sample 1
DESCRIPTION
sample for CFTRANSCRIPT
Corporate Finance
Final project:The Air transportation industry
Company Risk Characteristics Investment PerformanceCapital
Structure Dividend Policy Valuations
ach BetaJensen'sAlpha
Rsquared
ROE - COE
ROC - WACC EVA
Current Debt ratio
Optimal Debt Ratio
Change in
WACC Duration Dividends FCFE Value/share Price/ShareAmericanAirlines B 6.26 -5.92% 35.00% n.m.
-8.15% (1,129.50) 86.65% 20.00%
-7.06% 0 0 765.3 10.06 10.20
-Ryanair B 1.24 27.35% 27.00% 5.24% 2.01% 53.30 23.87% 10.00% 0.04% 5.3 0 23.5205 6.76 5.55
- -BAA B 1.42 4.43% 7.00% 2.80%
-2.27%
-(191.00) 44.86% 45.00% 0.00%
-3.3 145 257.1 3.22 5.80
Asur B 0.82 28.42% 15.00% 3.23% 3.53% (37.30) 0.00% 20.00% 0.54% 0 14.3 41.2 31.69 30.45
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EXECUTIVE SUMMARY ................................................................................................... 3
INTRODUCTION AND THE COMPANIES........................................................................ 4
1. Introduction ......................................................................................................................................................................... 4
2. Brief description of the companies .................................................................................................................................. 6
CORPORATE GOVERNANCE ANALYSIS ...................................................................... 8
1. Balance of power between management and shareholders .......................................................................................... 8
2. Management compensation.............................................................................................................................................. 9
3. Market coverage................................................................................................................................................................ 11
4. Social responsibility.......................................................................................................................................................... 12
STOCKHOLDER ANALYSIS .......................................................................................... 14
RISK PROFILE .............................................................................................................. . 16
1. Market risk and return...................................................................................................................................................... 16
2. Bottom up betas ................................................................................................................................................................ 20
3. Cost of equity .................................................................................................................................................................... 22
4. Cost of debt........................................................................................................................................................................ 23
5. Cost of capital.................................................................................................................................................................... 25
INVESTMENT RETURN ANALYSIS............................................................................... 27
1. Typical project ................................................................................................................................................................... 27
2. Measuring Returns
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........................................................................................................................................................... 28
3. Future outlook................................................................................................................................................................... 30
CAPITAL STRUCTURE CHOICES................................................................................ . 33
1. Current financing mix ...................................................................................................................................................... 33
2. Trade off on Debt and Equity......................................................................................................................................... 35
3
OPTIMAL CAPITAL STRUCTURE ................................................................................. 37
1. Current Cost of Capital / Financing Mix ...................................................................................................................... 37
2. Cost of Capital at Different Financing Mixes............................................................................................................... 37
3. Firm Value at Optimal ..................................................................................................................................................... 38
4. Optimal capital structure – APV approcah ................................................................................................................... 40
5. Sector and market debt ratios ......................................................................................................................................... 42
MECHANICS OF MOVING TOWARDS THE OPTIMAL................................................. 43
1. A Path to the Optimal...................................................................................................................................................... 43
2. Quantitative Analysis and Overall Recommendation on Financing Mix................................................................. 43
3. Summary of desirable debt charachteristics ................................................................................................................. 47
DIVIDEND POLICY ........................................................................................................ . 48
1. Current Dividend Policy .................................................................................................................................................. 48
DIVIDEND POLICY: A FRAMEWORK ........................................................................... 51
1. Affordable Dividends........................................................................................................................................................ 51
2. Management Trust and Changing Dividend Policy ................................................................................................... 51
VALUATION................................................................................................................... . 54
1. Valuation models .............................................................................................................................................................. 54
2. Valuation assumptions and inputs................................................................................................................................. 54
3. Valuation results .............................................................................................................................................................. 57
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I. Executive Summary
C o r p o r a t e G o v e r n a n c e a n d S t o c k h o l d e r a n a l y s i sWe believe that the stockholders’ interests are generally well
protected in the companies subject to our review of Chemical Industry of Pakistan. The marginal investor in all companies is well diversified, often national investors.
R i s k P r o f i l eWe used two measures of bete to estimate the exposure of each
company to market risk. Not surprisingly, the results reflect the fundamental characteristics of each company and in particular variance of earnings and leverage. The riskiest company as measured by historical regression beta is American Airlines and the least risky – BAA. Because of the historical character of the regressions beta and high standard errors of the estimates we used bottom-up betas in our further analysis.
In addition, we used two methods to compute returns of each company with relation to its risk
– Jensen’s Alpha and Treynor ratio. Under both methods the top performing companies were Ryanair and Asur.
I n v e s t m e n t a n a l y s i sIn analyzing the returns of the investment projects at which companies
we looked at a typical project in each line of business and computed accounting measures of returns, such as ROC and ROE. Ryanair proved to be the company with highest returns and it was the only company that generated positive EVA. In addition we assessed the future prospects of each company, analyzing the sustainability of its competitive advantages. This analysis was used as a basis for the valuation of thefirms.
C a p i t a l s t r u c t u r eThe four companies adopt very different policies with regards to their
capital structure, ranging from the highly overlevered American Airlines
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(debt ratio of 87%) to the all equity financed Asur. Taking into account the potential benefits and disadvantages from the use of debt we computed optimal capital structures for each firm and assessed the impact on the share price from moving from the current capital structure to the optimal. The result was an average of 8.12% increase in the firm
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value of the firms, although most of this increase comes from American Airlines. It was interesting to find that BAA’s current debt ratio is equal to its optimum – roughly 45%.
D i v i d e n d p o l i c yBoth Amrican Airlines and Ryanair are non-dividend paying
companies, although for very different reason. While focus of AA’s policies is to return to profitability before being able to afford any dividends, Ryanair exhibits a great potential to invest in projects with positive excess returns (ROC exceeds Cost of capital). BAA and Asur are companies with more steady and predictable cash flows and reinvestment needs and this is reflected in their dividend policies. Our analysis is presented in Sections X and XI.
V a l u a t i o nThe results from our valuations are presented in the table below:
Valuation summaryAmerican
Airlines Ryanair BAA AsurModel ChosenValue per Share
FCFF 2 Stage10.06
FCFF 3 Stage6.76
FCFF 2 Stage3.22
FCFF 2 Stage31.69
Current Stock Price 10.20 5.55 5.80 30.45Undervalued / (overvalued) -1.3% 21.8% -44.4% 4.1%Reccomendation HOLD BUY SELL HOLD
Source: Analysis
pages.
The valuation models are based on the results from our analysis as presented in the following
II. Introduction and the companies
1. IntroductionThe current report examines major trends in the Chemical sector of Pakistan focusing on four companies in particular – Ibrahim Fibres, Sitara Chemicals & Sitara Per Oxide. The companies reviewed operate in two different businesses, Non Petro Chemicals& Petro Chemicals and are at different stage of their life cycle. The purpose of the report is to analyze different aspects of
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their corporate finance policies and to assess the effect of these policies on the value the managements of these firms create for their shareholders.
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Figure 1 Summary company informationAmerican
Company
Throughout the report analysis has been presented based on information gathered from various sources, including statutory filings with regulatory authorities in the respective jurisdiction, company annual reports, management presentation and other publicly available information. We have tried to acknowledge each source of information where possible. Figures and data that is not referenced to any source has been result of our own analysis.
A list of commonly used terms and abbreviations is presented below:
Term MeaningAA, AMR American AirlinesBAA British Airport AuthorityBoD Board of Directors BVE Book value of equity BVD Book value of debtD DebtE EquityLoad Factor Percentage of seats sold to total available seatsMVE Market value of EquityMVD Market value of debtn.a, N/A Information not available n.m.
Information not meaningful RAPM or Revenue Yield Revenues per passenger per mile T Tax rate
1 Translated using the average Local Currency/ Dollar rate for 20042 Translated using the closing local currency / Dollar rate as at 31 December 2004
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For computational ease the analysis for each company has been undertaken in the reporting currency under which the company reports annual results – US dollars (for AA and Asur), Euro (Ryanair), British pounds (BAA). All figures are in million local currency unless otherwise indicated.
2. Brief description of the companiesA m e r i c a n A i r l i n e s
AMR was established in 1926 and had Charles Lindberg as chief pilot of its fleet of 3 DH 4 bi- planes. The company was listed in 1939 and throughout the years grew on acquisitions and survived several crisis (included World War II that forced them to turn half of the fleet to the military airline). The company grew internationally and domestically especially after the deregulation act of 1978. In2001, before September 11 acquired all the assets of TWA, but then was hit by an economic recession,increased competition from low cost carriers and the terrorist attack.
Nowadays AMR Corporation is a holding company that provides scheduled passenger and airfreight services to approximately 150 destinations in North America, the Caribbean, Latin America, Europe and the Pacific through its American Airlines subsidiary. The Company in 2004 employed roughly 92,000 people and its headquarter is at Dallas Forth Worth Airport, Texas. For the FY ended12/31/04, revenues rose 7% to $18.65B. Net loss fell 38% to $761M. Results reflect higher affiliatepassenger revenues a decline in wage costs but also an increase in fuel costs.
R y a n a i rRyanair was founded in 1985 by the Ryan family in Ireland. It started
with one scheduled flight between south-eastern Ireland and London Gatwick. First crew members were required to be less than 5 foot 2 inches tall in order to fit in the tiny cabin of the only 15-seater aircraft. Soon after its launch, the company acquires permission to challenge British Airways and
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Aer Lingus on the Dublin – London route. The number of passengers grew from 5,000 to 82,000 in the first 2 year of operations. The next few years are marked by growth in the number of routes and passengers between Ireland and the United Kingdom. However, by 1990 the company had accumulated over D20 million in losses. The Ryan family invested additional 20 million in capital in the business which went through substantial financial and operational restructuring – copying the South West Airlines model, Ryanair was re-launched as Europe’s first low cost airline. This was a revolutionary new model for the European air transportation market and some publications note that “people queued up for three days
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to get the Easter sale fares”. The new model incorporated move towards same aircraft fleet, direct sales, scrapping of drinks and food served on board and cutting turnaround time and costs. In 1995 the company launches the first low cost airfares on UK routes and in 1997 – in Europe. In the same year the company gets listed on the Irish Stock Exchange. Promotional fares of D1 on domestic and European routes attracted the attention of passengers. Today, Ryanair is the largest European low cost airline carrying over 7 million passengers annually on 220 routes across 19 countries. Operations are concentrated in 12 European bases and the company employees over 2,600 employees.
B A ABAA is engaged in the management and operation of airport facilities in
the UK and overseas. The company is headquartered in London, UK and has a workforce of about 12,500 employees. The company owns seven UK airports: Heathrow, Gatwick, Stansted, Glasgow, Edinburgh, Aberdeen and Southampton. BAA also has interests in 13 airports located in Italy, Australia, US and Oman. BAA’s airports in the UK and overseas serve 230 million passengers a year. The company’s operations are divided into the following segments: airports, retail, BAA Property, rail and other. The airport segment primarily oversees terminal and airfield management. In the terminal management area, the company looks after buildings, passenger services and cargo. In the airfield management division, the company maintains and operates runways and taxiways. BAA also develops, manages and markets commercial activities at its UK airports. BAA’s UK airport retail activity is made up of two complementary businesses: Retail management at UK airports and World Duty Free. Retail management at UK airports involves the development, management and marketing of commercial activities at BAA’s seven UK airports. These include shopping, catering, financial services, travel, services, parking, telecommunications and media management. The business specializes in luxury brands and operates64 stores across the UK
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airports.
A s u rGrupo Aeroportuario del Sureste (“Asur”) holds a concession from the
Mexican government to operate, maintain and develop nine airports in the, primarily touristic, Southeastern region of Mexico. The company’s main airport is the Cancun International Airport, which generates over 70% of Asur’s revenues and is the second busiest airport in Mexico. Cancun and the surrounding Mayan Riviera, are Mexico’s top tourist destination and among the fastest growing tourist developments in the country. Asur’s nine airports served more than 13.8 million passengers in 2004, of which around
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60% were international passengers and 40% were domestic passengers. Approximately 70% of the international passengers traveled on flights originating from the United States. As of 2003, 17Mexican and 45 international airlines operated directly or through code-sharing agreements fromAsur’s airports.
