Southwest Airlines Co. (LUV)

Team 12

Cohort: Golden Gate

Members: Bumchan Ahn

Guillermo Gonzalez Levan Kobakhidze

Natalia Rios Vaidhyaraman Srinivasa Swaminathan

Jäiri Terpsa

HIBS Consulting Group Southwest Airlines Co. (LUV) Financial Analysis

Figure 1. Southwest Profile (HIBS)

Figure 2. Historical Stock prices vs. S&P 500

(FactSet)

Figure 3. Global Market Growth (IATA)

Figure 4. Cargo Market Growth (IATA)

Now is the time to fly further and carry more!

Executive Summary

We recommend Southwest Airlines Co. (LUV) to gradually expand its airline business towards international travel and the cargo market beyond limited domestic travel business. This is primarily driven by a business and financial analysis below:

Business Strategy Cost reduction and low oil price effect. Low unit cost, low maintenance cost driven by the operation of only one type of aircraft Boeing 737, and low oil price have been efficiently reflected to the business over the past year. OPEX/Available Seat Km (ASK) is maintaining around $7 for the recent three fiscal years. AirTran Integration effect completed. Approximately $500 million in net pre-tax synergies excluding acquisition costs are being reflected to future cash flow. Rapid rewards frequent flyer program and Fleet modernization. Contribution to the revenue respectively $700 million to Revenue cumulatively and $500 million to EBITDA.

Competitive Positioning Highest performance among competitors. Passenger approach and operations restricted to the Americas, fuel management and efficiency program provided superior results in fuel cost in the industry. Strong competitor for travelers in the USA. generating EBITDA margins up to 19.20% competitors. 99% of revenue is from their passenger transport service capturing more market share, thereby generating high level of revenue the US market trends of growth.

Key Financials and Ratios Capital and Operating Lease. Southwest Airlines Co. Reports $ 5,155 million as an operating lease (93%) and $ 334 million as a capital lease in 2014. While delta reports $ 12.741 million as an operating lease (97%) and $ 398 million as a capital lease. Delta has more concentration of operating leases for using off-balance sheet. Fuel and Oil Expense. Since 2012 Southwest Co. Fuel & Oil Expenses decreased with nearly $ 827 M. Part of this change was caused by Jet Fuel Market Price decrease from $ 2.94 to $ 1.80 per gallon. Due to the Fuel Hedging program Southwest Co. fuel price was decreased only up to $ 2.92 in 2014. Transaction Cost. For acquiring AirTran, Southwest Airlines Co. paid approximately US$ 1 billion in cash and stock plus assumption of debt. The deal affected on the B/S creating $ 970 million Goodwill, decreasing Cash by $ 432 million, and increasing flight equipment by $ 2,078 million.

Figure 5. Transport cost reduction (IATA)

Figure 6. LUV. Revenue by region (Factset)

Figure 7. LUV Revue by global economy (Factset)

Figure 8. Fuel and Oil Cost Expense

Industry Metrics and Special Financials

Landing Fees. $ 1,111 million Landing Fees and $ 0.85 million per ASM in 2014, while Delta reported $ 1,442 milion and $ per ASM, which means Southwest Airlines Co. efficient airplane operation.

RPM (Revenue Per Mile) &. RPM / number of destinations served for Southwest Airlines Co. appeared to be $ 1,162 million, while for Delta it is $ 620 million. This measure shows that Southwest airlines Co. retain higher margins and is more profitable per destination, than Delta. Southwest Co.

Revenue per ASM (Available Seats Miles). Revenue per ASM was $ 14.20, which is 4.57% higher than previous year. Delta increased 3% on a 3% higher capacity. In 2014 Delta reported $ 13.17 million operating revenue per ASM. The industry average is $ 12.78 million. Based on the following statistics Southwest airlines Co. uses a very effective strategy to increase revenues per passenger and per mile.

Credit Analysis

Fitch Upgrades Southwest Airlines to 'BBB+'; Outlook Stable - October 30, 2015: Fitch Ratings has upgraded Southwest Airlines Co. (LUV) to 'BBB+' from 'BBB'. The Rating Outlook is revised to Stable from Positive. The upgrade reflects steady improvements to Southwest's credit profile over the past years as it worked through the integration of AirTran, paid down debt, and returned credit metrics to pre-recession levels.

Moody’s assigned a Baa1 rating. According to Southwest Airlines Co.'s new $500 million of senior unsecured notes due in November 2020. (2015). This positive classification is due to Southwest creating a plan to have good liquidity for the next years, having a Debt- to- EBITDA of 1.5 times and EBIT-to-interest of 12 times in 2015. According to these values, Southwest is improving its performance in terms of operations, waiting that demand for USA domestic travel continues increasing.

Estimates and Recommendation

Harder competition in the US domestic market. 12 major airlines and over 50 minor airlines are in the competition in the US market. Low entry barrier and copying business strategy would bring a low profit margin for the future. That’s why the growth rate of revenue is annually diminishing from 7%(2014) to 5% (2017E).

The Global Air travel market is drastically growing. Air travel growth (Revenue Passenger Km: RPK) this year varies to Asian market in strength, approximately India 20%, China 12%, Within Europe 9%, Within Asia 8%, in contrast with the US growth RPK which is good for 4%. Southwest Airlines Co. serving only domestic market could find potential revenue by entering international travel market before global economy recovery.

Renewed growth in international Cargo market. Since 2013 Cargo growth rate has been positive, and it began to break through a 20-year average growth rate of 5% from 2014. Southwest Airlines Co. has only 0.9% portion of revenue in the Cargo business even decreasing over years.

From Profitability to Growth. Southwest Airlines Co., as of 2014, has $3 billion of Cash and Short-term investment. Now is the best time to enter to global travel and cargo market not to focus on just domestic market, in a situation that most airlines are coming back to the US domestic travel market. To enter at the bottom of the global economy cycle would guarantee safe margin and big success along the recovery of the global market.

Figure 9. (LUV Southwest Airlines Co. Airlines Co. 10-K,

2015

Figure 10. Nasdaq LUV

Figure 11. Nasdaq LUV

Figura 12. Southwest Airlines Co. Annual report 2014

Business Description and Strategy

Southwest Airlines Company Southwest Airlines Company operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States and near-international markets, was founded in 1967 and is currently headquartered in Dallas, Texas. Southwest Airlines is the largest domestic flights operator in the United States. Southwest Airlines reported a record net income of $1.1 billion and, excluding special items, record net income of $1.4 billion in 2014. The company had 46,278 employees in 2014. (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015). Southwest Airlines Co. commenced service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities: Dallas, Houston, and San Antonio. The Company ended 2014 serving 93 destinations in 40 states and 5 international countries. The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) and is traded under the symbol “LUV.”

Properties (Assets) Aircraft Southwest operated a total of 665 Boeing 737 aircraft as of December 31, 2014, of which 98 and 14 were under operating and capital leases, respectively. Ground facilities and Services Southwest Airlines Co. either leases or pays a usage fee for terminal passenger service facilities at each of the airports it serves, to which various leasehold improvements have been made. The Company leases the land and structures on a long-term basis for its aircraft maintenance centers, its flight training center at Dallas Love Field and its main corporate headquarters building, also located at Dallas Love Field. The Company also leases a warehouse and engine repair facility in Atlanta. As of December 31, 2014, the Company operated seven Customer Support and Services call centers. The company also invested in the oversight, design in modern, convenient air travel facilities and air terminals at several airports.

