest airlines Singapore airlines. Airline Products. Provides fast passenger transportation, both nationally and internationally Freight can also be transported quickly

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Global airlines l.jpg

Global Airlines

James Bolegoh

Mauro Horie

Richard Konings

Zhe Liu

Robbie Lydon

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  • Introduction

  • Southwest airlines

  • Singapore airlines

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Airline Products

  • Provides fast passenger transportation, both nationally and internationally

  • Freight can also be transported quickly

  • Substitutes:

    • Car or bus

    • Train

    • Boat

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Industry Characteristics

  • Cyclical in nature, with over expansion during upturns, and large cutbacks during downturns

  • Only marginally profitable

  • A special case due to:

    • Defense

    • Economic

    • Flag

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Revenue Structure

  • The two main sources of revenue for Airlines are from:

    • Passenger fares

    • Cargo

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Adverse Industry Effects

  • 9/11, SARS, and Iraq war

  • The industry was already entering a down period prior to this catastrophic event

  • Increasing fuel costs began late 2000

  • Huge losses and layoffs were announced shortly afterwards

  • Large decline in the number of passengers

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Industry Outlook

  • Recovery from industry shocks

  • Expansion into developing markets

  • Increased use of Alliances

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Strategic Alliances

  • Sharing of resources

  • Seamless global network

  • Competitive advantage

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Regulatory Environment

  • Two key organizations that affect the international airlines are:

    • International Civil Aviation Organization

      • Composed of representatives from member countries

    • International Air Transport Association

      • Comprised of International Airlines

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US Regulatory Impact

  • Airline Deregulation Act (1978)

    • To encourage a competitive air transportation system

  • International Air Transport Competition Act (1979)

    • 3 goals

  • Open Skies Agreements

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Airline Risk Factors

  • Financial risk

    • Variability of revenue and costs

  • Strategic risk

    • Business design choices

  • Operational risk

    • Tactical aspects of running the business

  • Hazard risk

    • Safety of physical assets

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What Risks are Hedged?

  • Fuel Costs

  • Foreign Exchange Risk

  • Interest Rates

  • Credit Card Guarantees

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Section Overview

  • Company background

  • Major risks and risk management

  • Stock options

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Company Background

  • Founded in 1971 with flights between Dallas, Houston and San Antonio

  • Has become the forth largest major airline in the United States in terms of revenues as of Dec.2002

  • Has been the number one carrier in terms of domestic boardings in the U.S. since May 2003

  • Transports more than 64 million passengers per year to more than 58 cities in 30 states

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Fact Sheet

Daily Departures: 2,800 flights per day

Employees: 33,000 throughout the system

Common Stock: Traded under the symbol LUV at NYSE

2003 Financial Statistics:

  • Net Income: $442 million

  • Total Passengers Carried: $65.7 million

  • Total RPMs: $47.9 million

  • Total Operating Revenue: $5.9 billion

  • Passenger Load Factor: 66.8%

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Company Fleet Profile

  • Southwest operated 388 Boeing 737 Jets (as of Dec, 2003)

  • Company fleet has an average age of 9.5 years

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LUV Financial Position

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LUV Financial Position

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  • For the five years ended 2001, the average annual capacity growth was 10%

  • 2002 - over 5%

  • After 2002, the estimated annualized growth rate over the next 10 years is roughly 8%

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Cost Structure

Interest expenses1.7% 2.1% 1.4%

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Major Types of Risk

Market risk

  • Fuel price risk

  • Financial market risk

    • Interest rate risk

    • Credit risk

    • Liquidity and financing risk

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Fuel Price Risk

  • Fuel price risk

    • Estimated 1.2B gallons of jet fuel for 2004. A change of $0.01 in fuel prices would impact fuel expenses by $12M

    • Makes cash flow and earnings unpredictable

  • Southwest solution - fuel hedging

    • Not for trading purposes

    • Effective commodities - crude oil and heating oil

    • Short-term and long-term

    • Mixture of call options, collar structures, and fixed price swap agreements

    • Hedged 80% of 2004 fuel requirement, 60% of 2005, and portions of 2006-2007 as of Dec. 31, 2003

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Fuel Price Risk

Fuel hedging results

  • Recognized gains of $171M in fuel expense (Table 1) and unrealized gains of $123M, net of tax

  • A net asset of $251M at the end of 2003 (Table 2)

  • Sensitivity analysis: 10% change in commodity prices would change fair value of derivative instruments by approximately $125M and more or less than $125M of changes in cash flows (as of Dec. 31, 2003)