Asur was established in 1998 as part of the Mexican government’s airport privatization program, which included three regional airport groups and the Mexico City International Airport. A private consortium, ITA, led by Copenhagen Airports won the 50-year concession to operate the nine airports in the Southeastern group. The consortium acquired a 15% stake in Asur, while the remaining shares were floated in the NYSE and the Mexican Stock Exchange on October 3, 2000. The Mexican government, through one of its development banks, Nafin, retained an 11.1% stake in Asur to be floated on a future date. As the long-term operator of the airports, Asur generates revenues from two main sources: aeronautical services and non-aeronautical services. The former account for 75% of total revenues and are derived primarily from passenger and landing charges, aircraft parking charges, and general airport services. Non-aeronautical services are divided into retail operations and access fees charged to third-party providers of complementary services. While the aeronautical revenues are heavily regulated by the Mexican government, the retail operations and access fees provide an important growth opportunity for Asur. These have grown at a compounded annual growth rate of22.9% since 1999, when they accounted for only 14% of total revenues.Summary financial data for each company is presented in Appendix I.
III. Corporate Governance Analysis
1. Balance of power between management and shareholders
We believe that the interests of shareholders are relatively well
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protected by the corporate governance policies of the four companies analyzed, with the possible exception of American Airlines. As an example at AA, directors are nominated for life and more than half are CEOs of other companies, two of them in related businesses. A shareholder is challenging the lifetime rule at the next general shareholders’ meeting in May. Recently, some board members and the CEO have raised their own salaries.
Insiders are generally not overrepresented in the companies’ boards, while the CEOs tend to
have a long history with their companies, once again with the notable exception of American Airlines. One interesting common feature is that all of the CEOs are relatively young with an average age of
AA
BAA
Asur
Ryanair
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only 48 years. These last two factors could suggest a dynamic leadership with intimate knowledge of the challenges and opportunities facing their businesses. Although the balance of power seems to tilt in favor of shareholders, it is interesting to note that 3 out of the 4 companies have board members who are CEOs of other companies. This could indicate a lesser oversight due to the lack of time and possible conflicts of interest, although it should be noted that only AA board members are CEOs of related companies. Nonetheless, the large percentage of institutional shareholders in most firms, as well as the relative absence of insiders in the boards of directors, leads us to believe that shareholders hold an adequate level of power and oversight in their companies. An exception in terms of number of insiders is BAA, where company executives represent a majority of the board. We believe that management discretion is counterbalanced in this case by the oversight of the regulatory authority, the Civil Aviation Authority (“CAA”).Figure 2 Balance of power between stockholders and current managers
Stock holders
Incumbent managers
2. Management compensationManagement compensation does not appear to be an issue at any of the
companies analyzed. Only the CEO of Ryanair earns more than US$1 million in total compensation (half of which is in stock options). All firms, with the exception of Asur, use stock options as a mean to align management’s interest with those of shareholders, but with the exception of Ryanair,
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none of the CEOs own a significant stake in their companies. Details about the CEOs, their compensations and the composition of the Board are presented in Figure 3 and Figure 4.
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Figure 3 Brief presentation of management
Chief Executive OfficersAmerican
Airlines Ryanair BAA AsurName Gerard Arpey Michael O'Leary Mike Clasper Kjeld BingerAge 46 43 52 50
6 (Asur), 11Years at the Company 23 17 4 (CPH)Years as CEO 3 9 3 1Education MBA n.a. MA, Engeneering,
St John's College Cambridge
CEO Compensation
BSc in Structural and Civil
Engineering (Denmark)
Salary ('000) 518.8 505.0 553.0 N/A Bonus ('000) - 127.0 167.0 N/A Other (‘000) 0.2 49.0 21.0 N/A Stock Options (‘000.) 172.0 502.0 525.0 0Total Compensation (‘000).) 691.0 1,183.0 741.0 1,317.0* Stock Ownership (% of Total) 0.1% 5.44% 0.001% 0% Market Value of Stock Held (mm) 1.14 237 0.1 0.0
* Compensation to all 5 executive officers including the CEO Sou r ce : A nnua l r e po r t s , S t a t u t o r y f i li ng s
Figure 4 Board of Directors
Board of DirectorsAmerican
Airlines Ryanair BAA Asur
Number of members 13 9 9 7Insiders 1 1 5 3CEO of other Companies? 7 no yes 3
R e l a t e d C o m p a n i e s ? 2 n o N o Y e s
Source: Annual reports, Bloomberg, various public sources
AA
Ryanair
BA
A
Asur
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3. Market coverageFigure 5 Firms and markets – sources of information
Source of information
Firm Markets
All firms, with the exception of American Airlines, have shares listed in more than one stock exchange and thus garner significant investor’s interest outside of their home markets. In the case of Asur, its shares are more heavily traded in the NYSE than in its home market of Mexico. The two airlines in our sample are leaders in their sectors, while BAA is the largest airport group in the world and Asur is the only public airport company in the Americas. As such and despite the travails of the air transportation sector, all companies are relatively widely followed by the financial community and command significant trading volumes. Nevertheless, with the exception of American Airlines, most of the information on the companies is provided by the firms themselves, since some of the sub-sectors in which they operate, discount airlines and airport operations, are relatively new and with few comparable companies. With respect to the view of research analysts, this seems to be about evenly split between buy and hold recommendations, despite their out-performance of the market, once again with the notable exception of American Airlines.Figure 6 Listings
AmericanAirlines Ryanair BAA Asur
Year of Listing 1939 1997 1987 2000Main Listing NYSE ISE London New York Stock ExchangeOther listings no NASDAQ, LSE ADRs Mexican Stock ExchangeShares (million) 161.2 754.3 1,060.9 30.0Free Float 157.98 660.32 1,060.9 0.6941
T yp e o f S t o c k Ord i n a r y C o mm o n C o mm o n S e r i e s B (8 5 % ) a n d S e r i e s B B (15 % )
Source: Bloomberg
Social Consciousness
Ryanair
Asur
BA
A
AA
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Figure 7 Market coverageAnalyst coverage American Airlines Ryanair BAA AsurNumber of Analysts 10 19 12 5+Analysts Recommendations (%)Buy 50% 63.16% 50% 60.0%Hold 40% 26.32% 50% 40.0%Sell 10% 10.53% 0% 0.0%Daily Average Trading Volume (mm)2002 2.14 1.54 4.98 1.012003 8.06 2.64 7.01 0.832004 5.13 2.26 6.43 1.37
2005Y TD 4 . 0 6 3 . 4 1 6 . 9 3 3 . 2 7
Source: Annual reports, Statutory filings, Bloomberg, Zacks, Yahoo Finance and various public sources
4. Social responsibilityDue to the wide variability of business environments under which the
four firms operate, we have chosen to do a firm specific analysis of social issues.
Figure 8 Social consciousness and responsibility
Social Consciousness
Very lowVery High
A m e r i c a n A i r l i n e sGiven the poor operating performance of the past few years, driven by
(i) a steep fall-off in the demand for air travel, particularly business travel, (ii) reduced pricing power due to increasing competition from low-cost carriers and (iii) the aftermath of the terrorist attacks of September 11,2001, American Airlines did not consider corporate responsibility a top priority and stoppedpublishing the “Annual report for the Coalition for Environmentally Responsible Economies” in2001.
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AMR is therefore focusing on the mere respect of the many local and federal environmental laws and regulations (air and water pollution, noise).
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The company has been named as a potentially responsible party for land or water contaminations in California, Oklahoma and Florida. AMR has already accrued $ 6 millionn for settlement expected, but the actual amount that AMR will have to pay is still unknown.
R y a n a i rThe perceived image of Ryanair as a low cost air carrier and provider of
value of its passengers is extremely important for the company. This image is aligned with the operational model of the company, using modern fleet of aircrafts with lower fuel consumption reducing the emissions and environmental damage. In addition, its policy to operate from remote airports resulted in numerous benefits for the communities in these regions, increasing economic activity. However, major focus of the company is to be perceived as a value provider for its passengers.
B A AGiven its handling of all the major airports in the UK BAA as well
undergoes substantial public scrutiny. Recently the debate over the environmental impact of the new Terminal at Heathrow and the new runaway at Stansted has further heightened attention. BAA has always been receptive to issues coming from airport communities and currently pledges 0.15% of its pre-tax profits (equiv. to slightly under £1 mm in 2004). to 21st Century Communities Trust, a charity it created.
A s u rAs the monopoly provider of the main airport facilities in nine
southeastern Mexican cities, Asur faces significant public oversight and societal constraints. The Mexican Airport Law of 1995 established the general framework regulating the construction, operation, maintenance and development of Mexican airport facilities in the benefit of the public good. Moreover, Asur is also subject to Mexican federal and state laws and regulations relating to the protection of the environment. The level of
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environmental regulation in Mexico has increased in recent years, and the enforcement of the law is becoming more stringent.
Asur generally has a positive image with the Mexican public and a strong reputation as a good corporate citizen, since it has greatly improved the quality and scope of the facilities and services offered by its nine airports. However, in the near future the company could face criticism by local
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government officials that want to build new airport facilities in their regions, such as in Veracruz andQuintana Roo (Cancun and Cozumel airports).
IV. Stockholder Analysis
All firms in our sample, with the exception of BAA which has a more widespread investor base made up of small private investors, have a strong institutional shareholder base which commands over 2/3 of the total outstanding shares of their companies. This contrasts sharply with an industry average of only 33%, and gives credibility to our argument that corporate governance is relatively strong and minority shareholder rights are well protected. Moreover, the top 5 institutional shareholders in all companies are among the largest and most diversified asset management companies in the world. On the other hand and with the exception of Asur, insider holdings are relatively small and in line with the industry average of 6%. All these facts suggest that the marginal investor for all firms is a well diversified global institutional investor and we can thus proceed to carry out CAPM based risk and return analyses for the companies. In the case of BAA, even though the majority of the shares are held by private individuals, these tend to be buy-and-hold investors with the majority of the trading is done by institutional funds, which are therefore the marginal investor.
Most firms in our sample have only one type of share, common or ordinary. We take a look at the exceptions below:
A m e r i c a n A i r l i n e sAMR Corporation has only common stock outstanding, but the board of
directors has already authorized the CEO to issue 20million shares of preferred stock, probably to ease the deep financial stress of the company. Book value of equity has been negative for the last 3 quarters and debt ratio is around 90%.
A s u r
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Asur has two types of shares: B shares and BB shares. Series B shares currently represent 85%
of the company’s capital, while series BB shares represent the remaining 15%. Each series B share and series BB share entitles the holder to one vote at the general shareholders’ meeting. However, holders of series BB shares are entitled to elect only two members of the board of directors, while holders of series B shares are entitled to name the remaining directors. Under the company’s bylaws, each shareholder or group of shareholders owning at least 10% of Asur’s capital stock in the form of
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series B shares is entitled to elect one member to the board of directors for each 10% interest that it owns. Directors and senior management do not own any shares of Asur. Pursuant to the company’s bylaws, the holders of series BB shares are entitled to appoint and remove Asur’s CEO and one half of the executive officers reporting directly to the CEO. Currently, four executive officers report directly to the CEO, one of whom was appointed by ITA as holder of the BB shares.
The shareholders distribution as well as details about institutional and insiders holdings in the
companies are presented in Figure 9, Figure 10 and Figure 11.
