Financial Statement Analysis
Industry Analysis
Industry Definitions and Metrics
· Industry structure/keyplayers
· Primary performance metrics
Industry Trends
· Key trends in industry
Risk Factors
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Success factors
· Include exhibits if useful, for examplegrowth in customer base
· trends in input prices of primary goods
· trends towards consolidation/globalization
Strategy Analysis
· For Strategy Analysis, discuss the following:
· How does the company create value?
· What are the management intentions and plans? Are they realistic?Examples: growth, higher margins, new products, cost savings, product differentiation
· Key Success Factors (e.g., brand, patents, process, supply chain)
· Key Risk Factors (e.g., competition, ability to execute, ability to innovate)
· Is the company’s strategy sustainable?
· Include exhibits if they help illustrate a company’s strategy
Cost Structure
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Other Operational Value Drivers
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SAMPLE:
Southwest Airlines
Industry Analysis
Industry Definitions and Metrics Exhibit A: Major Airline Industry Players
The airlines industry focuses on providing domestic air transportation for passengers and cargo over regular routes and regular schedules. Southwest strives to differentiate itself from other air carriers by delivering exemplary customer service at a low comparative cost. Southwest operates within the low-cost airline industry. Within the domestic space, Southwest is the fourth largest airline holding 13% of the overall share of revenues for the industry1. The company’s primary competitors include Delta Air Lines Inc., American Airlines Group Inc., United Airlines Holdings Inc., and JetBlue. Including Southwest and their competitors, the domestic airline industry accounts for 66% of the industry’s revenue.
Revenues in the airline industry are driven by multiple metrics including Available Seat Miles (ASM), Revenue Passenger Miles (RPM), Revenue per Available Seat Miles (RASM), and Load Factors.
Seat miles are the number of miles a given airplane will be flying multiplied by the number of seats available for a given flight. ASM measures an airplane’s carrying capacity available to generate revenue and is measured by how many seat miles are actually available for purchase on an airline. RASM is a metric that shows how much operating revenue is generated per seat mile available for purchase. Higher RASM typically indicates that an airline is more profitable and casts them in a more positive light to investors. Airline industries drive up their operating margins by keeping RASM high and keeping Cost per Available Seat Mile (CASM) as low as possible. RPM is measured by the number of the number of miles traveled by paying passengers. Load Factors shows the correlation of RPM and ASM as a percentage indicating how effective an airline is at selling seats to passengers. Higher load factors indicate higher utilization of ASM, which directly translates to higher RASM.
Industry Trends
The COVID-19 pandemic (the pandemic) has led to numerous new trends in the airline industry that will play out over the next few years. Many airline companies have experienced significant losses due to the pandemic and the halting of a majority of international and domestic travel caused significant decreases in the number of passengers flying2. In Southwest’s case, it experienced its first annual net loss since 1972 and a 60% decrease in operating revenue yearover-year. Major industry operators have implemented drastic cost saving strategies to remain financially viable. Southwest achieved this by cutting its ASMs by 34.2% due to the drastic decrease in demand3.
While leisure travel has rebounded somewhat since late 2020, airlines have yet to see significant growth in business travelers. This has been particularly damaging to legacy airlines such as American and United as the majority of their high-fare passengers are business travelers. Southwest is less sensitive to business travel demand as its low fares primarily target leisure travelers. Many analysts expect travel demand to rebound significantly over the next few years.
Risk Factors
As the airline industry recovers from the extreme losses it faced in 2020, there must be a rebound in passenger traffic and RASM. The recovery of these factors is dependent on the risks currently facing the airline industry. The airline industry is also vulnerable to the current volatility of the economic and geopolitical environment. Industry wide credit ratings have decreased, making an eventual path to recovery more uncertain. Government travel regulations and consumer uncertainty were at all-time highs in the US market, completely eclipsing the effects felt after 9/11. In addition, established industry players face potential price competition from ultra-low-cost-carriers such as Spirit airlines leading to potentially decreased margins.
Success Factors
Even though the pandemic has slowed airline travel significantly, it is important to remember that the industry has become essential to consumers and businesses. Even though the demand is at all time low, it is only temporary. The industry will continue to innovate and grow once demand returns to pre-pandemic levels. Industry players can also gain competitive advantage by hedging against the price of jet fuel, which can decrease the volatility of their earnings. Southwest is able to do this with great success allowing the company to maintain its industry-leading profit margins.
Strategy Analysis
Southwest Airlines’ business model revolves around its ability to maintain low costs, low fares, and a strong focus on the customer experience with their campaign of “transfarency.” The company has differentiated itself through a marketing effect that highlights its policy of no hidden fees. This position has allowed the airline to increase its market share and ticket sales among price sensitive customers. Southwest does not charge a cancellation or flight change fee and also doesn’t charge an additional cost to check luggage unlike most other airlines.
