Southwest airlines financial analysis 2016

RUNNING HEAD: SOUTHWEST AIRLINES CO. VERSUS JETBLUE AIRWAYS CORP. 1

SOUTHWEST AIRLINES CO. VERSUS JETBLUE AIRWAYS CORP. 21

Group Names

FINC 331

Southwest Airlines Co. Versus JetBlue Airways Corp.: Financial/Non-Financial Comparison

December 10, 2017

Introduction

Financial ratio analysis is a valuable tool for researching and comparing relationships between companies by analyzing ratios in major categories such as liquidity, profitability, debt, and asset management. By completing an accurate financial ratio analysis using comparative data, one can learn a great deal about the financial position of the companies being compared and then make an informed decision as to which company to invest in depending on personal priorities. It's important to keep in mind that financial ratios are of no value unless they are compared to the same ratio of a company in the same industry or to the respective industry data in general. As an additional comparison factor, non-financial criteria, such as corporate social responsibility, type of organizational culture, and quality of a company's leadership and management, are increasingly playing a more significant role in the decision-making process of investors when it comes to where to allocate funds for investment. In this paper, two companies in the low-cost carrier sector of the U.S. airline industry, Southwest Airlines Co. and JetBlue Airways Corp., are compared to decide which one is a better choice for investment.

Companies' Backgrounds

Southwest Airlines Co. ("Southwest") is a major low-cost passenger airline that provides transportation to 99 destinations in the U.S. across 40 states, the District of Columbia, the Commonwealth of Puerto Rico, and 9 international markets. Southwest began service in 1971 to three Texas cities and by the end of 2016 it had been profitable for 44 consecutive years, earning $2.2 billion in net income. As of June 30, 2016, Southwest was the largest U.S. domestic air carrier by the number of domestic originating passengers boarded ("Annual Report of Southwest," 2017, p. 4). Southwest continues to differentiate itself from other air carriers with superior customer service by more than 55,000 employees to 115 million passengers annually while operating a fleet of 723 aircraft with more than 4,000 departures a day. Southwest was the first major airline to fly a single type of aircraft, introduce a ticketless travel system, develop a web site for online booking, and offer a profit-sharing plan to its employees ("Southwest Corporate Fact Sheet," n.d.).

JetBlue Airways Corp. ("JetBlue") is a low-fare airline which began service in the year 2000 with its first flight from New York to Fort Lauderdale/Hollywood Airport. Today, the airline’s network includes the focus cities of Boston, Fort Lauderdale, Los Angeles/Long Beach, New York, Orlando, and San Juan, Puerto Rico ("The JetBlue Focus Cities," n.d.). In 2016 it carried over 38 million customers with an average 925 daily flights operated by more than 20,000 employees serving 100 destinations in the U.S. and 22 countries in the Caribbean and Latin America. As of the end of 2016, JetBlue operated 227 aircraft and was the sixth largest passenger carrier in the U.S. based on available seat miles. JetBlue's differentiated culture and product which includes award-winning customer service, free snacks and in-flight internet service, and most legroom in coach, combined with its competitive cost structure enable it compete effectively in the high-value geographies it serves ("Annual Report of JetBlue," 2017, p. 3).

Industry and Market Background

The U.S. airline industry has historically been extremely volatile and subject to a variety of challenges, such as being cyclical; energy, labor, capital, and technology intensive; highly regulated; heavily taxed; and extremely competitive. It has also been susceptible to detrimental events such as acts of terrorism, poor weather, and natural disasters ("Annual Report of Southwest," 2017, p. 4). The growth of low-cost carriers, emergence of ultra-low-cost carriers, and mergers among major network carriers have led to additional competitors and new options for passengers in large and small markets. U.S. airlines have been striving to achieve an average U.S. corporate profitability rate, but in 2017 surging expenses have outpaced modest growth in revenues contributing to a gap which has been widening since 2015. The number of workers employed by U.S. passenger airlines stands at its highest level since 2005 and is growing at twice the rate of overall U.S. employment. By the end of 2017, U.S. airlines are projected to carry a record number of passengers driven by a steadily improving economy and continued air-travel affordability. As an additional positive trend, a combination of data from the U.S. Department of Transportation and independent entities shows a decline in customer complaints and an increase in customer satisfaction ("A4A Presentation," n.d., p. 64).

