Global Air Lines
David Marti
Sandy Schatz
Roshan Mann
Eric Yung
Agenda
• Industry Introduction
• Singapore Airlines
– Introduction
– Financials
– Hedging Strategy
• Southwest Airlines
– Introduction
– Financials
– Hedging Strategy
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?
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
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
How do airlines become profitable?
•Revenues are from ticket sales and shipping
•Costs
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Fuel Costs
Labour
Fleet Management
Financing Costs
•Profitability is cyclical and follows the economy
Airline Owners
•Public-Southwest, WestJet, Delta
•Private- Indo China Airlines
•Government owned- Aerolineas Argentinas,
Czech Airlines and Air India.
PROFITS
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
Singapore Airline
Company Introduction
Financials
Risks and Hedging Strategies
General Information
• Founded in 1947 as Malaysian Airlines
• SIA’s passenger network covers 61 cities in
34 countries
• Own parts of
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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%)
SIA Facts
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Founded in 1972
Provide world-class customer service
Most modern and comfortable aircraft
SIA Group employs 28,343 staffs
SIA’s 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
Marketing and Branding
• Company slogan “A great way to fly”
• Singapore emphasis
their staff
– Singapore Girls
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 World’s Most Admired
Companies rankings in 2009 by Fortunes
Financials
Net Profit and Operating Profit Margin
Earnings
Revenue Composition 07/08
Sales
12%
29%
East Asia
Americas
18%
Europe
South West Pacific
West Asia and Africa
22%
19%
Revenue Composition 08/09
Expenditures
Balance Sheet
Cash Flow
Cash Flow statement
Cash Flow Statement cont
SIA Hedging Philosophy
• The Group operates globally and generates revenue in various currencies. The Group’s
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 Group’s overall risk management approach is to moderate the effects of such
volatility on its financial performance.  The Group’s policy is to use derivatives to
hedge specific exposures.
• As derivative are used for the purpose of risk management, they don’t 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.
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.
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.
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.
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.
SIA Financial Risks
• Main Risks
– Jet Fuel
– Foreign Currency
– Interest Rate
• Other Risks
– Market Price Risk
– Liquidity Risk
– Credit Risk
Jet Fuel Price Risk
Jet Fuel Price Risk
Risk Exposure: The Group’s 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.
Jet Fuel Price Risk
Jet Fuel Price Risk
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.
Foreign Currency Risk
Foreign Currency Risk
Interest Rate Risk
Risk Exposure: The Group’s 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 Group’s 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.
Interest Rate Derivatives
• Interest Rate Cap
– Have a strike price of 6.5% and mature in 710 years
• Interest Rate Swap
– Exchanged for fixed at 3%-4.95% maturity
march 2014-2016
Market risk Sensitivity analysis
• Sensitivity report looking at increase or
decrease of .01% on market interest rates
Interest Rate Swap Contracts
Finance Charges –Interest Rates
Market Price Risk
Credit Risk
Credit Risk
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.
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.
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 Company’s 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
The Restricted Share Plan (“RSP”) and Performance Share
incentive plans for senior executives and key senior management
Plan (“PSP”), share-based
SIA Stock Options Cont.
SIA Stock Options Cont. (Singapore Airport Service Terminal)
SIA Stock Options Cont. (SIA Engineering Company)
South West Airlines
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
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
Route Map
Competitors
• AMR corporation
• Continental Airline
• JetBlue Airways
South West Airline
Market Share
• Despite only operating in the
United States, Southwest still
remains a top controlling
company
Stock Performance
Stock Performance
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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%)
Financials
Income Statement
Cash Flow Statement
Cash Flow Statement Cont
Risk Factor
Risk Factor
• From company’s 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 Company’s business
•
Insurance cost increases, or reductions in insurance coverage may
adversely impact the Company’s operation and financial results.
•
Disruptions to operations due to factors beyond Southwest’s control
could adversely affect the Company.
•
Southwest’s low cost structure is one of its primary competitive
advantages and many factors could affect the Company’s ability to
control its costs.
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
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
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
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
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
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
Balance Sheet - Assets
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
Balance Sheet – Liability & SW’s Equity
Cost Structure
Cost Control
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Reduced Hedge positions
Freedom 09
Reduce Capital Spending
Winglets
Risk Factor #2
• 82% of employees are represented by
Unions
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
Employee Stock Option
Employee Stock Option
An option’s 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.
Interest Rate Risk
- Interest rate risk (Debt)
• Fluctuations of interest rate affect firm’s interest obligation,
therefore have impact on the firm’s liquidity position
• May result in insolvency and bankruptcy
- Southwest Strategy
• Prepayment, redemption or termination for floating-rate debt
• Interest Swap
Interest Rate Hedging
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%
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
Insurance
• Purpose of Insurance:
– protect the Company and its property
– comply both with federal regulations and the Company’s
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
Conclusion
It is important to hedge and hedge
appropriately
THE END
Any questions or comments are welcomed!