AC 3115: Financial Statement Analysis and Valuation
The objective of this report is to compare and contrast two companies in the airline industry with respect to strategic, accounting and financial analysis. We will develop a detailed forecasting model on which we will base our valuation of the companies. Other issues which arise will also be discussed in detail. Ultimately we will decide on whether to put a buy or sell recommendation on the shares of Southwest Airlines and Continental Airlines.
From the above we conclude that we would put a BUY recommendation on BOTH Southwest Airlines and Continental Airlines. These recommendations are based on the forecasted share prices below. LUV:
Current Market Price
Current Market Price
In conclusion, we feel Southwest Airlines will continue to grow steadily into steady state. Continental Airlines still has significant room for expansion given the long haul sector that they operate in. We believe that Continental Airlines will reach stable growth in 2017, while Southwest Airlines are predicted to reach stable growth in 2014.
Table of Contents
Prospective / Forecasting Analysis
In order to understand the underlying economics of the airline industry and our two chosen companies, a strategic analysis was undertaken. The aim of this analysis is to highlight the firms cost structure, brands, risks and assets, including the firms’ external environment and how they perform within that environment. The following strategic analysis incorporates the PwC Corporate Reporting Framework and Generic Strategies analysis.
PWC Corporate Reporting Framework
The travel industry has gone through major upheaval and change. Soaring fuel prices and slowing economic growth have wiped out much of the airline industry’s profit in recent years. Many airlines do remain in debt and vulnerable to fuel price swings and the effects of an economic downturn. An airline industry analyst at Ernst & Young said ‘That the industry is so highly leveraged that you don’t need a big change in one factor to have a significant impact on profitability.’ After battling through consecutive years of difficult operating conditions, the United States air transport industry is poised to begin producing real contributions to economic growth, according to a report by IBISWorld, Inc. The turbulent market conditions that have been threatening the airline industry are well known. Even before the September 11th attacks, excess capacity (too many planes and not enough
passengers) and extremely high cost structures left many of the major airlines in a vulnerable position. Airlines aren’t out of danger, as the debt levels of many airlines still remains high.
The United States carries over a third of the globe’s total traffic. The year 2006 was a much improved year for the U.S. and the initial economic outlook for 2007 is looking the most promising since recent years, although given the current U.S. economic uncertainty, this could change. In the past, fuel accounted for only 10 to 15 percent of the airline industry’s operating expenses but now it accounts for about 20 to 30 percent of operating expenses and it has become the top cost for many carriers. A recent Bear Stearns report noted ‘the improved environment in the U.S is only temporary; in our judgement the business remains highly cyclical’. Whether the Bear Stearns report is correct or not the airlines have every reason to remain focused on reducing existing costs and dodging looming commercial or governmental impediments to...
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