Strategy The company’s main strategy is being competitive and gaining market share on the international market, since the ‘Wright Amendment’ is repealed (Appendix B). Southwest Airlines Co. operations are designed to generate growth and increase value through:

Commuter benefits - Point-to-point flights and neglecting major hubs.

Low unit costs - No meals are offered, customers have to pay for luggage, therefore the planes are clean and stocked very quickly. The aircraft turnaround time is reduced because of this.

Low maintenance cost - Southwest Airlines is only flying with Boing 737’s.

High employee satisfaction – Southwest Airlines never had a union strike, which saves them millions compared to other airlines.

Rapid Rewards frequent flyer program - Contributing almost $400 million in incremental year-over-year revenue in 2014, and approximately $700 million cumulative since the inception of the new program in 2011.

Fleet modernization - Contributed approximately $500 million to earnings before interest and taxes

Figure 13. Southwest Airlines Co. Annual report 2014

Figure 14. Unique city-pairs and real transport costs

Figure 15. Tax revenues and global supply chain jobs supported

AirTran Airlines integration completed - Produced approximately $500 million in net pre-tax synergies (excluding acquisition and integration costs)

Management & Governance Management Gary Kelly serves as the Chairman of the Board, President, and Chief Executive Officer at Southwest Airlines. Under Gary's leadership, Southwest Airlines Co. has grown to become the nation's largest airline in terms of originating domestic passengers carried. A full overview of the executive management and leadership organization chart can be found in Appendix C. Corporate Governance The Board of Directors of Southwest Airlines Co. has created Corporate Governance Guidelines and has adopted these guidelines to further it’s goal of providing effective governance of the Company’s business for the long-term benefit of the Company’s Shareholders, Employees, and Customers. The Guidelines will be reviewed annually. The main focus of Southwest Airlines Company corporate governance strategy can be seen in the following areas:

Committees – Established Audit, Compensation, Executive, Nominating and Corporate Governance Committee and Safety and Compliance Oversight Committee. (Appendix ….)

Company Code of Ethics – Created a code of ethics for entire company.

Insider Trading Policy – Prohibits employees, board members and consultants from purchasing or selling Southwest securities while in possession of material nonpublic information about the company.

Direct Stock Ownership - The Board believes that, in order to align the interests of Directors and Shareholders, Directors should have a financial stake in the Company.

Industry Economic Overview and Competitive Positioning Consumers (Travelers & Cargo) An overall of 1% ($763 billion) of the world’s GDP is expected to be spent on air transportation in 2015. The change of the economic cycle has driven accelerated growth for air travel, achieving the best results in the last 20 years with a 6.1% growth YoY in the last 3 years in RPK. (Appendix E) Overall passenger departures are expected to be 3,542 Million, a tendency growing from 5.8% in 2014 to 6.5% in 2015. The ton’s of cargo freight are expected to grow from 49.3 million in 2013 to 54.2 million in 2015 increasing gradually in average 4.03% YoY. Economic Development & Government As more cities are now connected, the capacity of air connections almost doubled since 20 years ago. Overall economic distance trading activities with reduced economic costs have been improving in the last 5 years and employment as a determinant indicator of economic development has increased in the sector to an estimate of 64.7 million ‘supply chain’ jobs in year 2014. For the government the increase of performance of the airline industry means more taxes are collected with a YoY growth in tax collection of 3.7% expecting an end collection of taxes for 2015 at $116 billion. This is almost $5 billion more than the collections in 2014, this represents on a 3 year average of 48% of the total GVA of the Airline Industry. (Appendix F) Direct employment and new hires are expected to accelerate in the 2015, with an expectancy of reaching 2.5 million jobs for airlines. The productivity has also risen with an average employee generating around 485,000 ATK

Figure 16. Fuel eddiciency and the price of jet fuel

Figure 17. Return on capital invested in airlines

Figure 18. Regions and Performance

Figure 19. Porter 5 Forces

Profits, Investments & Assets Airlines rely on investment, the ROIC has been growing from 4.9% on 2013 to an expected 7.5% by the end of 2015 providing a positive factor in the ROIC-WACC index generating a value for the investors of $4.9 billion, EBIT will grow from 3.5% in 2013 to 6.9% in 2015 (Appendix F). The net post tax profits are expected to hit $29.3 billion in 2015 a growth of 276% from 2013, the profit % of revenues is expected to reach 4% and profit per passenger has improved to almost $8.27 per passenger. Corporate Governance Assets (Fleet & Aircraft) The investment for commercial airlines is expected to be around $180 billion which accounts for 1,700 new aircraft deliveries in 2015. There are about 27,000 commercial aircraft in total which translates into 3,7 million seats available, more aircraft available, new routes and more productivity is rising the load factor in the industry estimating to achieve 80% by 2015. (Appendix G) The direct cost of infrastructure has increasingly been transferred to the passenger; this cost has risen in the last decade due to low competition and new entries on infrastructure providers. The routing and airspace inefficiencies in Europe are adding costs up to $ 2.9 billion to the industry and about $ 4.7 billion worth consumer cost. Fuel and Oil cost Impact Fuel is the major operating cost for airlines, however it has dropped from 33% in 2013 to 28.1% in 2015, the tendency is tied to cheap oil prices and is expected to keep dropping. For 2015 the total amount spent on fuel is expected to be $191 billion (Appendix H), price has dropped from $124.5 to $ 78 per barrel where fuel consumption driven by new technologies and new fuel efficient aircraft are using 35 liters per each 100 RTK. Regions & Performance Overall the industry is performing with a tendency to grow their profits YoY as a whole but there are interesting contrasts between regions, average revenue per passenger is $205.37, with costs up to $ 197.10 and average profit of $8.27. Africa is the weakest region with profit of $ 1.59 per passenger in contrast to North America that is the best performing region with profit of $18.12 per passenger, margins of 7.5% and net profits expected to be $15.7 billion USD by the end of the year. Competitive Positioning Southwest Airlines has a very good performance among their industry competitors, driven by their passenger approach and operations restricted to the Americas, fuel management and efficiency program provide superior results in fuel cost in the industry their business model has allowed them to remain as a strong competitor for travelers in USA generating EBITDAR margins up to 19.20% one of the highest among competitors. Almost 95% of this revenue is from their passenger transport service and their cargo division can improve performance to capture more marketshare and eventually revenue from this operations following market trends of growth. Southwest Porter’s five forces show the high intensity of the competition in the industry, rating 4 of 5 forces ‘High’ with the fifth ‘medium and rising’.

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Southwest AirlinesPorter 5 Forces Analysis

Source: Team Calculations

*as of December 31th 2014.

Southwest

Airlines Co.

United

Continental

Holdings, Inc.

Delta Air

Lines, Inc.

American

Airlines Group,

Inc.

JetBlue

Airways

Corporation

Alaska Air

Group, Inc.

