Simple Analysis and Parsimonious Forecasting and Valuation using Forecasts of Cash Flows
Southwest Airlines:Business Description Southwest Airlines Co. operates Southwest Airlines and AirTran Airways, major passenger airlines that provide scheduled air transportation in the US and near-international markets As of December 31, 2012, the company served 97 destinations in 41 states and consisted of 694 aircrafts Known for conveniently timed flights, low fares, and no supplementary fees for baggage Boeing is Southwest’s sole supplier for aircrafts The company’s business is somewhat seasonal and greater during summer months
Southwest and AirTran Acquisition On May 2, 2011, Southwest acquired all of the outstanding equity of AirTran Holdings, Inc. whose parent company was AirTran Airways Note 1: Summary of Significant Accounting Policies states the accompanying Consolidated Financial Statements for 2011 include the results of operations and cash flows for AirTran from May 2, 2011 through December 31, 2011
Overview of the Forecasting Process
Steps for Forecasting
2013 Extrapolated Income Statement Revenue growth is the change between Q3 2012 and Q3 2013 Expense growth is calculated using the percentage of sales method from 2012 10-K Income Taxes are Income Before Taxes*.37
Breaking Apart RNEA RNEA, EPM, and EATO are relatively stable historically. EPM is low because the airline industry is commoditized and based on price wars and EATO is high because Southwest’s assets are mostly off balance airplane leases
Parsimonious Assumptions 5% assumed sales revenue growth consistent and conservative with Analyst Reports especially with Southwest trying to expand internationally in 2014.
Industry Analysis Spirit Airlines is not comparable to Southwest in this analysis Spirit’s past sales growth ranges from 23% to 37% while Southwest’s range from 5.5% to 12% Spirit’s past EPM ranges from 8.2% to 10.8% while Southwest’s range from 2.8% to 3.6% Spirit’s past sales growth ranges from 6.4 to 8while Southwest’s range from 2.17 to 2.5 Southwest is a larger and more mature company compared to Spirit Southwest’s Revenue Growth, EPM from Sales, and EATO are appropriate compared to JetBlue Airways and Delta Airlines A macro issue that affected the industry in 2013 was PRASM Government shutdown in fall made PRASM uncertain and fairly choppy PRASM became consistent again in November and was very high in Q4
Valuation using Forecasts of Cash Flow
Multiyear Forecasts of FCF (millions) FCF= EPAT-∆NEA
Valuing Southwest Estimated growth rate beyond 2019: 3.0% Estimate of enterprise cost of capital: 10% V= $2,938
Discounted Cash Flow Model $2,938 is the estimated intrinsic value of enterprise operations of Southwest based on my assumptions thus far.
Works Cited Capital IQ SEC website Module 4 from Simple Analysis and Parsimonious Forecasting Module 5 from Valuation using Forecasts of Cash Flows 2013 10-K Earnings Conference Call