Global Air Lines

1

• Global Air Lines
• David MartiSandy SchatzRoshan MannEric Yung

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Agenda

• Industry Introduction
• Singapore Airlines
• Introduction
• Financials
• Hedging Strategy
• Southwest Airlines
• Introduction
• Financials
• Hedging Strategy

3
Goals

• Find out what risks the airlines currently have
• Find how these risks are hedged
• Find out if the hedges are successful
• What is successful?

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Air Lines

• The worlds first airline was in 1909 (Deutsche
  Luftschiffahrts-Aktiengesellschaft)
• Airlines provide air transportation for cargo and
  for passengers
• The cumulative net profit of all airlines put
  together since 1909 is negative
• Positive externalities
• Airlines are highly leveraged

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Air Line Alliances

• Star Alliance, Sky Team, Americas and Oneworld
• Cost Reduction
• Sales offices, maintenance facilities
• Traveler benefits
• More departure times
• Optimizes transfers
• Traveler disadvantages
• Less competition

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How do airlines become profitable?

• Revenues are from ticket sales and shipping
• Costs
• Fuel Costs
• Labour
• Fleet Management
• Financing Costs
• Profitability is cyclical and follows the economy

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Airline Owners

• Public-Southwest, WestJet, Delta
• Private- Indo China Airlines
• Government owned- Aerolineas Argentinas, Czech
  Airlines and Air India.

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PROFITS
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Risk For Airlines

• Strategic risk
• Business design choices
• Financial risk
• Variability of revenue and costs
• Operational risk
• Tactical aspects of running the business
• Hazard risk
• Safety of physical assets

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(No Transcript)
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Singapore Airline

• Company Introduction
• Financials
• Risks and Hedging Strategies

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General Information

• Founded in 1947 as Malaysian Airlines
• SIAs passenger network covers 61 cities in 34
  countries
• Own parts of
• Singapore Airlines Cargo (100)
• SIA Engineering Company (SIAEC) (81.9)
• Singapore Airport Terminal Services (81.9)
• SilkAir (100)
• Singapore Flying College ( 100)
• Virgin Atlantic Airways Limited (49)

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SIA Facts

• Founded in 1972
• Provide world-class customer service
• Most modern and comfortable aircraft
• SIA Group employs 28,343 staffs
• SIAs passenger network covers 64 cities in 35
  countries
• SIA Cargo offers a network linking 68 cities in
  36 countries, making it the 2nd largest
  international cargo airline

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Marketing and Branding

• Company slogan A great way to fly
• Singapore emphasis
• their staff
• Singapore Girls

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Awards

• Singapore airlines claims to be Worlds Most
  Awarded Airline
• Zagat Survey
• Placed first in premium and economy classes for
  comfort, service and food
• Fortune
• Was ranked 33rd Worlds Most Admired Companies
  rankings in 2009 by Fortunes

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• Financials

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Net Profit and Operating Profit Margin
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Earnings
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Revenue Composition 07/08
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Revenue Composition 08/09
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Expenditures
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Balance Sheet
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Cash Flow
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Cash Flow statement
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Cash Flow Statement cont
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SIA Hedging Philosophy

• The Group operates globally and generates revenue
  in various currencies. The Groups airline
  operations carry certain financial and commodity
  risks, including the effects of changes in jet
  fuel prices, foreign currency exchange rates,
  interest rates and the market value of its
  investments.
• The Groups overall risk management approach is
  to moderate the effects of such volatility on its
  financial performance. ? The Groups policy is to
  use derivatives to hedge specific exposures.
• As derivative are used for the purpose of risk
  management, they dont expose the Group to market
  risk because gains and losses on the derivatives
  offset losses and gain on the matching asset,
  liability, revenue or costs being hedged.

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Accounting Principles of Financial Instruments

• Financial assets are recognized on the balance
  sheet when, and only when, the Group becomes a
  party to the contractual provisions of the
  financial instrument.
• When financial assets are recognized initially,
  they are measured at fair value, plus, in the
  case of financial assets not at fair value
  through profit and loss, directly attributable
  transaction costs.
• A financial asset is derecognized when the
  contractual right to receive cash flows from the
  asset has expired.
• All regular way purchases and sales of financial
  assets are recognized or derecognized on the
  trade date, i.e., the date that the Group commits
  to purchase or sell the asset.