Planes Total 665 691 809 983 203 196

Owned Aircraft 553 451 618 510 137 147

Leased Aircraft 112 240 191 473 66 49

Average Aircraft Age 13.8 13.4 17.1 12.0 7.8 9.3

Employees 46,278 84,000 80,000 113,300 13,280 12,739

Load Factor (%) 82.50 83.60 84.70 82.00 84.00 85.10

Fuel Cost (Avg. liters/gallons) 2.94 2.99 3.00 2.91 2.99 3.02

Fuel Consumed (gallons) 1,801 3,905 3,893 4,332 639 469

Airline Revenue (In Millions) 18,605 38,901 40,362 42,650 5,817 5,368

Passengers 17658 33762 34954 37124 5343 4579

Cargo 175 938 934 875 0 114

Other 772 4201 4474 4651 474 675

Total Expenses (In Millions) 16,266 36,137 35,440 37,593 5,279 4,394

EBITDAR (In Millions) 3,572 5,326 6,768 7,819 982 1,378

EBITDAR Margin % 19.20 13.69 16.77 18.33 16.88 25.67

Revenue Analysis % LUV UAL DAL AAL JBLU ALK

Total LTM Revenue in Billion 19.5 38.1 40.6 41.5 6.3 5.5

Africa and Middle East 0.0 4.4 0.3 1.8 0.0 0.0

Americas 100.0 66.4 74.7 84.2 100.0 100.0

Asia/Pacific 0.0 14.5 9.5 3.4 0.0 0.0

Europe 0.0 14.8 15.4 10.6 0.0 0.0

Region Unespecified 0.0 0.0 0.0 0.0 0.0 0.0

Passenger 94.91% 86.79% 86.60% 87.04% 91.85% 85.30%

Cargo 0.94% 2.41% 2.31% 2.05% 0.00% 2.12%

Other 4.15% 10.80% 11.08% 10.91% 8.15% 12.57%

Key Financials and Ratios

Profitability % Southwest (SOUTHWEST AIRLINES CO.) Delta (DAL)

Years 2014 2013 2012 2014 2013 2012

Gross Margin 24.42 19.37 16.65 20.55 18.07 16.68

SG&A to Sales 11.85 12.01 11.93 4.23 4.26 4.34

Operating Margin 12.57 7.36 4.72 11.85 8.43 6.98

Asset Turnover 0.94 0.93 0.93 0.71 0.72 0.83

Net Margin 6.13 4.28 2.46 1.64 28.00 2.75

Return on Assets 5.77 3.99 2.30 1.16 20.28 2.29

Return on Equity 16.16 10.57 6.07 6.44 221.61 --

Table 1. Southwest Airlines Co (LUV) has outperformed Delta Airlines (DAL) in sheer numbers in terms of profitability ratios. Southwest Airlines Co. has increased their gross margin by approx. 8 points in the last two financial years whereas Delta has increased by 3.5 points. Southwest Airlines Co. has a very high SG&A to Sales ratio compared to Delta revealing that their administration an employee salary are much higher than the delta Airlines. Southwest has a higher employee satisfaction which is also due high employee salary. Even though both the companies have similar operating margin and asset turnover Southwest Airlines Co. has a very high net return on assets than Delta, this is mainly due to the high net margin, which was in turn driven by its lower operating expenses, which even offset the higher SG&A to sales ratio. Notably Delta has posted a huge ROA and ROE of 20.28 and 221.61 for the year 2013 we will see this abnormal variation in the later section ROE decomposition.

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Figure 20. Return on Assets

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Figure 21. Gross Margin

Figure 22. Liquidity Ratios - South West

Figure 23. Liquidity – Delta

Figure 24. ROE

Figure 25. Delta - Income tax provision/benefit

Liquidity

Liquidity Southwest Delta

Years 2014 2013 2012 2014 2013 2012

Current Ratio 0.74 0.79 0.91 0.74 0.68 0.62

Quick Ratio 0.69 0.70 0.81 0.69 0.61 0.55

Cash Ratio 0.50 0.56 0.64 0.26 0.28 0.28

Table 2. Quick ratio is one of the main parameters to consider for the airline industry since they are capital intensive and have significant amount of debt hence higher quick ratio is favorable. Delta relatively had a stable and increasing quick ratio. It is alarming that Southwest Airlines Co.’s quick ratio drops at a very high rate. The Figure 22 shows that Southwest Airlines Co. started having lower quick ratio from 2011. This is mainly due to the fact of Air Tran acquisition which resulted in higher current liability than the current assets to Southwest Airlines Co.. The company’s plan for expansion in the years can drive down their quick ratio still further but they have bought back considerable amount of Shares on year 2014 (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015) to refloat in to the market and maintain a stable liquidity.

ROE decomposition/DuPont analysis

ROE Southwest Delta

Years 2014 2013 2012 2014 2013 2012

Net Profit Margin (%) 6.13 4.28 2.46 1.64 28.00 2.75

Asset turnover (%) 0.94 0.93 0.93 0.71 0.72 0.83

Financial Leverage 2.80 2.65 2.64 5.55 10.93 --

ROE (%) 16.16 10.57 6.07 6.44 221.61 --

Table 3. Southwest Airlines Co. has a better ROE than Delta has. Even though Delta’s financial leverage is better than Southwest Airlines Co. they were not able to achieve very high ROE because of the fact that Southwest Airlines Co. has a higher net profit margin and asset turn over which offset the financial leverage. The financial leverage of 10.93 and 5.55 for years 2013 and 2014 are high for Delta when compared with the Southwest Airlines Co. but taken in to the fact the size of company and capital required, Delta needs to fund its operations with debt than equity. For the year 2013 Delta has posted a very huge number of 221.61 as its ROE this is way above any industry standard. The main reason for this difference is highlighted in the Figure 24. Delta got around $ 8013 million revenues approx. $ 8 billion as deferred tax benefit for the year 2013. As the deferred tax benefit was directly equable to shareholders income this resulted in a very huge ROE and ROA for Delta on year 2013. This clearly shows that Delta has been underestimating their financial statements / followed a big bath strategy by keeping a higher margin on the cost of goods sold for warranty repair and other costs. One of the other reasons of higher income tax benefit is because of the previous losses posted by the Delta in the previous financial years (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015).

