International Airlines

1. Presented By: Zaki Kasmani David Tran Laurence Wong Cecilia Fan Spring 2006 International Airlines Business 417

2. Industry Outlook Just Kidding! OR??

3. Basic Definitions • ATK (Available Tonne Kilometres) : • Used to measure available total capacity (combined passenger and cargo) • ASK (Available Seat Kilometers): • The number of seats an airline has available multiplied by the number of kilometers they are flown • Used to measure airline capacity • RPK (Revenue Passenger Kilometers): • The number of passengers multiplied by the number of kilometers they are flown • Used to measure actual passenger traffic • PLF (Passenger Load Factor): • % of ASK used • FTK (Freight Tonne Kilometers): • Used to measure actual freight traffic • UNIT COST: • The average operating cost incurred per ATK • YIELD: • The average amount of revenue received per RPK, net of taxes • Revenue divided by RPK • Represents an aggregate of all the airfare and airline charges and measured on a per kilometer basis • LOAD FACTOR: • RPK divided by ASK • The percentage of seating or freight capacity that is utilized. Computed as the ratio of RPK to ASK or in the case of cargo services, RTK to ATK • BREAK-EVEN LOAD FACTOR: • The Load Factor when operating revenues is equal to operating costs • Unit Cost divided by Yield

4. Types of Airlines • Legacy: International & National traditional airlines (ie: British Airways, Delta Airways) • Discount: Regional (Europe) or National (US) (ie: Easyjet, Southwest) • Cargo

5. Airline Characteristics • Capital intensive industry (highly leveraged) • Largest operating costs: Labour & Fuel • Historically low labour productivity • Very sensitive to global business cycles • Very competitive • Sensitive to geopolitical events ie: 9-11, SARS, etc

6. Types of Routes • Point to point (linear): direct flight to destination (low-cost/discount model) • Hub and spoke: connection flight (traditional model) • Hub: airport that is used as a transfer point • Spoke: routes that airplanes take

7. Past & Present Injuries • Deregulation (October 28, 1978) • Terrorist attacks (Sept 11, 2001) • The collapse of the dotcom bubble (late 1990) • The war in Iraq (2003 - present) • The SARS epidemic in Asia (start November 2002) • Fiercer competition from new low-cost carriers • High taxation • Rise in oil price

8. Future Threats • Additional terrorist attacks • Future price of oil • Further competition from regional airlines • Security impact on cost and travel convenience • Decrease in consumer confidence • World economy • Business cycle • Debt (airline industry’s debt load exceeds the US industry average) • Aircraft cost & maintenance

9. Bankruptcy Protection • 2002-2005: Majority of US legacy airlines entered & emerged from Chapter 11; some still working through restructuring (Delta) • Focus was cost reduction: reduced labour costs, pension restructuring, capital restructuring (fleet overhaul to cheaper, more fuel efficient aircraft – avoid the Jetsgo predicament) • Airlines include: Delta, American Airlines, Northwest, United

10. Growth Projections

11. Global Traffic Outlook

12. Historical Data

13. Historical Data

14. Fuel Costs

15. Fuel Costs

16. Labour Costs SOURCE : U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Products Accounts, tables 6.6b and 6.6c, Internet site http://www.bea.doc.gov/bea/dn1.htm available as of Feb. 17, 2004 AGGREGATE ECONOMY DATA SOURCE: US Bureau of Labour Statistics

17. Labour Costs Source: Aviation Career & Salary Ranges - Aviation Jobs (www.avjobs.com)

18. Labour Cost Implications • More median salaries above average than below = higher overall salary cost than for economy in general • Wide range in salaries, unionized labour; senior international route pilots can earn up to $190,000 USD per year • Majority of pensions are defined benefit: higher salaries = significantly higher pension obligations

19. Barriers to Operations • Airports: generally locally owned authorities, lease out gates to airlines for long terms • Exclusive use, preferential use, or common use • Signatory airlines receive preferential rates vs. non signatory (most new entrants). ie: Pittsburgh Int’l Airport non signatory rates min. 20% higher • FAA mandates that gate access be granted in a fair and non-discriminatory manner. Regulations should only maintain safety, not encourage dominance Gate access at airports can be a significant barrier

20. Barriers to Operations • In practice, established airlines can exercise significant dominance: gates are usually assigned via non market practices (bidding). Ability to bid depends on access. Large airlines can make contributions to/lobby municipal governments to restrict competing airlines’ access to airport • Majority in Interest (MII) clauses grant airlines rights to approve airport capital improvement plans (can restrict expansion to maintain monopoly access to a “hot” airport)

21. Barriers to Operations • FAA is currently reviewing gate lease practices in an attempt to make access more equitable. However, oversight still lies with the airport owner (local authority) Therefore, a carrier’s ability to grow may not be determined by its cost efficiency but rather by its ability to land at high traffic destinations

22. Bottom Line Airlines MUST reduce costs to achieve a return to sustained profitability.

23. Cost Minimization Strategies • Oil price forecasted to drop to $45-55 per barrel range in 2007 (March 22 WTI spot:$60.82)

24. Cost Minimization Strategies 1a) Acquire more fuel efficient aircraft: • Current Long Range Aircraft Fuel Consumption • Boeing 747-400 3.5 L/100 passenger KM (Average) • New Long Range Aircraft Fuel Consumption • Boeing 787: 2.4 L/100 passenger KM • Airbus A380: 3.0 L/100 passenger KM • Airbus A350: 3.0 L/100 passenger KM

25. Cost Minimization Strategies • 1b) Acquire more regional jets: • Regional Jets • Bombardier CRJ 200 (50 seat): ~3.12L/100 passenger KM • Bombardier CRJ 700 (78 seat): ~2.60L/100 passenger KM • All Russian aviation companies now under one banner – United Airplane Company. Focus will now be on Regional Jets, which will be of great demand in Russia.