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Fuel Price Risk

Fuel hedging results - Table 1

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Fuel Price Risk

Fuel hedging results - Table 2

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Financial Market Risk

  • Financial market risk

    • Interest Rate Risk

    • Credit Risk

    • Liquidity and Financing Risk

  • Southwest strategy

    • Capitalize conservatively

    • Grow capacity steadily and profitably

    • Strong B/S and modest financial leverage

    • High credit rating - “A” with S&P’s rating; “Baa1” with Moody’s rating on senior unsecured fixed-rate debt

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Interest Rate Risk

  • Debt

  • Short-term investment

  • Leasing

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Interest Rate Risk

  • Interest rate risk (debt)

    • Changes in interest rate affect I/S and cash flow; may result in insolvency and bankruptcy

  • Southwest solution

    • Low debt strategy

      • Total debt - $1.55B; low D/E ratio:0.30 (AMR:12.86, DAL:16.33, JBLU:1.65)

    • Market sensitive instruments

      • Fixed rates and modest financial leverage ($475M)

      • Interest rate swaps ($760M)

      • Prepayment, redemption or termination for floating-rate debt ($222M)

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Interest Rate Risk

  • Interest rate swap agreements (2003)

    • Agreement 1: pay LIBOR + a margin every 6 month and receive 6.5% every 6 month on $385M senior unsecured notes; due Mar-2012

    • Agreement 2: pay LIBOR + a margin every 6 month and receive 5.496% every 6 month on $375M, 5.496% pass-through certificates; due Nov-2006

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Interest Rate Risk

  • Interest rate risk (short-term investment)

    • Total cash and cash equivalents of $1.87B as of Dec. 31, 2003

    • Parallel closely with floating interest rates

    • Affects earnings and cash flow

  • Southwest solution

    • Invests in certificates of deposit, highly rated money markets, and investment grade commercial paper

    • No additional actions to cover interest rate market risk and other material market interest rate risk management activities

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Interest Rate Risk

  • Interest rate risk (leasing)

    • Total PV of leasing payments (2004 after):

      • Capital leasing - $91M

      • Operating leasing - $2.5B

    • Aircraft leases can be renewed at the end of the lease term for one to five years

    • However, leases are not considered market sensitive financial instruments and not included in the interest rate sensitivity analysis

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Interest Rate Risk

  • Results

    • No significant exposure to changing interest rates on fixed-rate debt

    • A liability of $18M - interest rate swap

    • Sensitivity analysis: 10% percent change would affect net earnings and cash flows by less than $1M (floating-rate debt, invested cash, and short-term investments)

    • An increase in rates has a net positive effect

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Credit Risk

  • Credit risk

    • Nonperfomance by the counterparties associated with outstanding financial derivative instruments

    • Results in credit loss

  • Southwest solution

    • Selects and periodically reviews counterparties based on credit ratings

    • Limits the exposure to a single counterparty

    • Monitors the market position

    • Agreements with seven counterparties (early termination rights, bilateral collateral provisions, security requirements)

  • Results

    • No counterparties fail to meet their obligations

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Liquidity and Financing Risk

  • Liquidity and financing risk

    • Agreements with financial institutions (credit card transactions)

    • Credit facility

    • Outstanding debt agreements

    • May reduce the availability of cash or increase the costs to keep the agreements

  • Southwest responsibility

    • Maintaining minimum credit ratings

    • Maintaining minimum assets fair values

    • Achieving minimum covenant ratios for available or outstanding debt agreements

  • Results

    • The company met or exceeded the minimum standards set forth in the agreements

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Risk Management Governance

  • No specific committee or RMO for Southwest’s risk management.

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Other Potential Risks and Uncertainties

  • War risk

  • Competitive factors

  • General economic conditions

  • Factors to control costs

  • Operational disruptions

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Stock Options

  • Stock-Based Employee Compensation covers:

    • Majority of employee groups

    • Board of directors

    • Plans related to certain contracts with certain executive officers of the company

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Stock Options

  • Two classes of employee stock plans:

    • Collective bargaining plans

      • Subjective to collective bargaining agreements

      • Granted at or above pair value

      • Normally have terms ranging from 6 to 12 years

      • No executive nor member of the Board of Directors are eligible to participate in this plan

      • Not required to be approved by Shareholders

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Stock Options

  • Other employee plans

    • Not subjective to collective bargaining agreements

    • Granted at fair market value

    • Have 10-year terms and become fully exercisable after three, five or ten years

    • Need to be approved by shareholders

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Stock Options

Shares Outstanding: 790 million

Stock Price: $14.33

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Section Overview

  • Background

  • Financials

  • Risks

  • Stock options

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SIA Facts

  • Founded in 1972

  • SIA’s passenger network covers 60 cities in 33 countries

  • Singapore Airlines Cargo offers a network linking 68 cities in 36 countries, making it the 2nd largest international cargo airline