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In Millions (413) 8,013 (16) 85 (15) 344 119

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Figure 26. Dividend Payout ratio

Common Size Southwest Delta

Years 2014 2013 2012 2014 2013 2012

Assets

Total Current Assets 21.8% 23.0% 22.7% 31.2% 23.8% 29.8%

Cash & Short-Term Investments 14.8% 16.3% 16.0% 8.1% 6.6% 8.4%

Cash Only 6.3% 7.0% 5.5% 3.9% 5.0% 6.3%

Accumulated Depreciation 40.7% 38.4% 36.2% 17.3% 13.1% 14.9%

Net Property, Plant & Equipment 70.8% 69.2% 68.6% 40.5% 36.8% 46.5%

Liability and Equity

Provision for Risks & Charges 0.8% 0.7% 1.6% 28.0% 20.9% 35.9%

Retained Earnings 36.7% 33.2% 31.0% 6.4% 5.1% -16.6%

Additional Paid-In Capital 6.5% 6.4% 6.5% 24.0% 23.5% 31.6%

Equity and dividend analysis

Per Share Southwest Delta

Years 2014 2013 2012 2014 2013 2012

EBIT (Operating Income) per Share

3.36 1.81 1.06 5.64 3.70 3.01

EPS (recurring) 2.28 1.20 0.48 3.36 12.21 1.60

EPS (diluted) 1.64 1.05 0.56 0.78 12.28 1.19

Dividends per Share 0.22 0.13 0.03 0.30 0.12 0.00

Table 4. EBIT and EPS analysis share a key new trend for the competitive analysis. Even though Delta was not performing better on other profitability and other financial ratio’s like ROE they have outperformed Southwest Airlines Co. in EBIT per share and EPS for the past three years. Therefore Delta is performing better on their equity part compared to southwest. The lower rate of EBIT, EPS for Southwest Airlines Co. is also due to the fact that much of the Southwest’s debt is financed by equity.

Figure 26 shows the dividend payout ratio for the Southwest Airlines Co. and Delta. Southwest Airlines Co. have been relatively steady in satisfying their shareholders with constant and increasing dividend payout in the recent years. But Delta has outperformed Southwest Airlines Co. during FY - 2014 with a higher dividend payout ratio this relates to their overall net income on FY13 with EPS of 12.21 (higher EPS because of 8 billion USD as deferred tax benefit). Delta is expected to yield a better EPS and dividend in the future because of their current high liquidity and the benefit of not paying the future income taxes.

Common Size Analysis Table 5. The common size analysis of the balance sheet two company reveals the percentage distribution of assets and liabilities between the two companies. Southwest Airlines Co. and Delta have a similar structure of percentage of the total current assets. Southwest Airlines Co. has a higher percentage of the of non-operating asset (cash and short term investments) revealing that they are running high on cash and short term investments which are good to pay out the short term debt. Southwest Airlines Co. has a very high percentage of accumulated depreciation of 40.7 % for FY14 compared to 17.3% for Delta which is due to very high percentage of Net Property, Plant & Equipment of their total assets (approx. 70.8% for FY14).

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Figure 27. Fuel and Oil Expenses of Southwest

Figure 28. Fuel and Oil Expenses of Delta

This basic difference occurs because of the capital structure of the company. Southwest Airlines Co. has invested a lot of capital in purchasing the flights therefore higher depreciation whereas DAL major fleet is leased (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015). The common size analysis of provision for risk and charges reveal different trends for both the company. Southwest Airlines Co. has a much lower provision for risk and charges than the industry standard, since Southwest Airlines Co. is entering the new international market it is better to have a higher provision to mitigate risk and charges. Delta on the other case has a very high provision for Risks and Charges implying they have parked funds there by following big bath strategy.

Operating Efficiency

Operating Efficiency Southwest Delta

Years 2014 2013 2012 2014 2013 2012

Receivables Turnover (x) 47.46 47.13 54.16 16.64 22.80 22.52

Inventory Turnover (x) 34.76 30.50 32.74 33.36 29.56 43.96

Payables Turnover (x) 20.34 12.12 13.23 12.89 13.44 16.03

Table 6. Southwest Airlines Co. payable turnover ratio has been considerably increased in the last year showing that they have paid their suppliers at a faster rate than Delta for FY14. Southwest Airlines Co. has a very higher turnover ratio than Delta this is mainly due two to couple of factors. First reason is Southwest Airlines Co. is operating more on cash and second it has a lower amount of account receivable. Delta on the other hand has a very low Receivables turnover ratio which clearly outlines Southwest Airlines Co. is performing better in recovering the account receivable and keep them under limits than Delta does.

Industry Metrics and Special Financials

Fuel and Oil expenses Fuel and Oil expenses are a significant part of the airline companies’ income statement. According to Factset data, Southwest Airlines Co. airlines reported $ 6,120 million for fuel and oil expenses in 2012. However, it started to decrease in the 2 years following 2012 and reached $ 5,293 million. Since 2012 Southwest Airlines Companies’ Fuel & Oil Expenses were decreasing with nearly $ 827 million. Part of this change was caused by the jet fuel market price decrease from $ 2.94 to $ 1.80 per gallon. Due to the ‘Fuel Hedging program’ Southwest Airlines Co. fuel’s price was decreased only up to $ 2.92 in 2014. Another driver of change was increased capacity of airplanes, which is measured by ASM’s. According to Wikipedia “ASM (Available Seat Miles) is a measure of an airline flight's passenger carrying capacity. It is equal to the number of seats available multiplied by the number of miles flown” (Wikipedia, 2015). Furthermore, according to Southwest Airlines Co. 10-k “Fuel efficiency improved slightly due to the Company’s fleet modernization efforts, as fuel gallon consumed decreased by 0.9 percent, compared with 2013. (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015). Southwest Airlines airlines has the lowest F&O expenses per ASM in the U.S. airline market. In contrast, Delta airlines reported in its 10-k, a significant increase in Fuel & Oil Expenses. The following expenses have increased from $ 10,150 million in 2012 to $ 11,668 million in 2014.

Figure 29. What AirTran did for Southwest

Figure 30. Southwest Balansheet

Such a big difference between two airlines’ absolute numbers are caused by a difference in number of flights and destinations. Southwest Airlines Co. operates on an average of 3,600 flights a day, serving 94 destinations. However, Delta performs international flights, serving 326 destinations across 59 countries and has an average of 5,400 flights per day, which is almost twice as big as Southwest Airlines Co. A better measure for fuel efficiency is ‘fuel and oil expenses per ASM’. According Factset’ statistics of the last three years, the average expense of Delta per ASM in 2014 was $ 4.87 million while the same number for Southwest Airlines Co. was equal to $ 4.04 million.

Aircraft maintenance costs The second significant part of operational expenses are the Aircraft maintenance costs. According to the Factset statistics, Southwest Airlines Co. managed to decrease its maintenance fees by roughly 14% for the last 2 years. The aircraft maintenance expense for 2014 was $ 978 million ($ 0.85 million per ASM). According to Southwest Airlines Companies’ 10-k report, the following significant decrease in maintenance costs are caused by completion of the “Evolve” program, which is an aircraft interior retrofit program. On top of that, “the remaining decrease was attributable to lower engine and avionics repair expense as a result of the 717-200 aircraft transitioning out of the Company's fleet” (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015). In contrast, Delta aircraft maintenance expenses were $ 1,828 million and 1,852 million in 2013 and 2014 respectively. Delta’s expenses are twice as big because it holds 100 more airplanes in service. (Current Air fleet: Southwest Airlines Co. – 679; Delta – 809)

Transactions costs In 2011, Southwest Airlines Co. decided to acquire AirTran Airways – an American low-cost airline headquartered in Dallas, Texas. AirTran executed 700 flights per day, mostly in eastern and Midwestern United States. The acquisition purpose was strategic. It allowed Southwest Airlines Co. to enter in key markets of the US and offer their customers more low-fare destinations. According to the New York Times: “Southwest Airlines Co. had clamored to get access to markets that it had once shunned, especially as it sought out business travelers who were asking for flights to the main airports in New York (La Guardia) and Washington” (Mouawad, A., NYT, 2010). The deal appeared to be very successful as Southwest Airlines Co.’s network expanded by 25% up to 70 airports and started its first international flights in the Caribbean and Mexico. According to Factset the Southwest Airlines Co. paid “$ 1 billion in cash and stock plus assumption of debt. Under the agreement Southwest Airlines Co. acquired each share of AirTran for US$ 3.75 and issued 0.321 for a share. After signing the ‘Federal Aviation Administration accepted agreement’, AirTran announced Southwest Airlines Co. as an owner of 78% outstanding shares. The deal was closed in May 02’ 2011. The current transaction is reflected on the Southwest Airlines Co. balance sheet of 2011. More specifically, $ 970 million of goodwill was recorded. Cash was decreased by $ 432 million and flight equipment was increased by $ 2,078 million.