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Accounting Principles of Financial Instruments

• There are two sub-categories
• 1. Financial Assets as fair value through profit
  or loss at inception. A financial asset is
  classified in this category if acquired
  principally for the purpose of selling in the
  short term. Derivatives are also classified under
  this category unless they are designated as
  hedging derivatives
• 2. Financial assets held for trading. Assets in
  this category are classified as current assets if
  they are either held for trading or are expected
  to be realized within 12 months after the balance
  sheet date.

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Accounting Principles of Financial Instruments

• Non-derivative financial assets with fixed or
  determinable payments that are not quoted in an
  active market are classified as loans and
  receivables. Such assets are carried at amortised
  cost using the effective interest method. Gains
  and losses are recognised in the profit and loss
  account when the loans and receivables are
  derecognised or impaired, as well as through the
  amortisation process.

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SIA Derivative Instruments And Hedging
Activity

• The Group uses derivative financial instruments
  such as forward contracts, interest rate swap
  contracts, jet fuel options and jet fuel swap
  contracts to hedge its risks associate with
  foreign currency, interest rate and jet fuel
  price fluctuations.
• Any gains or losses arising from changes in fair
  value on derivatives that do not qualify for
  hedge accounting are taken directly to the profit
  and loss account.
• The fair value of forward currency contracts is
  determined by reference to current forward
  contracts with similar maturity profiles. The
  fair value of interest rate contracts is
  calculated using rates assuming these contracts
  are liquidated at balance sheet date. The fair
  value of jet fuel swap contracts is determined by
  the reference to available market information and
  option valuation methodology.

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SIA Financial Risks

• Main Risks
• Jet Fuel
• Foreign Currency
• Interest Rate
• Other Risks
• Market Price Risk
• Liquidity Risk
• Credit Risk

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Jet Fuel Price Risk
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Jet Fuel Price Risk

• Risk Exposure The Groups earning are affected
  by changes in the price of jet fuel.
• Strategy Provide the Group with protection
  against sudden and significant increase in the
  jet fuel price.
• Derivative Instruments The group manages this
  fuel price risk by using jet fuel swap and option
  contracts and hedging up to 18 months, as well as
  gasoil swap hedging up to 24 month.

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Jet Fuel Price Risk
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Jet Fuel Price Risk
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Foreign Currency Risk

• Risk Exposure The Group is exposed to the
  effects of foreign exchange rate fluctuations
  because of its foreign currency denominated
  operating revenues and expenses.
• Strategy The Group manages its foreign exchange
  exposure by a policy of matching, as far as
  possible, receipts and payments in each
  individual currency.
• Derivative Instruments Surpluses of convertible
  currencies are sold, as soon as practicable, for
  USD and SGD. The Group also uses forward foreign
  currency contracts and foreign currency option
  contracts to hedge a portion of its future
  foreign exchange exposure. Such contracts provide
  for the Group to sell currencies at predetermined
  forward rates, buying either USD or SGD depending
  on forecast requirements, with settlement dates
  that range from one month up to one year.

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Foreign Currency Risk
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Foreign Currency Risk
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Interest Rate Risk

• Risk Exposure The Groups earning can also be
  affected by changes in interest rates as they
  have expenses from short term deposits and other
  interest bearing financial assets that are at a
  variable rate. Also, they earn variable rates on
  some financial investments.
• Strategy The majority of the Groups
  interest-bearing financial liabilities over a
  year are either offset by financial investments
  or have been initiated at a fixed rate.
• Derivative Instruments Interest rate swaps and
  interest rate cap contracts are used when
  liabilities are not at a fixed rate or offset.