Analysis of Companies' Current Ratios

Current ratio measures a business' market liquidity and ability to pay its creditors over the next 12 months. As of December 31, 2016, Southwest and JetBlue had current ratios of 0.66 and 0.70, respectively, which were slightly higher than the 2016 U.S. airline industry average of 0.63 (see Appendix A). Comparing their current ratios, one could say that JetBlue was doing slightly better than Southwest. Generally, the higher the current ratio the better, but this can also be an indication that a company is not making the most productive use of its assets. According to the Missouri Small Business & Technology Development Center, a current ratio of 2 is generally acceptable; however, since current ratios vary among industries, an industry-specific average may be a better standard (as cited in Zarb, 2010, p. 122). Although Southwest's and JetBlue's low current ratio values (less than 1) could indicate difficulty in meeting their current obligations, they are not necessarily an indication of a critical situation since both airlines have favorable long-term prospects based on their expanding operations and are able to borrow against these prospects ("Finc 331," n.d., p. 194). In this case, it is quite possible that both firms have increasingly come to realize that excessive investments in working capital can tie up funds that could be used profitably to invest in new airplanes, facilities, equipment, or corporate mergers/acquisitions. Nevertheless, since these businesses operate in a cyclical industry, they should maintain higher current ratios in order to improve their potential to remain solvent during future economic downturns. Southwest and JetBlue could increase their current ratios by paying off some of their debts, increasing current assets from equity contribution or long-term maturity loans, reinvesting profits, and/or converting non-current assets into current assets (Zarb, 2010, p. 122).

Analysis of Profitability and Operating Performance Ratios

Profitability ratios and operating performance ratios are two large areas of information that one should look at when considering a company to invest in. Profitability ratios and operating performance ratios are also helpful in determining how well a given company is doing in a particular industry. According to Investopedia, “Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings compared to its expenses and other relevant costs incurred during a specific period of time" ("Profitability Ratios," n.d.). Operating performance ratios are different from profitability ratios because operating performance ratios are more concerned with how the business is performing rather than the profits. “Operating performance ratios are intended to measure different aspects of an organization's core operations” ("Operating Performance Ratios," 2016).

When looking at the profitability ratios and operating performance ratios for Southwest and JetBlue, for the last three years, one will notice that each company has ups and downs in the ratios. Overall, for both Southwest and JetBlue, 2015 was a better performing year than 2014 and 2016 (See Appendix A). One way to determine if a company would be good choice to invest in is to look at how the company does from year to year. Even if a company does not do so well in one particular year, if the company improves within the next year, that would show growth and potential to be a good investment.

When reviewing which company one would rather invest in, between Southwest and JetBlue, strictly based on the profitability ratios and operating performance ratios, one would most likely choose to invest in Southwest. This company is a better choice based on its profitability and operating performance ratios because the company has shown more improvement than JetBlue.

Analysis of Cash Flow Indicator and Investment Valuation Ratios

Cash flow indicators can be used to determine which company potentially has more satisfied stockholders. Wardrope (2013) pointed out, “Historically, the stock market has outperformed most other types of investment strategies, but also contains the highest risk and requires the most astute monitoring and patience.” For this reason, when one is considering which company has more satisfied stockholders, one has to take into account that the cash flow indicators will change from year to year. “The operating cash flow is simply the amount of cash generated by the company from its main operations, which are used to keep the business funded” (Loth, n.d.). Investment valuation ratios are also used by investors or potential investors to determine how a company is doing and if the company is worth investing in. “Investment valuation ratios attempt to simplify this evaluation process by comparing relevant data that help users gain an estimate of valuation” ("Investment Valuation Ratios," n.d.).

When determining if one should invest in a particular company such as Southwest or JetBlue, one should use the cash flow indicators and investment valuation ratios. Based on the last four years, one would see that JetBlue has had significant growth. Between 2013 and 2016, JetBlue grew its net income by 451%, whereas Southwest had a growth rate of 297% ("Annual Report of Southwest," 2017, p. 35; "Annual Report of JetBlue," 2017, p. 30). The growth rate percentages from 2013 to 2016 for each company suggest that JetBlue's stockholders should be relatively more satisfied than Southwest's stockholders.

Also using the cash flow indicators and investment valuation ratios can suggest which company is performing better overall as well. When comparing JetBlue to Southwest, one has to take note that JetBlue had a strong growth rate from 2013 to 2016. Southwest also had a lot of growth in the same time period, however, JetBlue's growth was much larger. This growth rate shows that JetBlue is doing better than Southwest. In J.D. Power North America Airline Satisfaction Studies from 2006 to 2016, JetBlue scored higher than Southwest, but in 2017 Southwest surpassed JetBlue for the first time ("J.D. Power," 2017). One would need to decide if growth rate or customer satisfaction ratings hold more weight in determining which company one would want to invest in.