26. Cost Minimization Strategies 1b) Acquire more regional jets: • cost savings: Flights at capacity, lower cost (less people required to maintain and fly aircraft) SOURCE: Bombardier SOURCE: Bombardier

27. Cost Minimization Strategies 2) Reduce Labour Costs • Increase labour productivity through additional training, performance monitoring • Decrease salary/pension costs by: • hiring non-union workers where possible (new divisions) • renegotiating existing salary contracts • phasing out defined benefit pension plans in favour of defined contribution pension plans

28. Cost Minimization Strategies 3) Refine Business Model • Legacy airlines can employ 2 models: • point to point low cost model on domestic routes • traditional hub model on international routes. Thus far, traditional airlines (especially US based ones) have been entering bankruptcy protection to enable a restructuring that encompasses all 3 strategies. However, this is not exactly conducive to increasing consumer and investor confidence

29. Growth Projections

30. China Traffic Growth

31. Growth Strategies Focus on regions that are expected to yield the highest rate of RPK growth: • China & India: • burgeoning middle class now has resources to travel. • Increased trade and foreign investment means increased number of foreign business people visiting, and increased frequency of visits

32. Investment Criteria Given the investors’ current distaste for airlines, bargains could (?) be found • Cost efficiency: • fuel efficient fleet, appropriate business model, reasonable labour costs (non union, or balanced union power) • well funded pension obligations (defined contribution superior) • Exposure, or plans to operate in future high growth areas (China, India, Latin America) • Healthy financial structure; should not be overly leveraged, reasonable CAPX • Enough market power to secure additional airport access; ability to “withstand” competition from other carriers at high traffic airports (dominate?)

33. Southwest Airlines

34. Company Snapshot • Listed on: NYSE • Symbol: LUV • Industry: Regional Airlines • Market Cap: $14.14B • Stock Price: $17.65 (Closing 03/24/06) • Dividend Yield: .02 (0.10%) • P/E: 26.23 • Shares Outstanding: 804,661,597

35. Background • 1967: Incorporated in Texas (Rollin King and Herb Kelleher) • 1971: Commenced service with 3 Boeing 737s serving Dallas, Houston, and San Antonio • Short to medium-haul point-to-point regional carrier • Today: 448 Boeing 737s, 61 cities, 31 states • 31,729 employees as of January 1, 2006 • Posted 33rd consecutive year of profits in 2005 • Largest US carrier based on originating US passengers boarded and scheduled US departures

36. Mission • “Dedication to the highest quality of customer service delivered with a sense of warmth, friendliness, individual pride, and company spirit.” • “… to provide our employees a stable work environment with equal opportunity for learning and personal growth.”

37. Key Officers • Herbert Kelleher • Position: Founder / Executive Chairman • Age: 74 • Years of Service: 28 • Gary Kelly • Position: CEO • Age: 50 • Years of Service: 20 • Colleen Barrett • Position: President • Age: 61 • Years of Service: 28

38. Quick Facts • Average passenger airfare is $93.68 • Average passenger trip is 775 miles • Ranked first in customer satisfaction • Adopted the first profit sharing plan in US airline industry in 1973 • Employees own at least 10% of stock • Member of fortune 500 • Received 260,109 resumes and hired 2,766 new Employees in 2005

39. Destinations

40. Strengths & Weaknesses • Strengths • Known for superior customer service • Low-cost, no-frills • Direct one-way travel • Point-to-point efficiency • Largest carrier for domestic service • One fleet type • Hedge against exposure to fuel prices • Only airline rated investment grade • Weaknesses • Point-to-point creates excessive expenditure • Too many locations, administrative costs • Risk to shocks in US economy, since it is a domestic carrier

41. Operating Expenses

42. Fuel Costs

43. Fuel Strategies • Consumed 1.3B gallons of jet fuel in 2005 • Hedge on short and long term basis • 2005: 85% at $26/barrel crude oil • Savings of $892 Million • 2006: 65% at $32 • 2007: 45% at $31 • 2008: 30% at $33 • 2009: 24% at $35

44. Competition and Challenges • Increasing low fare and lower cost competition • Rising fuel costs • Competition from surface transportation in short-haul markets

45. Risk Factors • Business very sensitive to price of fuel • Business is labour intensive • 82% of employees are unionized • Relies heavily on technology for daily operations • Changes in government regulation can have a major impact on business • Airline industry is very competitive

46. Labour Unions

47. Aircraft Data

48. Operating Data

49. Financials

50. Revenue Composition