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Interest Rate Derivatives

• Interest Rate Cap
• Have a strike price of 6.5 and mature in 7-10
  years
• Interest Rate Swap
• Exchanged for fixed at 3-4.95 maturity march
  2014-2016

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Market risk Sensitivity analysis

• Sensitivity report looking at increase or
  decrease of .01 on market interest rates

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Interest Rate Swap Contracts
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Finance Charges Interest Rates
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Market Price Risk
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Credit Risk
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Credit Risk
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SIA Stock Options

• SIA Share Option Plan
• The Singapore Airlines Limited Employee Share
  Option Plan, which comprises the Senior Executive
  Share Option Scheme and the Employee Share Option
  Scheme for senior executives and all other
  employees respectively, was adopted in 2000.

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SIA Stock Options Cont.

• Restrictions on Stock Options
• No options have been granted to controlling
  shareholders or their associates, or parent group
  employees.
• No employee has received 5 or more of the total
  number of options available under the Plan.
• The options granted by the Company do not entitle
  the holders of the options, by virtue of such
  holding, to any rights to participate in any
  share issue of any other company.

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SIA Stock Options Cont.

• All Stock Options
• Have a term no longer than 10 years from the date
  of grant
• Exercise price will be the average of the closing
  prices of the Companys ordinary shares on the
  SGX-ST for the five market days immediately
  preceding the date of grant
• Options will vest
• For employee two years after the date of grant
• For senior executive
• - one year after the date of grant for 25 of the
  ordinary shares subject to the options.
• - two years after the date of grant for an
  additional 25 of the ordinary shares subject to
  the options
• - three years after the date of grant for an
  additional 25 of the ordinary shares subject to
  the options
• - four years after the date of grant for the
  remaining 25 of the ordinary shares subject to
  the options

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The Restricted Share Plan (RSP) and Performance
Share Plan (PSP), share-based
incentive plans for senior executives and key
senior management
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SIA Stock Options Cont.
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SIA Stock Options Cont. (Singapore Airport
Service Terminal)
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SIA Stock Options Cont. (SIA Engineering Company)
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South West Airlines
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Company Profile

• Founded in 1967 with headquartered in Love Field,
  Dallas, Texas ( NYSE LUV )
• As of December 31, 2009, the company operated 537
  Boeing 737 aircrafts and provided service to 68
  cities in 35 states
• Had 37 consecutive years of profitability

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Operating Strategy

• Point-to-point, rather than hub-and-spoke
  (Cheaper and more Efficient)
• Frequent, conveniently timed flights
• Decreased labour force to control CASM (cost per
  available seat mile) not related to passengers
• Low fares

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Route Map
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Competitors

• AMR corporation
• Continental Airline
• JetBlue Airways

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South West AirlineMarket Share

• Despite only operating in the United States,
  Southwest still remains a top controlling company

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Stock Performance
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Stock Performance

• Last Trade 13.00
• Change 0.03 (0.23)
• Prev Close 13.03 Open 13.03
• Day's Range 12.84 13.10
• 52wk Range 5.92 13.34
• Volume 5,795,819
• Avg Vol (3m) 9,669,430
• Market Cap 9.66B
• P/E (ttm) 97.01
• EPS (ttm) 0.13 Div Yield 0.02 (0.10)

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• Financials

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Income Statement
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Cash Flow Statement
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Cash Flow Statement Cont
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Risk Factor
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Risk Factor

• From companys Annual Report
• Southwest's business is labor-intensive
• Southwest relies on technology to operate its
  business and any failure of these system could
  harm the Companys business
• Insurance cost increases, or reductions in
  insurance coverage may adversely impact the
  Companys operation and financial results.
• Disruptions to operations due to factors beyond
  Southwests control could adversely affect the
  Company.
• Southwests low cost structure is one of its
  primary competitive advantages and many factors
  could affect the Companys ability to control its
  costs.