Which Airline is a Better Choice for Investment?

When deciding which airline to invest in, it is important to determine what type of benefit one wants to receive as an investor. There are three types of benefits one can receive when purchasing stock in a corporation. The first is growth, many investors purchase company stock at a lower price hoping to sell it sometime in the future for a higher price. The second benefit is income in the form of dividends instead of reinvesting back into the company; however, this will reduce share growth. In other words, one cannot have both and be prepared to sacrifice one for the other. The more dividends a company pays out the less the stock will grow in value because it reduces the cash that can be reinvested back into the company. The final benefits stockholders can receive are perks. Perks can be discounts on air travel if you own JetBlue stock (Bennet, 2011). Since JetBlue does not payout dividends, if an investor is seeking the benefit of growth as a priority, then JetBlue is the better choice.

Additional Ratios

Once an investor has decided that the benefit of growth is the top priority, the analysis of financial ratios can provide insight as to the sustained performance of a specific company. The Return on Assets ratio (ROA) is a profitability ratio that measures the net income produced by total assets during a period by comparing net income to the average total assets ("Return on Assets Ratio," n.d.). In other words, it measures how efficiently a company can manage its assets to produce profits during a period.

Chart 1. JetBlue and Southwest Return on Assets (See Appendix A)

As illustrated in Chart 1., Southwest tends to manage its assets slightly more efficiently than JetBlue during the same time period. A higher value of operating margin ratio is favorable indicating that a higher proportion of revenue is converted into operating income ("Operating Margin Ratio," n.d.). An increase in operating margin ratio over time means that profitability is improving. It is also important to compare the gross margin ratio of a business to the average gross profit margin of the industry. In general, a business which is more efficient in controlling its overall costs will have a higher operating margin ratio. As shown in Chart 2. below, in 2016 JetBlue had a considerably higher operating margin compared to Southwest.

Chart 2. JetBlue and Southwest Operating Margins (See Appendix A)

Chart 3. below is a comparison of the earnings per share between the two companies. This is considered the single most important aspect in determining a share's price and value, because the calculation of earnings per share shows the amount of money to which a shareholder would be entitled in the event of the company's liquidation ("What Is Earnings Per Share?" n.d.). In general, earnings per share applies only to common shares.

Chart 3. JetBlue and Southwest Earnings Per Share (See Appendix A)

One important fact about Earnings Per Share is that it allows one to obtain the Price-to-Earnings (P/E) ratio ("What is Earnings Per Share?" n.d.). The Price-to-Earnings ratio allows investors to compare companies within the same industry and will indicate whether or not the stock is under or overvalued.

Chart 4. JetBlue and Southwest Price-to-Earnings Ratios (See Appendix A)

Chart 4. indicates that JetBlue is the better value because their Price-to-Earnings ratio is lower than Southwest’s. The Price-to- Book ratio is the relationship between a company's share value and its book value ("Price to Book Ratio," n.d.). It is what would be left over for shareholders if it stopped operations, paid off all its debts, and liquidated all of its assets. The Price-to-Book ratio is also tied to Return on Equity (ROE), which is net income divided by shareholder equity. Given two companies that are otherwise equal, the one with the higher ROE will have a higher Price-to-Book ratio. A high Price-to-Book ratio shouldn't be cause for alarm, especially if the company continually earns a high ROE.

Chart 5. JetBlue and Southwest Price-to-Book Ratios (See Appendix A)

Chart 6. Return on Equity for JetBlue and Southwest Airlines (See Appendix A)

Both Charts 5. and 6. show that Price-to-Book and ROE ratios are related and consistent.

When analyzing companies' values one can use many different ratios but when looking to invest it comes down to the basics, buying low and selling high, therefore, it is important to find stock that is undervalued (Bennet, 2010). After looking at Southwest and JetBlue and comparing them side by side using different ratios, JetBlue seems to be undervalued and Southwest overpriced. In addition, cash flow indicators show that JetBlue has grown almost twice as fast as Southwest in the last five years. The bottom line is that looking at the different ratios, both Southwest and JetBlue are very similar; the only difference between the two is that Southwest is a much larger company and growth may be slowing, whereas, JetBlue still has more room to grow. Therefore, JetBlue appears to be the better investment.