Figure 31. Southwest Aircraft Landing Fees

Figure 32. Delta Aircraft Landing Fees

Figure 33. RPM

Figure 34. PRASM

Aircraft Landing Fees Landing fees are special charges paid by airlines to an Airport holding company. Some airports charge on-time fees for landing and exclude check-in facilities and use of the gates. Landing fees are gathered as a revenue source to improve Airport infrastructure. Some airports offer landing free of charge to attract more airlines, some of them are subsidized by local governments. According to the Factset Southwest Airlines Co. reported $ 1,111 million landing fees and $ 0.85 million per ASM in 2014, while Delta reported $ 1,442 million and $327 million per ASM. In order to compare how these two companies operate with landing fees, we should include the number of destinations served in calculations. So landing fees per ‘destination served ratio’ for Southwest Airlines Co. equals to $ 11.9 million while for Delta the ratio equals to $ 4.40 million. Therefore, Delta negotiates better with airports’ management and chooses cheaper options to land their airplanes.

RPM & PRASM RPM or ‘Revenue Passenger Mile’ is an industry specific measure for an airline which shows “One paying passenger flown one mile. Often referred to as the airline industry’s measure of “traffic”.” (Source: Southwest Airlines Co. Airline Glossary). Southwest Airlines Co. reported 108,035 annual RPM in 2014. RPM growth was relatively steady for the last 4 years. The biggest annual growth was reported after the AirTran Acquisition in 2011, when RPM was increased by 25%, from 78,047 to 97,583. The same RPM measure for Delta was defined as 202,925 in 2014, while industry average was 126,700. According to number Southwest Co. has a lower RPM (Traffic), but due to operating cost savings it retains higher operating margins. The second relevant industry specific measure is ‘PRASM’ (Available Seat Kilometers/ Miles). As Southwest Airlines Co. defines: it shows “Passenger Revenue per available “one seat (empty or full) flown one mile” (Source: Southwest Co. Airline Glossary). For the last 5 years (2010-2014) the Southwest Co. airlines managed to increase PRASM cumulatively by 1.81 cents which is equivalent to cumulative percentage increase by 15.51%. Delta’s 10-k reports that PRASM increased 3% on 3% higher capacity. In 2014 Delta reported 14.58 cents revenue per ASM, while the industry’s average is 12.78 cents. Based on the following statistics, Southwest Airlines Co. airlines has 1.11 cents lower revenues per passenger and per mile than Delta, but still manages to have 0.7 cents higher revenues than the total industry’s average. Furthermore its revenue growth in 2014 was 5.07%, which is the higher rate than industry average and Delta also. (Source: MIT Global Industry airline program – Airline data project).

Figure 35. Capital Leases

Figure 36. Operating Leases

Figure 37. S&P Rating

Figure 38. Moody’s Rating

Lease structure - Capital vs Operating According to the Southwest Airlines Co. 10-K report: “The Company has contractual obligations and commitments primarily with regards to future purchases of aircraft, payment of debt, and lease arrangements. For aircraft commitments with Boeing, the Company is required to make cash deposits toward the purchase of aircraft in advance. These deposits are classified as Deposits on flight equipment purchase contracts in the Consolidated Balance Sheet until the aircraft is delivered, at which time deposits previously made are deducted from the final purchase price of the aircraft and are reclassified as Flight equipment“(Southwest Airlines Co. 10-K, 2014). Generally, leases can be divided by capital and operational leases. Capital leases are the agreements with the supplier, while asset owners are the users of product and product, this is reflected on their balance sheet with its purchasing value. Operational leases retain under supplier ownership until the lease agreement will be completed. Southwest Airlines Co. Reports $ 5,155 million as an operating lease and $ 334 million as a capital lease in 2014. While delta reports $ 12.741 million as an operating lease and $ 398 million as a capital lease. Simple math helps us to define that Delta has more concentration of operating leases and prefer to not reflect aircraft on its balance sheet. (97% of leases are operational) The same ratio is lower for Southwest Airlines Co., however the general attitude can be defined as the same. (93% of leases are operational).

Risks Analysis

Credit Analysis For the Credit Analyst of Southwest airlines Co., we found that this is the only one US airline that has been graded for all the three credit rating agencies. Standard & Poor’s (or S&P) The last report of S&P is the one of 2014, where Southwest airlines Co. improved their rating from BBB- to BBB. In the report of the S&P they state that the explanation of this increase is due to the following “Crucial factors: improving financial conditions, expected increase in earnings, cash flow, credit measures supported by favorable conditions in the US airline industry, and revenue and cost synergies from the AirTran Holdings acquisition”. (10K, LUV, 2014) Moody’s According to the report of Moody's Investors Service, they “Assigned a Baa1 rating to Southwest Airlines Co.'s new $500 million of senior unsecured notes due in November 2020.” (2015). This positive classification is due to Southwest airlines Co. creating a plan to have good liquidity for the next years, having a Debt- to- EBITDA of 1.5 times and EBIT-to-interest of 12 times in 2015. According to these values, Southwest airlines Co. is improving its performance in terms of operations, knowing that demand for USA domestic travel continues to increase. In the case of a decrease in the number of travels during 2016, according to the previous values, Southwest airlines Co. is going to be able to fight this decrease. Another important point to mention is that according to Moody’s, Southwest Airlines Co. “anticipates that the average spot price of jet fuel Will Remain well below $ 2.00 per gallon in 2016, removing jet fuel as a pressure point on earnings in 2016”. (2015)

Figure 39. Fitch Rating

Figure 40. Passenger Revenues

Figure 41. Cargo / Sales (%)

Figure 42. Airline profitability improves when economy strong

Fitch As we can see in the rating of Fitch, Southwest Airlines Co. has increased their classification from BBB to BBB+, mainly because of their credit profile, followed by their strong and competitive position in the US domestic market, and their strong brand. This is strongly supported because of the payment of their debts, the integration of AirTran, and having good credit metrics. As it states in the Fitch report, they “Expect Southwest Airlines Co. to continue to generate solid free cash flow (FCF), exhibit stable or modestly declining leverage, and maintain its substantial financial flexibility.” (2015) Southwest's investment-grade credit ratings are also supported by its competitive position in the U.S. domestic market, its strong brand, and its sizeable base of high-quality unencumbered assets.