  • Average number of employees: 14,418

  • Passengers carried: 15,326,000

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The Group

  • Subsidiaries and Associated Companies

    • Singapore Airlines Cargo

    • SIA Engineering Company (SIAEC)

    • Singapore Airport Terminal Services (SATS)

    • SilkAir

    • Singapore Flying College

    • Singapore Aircraft Leasing Enterprise (SALE)

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Awards and Accolades

  • Forbes

    • Made the world’s best companies ranking

    • Top 10 travel and transport companies

  • Fortune

    • Ranked 21st in world’s most admired companies

    • Most admired airline

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5-Year Stock Price Evolution




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Financial Risk Management Objectives and Policies

  • Financial and commodity risk

    • Market risk

      • Jet fuel price risk

      • Foreign currency risk

      • Interest rate risk

      • Market price risk

    • Counterparty risk

    • Liquidity risk

  • Other possible risk

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Market Risk

  • Jet fuel price risk

    • A change in price of US$0.01 per American gallon of jet fuel affects the Group’s annual fuel costs by US$13.1 million

  • Jet fuel price risk management

    • Swaps and options contracts hedged up to 24 months forward

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Market Risk cont.

  • Foreign currency risk

    • Foreign currency 78.4% of total revenue

    • Largest exposures are from USD, UK Sterling Pound, Japanese Yen, Euro, Swiss Franc, Australian Dollar, New Zealand Dollar, Indian Rupee, Hong Kong Dollar, Taiwan Dollar, Chinese Yuan, Korean Won, Thai Baht and Malaysian Ringgit (surplus)

    • Exposure from USD (deficit) due to capital expenditure, leasing costs and fuel costs

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Market Risk cont.

  • Foreign currency risk management

    • Matching policy, as far as possible, receipts and payments in each individual currency

    • Surpluses of convertible currencies are sold, as soon as practicable, for USD and SGD

    • Forward foreign currency contracts to hedge

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Market Risk cont.

  • Interest rate risk

    • Changes in interest rates impact interest income and expense from short-term deposits and other interest-bearing financial assets and liabilities

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Market Risk cont.

  • Interest rate risk management

    • Interest-bearing financial liabilities with maturities above one year have predominantly fixed rates of interest

    • If this is not the case they are hedged by matching interest-bearing financial assets in which case interest rate swaps are used to convert interest income into the same floating interest rate basis as interest expense

    • Interest swap agreements are in place with notional amounts ranging from $50.8 million to $70.2 million whereby SIA pays a fixed rate of interest and receives a variable rate linked to LIBOR

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Market Risk cont.

  • Market price risk

    • Potential loss resulting from a decrease in market prices

    • The Group owned $454.6 million (down 1.5% from 2002) in quoted equity and non-equity investments

    • Estimated market value of these investments was $522.9 million

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Counterparty Risk

  • Surplus funds invested in interest-bearing bank deposits and other high quality short-term liquid investments

  • Counterparty risks are managed by limiting aggregated exposure on all outstanding financial instruments to any individual counterparty, taking into account its credit rating

  • These exposures are regularly reviewed, and adjusted as necessary

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Liquidity Risk

  • The Group had cash and short-term deposits of $819.9 million (down 25% from 2002)

  • Available short-term credit facilities of $1,550 million (down 8.8% from 2002)

  • These are expected to be sufficient to cover the cost of all firm aircraft deliveries due in the next financial year

  • Additional financing through structured leases, bank borrowings, or public market funding

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Financial and Commodity Risk cont.

* No balance sheet carrying amounts are shown as these are commitments as at year end.

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Other Possible Risk

  • Risk management committee’s of the different subsidiaries and associated companies create the ability to react to unforeseen events such as

    • 9-11

    • SARS

    • Iraq war

    • Bali bombing

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Stock Options

  • SIA Share Option Plan

    • Employee Share Option Scheme

      • 99.1% of options offered in 2002

    • Senior Executive Share Option Scheme

      • 0.9% of options offered in 2002

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Stock Options cont.

  • All Stock Options

    • Terms no longer than 10 years

    • Price is determined by average 5 days prior to date of grant

    • Timing

      • Employee – must wait 2 years to exercise

      • Senior Executive – 1 year wait for access to 25%, and an additional 25% per year thereafter

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Stock Options cont.

 609,072,000 shares in the market

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Stock Options cont.

  • SIA Subsidiaries Share Option Plan

    • SATS

      • 61,799,200 outstanding

         100,588,000 shares in the market

    • SIAEC

      • 60,301,000 outstanding

         100,444,000 shares in the market

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  • Industry overview

  • Firm specific examples

    • Southwest Airlines

    • Singapore Airlines

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