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Profits

October 30, 2010 BE_Articles, BE_Post No Comments

 

TOPIC: PROFITS

LEVEL: DIFFICULT

Read the text about Southwest Airline’s earnings report. Follow links for additional reading material.

Southwest Airline Co. is a low-cost carrier headquartered in Dallas, Texas that has recently reported a second-quarter profit surpassing all expectations on Wall Street (http://www.dallasnews.com/sharedcontent/dws/bus/industries/airlines/stories/DN-swearns_30bus.ART0.State.Edition1.26d4f26.html ).

According to Reuters, the airline’s net income rose to $112 million (15 cents per share) from $91 million (12 cents per share) a year ago. The company posted a profit of 29 cents per share and revenue rose 21.1 percent to $3.2 billion.

Southwest is known for its aggressive policy aimed at hedging fuel prices, and although this strategy has backfired a number of times, Southwest is soaring despite all predictions. The company’s Chairman of the Board and CEO Gary C. Kelly (http://www.southwest.com/swamedia/bios/gary_kelly.html )gives CNBC an overview of their recent accomplishments and future plans.

1. Watch the video http://www.cnbc.com/id/38464803

featuring Southwest Air’s Chairman and CEO. Answer the following questions:

1.   According to Chairman and CEO of Southwest, how has business been going for them? (answer: Gary Kelly says it’s been a very strong quarter and the revenue performance is setting records in many ways)

2.   What is the increasing revenue cited by Gary Kelly for Southwest? (answer: 21%)

3.   Are there any signs of a slowdown in the future?(answer: No. The bookings look very strong and there are no signs of a slowdown in their revenue momentum)

4.   Why will Southwest be unable to keep up the 20+% growth? (answer: This is highly unlikely, because the comps get harder going forward)

5.   What is the breakdown of Southwest’s customers? (answer: about 35% business-65% leisure split)

6.   How has the business customer market been improving recently?(answer: Southwest are seeing an increase in business customers, but are not back to their pre-recession figures yet)

7.   According to the CEO, what is important in the new regulations by the Congress and Obama Administration? (answer: He sees great importance in the details and thinks that it’s important that they are able to continue to hedge. They also put value in the transparency).

8.   What is Southwest’s strategy at the moment (answer: no plans to increase the fleet, but will continue to adjust their route schedule and will add 2 new markets)?

9.   What is the newest destination for Southwest? (answer: Florida)

10.               How have other businesses been affected by the oil spill and what does Gary Kelly say about Southwest’s potential loss of profits in Florida? (answer: It is tough for them to say whether they have experienced any losses yet, because it’s a new market for them, but they are aware that hotel traffic is down. However, their business has been very good, so even if they have lost some traffic, they have made up for that)

2. Look through the transcript of the interview and fill in the gaps with the exact words that are missing:

CNBC: Gary, I’m reading here record ……………………….during the quarter, ……………………………………..performance – despite the fact that by anyone’s count fuel costs were significantly higher than they were in the quarter last year. How did you do it? (Answers: traffic levels, record revenue)

GK: Well, obviously I’m very, very pleased. It’s a very strong………………. Gosh, what a difference a year makes. We had such a tough year in 2009. The …………………………………in many, many ways is setting records for us. Our top line was up over 21%. Our earnings were over triple a year ago, as you said despite higher fuel costs.  But that’s the story. In other words, increasing revenue is 21% and our employees are doing a fantastic job – so a very good performance. (Answers: quarter, revenue performance)

CNBC: Give us some guidance, then. Going into the next quarter, could you keep the good showing up?

GK: Well, I think so. The traffic so far through July and the bookings for the rest of this quarter look very strong.  It’s a little too close to call yet but our July load factor again will be a very strong performance. Whether it’s a record I can’t quite say yet, but that’s possible. And that would be an all-time monthly record if that occurs.  So, so far so good. I don’t see any signs of a slowdown in our revenue …………………….. I don’t think we’ll continue to grow 20+ % because the comps get harder going forward, but on a normalized seasonalized basis our …………………looks very good for the rest of this year. (Answers: momentum, outlook)

CNBC: Gary, where do you see the breakdown of your traveler? Business? Leisure? Where are the strong points? (…) Where do you see the usage coming from?

GK: Very strong……………………… Of course we are such a low-fare brand and a low-fare leader in the United States and that’s underscored with “our bags fly free” position and campaign.  We are seeing some improvement in business travel though. We’re not quite back to our …………………………………. levels with our business market. We’ve got about I’d say a 35 business –  65 leisure split in our business, and with our size in the United States arguably we carry more business customers than anyone else. But definitely our strength right now is driven by the consumer. (Answers: consumer demand, pre-recession)

3.Review the article about hedging, oil speculation and the reforms proposed by Obama administration that are mentioned in the CNBCE interview:

http://money.cnn.com/2010/05/13/news/economy/airlines_regulation_derivatives.fortune/index.htm?postversion=2010051312

1) Based on this text, how would you define the following:

1.   Derivatives trading: a) trading fuel prices, b) speculating, c) trading a financial instrument, the price of which is directly dependent on the value of one or more underlying securities

2.   Fuel hedging: a) a contractual tool used by some airlines to stabilize jet fuel costs, b) a contractual tool used by traders to increase fuel costs, c) a hedge fund

3.   Market volatility: a) the unpredictability of the investment market, b) the unpredictability of flights, c) the unstable nature of fuel prices

4.   Derivatives trade on exchanges: a) derivatives instruments being traded via specialized exchanges acting as intermediary, b) exchanging derivatives, c) speculating trade

Answers: 1c, 2a, 3a, 4a

2) Answer the following questions based on what you have read:

a.   Why has the airline industry changed its opinion on business regulation policies? (Answer: Airlines are blaming the unchecked derivatives trading market for severe price swings that have made it impossible for them to control their fuel costs)

b.   What did Delta's CEO mean when he said that "Prices are artificially inflated and volatility is created as a consequence of excessive speculation and trading by parties with no tangible need for the commodities."? (Answer: It means that hedge funds and other investors with no intention of taking delivery are betting on oil futures, and it's making fuel hedging harder and more expensive for the parties that actually burn the jet fuel-the airline carriers)

c.   What was fuel hedging intended for originally? (Answer: Fuel hedging started out as an innovative way to smooth out the price of fuel for carriers and match supply to the demand for air travel. By controlling costs, airlines could run their businesses more predictably)

d.   How does the proposed regulation by Obama Administration and the Congress change the situation? (Answer: It would limit speculation and require that derivatives trade on exchanges, making the process more transparent)

e.   What lies at the core of the issue creating volatility in the fuel market? (Answer: At the core of the issue is the transformation of oil from strictly a commodity to an asset class.)

4. Listen to Garry Kelly talk about fuel hedging implemented in Southwest and determine whether the following statements are true or false:

1.   Gary Kelly believes that the new regulations will prevent Southwest Airlines from hedging in the future (t/f)

2.   The CEO states that the Obama Administration regulation proposal makes business more transparent (t/f)

 

Answers: 1f, 2t

5.   Listen to Garry Kelly answering the question on the airline’s strategy and choose the correct answers from the options provided:

1)   Southwest are not planning to buy more fleet until: a) the Obama administration regulations are lifted, b) until they hit their 15% return on capital mark, c) until 2012

2)   Southwest are: a) rethinking their route schedule, b) readjusting their route schedule, c) reallocating their schedule

3)   Southwest : a) have suffered a loss in profits due to the oil spill in the Gulf of Mexico, b)have not yet felt any influence of the oil spill, c)have not suffered from the ecological disaster.

Answers:  1b, 2b, 3b

 

 

 

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