Projections and Estimates. LUV vs. Delta Projections and Estimates These projections are generated by the guidance provided by the company and the consensus of analysts starting from the average growth rate of past revenues. The estimates could be used to forecast the company’s future business and financial trends, and investors would take advantage of predicting future stock prices. The key segments below are comprised with the two companies that are a regional airline Southwest Airlines Co. and an international airline Delta to find out performances along with a different business strategy. Product Segment (Passenger and Cargo) Due to the worldwide economic development and low oil prices, the airline economic cycle has driven accelerated growth for air travel. In particular, the US air travel market with the strong economic recovery of the US has achieved the best results in the last two decades, recording over 7% net profit margin. Thus, the increasing trend in passenger revenues is estimated to continue. Southwest Airlines Co. would take more benefit from the US central economy than Delta, because Delta’s revenue is dispersed internationally, and vice versa (Figure 41). Southwest Airlines Co. and Delta are reducing the portion due to the uncertainty of global economy and profitability of passenger market. Cargo/Sales of Southwest Airlines Co. stays below 1%. However, Cargo is expected to achieve the best growth ratio since 2010 due to the re-activation of the economy. For the long-term perspective, Southwest Airlines Co. need to expand cargo business in case of global economy boom (Figure.).

Table 7.

Figure 43. Opex / Ask

Figure 44. Cost typicaly passed through to prices

Figure 45. Net Profit Margins

Figure 46. Longer-term impact of lower fuel prices

not clear

Figure 47. Free Cash Flows

Industry Metrics (Revenue and Cost) Total Revenue/ASK is remained at the similar level of the two companies. That means the revenue structure is stable and increasing the number of passengers is only way to increase revenue. In the meanwhile, Southwest Airlines Co. has been successfully reducing operating expenses, so it no longer reduce it, while Delta should keep reducing cost (Figure.). This shows how Southwest Airlines Co. should develop its business for the future. To make organic growth and profit, reducing cost no longer benefit, so Southwest Airlines Co. is necessary to increase new routes and airplanes domestically and internationally (Figure 43).

Table 8. I/S (Profit Margin) Southwest Airlines Co. had recorded highest growth in Net Income for 2014 and 2015(E) because of the historically low oil price that reduced operating cost over $400 M for 2014 and of the AirTran integration effect completing the transaction in 2015. However, the revenue trend of Southwest Airlines Co. as well as Delta has been steady and are going to still steady because market growth is restricted by global economy and competition of domestic market. Thus, the increase in the Net Income not based on the organic growth of revenue would be possible to cease with in short-term (Figure.). Furthermore, the historically lowest oil price obviously helps all airline industry in the short and mid-term reducing jet fuel cost significantly. However, low oil price means the recession of global economy, so the effect of low oil price would not contribute much to the industry in the long run. Therefore, the increasing trend in Net Income and Net profit margin after 2015 will be expected to be diminished (Figure 45).

Table 9.

Cash Flow (Free Cash Flow) Market consensus give Delta high score in predicting Free Cash Flows, which means Delta has more potential growth than Southwest Airlines Co.. This results from the different business models between two companies. Southwest Airlines Co. has been almost 100% focused on the regional air travel market based on the North America, while Delta has pursued global market both air travel and Cargo business. So, when global business cycle is growing, Delta would generate more cash than regional airlines. Analysts are expecting global economy will be gradually recovered for the future that’s why Delta is better off on the assumption (Figure 47).

Table 10.

Figure 48. EPS

Figure 49. P / E ratios

Figure 50. Delta’s Revenue by Country

Figure 51. Delta’s Revenue by Region

Figure 52. Delta’s Revenue by Economy

Per Share (EPS) Since 2013 the EPS of Southwest Airlines Co. has explosively grown from $1.12 to $3.54. Along with the increase of EPS, the stock price also has increased from around $10 to $45. Again, what we have to carefully observe is whether this radical EPS growth has been mostly generated by its Revenue or more related to cost reduction. As mentioned above, over half of operating income has owed the historically low oil price. Market consensus sees that oil price would rebound from 2016 due to recovery of global economy, and the growth rate of EPS will be diminished.

Table 11. Valuation (P/E ratio) Price to Earnings ratio increase when market has strongly positive expectation to the future performance of the company. Conversely, P/E ratio could decrease when the company makes continuous earning surprises. In 2015, Southwest Airlines Co. is making continuous earning surprises, P/E ratio decreases. However, analysts are expecting P/E ratio will have decreased after 2015 due to the steady increase in EPS.

Table 12.

Consensus of Analyst. (Target Price) Now, the Southwest Airlines Co. target price formed by analysts is $53.13 upside potential 18% from the current price $45.89. Since 2013 the green portion, Buy plus Overweighting ratings, has been increased to 72% from 44%, while Holding ratings, yellow portion, and Underweight plus Selling ratings, red portion, have been reduced respectively to 17% and 11% from 38% and 19%. This shows market consensus view Southwest Airlines Co. very positive to making future performance. And the distance between target price and current price gets closer. That means new higher target prices would come up with.

Figure 53. Flow of Target Price

Appendix A Corporate Governance strengths

Company Code of Ethics Southwest Airlines Code of Ethics sets forth the expectation that their Employees, Board members, and certain business associates comply with the law, both in letter and in spirit, and specifically addresses matters such as confidentiality, insider trading, competition and fair dealing, payments to government personnel, conflicts of interest, corporate opportunities, safeguarding of Company property, and recordkeeping. Insider Trading Policy Southwest Airlines Insider Trading Policy prohibits their Employees, Board members, and consultants as well as related persons from (i) purchasing or selling Southwest securities while in possession of material nonpublic information about the Company, (ii) purchasing or selling securities of another company while in possession of material nonpublic information about that company that has been acquired while in the course of performing services for the Company, and (iii) communicating material nonpublic information about the Company or about other companies with which they do business to others who may trade based on the information. Auditing Procedures Southwest Airlines also employs robust auditing procedures to analyze and monitor business activities, which further enhance our ability to maintain high ethical standards. They continually review their systems to provide transparency and accountability, and they update their corporate governance policies when needed.

Direct Stock Ownership

The Board believes that, in order to align the interests of Directors and Shareholders, Directors should have a financial stake in the

Company. Each Director who has served on the Board for a minimum of at least two years should beneficially own a minimum of

1,000 shares of Southwest common stock. The Board will evaluate whether exceptions should be made for any Director on the basis

of financial hardship.