Figure 9 Distribution of stockholders
100% Ot her 1%
90%80%70%60%50%40%30%20%10%
0%
Insider 2%
Inst it ut ional 98%
Insider 12%
Inst it ut ional 87%
Ot her 88%
Insider 0.03%
Inst it ut ional
12%
Insider 31%
Inst it ut ional 69%
AA Ry an BAA Asur
Figure 10 Institutional HoldingsInstitutional holdings American Airlines Ryanair BAA AsurNumber of shares held 158.0 n/a 124.2 20.8(million)% of Shares 98.0% 70% + 11.6% 69.41%OutstandingTop 5 Holders Fidelity Management Fidelity Investment Legal & General First State Investment
Management UKPrimecap Management Capital Group Company Scottish Widows Columbia Wagner Asset
ManagementWellington Guilder Gagnon Newton Inv. Oakmark International
Management Holding Mgmt Small Cap FundAllianz Global Wellington Threadneedle Inv. Schroder Investment
Management Management GroupHall Phoenix Janus Causeway Capital American Express
Financial CorpNumber of shares held 69.5 392.2 93.1 6.5
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by Top 5 (million)% of Shares
O u t s t a nd i n g 43 . 1 % 52 . 0 % 8 . 7 % 21 . 57 %
Source: Bloomberg, Statutory filings
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Figure 11 Insiders holdings
Insiders ownershipAmericanAirlines Ryanair BAA Asur
Number of shares held(million) 3.22 88.3 0.3 9.2
% of Shares OutstandingMajor Holders
2% Daniel Garton (CEO)
Jeffrey Campbell
Charles Marlett (Executive VP) Gary Kennedy
12.47% Michael O'Leary
Anthony Ryan
Ryan Family members
0.03%Sir Mike Hodgkinson (Exec. Director) Joel
Hoerner(Non-exec. Dir)
Tony Ward (Exec. Director)
30.59% ITA (15.01%)
Nafin (11.10%)
Copenhagen Airports(2.50%)
Fernando Chico Pardo J a n i s Kon g ( E x e c . D i r . ) (1 . 98 % )
Source: Bloomberg, Statutory filings, various public sources
V. Risk Profile
1. Market risk and returnIn analyzing the risk characteristics of the four companies we first
looked at their returns over a five year period compared them to the returns of a broad based market index such as the S&P 500. Figure 12 below presents the rebased share prices of all four companies and the level of the S&P 500 (Jan 2000 = 100).
"' "' "' "' " " "
Figure 12 Stock price performance
300%
250%A sur
200%
150%
100%
50%
0%0 0 0 C) ..;-S' 0 S' '3 S' 0 '3 '3 S' 0 S' '3 S' 0 S' '3 S' 0 S' Sg' S'
"' >"--'. 0 "' >
"--'.0 "' >
"--'.0 "' >
"--'.0 "' >"--'.
In general, three out of the four firms (Ryanair, BAA and Asur) did better than the market.
These results were expected for Ryanair and Asur since the two companies are at the growth stage of
their evolutionary cycle. BAA on the other hand, is more mature less volatile company characterized
by steady income stream and cash flows. AA suffered serious problems after swift change in its
operating environment - dramatic drop in air transport passengers, higher security related costs and
economic slowdown impacted negatively the company, especially after September 11 terrorist attacks
in the US.
To analyze the market risk of the four firms we regressed their returns against broad based
market index and used the coefficient of the regression as a measure of market risk. We used 5 year
monthly returns for the regression, with the exception of Asur, which was listed in late 2000. The
choice of index reflected the marginal investor in each company, assuming that each investor is
exposed to the same market risks in their respective market. Although based in Europe, Ryanair and
BAA attracted a number of large institutional investors with operations around the world and with the
ability to diversify their holdings more broadly. Therefore, the reference index used in the regression
for these companies was the Morgan Stanley Global Index. The reference index used for Asur was the
S&P 500, since it is traded mostly in the US and its marginal investor is based in the US. Our analysis
17
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focuses on the regression coefficient (beta), the regression constant (used for computation of Jensen’s alpha) and the regression R-squared. The results from the regressions are summarized in Figure 13.Figure 13 Risk return characteristics
Risk profile American Airlines Ryanair BAA AsurRegression BetaReference index
4.67S&P 500
1.21MS Global Index
0.35MS Global Index
0.99S&P 500
Industry average beta 1.34 1.80 0.95 0.95Average Risk free rate 4.59% 4.58% 4.24%Jensen's Alpha -5.92% 27.35% 4.43% 28.42%
R2 of Regression 35.0% 27.0% 7.0% 15.0%Standard Error of BetaJansen's Alpha -
0.56 0.48 0.17 0.32
i ndu s t r y av e r ag e -4 . 27 % -4 . 27 % n / a n / a
Sou r ce : B l oomb e r g , ana l y s i s , ww w . damoda r an .c o m
Slope of the regression - Beta
The coefficients of the individual regressions are the companies’ betas and are used as a measure of the company exposure to market risk. The analysis indicates that American Airlines is the company with highest exposure to market risk (regression beta of 4.67), which is also more than 3 times the industry average. This is a reflection of high indebtedness and negative and volatile earnings. Ryanair and BAA on the other hand have regression betas much lower than the industry averages, while Asur is close to its peers. The reasons behind the different risk profiles of each firm will be examined in greater details further in the report.
We also examined the excess returns of each firm as measured by its Treynor ratio. The
Treynor ratio measures the excess return of a stock given its level of risk (non-diversifiable) and is computed with the formula below:
Treynor Rstock " Rf=!
Figure 14 below presents the Treynor ratios and the spread between stock Treynor ratio and the market Treynor ratio over different investment horizons. The results suggest that over the last 5 years Ryanair had highest excess return compared to the market taking into consideration its risk. None of the stocks outperformed the market over a 10 year period. Over the
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last couple of years the best performing stock was Asur. These two stock were excluded from the 10 year horizon analysis, as data for them was not available.
Treynor ratioE
xces
s ret
urn
.
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Figure 14 Treynor ratios
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
-10.0%
-20.0%
1 year 2 year 5 year 10 year
Investment horizon
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
-10.00%
-20.00%
Treynor ratio AA Treynor ratio Ryanair Treynor ratio BAA Treynor ratio Asur
Excess return AA Excess return Ryanair Excess return BAA Excess return Asur
The calculations of the Treynor ratios are presented in Appendix II.
I n t e r c e p t o f t h e r e g r e s s i o n a n d J e n s e n ’ s a l p h aWe further used the intercept of the regression to compare the
actual stock performance of each company to the market expectation. For each stock we computed Jensen’s alpha equal toI n t e r c e p t – R i s k F r e e r a t e x ( 1 – B e t a ) , using the average monthly risk free over the period. The results were annualized using the formula:
( 1 + M o n t h l y e xc e s s r e t u rn ) 1 2 – 1The annualized returns indicated that on average all companies except
for American generated returns that exceeded the markets expectations. In addition, comparing Ryanair’s high excess return to the negative industry Jensen’s alpha suggests that the company performed better than expected at a time when the sector as whole did not meet the market’s expectations.
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R - s q u a r e dR-squared of the regression provides information as to what proportion
of the variability in returns could be explained by the regression, or in other words what part of the variability in the returns (total risk) can be attributed to beta (market risk). The market non-diversifiable risk represents35%, 27%, 7% and 15% for AA, Ryanair, BAA and Asur respectively. The remainder is company specific, non-diversifiable risk. While the relatively low R-squared for Ryanair and Asur could be explained by the fact that they were small, fast growing companies during the observed period and were facing numerous company specific challenges in establishing their business models, we were surprised to estimate that BAA was characterized by a large proportion of (93%) of company specific, diversifiable risk. One possible explanation could be the fact that airport operators’ revenues are generally much more stable stream and have a fixed nature – they are based on long term contracts under which airport slots are sold to airline companies. Even in the event of drop in passenger numbers the charge payable to airports is generally steady.
S t a n d a r d e r r o r sThe standard errors of the regression betas appear to be significant,
suggesting a wide interval for the possible values of the beta. This is one of the reasons why we considered an alternative approach to measuring the companies exposure to market risk, which is described bellow.
2. Bottom up betas
As an alternative approach to regressions betas we considered using bottom-up betas for our analysis. This is mainly due to the following factors:
As growing companies Ryanair and Asur are likely to change over time, hence alter their risk profile. In addition, their capital structure is likely to change;
BAA is mature, steady company which risk profile is likely to remain similar.
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However, the standard error of the regression beta indicates that it might nor be a reliable measure of risk;
American Airline as a company facing financial difficulties is likely to change in the
long term if it is to return to profitability. Making a going concern assumption about the business requires change in the company and hence, its risk profile. Therefore we believed that historical indicators might not be a reliable measure for the future.
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E s t i m a t e s o f u n l e v e r e d b e t aWe used market information about firms in the sector to estimate the
risk profile of each of the companies. While the main stream of cash flows for BAA and Asur come from their core business (Airport Development and Maintenance), a significant part is generated from general retail services, electronics and luxury goods retail and restaurants. Each of the businesses is exposed to a different extend to market risks. In order to capture these differences in the risk profile of each business we estimated the value of each business and used these values as a weight to come up with an overall beta of the firms. The value of each business unit was estimated by applying a market Enterprise Value / Sales ratio to the respective revenue streams from each business. The average unlevered beta for each respective sector was then used to compute the firm beta. Calculation of the unlevered beta of BAAand Asur is presented in Figure 15 and Figure 16.
Figure 15 Unlevered Bottom up Beta for BAA Estimated Unlevered Division Weight *
Business line Value Comparable Firms Beta Weight BetaAirport 4,125 Airport
Development/Maintenance
Retail 4,770 Retail (Consumer Electronics / Luxury / Restaurants)
0.73 46% 0.34
1.05 54% 0.56
Firm total 8,895 0.90
Figure 16 Unlevered Bottom up Beta for AsurEstimated Unlevered Division Weight *
Business Line Value Comparable Firms Beta Weight BetaAeronautical services 684.2 Airports 0.88 75.0% 0.66Non-aeronautical services 228.5
Commercial activities 76.3
Luxury 38.2Retail – Perfume &
Cosmetics 1.08 4.2% 0.05Restaurants 38.2 Retail - Restaurants 0.82 4.2% 0.03
Real Estate A c c e ss f ee s 152 . 2 M g m t / S e rv i c e s 0 . 4 7 16 . 7 % 0 . 0 8
Firm total 912.7 100.0% 0.82
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Since Ryanair and American Airlines operate in a single business we used the respective unlevered sector average betas (for European and US firms) to compute bottom-up betas.
Bottom-up betasAfter estimating unlevered beta for each firm we levered back the beta to estimate a firm beta
that reflects the additional risk associated with financial leverage. The sector betas were unlevered and
re-levered using the formulae bellow:
{3unle vered
Where:
•T
f3ma rket
(1+ (1- T)(D I E)
applicable tax rate;
f3te vered = f3unte vered x(l + (1 - T )x(D I E))
• D /E market value of debt / market value of equity
The market value of equity has been computed as current share price multiplied by the number of
shares outstanding. Details of the computation of the market value of debt are presented in Figure 21.
Figure 17 Beta estimation - summaryAmerican
Beta measure Airlines Ryanair BAA Asur
Top down Beta 4.67 1.21 0.35 0.99
Bottom up Beta (levered) 6.26 1.24 1.42 0.82
Industry avg. Beta (levered) 1.34 1.80 0.95 0.88
3. Cost of equity
The computed bottom up beta has been use to compute the cost of equity for the firms. This is the
return expected return by equity investors in the observed companies and an important input for the
calculation of the overall cost of capital. The cost of equity has been calculate using the Capital Asset
Pricing Model and includes the following inputs:
• Risk free rate of return (Rf) -in estimating the cost of equity we have used long term government
bond denominated in the respective currency to come up with the risk free. The current 10 year
US, German and UK bond yields were used in the analysis for AA, Ryanair and BAA respectively.
The 10 year maturity of the bond used reflects the long term investment horizon of the likely
projects. Other periods should be considered for shorter term projects. The analysis for Asur is
done in US dollars and the relevant risk free rate used in the analysis is the 10 years US treasure
bond.
• Market risk premium (Rp)- this measure reflects the excess return to which an investor is entitled
as a compensation for the higher risk he / she undertakes by investing in risky security rather than a
??
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riskless one. We have used the geometric average of excess returns from the US market over long term Treasury bonds for the period between 1929 and 2004. We assumed that the US market, being the largest and most mature capital market in the world is a good proxy for the market risk premium required by the investors. In the case of Asur, we added an additional country risk premium of 1.8%, to account for the increased risk to equity investors of investing in a Mexican- based company. The country risk premium is based on the Mexican sovereign debt rating of Baa (spread of 1.2%) and relative volatility of equity compared to bonds (assumed to be 1.5 times). The country risk premium applied to Asur was 1.8%
Beta – as computed above.The cost of equity, for all companies except Asur, is defined as:Ke = Rf + β x Rp
The cost of equity for Asur, is defined as:Ke = Rf + β x (Rp+Country Risk)
We did not add any country risk premium for AMR, Ryanair or BAA, since the US, Republic ofIreland and the UK are all AAA rated countries.
The cost of equity computation is summarized in Figure 18.
