Presented by:

1
Southwest Airlines

• Presented by
• Brad Newton
• Tiffany Nachtwey
• Laura Comeaux
• Carmen Franco
• Uyen Phan

Southwest Airlines
2
Background Analysis
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Mission Statement

• The mission of Southwest Airlines is dedication
  to the highest quality of Customer Service
  delivered with a sense of warmth, friendliness,
  individual pride, and Company Spirit.

4
We are Ready for Take-Off

• Founded by Rollin King and Herb Kelleher
• Started in 1971
• Focus on low prices and customer service
• Maiden voyage between Dallas, Houston, and San
  Antonio

5
UpUp Away

• First airline to win the Triple Crown
• Best On-Time Record, Best Baggage Handling, and
  Fewest Costumer Complaints.
  
• Southwest has won it more than 30 times
• Top Ten Most Admired Corporations
• Fortune Magazine 2003
• Number one carrier in domestic passengers

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Southwest Aircrafts

• Southwest Airlines has more than 355 of the
  newest jets in the nation.
  
• Several of the aircrafts are painted with various
  themes.

Classic Color Scheme
Shamu One
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Southwest Aircrafts
Canyon Blue Color Scheme
Triple Crown One
Silver One
Lone Star One
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Interesting Facts

• Southwest received 202,357 resumes and hired 908
  new Employees in 2003
  
• In 2003 Southwest served
• 52.6 million cans of soda, juices, and water
• 8.7 million alcoholic beverages
• 3 million bags of pretzels
• 85 million bags of peanuts
• 1.1 billion gallons of jet fuel in 2003
• 236 million pounds of cargo and mail in 2003
• Over 2,000 Southwest Employees have spouses who
  also work for the company
  
• Member of the FORTUNE 500

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Top Ten Domestic Airlines
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Where we Fly

• Southwest flies to 58 cities in 30 states

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Who is Southwest
Colleen Barrett President, COO
James F. Parker CEO
Herb Kelleher Chairman of the Board
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Financial Ratio Analysis
LUVs Growth Rate is UNSATISFACTORY
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Financial Ratio Analysis
LUV has MORE production risk and earnings are
GROWING SLOWLY
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Financial Ratio Analysis
LUVs management is making investment and
financial decisions VERY WELL
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Financial Ratio Analysis
LUV is more EFFICIENT than other airlines
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Financial Ratio Analysis
Investment returns of LUV over all are EXCELLENT
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Financial Ratios
Overall, Management Efficiency is FAIR
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Holding Period Return

• Ending Price Beginning Price Distributions
• Beginning Price

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Free Cash Flow to Equity
Estimated Growth Rate 57.6
Shares 789 Million
Current Price 14.80
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Cost of Equity

• Whats the Cost of Equity?
• Ke0(FCFE1/Shares0) G
• P0
• KeLUV -112

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Risk Analysis
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Beta Calculated, ß

• ßLUV COV(RLUV, RSP500)
• VAR(RSP500)
• ßLUV 0.8266
• LUV is LESS RISKY than the average security.
• This is a STRENGTH.
• It causes a lower Required Return from
  Investors.
  

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Cost of Equity

• DCF model yielded negative Ke
• Due to negative FCFE
• Dividend model yielded an unreasonable result
• Due to the small dividend
• Both models failed, so how do we estimate Ke?

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Estimating Ke

• Based on Kd
• Government grants in 2001 and 2003
• Totaling over 550 million
• Interest expense

Ke
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Weighted Average Cost of Capital

• No preferred stock issued
• WACC fairly stable especially considering industry

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Capital Structure

• Southwest has much less debt than the industry.

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M M Proposition Chart
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M M Proposition Chart

• Southwest Airlines does not actually fall into
  any of the models in the MM proposition
  
• We can assume that LUV would fall under the Model
  III
  
• Why? Because most United States companies are
  taxed, calculate distress costs and have agency
  costs

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Market Efficiency
Company Specific News
News 8.8 increase in passenger revenue over the
previous year

• Weak Form

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Market Efficiency
Non-Company Specific News
News OPEC cuts oil production by 4

• Weak Form

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Strengths Weaknesses

• Strengths
• Financial Ratios
• Gross Margin
• Net Profit Margin
• Debt Ratio
• Income/Employee
• EPS
• Stable WACC
• Low Beta (.83)
• 31 years of profit

• Weaknesses
• Financial Ratios
• Sales Growth
• Return on Equity
• Asset Turnover
• Small Dividend
• 2 cents per year

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5 Year Stock Price Chart

• Current price is in the middle of the 5 year range

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Analyst Opinion

• Overall recommendation is BUY.

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Buy, Sell or Hold

• Analyst Opinion BUY
• 67 say buy
• 5-year Stock Price HOLD
• Middle of 5 year range
• DCF Ke vs. CAPM Ke UNDETERMINED
• -120 vs. 20
• Holding Period Return BUY
• 19.1 return for 2004
• OVERALL RECOMMENDATION - BUY