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Risk Factor

• Jet Fuel
• Unpredictable price movement
• Unable to increase fares when fuel price rise
• Changes in hedging strategy and the effectiveness
  of hedging arrangement have significant impact on
  operating results

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Risk Factor Jet Fuel

• Uncertainty about future jet fuel prices
• Not as strong hedge position from 2009 to 2013
• Created a table to show what current hedged
  positions would yield based on oil prices

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Purpose of Hedging

• Airline operators are inherently dependent upon
  jet fuel to operate, and therefore, impacted by
  change in jet fuel prices
• Jet fuel and oil consumed in 2009 and 2008 30 and
  35 of operating expenses respectively
• Southwest expects to consume 1.4 billion gallons
  of fuel in 2010

Fuel and oil expense 1.4 billion X .01
14 million
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Hedging Strategy - Jet Fuel

• Hedging Commodities
• Primarily crude oil
• Heating oil
• Unleaded gas
• Components of hedging positions
• Call options
• Collar structures
• Fixed price swap agreements

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Hedging Strategy Jet Fuel

• Hedge ratio
• 55 for 2009 at 51/barrel
• 25 for 2010 at 63/barrel
• 15 for 2011 at 64/barrel
• 15 for 2012 at 63/barrel
• Near term hedge positions are in the form of
  option contracts
• Limit the cost of rising fuel price and benefit
  the company of declining fuel price

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Value of Hedge Contracts

• As of December 31, 2009, the company had 1.02
  billion derivative instruments
• 347 million of that was classified as Fuel
  hedge contracts
• Fair value is determined by the use of present
  value methods or standard option value model with
  assumptions about the commodity prices based on
  those observed in underlying markets

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Balance Sheet - Assets
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Performance of Hedging

• Gains from hedging
• 406 million gain, as of December 31, 2009
• Of that amount, 378 million came from fuel
  hedged derivatives and 28 million from changes
  in fair values of derivatives

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Balance Sheet Liability SWs Equity
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Cost Structure
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Cost Control

• Reduced Hedge positions
• Freedom 09
• Reduce Capital Spending
• Winglets

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Risk Factor 2

• 82 of employees are represented by Unions

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Employee Stock Option
ESO - Options grated at or above FMV of the common stock - 6-12 year terms - Neither Executive officer nor members of the board of directors are allow to participate Other Employee plans - Options granted at the money - 10 year terms - Fully exercisable over 3, 5 or 10 years of continued employment
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Employee Stock Option
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Employee Stock Option
An options exercise price may be paid (i) in
cash, (ii) in shares of Common Stock,
(iii) through a cashless exercise, or (iv) in
any other manner permitted by the committee.
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Interest Rate Risk

• - Interest rate risk (Debt)
• Fluctuations of interest rate affect firms
  interest obligation, therefore have impact on the
  firms liquidity position
• May result in insolvency and bankruptcy
• - Southwest Strategy
• Prepayment, redemption or termination for
  floating-rate debt
• Interest Swap

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Interest Rate Hedging
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Interest Rate Swaps

• Take advantage of short term rate vs LT
• fixed rate in 2009
• - Reduce Volatility

Debt Instrument (million) Fixed rate Average Floating rate 2009
2012 385 6.5 3.18
2014 350 5.25 2.72
2016 300 5.75 3.16
2017 300 5.125 0.39
2027 100 7.375 2.48
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Credit risk

• The Company does not expect any of the
  counterparties to fail to meet their obligations
• To manage credit risk
• selects and periodically reviews counterparties
  based on credit ratings
• limits its exposure to a single counterparty
• and monitors the market position of the program
  and its relative market position with each
  counterparty
• The Company had agreements with several
  counterparties containing early termination
  rights and/or bilateral collateral provisions
  whereby security is required if market risk
  exposure exceeds a specified threshold amount or
  credit ratings fall below certain levels.
• held 478 million in fuel hedge related cash
  collateral deposits under these bilateral
  collateral provisions
• decrease, but not totally eliminate, the credit
  risk associated with the Company's hedging program

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Insurance

• Purpose of Insurance
• protect the Company and its property
• comply both with federal regulations and the
  Companys credit and lease agreements.
• General Coverage
• public and passenger liability, property damage,
  cargo and baggage liability, loss or damage to
  aircraft, engines, and spare parts, and workers
  compensation.
• Increasing insurance cost after 9-11

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Conclusion

• It is important to hedge and hedge appropriately

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THE END

• Any questions or comments are welcomed!