Figure 18 Calculation of cost of equityCost of Equity American Airlines Ryanair BAA AsurRisk Free Rate 4.27% 3.47% 4.5% 4.24%Beta 6.26 1.24 1.42 0.82Risk Premium 4.82% 4.82% 4.82% 4.82%
C oun t r y R i sk - - - 1 . 80 %
Cost of Equity 34.54% 9.45% 11.30% 9.65%
4. Cost of debt
The other important component of the cost of capital is the cost of debt. It reflects the perceived risk of the companies by lenders and debt investors, or its credit risk. The two components of credit risk are default risk (or the probability that a company will cease making payments as agreed in the credit agreement) and non-recovery risk (or the probability of
24
recovery of the capital provided, once the company goes in default). More detailed analysis of the borrowing policies of all firms is presented in Section VII Capital Structure.
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The cost of debt for each company has two components – a risk free rate of return and compensation for the credit risk associated with the company. In estimating the credit risk for each company we took 2 approaches:
For American Airlines and BAA we looked at the current credit rating of the company.
The companies had recently issued traded bonds which represent a good indicator of the risk of their debt and hence we used the implied default read on long term publicly traded debt.
Since Ryanair has not issued any publicly traded debt, we computed synthetic credit
rating for the firm based on its interest rate cover ratio. Asur currently has no debt.
After obtaining the respective credit ratings we looked at the credit default spreads corresponding to each rating, which is a measure of the risk premium required. For AA and BAA we used the credit default spread embedded in current yields of publicly traded debt. We computed the cost of debt for each by adding the default spread to the risk free rate for the respective company. The results are presented in Figure 19.Figure 19 Calculation of cost of debt
Cost of debt American Airlines Ryanair BAA AsurCredit RatingSpread vs. Treasury (a)
CCC9.66%
A-1.00%
A+0.70%
n.a.0.00%
Risk Free Rate (b) 4.27% 3.47% 4.47% 0.00%Pre-tax Cost of Debt (c) = (a) + (b) 13.93% 4.47% 5.17% 0.00%Marginal Tax Rate 35.00% 12.50% 30.00% 33.00%
After Tax Cost of Debt (c) * (1-tax rate) 13.93% 3.91% 3.62% 0.00%
After computing the cost of debt for each firm we computed the after tax cost of debt. The after tax cost of debt reflects the fact that interest payable on debt is deductible from the operating income for tax purposes and results in tax savings for the firms.
In the case of American Airlines, the company cannot benefit from lower tax bill by financing its operations with debt. The company has net operating loss before interest and hence pays no taxes. In addition American Airlines has a huge accumulated tax loss, which could be carried forward and
26
used to offset future taxable income. Therefore the company does not enjoy tax benefits from the use of debt and we excluded this component from the cost of capital calculation.
27
5. Cost of capitalM a r k e t v a l u e o f e q u i t yThe market value of equity for each firm has been estimated by
multiplying the number of shares outstanding for each company by the current share price. The market values of equity are presented in Figure 20.Figure 20 Market values of equity
Market Value of Equity (million) American Airlines Ryanair BAA Asur
M a rk e t V a l u e o f E qu i t y ( m i l l i on ) 1 , 862 . 2 4 , 352 . 4 6 , 153 . 3 912 . 7
Source: Bloomberg
M a r k e t v a l u e o f d e b tIn estimating the market value of debt we again took two approaches:
Use the current value for debt that is publicly traded and information is obtainable;
Project interest and principal payments and discount them back at the current cost of debt as estimated above.
In projecting the interest payments we have used the current interest payments to book value of debt ratio as a proxy for the average interest rate payable on the debt; and the average maturity of the outstanding debt.
In addition, AA, Ryanair and BAA have significant operating lease commitments, which are
not recorded in their books. Such commitments require that the firms make regular payments to the lessors in exchange for the use of assets (aircrafts, real estate). Such transactions are treated as rent for accounting purposes and lease payments are recorded as operating expense. The essence of the transaction, however, is financing the use of the assets and lease payments could be viewed as interest and principal repayment of a loan provided for the acquisition of the assets. Moreover, the companies are committed to making these payments for a long period of time.
We treated lease commitment as another form of debt and discounted the future lease payments at the current cost of debt to estimate their current market value. The present value of all future lease payments have been included in the market value of the companies’ debt and the operating income has been adjusted by adding back the operating lease
28
payment and subtracting the estimated depreciation charge associated with recording the leased assets in the companies’ books.
Summary of the market value of debt calculation is presented in Figure 21.
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Figure 21 Estimation of market value of debtMarket value of debt (million) American Airlines Ryanair BAA AsurBook Value of Debt 14,254.0 1,178.7 4,578.7 -Current cost of debt 13.93% 4.47% 5.17% 0.00%Average maturity 7.3 6.4 11.1 -Interest Expense 894.0 53.3 143.0 -Market Value of Debt (a) 6,261.3 1,179.6 4,618.2 -
P V o f Op e r a t i n g L ea s e s (b ) 5 , 822 . 5 7 181 . 6 4 388 . 8 2 -
Total Market Value of Debt (a) + (b) 12,083.9 1,361.3 5,007.1 -
D e b t a n d E q u i t y r a t i o sThe market values of debt and equity have been used as weights in
calculating the weighted average cost of capital.
Figure 22 Capital weightsAmerican
Airlines RyanairIndustry
Avg.* BAA AsurIndustry
Avg.**Market Value of Equity (a) 1,862.2 4,352.4 6,153.3 912.7Market Value of Debt (b) 12,083.8 1,361.3 5,007.1 -Firm Value (a) + (b) 13,946.0 5,713.7 11,160.4 912.7D/(D+E) 86.65% 23.82% 33% - 49% 44.86% 0% 9% - 35%
E / (D + E) 13 . 4 % 76 . 2 % 67 % - 51 % 55 . 1 % 100 % 91 % - 65 %
Source: Bloomberg, own analysis, www.damodaran.com * A i r li n e T r an s po r t a t i o n i ndu s t r y , ** A i r po rt ma i n t e nan c e a n d op e r a t i o n i ndu s t ry
Comparing the debt ratios for the analyzed companies to the industry average we observe that AA’s financial leverage is significantly higher than that of the average for the sector (between 39% for European companies and 49% for US airlines.). On the other hand, Asur is rather unusual in its industry since it does not have any debt.
These inputs are used in computing the cost of capital for each firm. The weighted average cost of capital is computed as follows:
W A C C = K e x E / ( D + E ) + K d x D /( E + D )The inputs and results are summarized inFigure 23.
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Figure 23 Calculation of cost of capitalCost of capital American Airlines Ryanair BAA AsurBeta 6.26 1.24 1.42 0.82Cost of Equity 34.54% 9.45% 11.30% 9.65%E/(D+E) 13.35% 76.18% 55.14% 100.00%After-tax Cost of Debt 13.93% 3.91% 3.62% 0.00%
D / (D + E) 86 . 65 % 23 . 82 % 44 . 86 % 0 . 00 %
WACC 16.69% 8.13% 7.85% 9.65%
Not surprisingly the company with highest cost of capital is American Airlines, reflecting its high risk. The high cost of capital is driven by two factors – high beta (volatile earnings and high debt to equity ratio) and high cost of debt (low credit rating because of high debt and huge interest payments). The lowest cost of capital, that of BAA, reflects the fact that the company is relatively mature and stable, with predictable earnings and cash flows and is less subjective to market fluctuations.
The estimated cost of capital of and cost equity are the hurdle rates that should be used in
capital allocation decisions in each company. These are the minimum acceptable rates against performance of each new project considered should be measured – return on equity against the cost of equity and return on capital against cost of capital. In addition, the cost of equity and cost of capital rates are the rates at which projects’ cash flows should be discounted to estimate their net presentvalue.
VI. Investment Return Analysis
The ability of each firm to grow and create value for its stockholders ultimately depends on its management capability to identify and undertake projects that generate returns exceeding the cost of capital employed. In this section we will analyze the quality of the projects that the four companies undertake ad review the past performance of the companies as measured by indicators such as Return on Capital (ROC) and Return on Equity (ROE).
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1. Typical project
The companies, subject to our analysis are involved primarily in 3 types of businesses – air transportation, aeronautical services and retail services. Aeronautical services include operation and maintenance of airport and all related facilities that are used by passengers and airlines. Some of the characteristics of a typical project for each business are presented in Figure 24.
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Figure 24 Typical projectsBusiness Typical Project / Flow Characteristics
Airlines
Aeronautical Services
Retail
Fleet Acquisition: Long term payment, Long life of the assetNew Route Opening: local offices and labor force. Long term and different currenciesSet up of new bases – long term, may have option value to expand in new routes at a later stage.New Terminal buildings and maintenance. Long term, single currencyCash flows are volatile and sensitive to macroeconomic risk factors. Medium to long termCash outflows that are primarily in local currency,but there could be a significant dollar componentCash inflows that are almost exclusively in local currencyPart of cash flows related to passengers can be volatile and sensitive to global risk factors.Another significant part of cash flows is less volatile as it consists of fixed payments made by airlines for use of facilities and servicing. Medium termCash outflows that are almost exclusively in local currencyCash inflows that are primarily in local currency, but there could be a significant dollar component
Can be very volatile, specially sensitive to global risk factors
In general, the time horizon of the core businesses of companies is long term with the exception of the retail business which has shorter duration of its projects. Airline and retail businesses cash flows are sensitive to macro risk factors and certain cyclicality (following the economic cycles) might exist. Aeronautical services business, however, is less exposed to such cyclicality as the bulk of its revenues are generated from long term contracts with airlines for the use of their facilities. Even in the case of an airline to meet its payments, big international hubs such as Heathrow and Gatwick operated by BAA have a solid backlog of airlines, which are ready to purchase potentially available landing slots.
2. Measuring Returns
ROE and ROC
For each of the company we computed the Return on Equity (ROE) and Return on Capital (ROC) as follows:
where:
ROE = NetIncome
33
(BVEt + BVEt !1 )
/ 2
ROC =Op.Income(1 ! T )
(BVEt + BVDt + BVEt !1
+ BVDt !
1 ) / 2
34
BVE - book value of equityBVD - book value of debtT - tax ratet - time period
The historical returns are presented inFigure 25 and Figure 26.
Figure 25 ROE, ROC and industry averages
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
American Airlines Ry anair BAA Asur
16.00%14.00%12.00%10.00%8.00%6.00%4.00%2.00%0.00%-2.00%-4.00%
ROE ROC ROE (indusry average) ROC (industry average)
Source: Analysis and industry average from www.damodaran.com
Figure 26 Investment returnsAmerican
Airlines Ryanair BAA AsurROE n.m.3 14.69% 8.50% 5.15%ROC 8.54% 16.94% 5.59% 4.76%
E c o n o m i c V a l u e A d d e d
We further compared the obtained returns to the cost of equity and cost of capital. The results are presented in Figure 27 and Figure 28.
3 The ROE calculation is not meaningful as it has negative net earnings and negative book value of equity
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Figure 27 Equity Economic Value AddedAmerican
Airlines Ryanair BAA AsurROE (a)4 nm 14.69% 8.50% 5.15%Cost of Equity (b) 34.54% 9.45% 11.30% 9.65%Equity Return Spread (a)-(b) nm 5.24% -2.80% -3.23%
Av e r a g e boo k v a l u e o f e qu it y (268 . 0 ) 1 , 574 . 7 4 , 797 . 0 1 , 057 . 7
Equity EVA n.a 82.5 (134.5) (47.6)
From the companies included in the analysis only Ryanair created excess returns on equity
(Return in Equity – Cost of Equity). It created a positive equity economic value added (EVA) of €82.5 million based on the last 12 months results. At the same time the airline industry destroyed on average value of $ 4,95765.7 in 20045. Both BAA and Asur had return on equity lower than their cost of equity. Comparing these results with the positive Jensen’s alpha values calculated in Section IV, we can conclude that although both firms performed better that the market expected, they still have not generated equity returns in excess of their equity costs.