Appendix B The Wright Amendment “The Wright Amendment Section 29 of the International Air Transportation Competition Act of 1979, as amended (commonly known as the “Wright Amendment”), prohibited the carriage of nonstop and through passengers on commercial flights between Dallas Love Field and all states outside of Texas, with the exception of the following states (the “Wright Amendment States”): Alabama, Arkansas, Kansas, Louisiana, Mississippi, Missouri, New Mexico, and Oklahoma. Originally, the Wright Amendment permitted an airline to offer flights between Dallas Love Field and the Wright Amendment States only to the extent the airline did not offer or provide any through service or ticketing with another air carrier at Dallas Love Field and did not market service to or from Dallas Love Field and any point outside of a Wright Amendment State. In other words, a Customer could not purchase a single ticket between Dallas Love Field and any destination other than a Wright Amendment State. These restrictions did not apply to flights operated with aircraft having 56 or fewer passenger seats. The Wright Amendment also 17 did not restrict the Company’s intrastate Texas flights or its air service to or from points other than Dallas Love Field. In 2006, the Company entered into an agreement with the City of Dallas, the City of Fort Worth, American Airlines, Inc., and the DFW International Airport Board, pursuant to which the five parties sought enactment of legislation to amend the Wright Amendment. Congress responded by passing the Wright Amendment Reform Act of 2006, which immediately repealed the original through service and ticketing restrictions by allowing the purchase of a single ticket between Dallas Love Field and any destination (while still requiring the Customer to make a stop in a Wright Amendment State), and reduced the maximum number of gates available for commercial air service at Dallas Love Field from 32 to 20. The Wright Amendment Reform Act also provided for the repeal, on October 13, 2014, of the Wright Amendment federal flight restrictions at Dallas Love Field, for travel to destinations within the 50 States and to the District of Columbia. Accordingly, the Company became, and remains, authorized to fly to any U.S. destination from Dallas Love Field unless such destination is restricted or otherwise limited by law. Nonstop international service to or from Dallas Love Field will continue to be prohibited. The Company currently operates out of 16 gates it leases at Dallas Love Field. As discussed further in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in January 2015, the Company announced a long-term sublease agreement that will transfer usage of two additional gates, giving the Company 18 gates at Dallas Love Field.” (LUV Southwest Airlines Co. Airlines Co. 10-K, 2015

Appendix C Organizational Structure

Appendix D – Glossary of Airline Industry Terminology RPK= Revenue Passenger Km FTK= Freight Tonne Km ATK= Available Tonne Kilometer ASK= Available Seat Kilometer GVA = Gross Value Added (firm level GDP) ROIC= Return on invested Capital WACC= Weighted Average Cost of Capital EBIT= Earnings Before Interest and Tax YoY= Year on Year. Appendix E – Airline Industry performance

Appendix F – Tax Collection for Government

Appendix G – Airline Industry Investments and Profits

Appendix H – Worldwide Aircraft Fleet, departures and load factors.

Appendix I – Fuel Spend and Efficiency

Appendix J

Balance Sheet

Years 2014 2013 2012 2014 2013 2012

Assets Southwest airlines Co. Delta airlines

Cash & Short-Term Investments 2988 3152 2970 4383 3925 3749

Cash Only 1282 1355 1024 2088 2966 2791

Total Short Term Investments 1706 1797 1946 2295 959 958

Short-Term Receivables 365 419 332 3222 1609 1693

Inventories 342 467 469 852 1063 1023

Other Current Assets 709 418 456 4008 3054 1807

Total Current Assets 4404 4456 4227 12465 9651 8272

Net Property, Plant & Equipment 14292 13389 12766 21929 21854 20713

Construction in Progress 621 453 -- 617 -- --

Leases 214 -- -- 1141 1296 1381

Other Property, Plant & Equipment 566 764 -- -- 381 253

Accumulated Depreciation 8221 7431 6731 9340 7792 6656

Total Investments and Advances 48 189 347 118 -- --

Intangible Assets 1333 1136 1108 14397 14452 14473

Net Goodwill 970 970 970 9794 9794 9794

Net Other Intangibles 363 166 138 4603 4658 4679

Other Assets 123 175 148 892 1303 1092

Total Assets 20200 19345 18596 54121 59394 44550

Liabilities & Shareholders' Equity

Accounts Payable 123 1247 1107 2622 2300 2293

Income Tax Payable 163 -- -- -- 673 585

Other Current Liabilities 5379 3800 3272 13041 9632 8765

Accrued Payroll 325 161 634 2266 1926 1680

Miscellaneous Current Liabilities 5054 3639 2638 10775 7706 7085

Total Current Liabilities 5923 5676 4650 16879 14152 13270

Long-Term Debt 2434 2191 2883 8561 9795 11082

Provision for Risks & Charges 169 138 289 15138 12392 16005

Deferred Tax Liabilities 3259 2934 2884 -- 7142 2047

Other Liabilities 1640 1070 898 4730 4270 4277

Other Liabilities (excl. Deferred Income) 1413 842 835 2128 1711 1649

Deferred Income 227 228 63 2602 2559 2628

Total Liabilities 13425 12009 11604 45308 47751 46681

Common Equity 6775 7336 6992 8813 11643 -2131

Common Stock Par/Carry Value 808 808 808 0 0 0

Additional Paid-In Capital/Capital Surplus 1315 1231 1210 12981 13982 14069

Retained Earnings 7416 6431 5768 3456 3049 -7389

Treasury Stock -2026 -1131 -675 -313 -258 -234

Total Shareholders' Equity 6775 7336 6992 8813 11643 -2131

Total Equity 6775 7336 6992 8813 11643 -2131

Total Liabilities & Shareholders' Equity 20200 19345 18596 54121 59394 44550

Balance Sheet Common Size

Years 2014 2013 2012 2014 2013 2012

Assets Southwest airlines Co. Delta airlines

Cash & Short-Term Investments 14.8% 16.3% 16.0% 8.1% 6.6% 8.4%

Cash Only 6.3% 7.0% 5.5% 3.9% 5.0% 6.3%

Total Short Term Investments 8.4% 9.3% 10.5% 4.2% 1.6% 2.2%

Short-Term Receivables 1.8% 2.2% 1.8% 6.0% 2.7% 3.8%

Inventories 1.7% 2.4% 2.5% 1.6% 1.8% 2.3%

Other Current Assets 3.5% 2.2% 2.5% 7.4% 5.1% 4.1%

Total Current Assets 21.8% 23.0% 22.7% 23.0% 16.2% 18.6%

Net Property, Plant & Equipment 70.8% 69.2% 68.6% 40.5% 36.8% 46.5%

Construction in Progress 3.1% 2.3% -- 1.1% -- --

Leases 1.1% -- -- 2.1% 2.2% 3.1%

Other Property, Plant & Equipment 2.8% 3.9% -- -- 0.6% 0.6%

Accumulated Depreciation 40.7% 38.4% 36.2% 17.3% 13.1% 14.9%

Total Investments and Advances 0.2% 1.0% 1.9% 0.2% -- --

Intangible Assets 6.6% 5.9% 6.0% 26.6% 24.3% 32.5%

Net Goodwill 4.8% 5.0% 5.2% 18.1% 16.5% 22.0%

Net Other Intangibles 1.8% 0.9% 0.7% 8.5% 7.8% 10.5%

Other Assets 0.6% 0.9% 0.8% 1.6% 2.2% 2.5%

Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Liabilities & Shareholders' Equity