Discussion of Non-Financial Criteria to Consider Between Companies

There are at least three reasons to invest in JetBlue besides the ones derived from the analysis of financial ratios. First, is its commitment to customer satisfaction. Between 2006 and 2016, JetBlue has received the best customer satisfaction score every single year in the low-cost carrier segment (Levin-Weinberg, 2016). Annual surveys find that cost and fees, in-flight services, boarding, deplaning, flight crews, check-in, and reservations all contribute to the high customer satisfaction score. Also contributing to JetBlue’s higher customer satisfaction score is that it offers significantly more legroom than other carriers, free satellite radio, unlimited snacks, a free first checked bag, and low fares. Furthermore, to keep its place in the top spot JetBlue is going to install Wi-Fi on more than 80% of its planes and install power outlets in every row.

The second non-financial reason to invest in JetBlue is its commitment to corporate social responsibility. JetBlue has developed corporate citizenship programs that encourage employee engagement by committing to sustainability and community involvement. These commitments include youth education and environmental programs. For example, when it comes to youth education, JetBlue has provided access to age appropriate books through their JetBlue’s Soar Through Reading Campaign. In 2011, JetBlue introduced Community Connection, a program that recruits employees to volunteer time and in return, JetBlue will donate free travel hours to their favorite charities. In addition, staying true to their environmental commitments, JetBlue partnered up with Carbonfund.org to implement recycling and carbon emission offset programs. The recycling program includes composting and electronics reclamation. Since the program was established, JetBlue has offset 1.4 billion pounds of carbon emissions (Smith, 2015).

Finally, the third non-financial reason to invest in JetBlue is its commitment to humanity. Earlier this year, JetBlue partnered up with Atlas Air Worldwide and transported more than 110 tons of much needed supplies to the hurricane-ravaged island of Puerto Rico. The airline has been sending relief supplies to the island since the first day flights were allowed to land after Hurricane Maria. JetBlue also launched 100X35JetBlue, a program that will continue to help the people of Puerto Rico by providing airlift support, relief pricing, and fundraising and will roll out long-term plans to help the island’s economy to recover (Kaye, 2017).

Conclusion

Based on financial statements and ratios analyses, the decision whether to invest in JetBlue or Southwest is not an easy one, as is investing in general. The analyses included in this paper are based on the historical financial performance of both companies. Currently, Southwest stock is up more than 10.57% in the third quarter of 2017, whereas, JetBlue Airlines is down 12.62%. These figures make it appear that Southwest is the better investment between the two most active stocks in the low-cost carrier industry. Southwest is expected to grow over 10% in the next five years compared to JetBlue’s 1.66% (Farmer, 2017). This does not look good for JetBlue investors, however, as indicated earlier in this paper, growth and size are not the complete picture when it comes to buying low and selling high. Based on the Book-to-Value, Price-to-Earnings, and Return-on-Equity ratios, JetBlue's stock is undervalued relative to its target price. And when one takes into consideration that JetBlue has been rated higher than Southwest in the J.D. Powers’ low-cost airline customer satisfaction survey for the last 11 years, its active commitment to corporate social responsibility, and their extensive humanitarian outreach, JetBlue is the better investment at this time.

References

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Appendix A

Southwest Airlines Co. and JetBlue Airways Corp. Financial Ratios (in USD)

Southwest Airlines Co.