Multiplying the spread between the return on capital and cost of capital for each company by the average book value of total capital (equity + debt) we estimated the economic value added for each firm.Figure 28 Economic Value Added
AmericanAirlines Ryanair BAA Asur
ROC 8.54% 10.14% 5.59% 4.76%Cost of Capital (b) 16.69% 8.13% 7.85% 9.65%Capital Return Spread (a)-(b) -8.15% 2.01% -2.27% -4.89%Average book value of capital 13,862.5 2,652.8 8,427.0 1,057.7
EVA (million) (1,129.5) 53.3 (191.0) (51.7)
Again the only company that created value during the observed period was Ryanair. The average EVA for the sector in 2004 was $9,551.76
3. Future outlookThe ability of any of the companies to generate positive excess returns depends on its competitive
36
advantages and their sustainability in the medium and long term. In this section we look at some key
4 The ROE calculation is not meaningful as it has negative net earnings and negative book value of equity5 Equity EVA for US market used as a comparison. Source: www.damodaran.com6 EVA for US air transportation sector used as comparable. Source: www.damodaran.com
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indicators for the air transportation sector, which could help us to understand how the companies are positioned for the future.Figure 29 Comparison of key figures – airline transportation
Traditional and low cost air carriers at a glance AMR RyanAirUS Industry
AverageEU Industry
AverageRevenue Yield per Passenger Mile (RAPM) ($ cents) 11.5 n.a. 12.3 15.8Load Factor 72.8% 84.0% 73.4% 64.8%Number of Planes 1,013 79 213 80.9Revenue per Employee ('000 $ or EURO) 202.4 489.3 174.6 n.a.Average Age of planes 12.5 n.a. 11.2 n.a.Source: AMR annual Report, Ryan Air Annual Report, ATA (Air Transport Association), AEA (association of EuropeanAirlines) and Elfaa (association of low fares airlines) Economic reports
The analysis suggests that while Ryanair is relatively small airline in terms of number of aircrafts it has more efficient operations which is evident from higher load factor (seats capacity utilization) and higher revenues per employee ($635K7 compared to $202K for American Airlines). Further analysis supports the fact that Ryanair relies on operational efficiencies to maintain its costadvantages:Figure 30 Key Performance IndicatorsKPI Ryanair Low cost carriers Industry Average
Passenger per employee 10,050 6,000 1,069Average fare (Euros) 40.0 86.3 206.6Lost bags per 1000 passengers 0.5 n.a. 11.3Employees per aircraft 35 n.a. n.a.Schedule on time 93.0% 85.0% 81.2%
Source:Ryanair, Association of European Low Cost Airlines (www.elfaa.com)
On average Ryanair benefits from much higher passenger to employee ratio and much lower employees to aircraft ratio, which helps the company to maintain cost efficiency. Indicators such as lost bags per 1,000 and schedule on time suggest operational efficiencies and customer satisfaction. One of the reasons for this is the structure of the aircraft fleet that Ryanair uses as compared to its peers – Ryanair currently employes predominantly two types of aircrafts – Boeing 737-200 and Boeing737-800 and a program whereby all aircrafts will be replaced with 737-800 machines is in place.American Airlines, on the other hand, has a large fleet comprising of 11
38
different types of aircrafts, which have different technical and maintenance requirements, adding to the costs of the company.Composition of the fleet is presented in Figure 31.
7 At approximate exchange rate of $1.3 per Euro 1
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Figure 31 Composition of the aircraft fleet – American AirlinesNumber of Number of different Average Age
Age and Costs planes models (years)Long Haul 727 7 12.5Short Haul 286 4 4.8
T o t a l 1 , 01 3 1 1 10 . 3
Source AMR and ATA Economic Report
C o n c l u s i o n sIn conclusion, we believe that in the medium term Ryanair can sustain
competitive advantages which will allow the company to earn return on capital in excess of its cost of capital. The company has an investment program aimed at increasing its capacity from the current 15 million passenger per year to 50 million by 2010. This would enhance Ryanair’s growth, however at the expense of huge capital spending.
American Airlines, on the other hand is facing fierce competition in a market where it clearly lacks significant competitive advantages. Excess domestic capacity, fragmented market and increasing competition from low cost carriers such as JetBlue and SouthWest Airlines are all factors that have negative impact on the company. We believe that the renewal of the fleet is crucial for AMR: the current aged and too diverse fleet generates, by itself, an inefficient cost structure (more maintenance costs, different training for pilots and mechanics, different scheduling of engines check up). Moreover the average age of AMR fleet is over 10 years and this represent a huge cost in term fuel (old airplanes are less efficient) landing fees at the airports (old airplanes are heavier) and customer satisfaction (old airplane are less comfortable and therefore less attractive). Finally the company is targeting expansion in international markets, where it believes it can enjoy higher growth an margins, but new long haul planes are needed to successfully compete in that arena. AMR average age of long haul planes is close to 13 years. Overall we believe that AMR as a traditional flag carrier should focus on the international long haul segment (not threatened by low cost carriers, as passenger need to be comfortable in a long trip) by renewing its fleet on offering a vast network of routes thanks to international alliances.
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Returns on capital and operating margin long term are going to be positive again, but below the peaksof the mid nineties.
In the case of BAA what project it takes and the associated returns depend on negotiations with the CAA, the regulatory authority. Negotiations take place every place 5-years with the next one scheduled to be in March 2008. Tariffs are currently set below their market prices and the consequence of this is that BAA shareholders are subsidizing the airlines landing at its airports. We
41
think that this situation is very unlikely to change in the short term, at least until the new review inMarch 2008.
Similarly for Asur, the company faces mandatory capital investments which are negotiated with the Mexican Ministry of Communications and Transportation every five years. In the coming years, Asur’s main investment project will be the construction of a second runway at the Cancun airport, to handle the higher than expected growth in passenger volumes. This project has already been moved forward five years from its original start date, signaling the company’s strong confidence in its growthprospects for the coming years.
VII. Capital Structure Choices
1. Current financing mix
Figure 32 below summarizes the current debt structure of American Airlines, BAA and Ryanir (Asur has no debt). As can be observed, the three companies employ very different kinds of debt:
A m e r i c a n A i r l i n e sAA has outstanding a wide variety of notes, from bank debt, plain vanilla bonds to more structured debt instruments. On one hand this is driven by the necessity to tailor the debt to match the company’s cash flow profile and risk, which is very specific. On the other hand this is a symptom of the financial difficulties the company has been going through and the need to raise capital in any form it was available. With this respect, it is worth noticing that the BoD has even authorized (but not yet issued) the emission of 20million preferred shares.
R y a n a i r
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Ryanair has only bank debt outstanding and this is a reflection of both the early stage of the life cycle is in and its ability to generate cash flows, thus funding growth largely with internal funds. We expect the financing mix to change as the company continues to expand and it will need to access the public bond markets to fund its future projects.
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B A ABAA’s debt is almost all made up by straight bonds (82% of the total), with the rest coming from bank debt and two outstanding convertible bonds issues. This is due to the high stability and predictability of its cash flows, which has given BAA easy access to the public the bond markets. The company has issued substantial debt over the last years (Gross Debt went from approx. £1.0 bn in 1995 to over £4 bn today with D/E climbing from 20% to 81%) as a result of the expected capex expenditures connected with the fifth terminal at Heathrow and other projects.
A s u rAsur has no debt outstanding as it has been able to fund all its capex requirements through internal cash-flows.
Figure 32 Current debt characteristics
Company Type of Financing Amount (mm)Secured Variable and Fixed rate
Interest Rate onBooks Maturity
Americal Airlines
indebtness 6,340.0 2.03% - 9.16% 2021Enhanced Equipment trustcertificates 3,707.0 2.14% - 9.09% 2011Special facility revenue bond 946.0 6.00% - 8.50% 2036Credit Facility Agreement 850.0 9.150% 2010Senior Convertibles Notes 619.0 4.25% - 4.50% 2023-2024Debentures 330.0 9.00% - 10.20% 2021Notes 303.0 7.88% - 10.55% 2039
O t h e r 1 , 159 . 0 Straight Bond 200.0 7.875% 2007Straight Bond 400.0 5.750% 2013Straight Bond 300.0 11.750% 2016Straight Bond 250.0 8.500% 2021
BAA Straight Bond 200.0 6.375% 2028Straight Bond 900.0 5.750% 2031Straight Bond 750.0 4.500% 2014Convertible Bond 424.0 2.940% 2008
C onv e r t i b l e B on d 425 . 0 2 . 625 % 200 9 Secured bank debt 80.3 n.a. 2005Secured bank debt 84.2 n.a. 2006
Ryanair Secured bank debt 88.1 n.a. 2007Secured bank debt 92.1 n.a. 2008
S ec ur e d b a n k d e b t 608 . 2 n .a . 200 9 - 201 6
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In addition to the balance sheet debt 3 of the 4 companies analyzed have relevant off-balance sheet items related to operating leases that we summarize below.
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Figure 33 Debt embedded in operating lease commitments
Off Balance Sheet Debt American Airlines Ryanair BAA AsurPV of Operating LeasesAs a % of total market value of debt
5,822.57
48%
181.64
13%
388.82
8%
-
2. Trade off on Debt and Equity
Each company advantages and disadvantages of debt are analyzed in the table on the next page.
Figure 34 Assessment of Debt / Equity Trade offFactor American Airlines Ryanair BAA AsurAdded discipline AMR debt is so overwhelming that an increase in debt
would not be a benefit for the company. TheRyanair's stockholder base is quite concentrated and major shareholders are
BAA would not benefit from an increase in debt as it is already very close to its optimal
The additional debt is likely to provide little in added
management is struggling to bring the p&l back to represented in the management. The added debt ratio and an increase would therefore management discipline, sinceblack in order to be able to meet the payments for the discipline from increased debt would not be push up its cost of capital. Furthermore there is Asur is a highly regulateddebt major benefit for the company very little to gain from a discipline perspective company with strong
given the highly regulated environment in shareholder representation inwhich it operates, which already restricts management and a primarilymanagement discretion institutional shareholder base
Tax benefits Since the company has been losing money in the past 5 years, there are no tax advantages related to the use of
The marginal tax rate of the company is12.5% while the effective tax rate is only
BAA effective tax rate is 30% with nearly no variation over the years and it is equal to the
Asur could derive a significant tax benefit if it carried some debt
debt. Moreover due to high tax losses carried forward it 9.6% (9.5% average over the last 3 years) marginal tax rate in its balance sheet, since it facesis quite likely that the company is not going to pay a 33% marginal tax ratetaxes in the next few years. This is also reflected in ourCost of capital calculations
Bankruptcy risk With a negative book value in the past 3 quarters, a negative operating income in the past 4 years and a
The earnings of the company have been growing steadily, although in the long term
Bankruptcy risk is very remote thanks not only to the very stable nature of its cash flows, but
Given that Asur's cashflows are highly sensitive to external
88% debt ratio the company is clearly risking this might be more difficult to sustain. In most importantly to the regulatory shocks, it would facebankruptcy. The company has no sustainable general, the company is less volatile to the environment and the resulting indirect considerable bankruptcy costs ifadvantage in the competitive arena and in the 2004 economic cycle relative to its peers because oversight on its activities exercised by the it were to carry significantannual report the management stated that "the reduced of more efficient cost structure. In addition, British government through the Civil Aviation amounts of debtpricing power, resulting mainly from greater cost it provides low price services which might Authoritysensitivity on the part of travelers (especially business be preferred in times of recession, i.e. sometravelers), increasing competition from low-cost counter-cyclicality may exist.carriers and the continuing increase in pricingtransparency resulting from the use of the Internet, willpersist indefinitely and possibly permanently".
Agency costs Typical projects for the company are expansion of aircraft fleet and set of of new hubs. Funds are easy
Typical projects for the company are expansion of aircraft fleet and set of of new
Agency costs are minimized by the restrictions imposed on the projects BAA can take and the
Asur's well-regarded management team is largely
track and agency costs are not expected to be high hubs. Funds are easy to track and agency return on capital is allowed to earn, which is drawn from the ITA consortiumcosts are not expected to be high negotiated with the CAA every 5 years. Given which is the largest shareholder
these factors, BAA's stock has very similar in the companycharacteristics to a bond, minimizing thereforeconflicts of interest between stockholders andlenders
Future flexibility The company has at the moment no financial flexibility: covenants on debt are stringent and the
As the company is in its growth phase, the need for financial flexibility is high.