Accounts Payable 0.6% 6.4% 6.0% 4.8% 3.9% 5.1%

Income Tax Payable 0.8% -- -- -- 1.1% 1.3%

Other Current Liabilities 26.6% 19.6% 17.6% 24.1% 16.2% 19.7%

Accrued Payroll 1.6% 0.8% 3.4% 4.2% 3.2% 3.8%

Miscellaneous Current Liabilities 25.0% 18.8% 14.2% 19.9% 13.0% 15.9%

Total Current Liabilities 29.3% 29.3% 25.0% 31.2% 23.8% 29.8%

Long-Term Debt 12.0% 11.3% 15.5% 15.8% 16.5% 24.9%

Provision for Risks & Charges 0.8% 0.7% 1.6% 28.0% 20.9% 35.9%

Deferred Tax Liabilities 16.1% 15.2% 15.5% -- 12.0% 4.6%

Other Liabilities 8.1% 5.5% 4.8% 8.7% 7.2% 9.6%

Other Liabilities (excl. Deferred Income) 7.0% 4.4% 4.5% 3.9% 2.9% 3.7%

Deferred Income 1.1% 1.2% 0.3% 4.8% 4.3% 5.9%

Total Liabilities 66.5% 62.1% 62.4% 83.7% 80.4% 104.8%

Common Equity 33.5% 37.9% 37.6% 16.3% 19.6% -4.8%

Common Stock Par/Carry Value 4.0% 4.2% 4.3% 0.0% 0.0% 0.0%

Additional Paid-In Capital/Capital Surplus 6.5% 6.4% 6.5% 24.0% 23.5% 31.6%

Retained Earnings 36.7% 33.2% 31.0% 6.4% 5.1% -16.6%

Treasury Stock -10.0% -5.8% -3.6% -0.6% -0.4% -0.5%

Total Shareholders' Equity 33.5% 37.9% 37.6% 16.3% 19.6% -4.8%

Total Equity 33.5% 37.9% 37.6% 16.3% 19.6% -4.8%

Total Liabilities & Shareholders' Equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Southwest Airlines Co. - Income Statement Common Size

Years 2014 2013 2012

Total operating revenues

100.0% 100.0% 100.0%

Passenger 94.9% 94.5% 94.2%

Freight 0.9% 0.9% 0.9%

Other 4.1% 4.6% 4.9%

Total operating expenses

-88.0% -92.8% -96.4%

Salaries, wages, and benefits

-29.2% -28.4% -27.8%

Fuel and oil -28.4% -32.6% -35.8%

Maintenance materials and repairs

-5.3% -6.1% -6.6%

Aircraft rentals -1.6% -2.0% -2.1%

Landing fees and other rentals

-6.0% -6.2% -6.1%

Depreciation and amortization

-5.0% -4.9% -4.9%

Other operating expenses

-12.5% -12.5% -13.0%

Acquisition and integration

-0.7% -0.5% -1.1%

Other operating expenses excluding acquisition and integration

-11.9% -12.0% -11.9%

Operating income / loss

12.0% 7.2% 3.6%

Total other expenses / income

-2.2% -0.4% 0.4%

Interest expense -0.7% -0.7% -0.9%

Capitalized interest 0.1% 0.1% 0.1%

Interest income 0.0% 0.0% 0.0%

Other gains / losses, net

-1.7% 0.2% 1.1%

Income / loss before income taxes

9.8% 6.8% 4.0%

Provision / benefit for income taxes

-3.7% -2.6% -1.5%

Net income / loss 6.1% 4.3% 2.5%

Delta airlines - Income Statement Common Size

Years 2014 2013 2012

Total operating revenues 100.0% 100.0% 100.0%

Total passenger revenue 86.6% 87.2% 86.6%

Mainline 71.1% 70.2% 68.6%

Regional carriers 15.5% 17.0% 17.9%

Cargo 2.3% 2.5% 2.7%

Other 11.1% 10.3% 10.7%

Total operating expense -94.5% -91.0% -94.1%

Salaries and related costs -20.1% -20.4% -19.8%

Aircraft fuel and related taxes -28.9% -24.9% -27.7%

Regional carrier expense -13.0% -15.0% -15.4%

Fuel

Other

Aircraft maintenance materials and outside repairs

-4.5% -4.9% -5.3%

Depreciation and amortization -4.4% -4.4% -4.3%

Contracted services -4.3% -4.4% -4.3%

Passenger commissions and other selling expenses

-4.2% -4.2% -4.3%

Landing fees and other rents -3.6% -3.7% -3.6%

Profit sharing -2.7% -1.3% -1.0%

Passenger service -2.0% -2.0% -2.0%

Aircraft rent -0.6% -0.6% -0.7%

Restructuring and other items -1.8% -1.1% -1.2%

Other -4.5% -4.0% -4.3%

Operating income / loss 5.5% 9.0% 5.9%

Total other expense, net -2.8% -2.3% -3.1%

Interest expense, net -1.6% -2.3% -2.7%

Miscellaneous, net -1.2% -0.1% -0.4%

Loss on extinguishment of debt -0.7% 0.0% -0.3%

Miscellaneous, net excluding loss on extinguishment of debt

-0.5% -0.1% -0.1%

Loss / income before reorganization items, net

2.7% 6.7% 2.8%

Income / loss before income taxes 2.7% 6.7% 2.8%

Income tax provision / benefit -1.0% 21.2% 0.0%

Net income / loss 1.6% 27.9% 2.8%

Net loss / income attributable to common stockholders

1.6% 27.9% 2.8%

Appendix M. Estimates. Southwest Airlines Co. and Delta

Southwest Airlines Co. Estimates

Delta Air Lines, Inco. Estimates

Appendix N. Recent News Southwest Air reports October traffic +10.8% - November 06, 2015: Capacity +7.2%, Load factor +2.8 pts to 85.9%, Reaffirms 4Q15 RASM +1.0% y/y. The Company flew 10.0 billion revenue passenger miles in October 2015, a 10.8 percent increase from the 9.0 billion RPMs flown MoM2014. Available seat miles (ASMs) increased 7.2 percent to 11.6 billion in October 2015, compared with MoM2014 level of 10.8 billion. Southwest Airlines Pilot Union rejects agreement: company expects mediated discussions to resume in the spring of 2016 - Wednesday, November 04, 2015 Southwest Airlines announced 10 new non-stop routes that will begin flying this spring, along with a round of route cuts - October 28, 2015 According to the report of Moody's Investors Service, they “assigned a Baa1 rating to Southwest Airlines Co.'s new $500 million of senior unsecured notes due in November 2020.”(2015) As we can see this classification is positive. This positive classification is due Southwest is creating a plan to have good liquidity for the next years, having a Debt- to- EBITDA of 1.5 times and EBIT-to-interest of 12 times in 2015. According to these values, Southwest is improving its performance in terms of operations, waiting that demand for USA domestic travel continues increasing. However, if there is a decrease in the number of travels during 2016, according to the previous values, Southwest is going to be able to fight to this decreasing. Another important point to mention is that according to Moody “anticipates that the average spot price of jet fuel Will Remain well below $ 2.00 per gallon in 2016 , removing jet fuel as a pressure point on earnings in 2016”. (2015) Comparing with the classification that Delta has, according to report of Moody's Investors Service, “Delta Air Lines, Inc. ("Delta"), including the Corporate Family Rating to Ba2 from Ba3”. (2015), which is lower that the classification of Southwest.

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Wikipedia – Southwest Airlines https://en.wikipedia.org/wiki/Southwest_Airlines, 2015

Southwest Airlines Co – 2014 Annual Report Southwest Airlines, March 15, 2015

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