Cost Structure
The company is the largest low-cost carrier globally and is able to charge competitively low fares on account of its cost structure. Southwest’s low-cost strategy revolves around its single aircraft fleet and point-to-point route structure. The volatility in price of crude oil is a large risk factor to the business’s success. Southwest has focused on minimizing fuel consumption and improving fuel efficiency through fleet moderation and other fuel initiatives. The company solely uses Boeing 737s, whereas other major airlines have a diversified fleet. This single aircraft type enables Southwest to simplify its flight scheduling, maintenance, safety management, and training activities while also spending a reduced amount of time on servicing these planes.
Fuel Efficiency
The company has made an effort in the past to incorporate more Boeing 737 MAX aircrafts into its fleet, which are proven to be more fuel efficient and result in saving on maintenance costs. However, in March 2019, the Federal Aviation Administration (FAA) forced the grounding of the MAX models due to the previous fatal crashes and overall safety issues. These grounding resulted in lower fuel efficiency for Southwest in 2019 as they had to rely on older aircraft. The FAA lifted the ban on the MAX aircraft in late 2020, and Southwest has begun slowly integrating the aircraft back into its fleet. Management announced a deal with Boeing in March to purchase 100 of Boeing’s 737 MAX-7 airplanes in order to retire more of its older 737-700 jets, which consumes more fuel. The total order with Boeing now amounts to 200 MAX-7 and 149 MAX-8 planes. This is appropriate given Southwest’s business model because of their point-to-point flight schedule and high utilization model. Management also spoke about the company’s deal with GE and CFM International for the LEAP-1B engines during the first quarter earning call for 20213. This deal will provide Southwest with 14% better fuel efficiency per plane. The company has entered into fuel derivative contracts in order to manage its risk associated with volatility in crude oil prices. The company has also created a focus on maintaining its liquidity in the event of another unforeseen issue.
Other Operational Value Drivers
Southwest also operates under a point-to-point route structure like other low-cost airlines. This allows the company to travel directly to destinations at less congested airports. Flying to these less congested airports creates cost savings for the company because it is able to pay lower gate access fees. This route structure also allows for more direct, nonstop flights at lower fares because of less air traffic. Customer experience can also benefit under this model as they can save time by avoiding long layovers since this system is less dependent on connecting flights. It also reduces travel time and risk of baggage losses and delays and reduces total fuel per passenger. Since these airports are typically less congested, it helps contribute to Southwest’s ability to achieve high asset utilization because aircrafts can be scheduled to minimize the amount of time they are on the ground.
Over the past few months, the company has set out plans to improve operations by expanding its current route network. It plans on adding new airports to the existing network and reintroducing routes that were halted because of the pandemic. In an effort to reach more business travelers and grow its share within corporate travel, the company has expanded its booking access by expanding its presence in global distribution systems (GDS). In October of 2020, it partnered with companies like Amadeus and Travelport to expand the amount of content it offers and ability to reach more business travelers, while providing a better customer experience5. GDS has been the preferred method for travel bookings among corporate travelers. Amadeus is the world’s largest GDS, and this partnership will allow corporate travels to easily book flights and other services on the platform. While there is still uncertainty regarding demand for business travel, this move will set up Southwest in a better position going forward to increase its presence in that market.
Exhibit B: Revenue Comparison and Load Factors
To get a better sense of Southwest’s strategy compared to its peers, it is interesting to see how the pandemic affected the industry. Southwest’s route network is primarily domestic and has served as a point of advantage over the other major airlines during the pandemic. These other airlines have faced significant losses on their international networks as overseas travel demand collapsed when quarantine restrictions tightened. In recent months, domestic travel has picked up, resulting in Southwest rebounding at a quicker pace. Demand in leisure travel has also seen a faster rebound than business travel, which continues to lag at this point in the pandemic. Major airlines such as American, United, and Delta have taken a bigger hit because a larger portion of their core business targets business travel due to the segment’s higher profitability. Southwest operates as a low-cost carrier that serves both market segments but has positioned itself to cater more towards leisure travel. Among the major airlines, Southwest requires the lowest load factors (72.5%) to breakeven6. On average it takes these airlines to operate at 75% capacity to breakeven due to the large variety of expenses such as wages, fuel, maintenance, and landing fees to name a few. This shows why the industry is so competitive and how difficult it is to maintain high margins.
Southwest’s low-cost model allows it to breakeven at a low load factor, which contributes to the idea that Southwest is in one of the best positions to rebound from the effects of the pandemic.