The company has in theory excess debt capacity, although using debt to fund new
Given Asur's considerable visibility on its investments
price war on the market can be met only renewing the Ryanair has a big number of projects - projects (assuming similar returns to the requirements, additional debt isfleet. The company also intend to expand in the launching new routes and setting up new current ones) would be value destroying, given unlikely to take away muchinternational markets in search for higher growht and bases every year and the ability to take such the current negative ROC-WACC spread. future financing flexibilitymarkets, but do not have the financial resources to fully projects in the future depends on its Notwithstanding this, BAA plans to use debtsupport such initiatives. financial flexibility. to fund the very large capital commitments it
will face over the next 5 Year, which arealmost totally due to the construction of a fifthterminal at Heathrow (2004-2009 totalexpected capex is over £6.0 bn. with averagecapex/sales climbing from 27% in 1993-2003
t o 49 % i n 2004 - 20 0 9 )
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Based on the above analysis, we draw the following conclusions: BAA and Asur have the ability to carry higher debt ratios given the
relative stability of their cash flow profile compared to Ryanair and American Airlines. Whereas BAA debt ratio is a at the correct level, Asur has substantial untapped debt capacity which it should use
Given its profitability (and the resulting capacity to reap the tax advantages of debt) and relative lower sensitivity to economic cycles compared to other airlines, Ryanair should be able to have a higher debt ratio.
American Airlines debt ratio is clearly too high, even though it must be noted that AA’s distress
is more the result of its negative operating profitability than excessive debt in the first place.
VIII. Optimal Capital Structure
1. Current Cost of Capital / Financing MixIn the table below we computed the current cost of capital for each of
our companies, with the cost of equity based on a levered bottom-up beta and using market values to compute the debt/equity weights. As expected given their operating and financial profiles, American Airlines has the highest cost of capital and BAA the lowest. Asur’s cost of capital is equal to its cost of equity given that it is only equity financed.
Figure 35 Current cost of capital and inputs for calculation of optimal cost of capitalCost of capital - summary American Airlines Ryanair BAA AsurCost of Equity 34.54% 9.45% 11.30% 9.65%After-tax Cost of Debt 14% 4% 4% 0%D/(D+E) 87% 24% 45% 0%E/(D+E) Rating
13% CCC
76% A-
55% A+
100%Not Rated
Stock Price 10.2 5.77 5.8 30.45Cost of Capital 16.69% 8.13% 7.85% 9.65%Firm Value (million) 13,946.0 5,713.7 11,160.4 912.7
2. Cost of Capital at Different Financing MixesAs the next step in our analysis to estimate the optimal capital
38
structure we used the cost of capital approach to compute a different WACC at each debt ratio for our companies. The table belowsummarizes our results
Cost of capital
39
Debt Ratio American Airlines Ryanair BAA Asur0.0% 10.07% 8.16% 8.82% 9.65%10.0% 9.76% 8.09% 8.58% 9.48%20.0% 9.63% 8.13% 8.39% 9.39%30.0% 10.96% 8.71% 8.24% 9.56%40.0% 11.78% 11.30% 8.18% 9.93%50.0% 13.86% 13.33% 8.90% 12.01%60.0% 20.06% 14.53% 11.03% 12.48%70.0% 22.06% 21.40% 14.79% 13.89%80.0% 24.06% 23.40% 15.99% 14.50%90.0% 26.06% 25.40% 17.19% 15.11%
Based on the objective of minimizing the cost of capital, the table above yields the following results:
American Airlines: assuming a normalized EBIT of $ 2600million (which results in a ROC of
8.54%, American Airlines should reduce its debt/capital ratio from the current 87% to 20%.
Ryanair: contrary to the result of our qualitative analysis, this analysis shows that Ryanair is currently over levered and should decrease its debt/capital ratio from its current 24% to 10%.
BAA: BAA is currently at its optimal capital ratio (the actual optimum is at the current debt ratio of around 45%). The higher optimum can be explained by the low variability and uncertainty of its operating profitability due to the regulatory environment in which BAA operates. This enables the management to design the company’s debt profile with a low level of error.
Asur: The company is clearly under levered and should move to a 20% debt/capital ratio in order to maximize firm value.3. Firm Value at OptimalThe following tables present the computed expected Firm Value and
Stock Price (both assuming positive growth and no growth) if our companies were to move to their optimal capital ratios.
( 2 )
40
Figure 36 Effect of moving to the optimal capital structure
AmericanOptimal Ratios
Airlines Ryanair BAA Asur Cost of Equity 11.01% 8.62% 11.30% 10.56% After-tax Cost of Debt 4.07% 3.34% 3.62% 4.72% D/(D+E) 20.00% 10.00% 44.86% 20.00% E/(D+E) 80.00% 90.00% 55.14% 80.00%
A- (probably capped atRating BB+ AAA A+ BBB)Current stock price 10.20 5.77 5.8 30.45Cost of Capital 9.63% 8.09% 7.85% 9.39%
Firm Value (1) (million) 24,173.0 5,742.7 11,160.4 938.1
Firm Value (2) (million) 33,107.3 5,763.7 * 951.2
Stock Price at optimum (1) $74.99 $5.80 * 31.30
31 .7 4 S to ck P r ic e at op t imu m $130 .4 1 $5 .8 3 *
(1) assuming no growth, (2) assuming 3% growth* BAA is currently at its optimum debt ratio
Figure 37 Firm value at the optimum capital structureFirm value at structure
optimal capital AmericanAirlines Ryanair BAA Asur
Debt Ratio Current 86.65% 23.87% 44.86% 0%Optimal 20.00% 10.00% - 20%
Rating Current
Optimal
CCC
BB+
A-
AAA
A+
-
Not Rated A- (probably
capped at BBB)
Cost of Capital Current 16.69% 8.13% 7.85% 10.13%Optimal 9.63% 8.09% 7.85% 9.59%
Firm Value (1) Current 13,946.0 5,716.8 11,160.4 912.7
Optimal 24,173.0 5,742.7 11,160.4 963.5
Change in firm value 10,227.0 25.9 0.0 50.8(1) assuming no growth
As the table shows American Airlines is the company that would benefit the most from the transition, whereas the effect on Ryanair and Asur’s value would be more limited. More in detail:
American Airlines: a strong deleveraging (from 86.65% to 20% debt/capital) will be difficult to execute in the short term, barring a Chapter 11 situation which in any event would significantly impact the equity value as well. The crucial aspect is that we believe that AMR cannot but maintain current Capex. We therefore believe that even though necessary, moving to the Optimal capital structure is going to
41
be a very long process. More specifically, the company needs to reinvest in the fleet (particularly the long haul fleet: the only one that cannot be
42
threatened by low cost carriers, and the one that is operating where the company believes the higher growth and margins are) in order to be able to compete in the market and get back to profitability.
Ryanair: the company should focus on reducing its debt/capital ratio by raising more equity
capital to fund its future projects, instead of using debt as it has done in the last years.
Asur: raising its debt ratio by issuing debt would benefit the company not only from an increase in firm value, but also from opening a new capital source, therefore facilitating access to it in the future. We estimate, that although Asur’s interest coverage ratio at its optimum 20% debt ratio would warrant an A- rating, this would probably be capped at BBB, which is the sovereign debt ratio for Mexico.
4. Optimal capital structure – APV approcahWe also applied the APV approach with American airlines in order to
verify the optimal capital structure we have identified earlier. Given its state of financial distress we believed that this additional approach can give us more insight about their real debt capacity.
Our basic assumptions in this process are:
Cost of Bankruptcy: direct and indirect costs of bankruptcy are estimated very high given the high capital intensive business model and the complex regulations of the industry. Our guess estimate is45% of firm value.
Tax rate is assumed at 35% stable Unlevered firm value is calculated as Current Firm Value – tax benefits on debt + Expected
Bankruptcy cost.Figure 38 APV optimal capital structure - assumptions
BasicAmerican Airlines AssumptionsCurrent Debt ratio 86.8% Unlevered Firm Value = $12,615.13Current Firm Market Value $13,923.99
43
Tax rate 35% Debt Market value $12,083.85Tax Benefits on Debt $4,229.35Expected Bankruptcy costs 45% Bankruptcy probability 47% Cost of Bankruptcy $2,920.49
44
We have undergone an iterative process that yielded us the capital structure that maximize the firmvalue.
Figure 39 AA optimum debt level – APC approachUnlevered ExpectedDebt
ratio $ Debt Tax
Rate FirmValue
Taxbenefit Rating
Prob ofDefault Bankruptcy
Costs
Value ofFirm
0% $0.00 35% $12,615.13 $0.00 AAA 0.01% $0.57 $12,614.5710% $1,307.21 35% $12,615.13 $457.52 AAA 0.01% $0.59 $13,072.0720% $2,707.69 35% $12,615.13 $947.69 A+ 0.40% $24.37 $13,538.4630% $4,198.77 35% $12,615.13 $1,469.57 A- 1.41% $88.80 $13,995.9040% $5,515.42 35% $12,615.13 $1,930.40 BB 12.20% $756.99 $13,788.5450% $6,687.62 35% $12,615.13 $2,340.67 B 26.26% $1,580.55 $13,375.2560% $7,457.22 35% $12,615.13 $2,610.03 CCC 50.00% $2,796.46 $12,428.7070% $9,010.81 35% $12,615.13 $3,153.78 CCC 50.00% $2,896.33 $12,872.5980% $10,679.48 35% $12,615.13 $3,737.82 CCC 50.00% $3,003.60 $13,349.3587% $11,072.48 35% $12,615.13 $3,875.37 0 65.00% $3,731.89 $12,758.61
90 % $11 , 614 . 9 6 35 % $12 , 615 . 1 3 $4 , 065 . 2 4 C C 65 . 00 % $3 , 774 . 8 6 $12 , 905 . 5 1
Source Aswath Damodaran, AMR Annual Report, our estimates
The analysis yields us an optimal debt ratio of 30%, not far from the results obtained with the optimal capital structure model.
However, given the high subjectivity of the bankruptcy cost, we have run a sensitivity analysis that, taking into account also the tax rate, provide a measure of the debt ratio that maximize the firm value.Figure 40 Sensitivity analysis – tax rate (horizontal axis) and bankruptcy costs (vertical axis)
$0.30 20% 25% 30% 35% 40% 45% 50% 55% 60%20% 80% 80% 90% 90% 90% 90% 90% 90% 90%25% 30% 80% 80% 80% 90% 90% 90% 90% 90%30% 30% 30% 80% 80% 80% 90% 90% 90% 90%35% 30% 30% 30% 80% 80% 80% 80% 90% 90%40% 30% 30% 30% 30% 80% 80% 80% 80% 90%45% 30% 30% 30% 30% 30% 80% 80% 80% 80%50% 30% 30% 30% 30% 30% 30% 80% 80% 80%55% 30% 30% 30% 30% 30% 30% 30% 80% 80%60% 30% 30% 30% 30% 30% 30% 30% 30% 80%65% 30% 30% 30% 30% 30% 30% 30% 30% 30%70% 30% 30% 30% 30% 30% 30% 30% 30% 30%
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5. Sector and market debt ratiosS e c t o r d e b t r a t i o sIn addition, we looked at the sector and the debt ratios at which other
firms in the air transportation industry operate. We looked at a sample of 44 companies at analyzed their debt to capital ratios. In order to account for the difference in size, risk and tax rate we regressed the market debt ratio against ln(Revenues), beta and effective tax rate for each company. The resultant regression is as follows: M a r k e t D e b t t o C a p i t a l = 0 . 3 8 7 - 0 .2 6 0 E f f Ta x R a t e - 0 . 0 1 9 5 L n R e v + 0 . 1 3 7 3 - y rR e g r e s s i o n B e t aThe R-squared of the regression is 41.1%. The T-statistics reveal insignificance at 95% confidence interval. The results from the regression indicate the following debt ratios:Figure 41 Debt ratios based on sector information.
Variable Coefficient AA Ryanair BAA AsurConstantTax rate
0.387-0.26 0% 9.90% 29% 33.5%
LnRev -0.0195 9.83 6.98 7.59 7.59 B e t a 0 . 13 7 6 . 2 6 1 . 2 4 1 . 4 2 0 . 8 2
Predicted Debt ratio 105% 40% 36% 26%
We are quite reluctant to base our recommendations on this ratios for two reasons:
Although the relatively high R-squared of the regression the coefficients are with large standard errors and statistically insignificant (as indicated by the low T-values)
The sector as a whole is characterized by high degree of financial leverage, which might result in the regression overestimating the appropriate level of debt.