Current ratio = Current Assets / Current Liabilities

2016 4,498M/6,844M = 0.66

Debt Ratio = Total Liabilities / Total Assets

2016 14,845M/23,286M = 0.64

Fixed Asset Turnover Ratio = Net sales / Average net fixed assets

2016 20,425M/22,299M = 0.92

Dividend Payout Ratio = Dividends Per Share / EPS Without Non-Recurring Items

2016 0.375/3.55 = 0.11

Operating Margin Ratio = Operating Income/Revenue

2012 877M/17.1B = 5.1%

2013 1.16B/17.7B = 6.5%

2014 1.71B/18.6B = 9.2%

2015 3.5B/19.8B = 19.8%

2016 4.66B/20.4B = 22.8%

Return on Assets Ratio = Net income / Total Assets

2012 421M/18.6B = 2.2%

2013 757M/19.4B = 3.9%

2014 1.14B/20.2B = 5.6%

2015 2.19B/23.3B = 9.4%

2016 2.25B/24.5B= 9.2%

Price/Earnings Ratio = Market price per share / Earnings per share

2012 10.13/.56 = 18.08

2013 18.84/1.05 = 17.94

2014 42.50/1.64 = 25.91

2015 43.18/3.27 = 13.02

2016 59.10/3.55 = 14.08

P/E to Growth Ratio = P/E Ratio/Earnings Growth Rate = 16.64/19 = 0.87

Return on Equity = Net Profit / Equity

2012 421M/6.99B = 6.0%

2013 757M/7.34B = 10%

2014 1.48B/6.78B = 21%

2015 219B/7.36B = 29%

2016 $2.25B/$8.44B = 27%

Price/Book Value Ratio = Stock price per share/ Shareholders’ Equity per Share

2012 18.6B-11.6B/750M = 9.3

2013 19.3B-21.0/710M = 10.3

2014 20.2B-13.4B/687 = 9.9

2015 23.31B-15.96/661M = 11.11

2016 24.77-16.33/627M = 13.46

JetBlue Airways Corp.

Current ratio = Current Assets / Current Liabilities

2016 1,567M/2,223M = 0.70

Debt Ratio = Total Liabilities / Total Assets

2016 5,474M/9,487M = 0.58

Fixed Asset Turnover Ratio = Net sales / Average net fixed assets

2016 6,632M/9,065M = 0.73

Dividend Payout Ratio = Dividends Per Share / EPS Without Non-Recurring Items

2016 JetBlue did not payout any dividends

Operating Margin Ratio = Operating Income / Revenue

2012 365M/4.89B = 7.3%

2013 418M/5.44B = 7.7%

2014 522M/5.82B = 8.9%

2015 1.3B/6.42B = 20%

2016 1.3B/6.63B = 19%

Return on Assets Ratio = Net Income / Total Assets

2012 128M/7.07B = 1.8%

2013 168M/7.35 = 2.3%

2014 401M/7.84B = 5.1%

2015 677M/8.64B = 7.8%

2016 759M/9.49B = 7.9%

Price/Earnings Ratio = Market price per share / Earnings per share

2012 5.57/.40 = $13.90

2013 8.47/.52 = $16.28

2014 15.68/1.19 = $13.17

2015 22.89/1.96 = $11.67

2016 22.25/2.22 = $10.02

P/E to Growth Ratio = P/E Ratio / Earnings Growth Rate = 8.65/19 = 0.45

Return on Equity = Net Profit / Equity

2012 128M/1.89B = 6.7%

2013 168M/2.13B = 7.8%

2014 401M/2.53B = 16%

2015 677M/3.21B = 21%

2016 $759M/$4.01B = 18%

Price/Book Value = Stock price per share / Shareholders’ Equity per Share

2012 7.07B-5.18B/282M = 6.7

2013 7.35B-5.22B/282.7M = 7.5

2014 7.84B-5.31B/294.7M = 8.6

2015 8.64B-5.43B/315.1M = 10.2

2016 9.49B-5.47B/326.5M = 12.3

Earnings Per Share

Southwest
2012 2013 2014 2015 2016 0.56000000000000005 1.05 1.64 3.27 3.55 JetBlue

2012 2013 2014 2015 2016 0.4 0.52 1.36 2.15 2.3199999999999998

Price to Earnings Ratios

Southwest 2012 2013 2014 2015 2016 18.079999999999998 17.940000000000001 25.91 13.02 16.64 JetBlue 2012 2013 2014 2015 2016 13.9 16.28 13.17 11.67 10.02
Price-to-Book Ratios

Southwest 2012 2013 2014 2015 2016 18.079999999999998 17.940000000000001 25.91 13.02 16.64 JetBlue 2012 2013 2014 2015 2016 13.9 16.28 13.17 11.67 10.02
Return on Equity

Southwest 2012 2013 2014 2015 2016 0.06 0.1 0.21 0.28999999999999998 0.27 JetBlue 2012 2013 2014 2015 2016 6.7000000000000004E-2 7.8E-2 0.16 0.21 0.19
Return on Assets

Southwest 2012 2013 2014 2015 2016 2.1999999999999999E-2 3.9E-2 5.6000000000000001E-2 9.2999999999999999E-2 0.09 JetBlue 2012 2013 2014 2015 2016 1.7999999999999999E-2 2.3E-2 5.0999999999999997E-2 7.8E-2 7.0000000000000007E-2
Operating Margins

Southwest
2012 2013 2014 2015 2016 7.2999999999999995E-2 7.6999999999999999E-2 8.8999999999999996E-2 0.2 0.19 JetBlue

2012 2013 2014 2015 2016 5.0999999999999997E-2 6.5000000000000002E-2 9.1999999999999998E-2 0.18 0.28000000000000003