M a r k e t d e b t r a t i o sWe additionally looked at a regression based on the overall market. The regression applied is:M a r k e t D e b t t o C a p i t a l = 4 . 8 8 1 + 0 . 8 1 E f f T a x R a t e - 0 . 3 0 4 I n s i d e r h o l d i n g +0 . 8 4 1 E B I T D A / A V – C a p e x / T o t a l a s s e t sThe results are summarized below:
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Figure 42 Optimal capital structure – market regressionVariable Coefficient AA Ryanair BAA Asur
Constant 4.881Insider holdings -0.304 2.00 12.47 0.03 30.59Effective tax rate 0.81 - 9.9 29.0 33.5EBITDA/EV 0.841 7.92 9.03 9.46 13.75Capex/Total assets -2.987 2.85 10.44 12.56 3.25
Predicted Debt ratio 2.44% -14.47% -1.20% 24.61%
47
The market debt ratio regression clearly provided some controversial results for AA, Ryanair and
BAA, suggesting a negative market debt ratio, which is contrary to our previous analysis based on cost of capital or APV (for American Airlines)
IX. Mechanics of moving towards the optimal
1. A Path to the Optimal
In the table below we have listed the main cash flow characteristics of the three businesses our companies are in: Airlines (American Airlines and Ryanair), Aeronautical service and Retail (BAA and Asur). We have then listed what would be the optimal features of the debt for each business.
Figure 43 Typical projects and cash flow characteristicsBusiness Typical Project Type of Financing
Cash Flow Characteristics Debt should beAirlines
Aeronautical
Fleet Acquisition: Long term payment, Long life ofthe asset
Long term
New Route Opening: local offices and labor force.Long term and different currencies
Multiple currencies
New Terminal buildings and maintenance
Medium to long term Medium/Long termServices Cash outflows that are primarily in local currency,
(there could be a significant dollar component for Asur)Cash inflows that are almost exclusively in local currencyBAA: very stable cash flowsAsur: volatile due to exposure to tourism travel
Single currency (dollar portion forAsur)
Asur: if possible tied to influx of tourism
Retail Medium term Medium TermCash outflows that are almost exclusively in localcurrency
Mix of currencies
Cash inflows that are primarily in local currencyalthough influenced by relative strength of pound/pesoCan be very volatile, specially sensitive to global risk factors
Asur: if possible tied to influx oftourism
2. Quantitative Analysis and Overall Recommendation on Financing MixTo further evaluate the optimal debt characteristics for each company
we regressed the firm value and the EBITDA of each of our companies
48
against: Change in Long Term Rate, GDP growth, Change in local currency, Change in inflation and Change in the price of oil (only for American Airlines
49
and Ryanair). The Firm value regression results and the conclusion for each company are shown below. Regressions on EBITDA against macroeconomic variables are presented in Appendix IV.
A m e r i c a n A i r l i n e sThe current crisis of the company makes firm variations very unpredictable and driven much more by company specific issues rather than macroeconomic variables. Not surprisingly results are disappointing in terms of signs of the coefficients and T statistic significance.
Long Term Interest Rates: very weak R square and T statistic. The regression suggests that the duration of the operating assets of the company is very low. .
GDP Growth: The company’s earnings are cyclical and shows a positive coefficient with EBITDA. R-squared is fairly significant: AMR is undoubtedly a cyclical company. The negative coefficient with firm value is likely to be related to the high leverage: high GDP growth rates are usually related to high interest rates that affects negatively the firm value.
Dollar: A weaker dollar helps EBITDA, but at the same time has a slightly negative effect on firm value. Revenues in foreign currencies (about 35% of total sales) explain the relations with EBITDA, although the effect is small (probably offset by foreign currency costs and expenses). The company should use predominantly dollar denominated debt.
Inflation: Does not impact significantly EBITDA, while is negatively correlated to the firm value, probably due to the high amount of debt, hence higher discount rate.
Price of Oil: Oil seems to be completely non influent on company firm value or EBITDA.
This can be due to two factors: 1) the company has pursued an efficient hedging strategy 2) company’s firm value is driven by
50
company specific issues related to bankruptcy risk, rather than industry themes.
Based on this analysis we would suggest the company to use mainly dollar denominated debt with fixedrates.The regression results for FV are presented below
Figure 44 Regression of Firm value against macroeconomic variables
51
American Airlines Constant Coefficient T-statistic R2
Firm value (dependent variable)Change in Long Term rate 8.205 1.81 0.55 1.6%GDP growth 20.3 -4.08 -2.08 19.3%Change in Dollar 8.2 0.61 1.2 7.4%Change in Inflation 7.29 -3.3 -1.13 6.6%Change in price of oil 7.34 0.047 0.24 0.3%
R y a n a i r L o n g T e r m I n t e r e s t R a t e s : - the regression on change of
firm value on change in long term rates indicates that the average duration of the operating assets of the firm is approximately 5.3 year
G D P G r o w t h : - interestingly the firm value is positively related to the combined GDP growth of EU 15 countries (where the companies generates its revenues), while the operating income is negatively related. One possible interpretation of this is that higher GDP growth boasts company’s long term growth prospects. On the other hand, fundamentally the low cost airline model attracts more passengers during economic slowdown when travelers are generally more price sensitive, hence negative correlation with the operating earnings.
E u r o : - Alhough the value of the firm does not appear to be influenced by the Euro exchange
rate, stronger currency has significant negative impact on operating income. Therefore we would recommend use of mix of currencies in the capital structure
I n f l a t i o n : - Ryanair’s firm value seems to be significantly related to the inflation rate and our
recommendation would be to use floating rate financing. P r i c e o f O i l : - in addition, we looked at the price of oil as a facto
that might impact the firm’s value and profitability. It appeared that changes in the oil prices have little impact on the firm, which is the result of the airline’s hedging strategy. In addition, during the analyzed period Ryanair was less exposed to the increasing oil prices
Figure 44 Regression of Firm value against macroeconomic variables
52
compared to some its American counterparties as the price increases were partially offset by the loss of value of the US dollar, which is the referent currency for the price of oil.
The results from the regressions are presented in the tables below.
Figure 45 Regression of Firm value against macroeconomic variables
BAA Constant Coefficient T-statisticFirm value (dependent variable)Change in Long Term rate 8.80 -3.30 0.21GDP growth 6.60 1.72 0.20Change in GBP 10.30 -0.72 -0.04Change in Inflation 11.50 15.9 0.74
53
Ryanair Constant CoefficientT-statistic of
coefficient R2
Firm value (dependent variable)Change in Long Term rate 30.2 -5.3 -0.2 0.70%GDP growth 6.03 3.24 2.63 36.60%Change in EURO 32.4 0.68 -0.27 1.20%Change in Inflation 18.8 6.56 1.56 16.80%Change in price of oil 38.5 -0.532 -1.08 16.3%
BAA
Long Term Interest Rates: Both regressions have a negative coefficient which points to a longer duration of debt, approx. 2 years. It should be noted that the T-statistic and the R2 of both regressions are very weak.
GDP Growth: BAA is positively correlated to GDP growth but shows a low degree of cyclicality as evidenced by the coefficients.
GBP: BAA is not influenced by changes in the British Pound. Inflation: the FV regression shows a high positive sensitivity to
changes in inflation, which therefore suggests the use of floating rate debt
Based upon this analysis, we would recommend that BAA issues debt: With a high duration. Given the weakness of the regression we would
not use the coefficient number as a proxy for the duration In British pounds Floating rate
BAA’ current debt satisfies all these characteristics, except for the fact that most of the current debt is with fixed rate. The regressions results are presented in the tables below.
Figure 46 Regression of Firm value against macroeconomic variables
R2
0.6%0.2%0.0%
Figure 45 Regression of Firm value against macroeconomic variables
54
7.2%
55
A s u r
Long Term Interest Rates: the regressions on interest rates, suggest that Asur market value and EBITDA increase with higher Mexican interest rates, which is somewhat counterintuitive. A possible explanation might be that, often a rise in domestic rates is a response to higher inflation and/or a depreciation in the peso, both of which might entice more US tourists to visit Asur’s destinations. It is interesting to note the relatively high R2 of 54.4% in the EBITDA regression.
GDP Growth: Once again we note the relatively high R2s, compared to the other three
companies in our sample. Clearly, Asur’s prospects are highly correlated to economic activity as would be expected from a tourism-based company. The cyclicality of Asur’s business was quite evident after the terrorist attacks of 9/11, when its foreign passengers arrivals contracted dramatically. This leads to a recommendation for careful use of debt.
Exchange Rate: Asur’s firm value and EBITDA seems to be affected little by changes in the
value of the peso with respect to the dollar, which is, once again, a surprising result. Nevertheless, we would advise that if Asur issues debt in the future, it should do so for the most part in the domestic market and in peso denominations.
Inflation: the link between firm value and domestic inflation suggests that Asur should issue
any future debt with a variable, rather than a fixed, rate.
Figure 47 Regression of Firm value against macroeconomic variables
ASUR Constant Coefficient T-statistic R2
Firm value (dependent variable)Interest Rate (Cetes) 27.7 2.99 1.12 10.3% Mexican GDP 2.5 10.4 2.52 36.6% Exchange Rate (Peso/Dollar) 28.4 -0.98 -0.63 3.5%Mexican Inflation 163 29.7 -1.68 20.3%
3. Summary of desirable debt charachteristics
56
The profile of the ideal debt that the companies should use is presented in Figure 48 below:
48
Figure 48 Summary of desired debt featuresCompany Maturity Currency Interest rate Comments Other featuresAmerican Airlines Medium to long term, US dollars Fixed rate Analysis distorted by None, provided
despite the regression the distressed state of that the companythe firm is hedged against
sharp movement inprice of oil
Ryanair medium term (5 Euro Floating rate Analysis is distorted None, providedyears) by the growth stage of that the company
the firm is hedged againstsharp movement inprice of oil
BAA short term (2 years) British Fixed rate n.a. n.a.Pounds
Asur short to medium term Peso Floating rate n.a. n.a.
X. Dividend Policy
1. Current Dividend Policy
Of the four companies that we are analyzing, only two of them pay dividends: BAA and Asur. This is consistent with their different characteristics in terms of cash flow profile, expected growth and profitability. The main factors behind American Airlines and Ryanair not issuing dividends are the following:
American Airlines: The constraint is clearly the financial and operational distress the company is going through
Ryanair: although the company is profitable it chooses not to pay dividend given the stage of the life cycle and the consequent growth it has to fund. Investors have been rewarded by the high stock price appreciation over the last years. In addition, the management of Ryanair stated on a number of occasion that it does not intend to pay out dividends in the foreseeable future as it intends to fund a large scale capacity expansion program. The management put up the issue for a large purchase of 50 new Boeing 737-800 aircrafts for vote at the forthcoming general annual meeting.
B A ABAA has kept a stable dividend policy over the past 5 years, with an average dividend yield of
49
3.3%. The company’s policy of keeping a stable dividend yield was evidenced in 2002 when it paid a dividend although it recorded a much lower net income (this resulted in a dividend payout ratio of
49
114%). The only year in which BAA bought back stock has been in 2001 to return cash to its shareholders after it had sold some non-core assets.
Figure 49 Dividend policy - BAAHistorical Dividends BAA 2000 2001 2002 2003 2004Dividend Paid (mm) 150 178 188 196 205Stock Buyback 0 141 0 0 0Total Cash to shareholders 150 319 188 196 205Average Market Cap 4,071 6,604 6,787 5,027 6,106Dividend Yield (%) 3.7% 2.7% 2.8% 3.9% 3.4%
D i v i d e n d P a you t ( % ) 58 % 46 % 114 % 52 % 54 %
Source: BAA annual reports, Bloomberg
A s u rAsur has only recently started to pay dividends to its shareholders
through a special cash dividend in 2002, in which it paid over 200% of its net income. The company generates enough cash to fully fund its increased capital expenditures and still have a significant dividend payout ratio. In the last general shareholder meeting, the company decided to begin a regular cash dividend of approximately US$0.50 per share and to set up a reserve account for stock buybacks. We welcome both moves, as the company‘s ROC is far lower than its cost of capital and it is rapidly accumulating excess cash.Figure 50 Dividend policy - AsurDividend policy – ASUR 2000 2001 2002 2003 2004Dividend Paid ($ mm) 0.00 0.00 43.42 13.88 n.a.Stock Buyback 0.00 0.00 0.00 0.00 n.a.Total Cash to shareholders 0.00 0.00 43.42 13.88 n.a.Dividend Yield (%) 0.0% 0.0% 12.0% 3.4% n.a.Dividend Payout (%) 0.0% 0.0% 213.0% 56.5% n.a.
Source: Asur Annual reports
Figure 51 Trade Offs on Dividend PolicyFactor American Airlines Ryanair BAA AsurStockholder TaxPreferences
Information Effects and signaling Incentives
Effects on flexibility
Most of the stockholder are American Institutional investors and should be therefore indifferent between the choice of dividends or buybacks. Given the financial situation of the company no investor is buying AMR shares expecting other than stock appreciation.
In the unlikely case of a change in dividend policy (the company paid no dividend in the past 5 years) the market would read that a strong signal of confidence.
The good side of the crisis the company is suffering it is it could cancel dividends and now has free hands on this policy.
The marginal stockholder in Ryanair is large internationally diversified institutional investor, who probably has the flexibility to move any dividend and capital gains to locations with highest tax advantage. From this standpoint the stockholders might indifferent between capital or income gains.Given the good returns on capital and the largely announced capital investments plans a dividend announcement might signal that the company has run out of good projects and have a negative impact on the growth expectation hence on the stock valueDividend policy is constrained by the huge capital expenditure requirements related to the companies expansion program.
The Company has a consistent history of paying dividends. This is reflected in its stockholders base, which is made up mostly of small private shareholders
Given the high number of analysts that follow the stock and the amount of disclosure given by the company, any signal imbedded in a change in dividend policy would have most probably already been captured by the market
BAA’s dividend policy in the short medium term is constrained by the heavy capex spending related to the new terminal at Heathrow.
Investor’s in Asur expect recurrent dividend payments
Minimal, as Asur has no history of sticky dividends and is more inclined topay special dividends
Asur has no debt
Bond Covenants and Rating Agency
Debt covenants are pretty high. The company must meet a detailed schedule of financing for the $ 850mn credit facility in terms of current assets (no less than 1.5bn every quarter)
Neither of these would be a constraint forRyan air.
Neither of these factors would be a restraint toBAA raising dividends
Investor’s in Asur expect recurrent dividend payments
C on stra in ts and Cash flow to fixed charges around 1x.
Page 50
51
XI. Dividend Policy: a Framework
1. Affordable Dividends
In order to determine the amount our companies could have paid out in dividends we have computed the average FCFE over the last 5-year and compared it to the dividends and buyback paid by the companies. As mentioned before American Airlines and Ryanair do not payout any dividends. Even though both companies could have potentially returned cash to their shareholders, none of them did, but for completely different reasons: American Airlines positive FCFE come exclusively from the borrowings necessary to pay previous debt and try to renew the old fleet; Ryan Air decided to retain its FCFE to fund future growth. BAA and Asur have as well paid out less than what they could have to their shareholders.Figure 52 Dividend policy – sector analysis
Dividend policy analysisAmerican
Airlines Ryanair BAA AsurAverage FCFE in million (last 5 years) 765.3 23.5 248 41.2Average Dividends & Stock Buybacks 0 0 183 14.3Difference 765.3 23.5 -65 26.9% Dividends / Stock Buybacks 0.0% 0.0% 74% 34.7%
Figure 53 Dividend policy – sector analysisAmerican
Dividend policy - Sector analysis Airlines Ryanair BAA AsurDividend Yield 0.0% 0.0% 3.4% 3.9%Dividend Yield (sector) 0.06% 0.05%Difference -0.06% -0.05% 3.36% 3.90%Payout Ratio 0.0% 0.0% 54.4% 67.4%Payout Ratio (sector) 2.6% 79.4%Difference -2.6% -79.4% 54.4% 67.4%
2. Management Trust and Changing Dividend PolicyAs a second step in our analysis we analyzed past ROE and ROC to judge
if firms that paid out less than they could afford created value for their shareholders. In the case of Ryanair the company has been justified in its policy of not paying out dividends by the largely positive spread, both in terms of ROE-Cost of Equity and ROC-WACC. On the other hand BAA and Asur both have recorded negative ROE-Cost of Equity / ROC-WACC spreads. This
52
suggests that they should increase their dividend payout ratios.
Figure 54 Analysis of past returns and dividend policy
52
American Industry IndustryAnalysis of dividend policy Airlines Ryanair Average BAA Asur averageROE n.m. 14.69% Cost of Equity 34.54% 9.45% Difference Na 5.24% ROC 8.54% 16.94% WACC 16.69% 8.13% Difference -8.15% 8.81%
2.76%10.69%-7.93%14.22%
8.65%5.57%
8.23% 5.15%11.30% 9.65%-3.07% -4.50%
5.59% 4.76%7.85% 9.65%
-2.27% -4.89%
10.20% n.a. n.a.
5.71% n.a. n.a.
Figure 55 Analysis of past returns AAHistorical returns AA 2001 2002 2003 2004ROECost of Equity Difference ROCWACC
-32.79%15.69%
-48.49%-12.29%14.32%
-366.88%42.69%
-409.56%-16.82%16.04%
-2669.57%26.01%
-2695.58%-4.23%15.70%
Nm29.88%
Nm-0.72%15.96%
Difference -26.62% -32.86% -19.94% -16.68%
Figure 56 Analysis of past returns RyanairHistorical returns – Ryanair 2001 2002 2003 LTMROE 18.80% 17.99% 21.34% 14.69%Cost of Equity 8.25% 9.46% 9.53% 9.45%Difference 10.56% 8.53% 11.81% 5.24%ROC 12.02% 10.74% 12.59% 16.94%WACC 7.85% 8.95% 8.57% 8.13%Difference 4.17% 1.80% 4.02% 8.81%
Figure 57 Analysis of past returns BAAHistorical returns BAA 2001 2002 2003 2004ROE 8.59% 3.41% 7.89% 8.23%Cost of Equity Difference ROC
10.35%-1.76%6.07%
9.48%-6.07%5.72%
10.51%-2.63%5.56%
11.30%-3.07%5.59%
W A C C 8 . 92 % 7 . 77 % 7 . 85 % 7 . 85 %
Difference -2.85% -2.05% -2.30% -2.27%
Figure 58 Analysis of past returns AsurHistorical Returns – Asur 2001 2002 2003 2004ROE 2.31% 1.81% 2.45% 5.15%Cost of EquityDifference
9.89%-7.58%
9.94%-8.14%
10.46%-8.01%
9.65%-4.50%
ROC 2.25% 1.89% 2.94% 4.76%WACCDifference
9.89%-7.65%
9.94%-8.05%
10.46%-7.52%
9.65%-4.89%
53
\Figure 59 Analysis of historical returns
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
-20.00%
-25.00%
-30.00%
2001 2002 2003 2004
- 32.8%- 366.9%
- 2669.6%
20.00%
10.00%
0.00%
-10.00%
-20.00%
-30.00%
-40.00%
-50.00%
American airlines ROE Ryanair ROE BAA ROE
Asur ROE AA Spread Ryanair Spread
BAA Spread Asur Spread
R e c o m m e n d a t i o n s American Airlines – AA has the priority to return back to
profitability before being able to give any cash back to its stockholders. It seems that to a significant extend the problems of AA stem from its high leverage and any dividend payment would reduce the value of the equity, resulting in even worse debt ratio
Ryanair – the company has not paid any dividends, but it appears that it has a good portfolio of investment projects that can and do generate positive value for its stockholders. In addition, good corporate governance practices ensure that investors money is in good hands with Ryanair’s management and we support the current non-divident policy of the company
BAA – with its low risk profile and in its steady and reliable cash flows, BAA has definitely attracted “dividend addict” shareholders, evident by the distribution of ownership. It is the company with a large number of smaller investors who probably rely more on income than on capital gain from this company. Appropriately it payout out large portion of its available free cash flow to equity (74%) back to its
54
shareholders. Taken into account the regulated nature of the business and the fact that BAA cannot upgrade the prices it currently charges from Airline until 2008, we suggest it accumulate a certain cash cushion to meet unexpected turns in the economic trends. Current retention ration of about 25% seems appropriate.
54
Asur – Asur has been retaining a significant portion of their available free cash flow to equity and on the other hand has not been able to deliver excess returns over it s cost of capital. We believe that it should return more cash to its stockholders in the form of dividends. In addition, it is not constrained by high debt ratio as its debt capacity is stillunused.
XII. Valuation
1. Valuation modelsBased on the analysis presented above we proceeded to perform
valuation of the market value of the equity of all four companies. Table Figure
60 below summarizes the choice of our valuation model and the results.Figure 60 Summary of valuation results
Valuation summaryAmerican
Airlines Ryanair BAA AsurModel ChosenValue per Share
FCFF 2 Stage10.06
FCFF 3 Stage6.76
FCFF 2 Stage3.22
FCFF 2 Stage31.69
Current Stock Price 10.20 5.55 5.80 30.45Undervalued / (overvalued) -1.3% 21.8% -44.4% 4.1%
R e cc o m e nd a ti o n HO LD B U Y S E L L HO LD
Source: Analysis
The choice of growth period reflects the sustainability of competitive advantages of each firm as outlined in Part 3 Section IV – Investment Returns and Future prospects.
2. Valuation assumptions and inputs.The valuation assumptions are presented in Figure 61 to Figure 64 below.
55
Figure 61 American Airlines – DCF valuation assumptionsAmerican Airlines High Growth Phase Stable GrowthLength of Period 10.0 ForverRevenues 18,883.0Pre-tax Operating Margin 13.8%Tax Rate 35% (theoretical) 35.0%Return on Capital 8.5% 10.5%Non-Cash Working Capital -8.4% -8.4%Reinvestment Rate (Net Cap Ex + WorkingCapital Investments/EBIT 16.5% 19.0%Expected growth Rate in EBIT 1.4% 2.0%Debt Capital Ratio 86.6% 25.0%Beta 6.26 1.22Cost of Equity 34.5% 10.2%
C o st o f D e b t 13 . 9 % 25 . 0 %
Source: Company reports, analysis
Figure 62 Ryanair – DCF valuation assumptionsRyanair High Growth Phase Stable GrowthLength of Period 4 years and 4 years transitional period ForeverOperating income growth 22.53% 3%
Tax Rate 12.50% 20.00%Return on Capital 15.48% 7.78%Cost of capital 8.13% 7.78%Non-Cash Working Capital starting at 8.45% and declining to 2% 2.00%Reinvestment Rate (Net Cap Ex + WorkingCapital Investments/EBIT 146% 39%Debt Capital Ratio 23.87% 10.00%Beta 1.24 1.00Cost of Equity 9.5% 8.3%Cost of Debt 4.5% 4.0%
Source: Company reports, analysis
Figure 63 BAA – DCF valuation assumptionsBAA High Growth Phase Stable GrowthLength of Period 4 Years Forever
Starting at £1,970 and growing with 4.8%Revenues CAGR Growing at 2.00%Tax Rate 30% 30% Return on Capital 5.23% 6.93% Reinvestment Rate (Net Cap Ex + WorkingCapital Investments/EBIT Starting at 161.65% and declining to 28.85% 28.85%Expected growth Rate in EBIT starting at 8.45% and declining to 2% 2.00% Debt Capital Ratio 45% 45% Beta 1.42 0.90Cost of Equity 11.30% 8.81%
C o st o f D e b t 5 . 17 % 5 . 17 %
Source: Company reports, analysis
56
Figure 64 Asur – DCF valuation assumptionsAsur High Growth Phase Stable GrowthLength of Period 5.0 ForeverRevenues 177.2Pre-tax Operating MarginTax Rate 33.0% 33.0%Return on Capital 7.5% 11.0%Non-Cash Working Capital 5.93 5.93Reinvestment Rate (Net Cap Ex + WorkingCapital Investments/EBIT 85.0% 30.0%Expected growth Rate in EBIT 7.0% 3.0%Debt Capital Ratio 0.0% 20.0%Beta 0.82 0.80Cost of Equity 10.0% 8.1%
C o st o f D e b t 0 . 0 % 7 . 0 %
Source: Company reports, analysis
In building our assumptions into the valuation model we had the following approach: We have used the bottom-up beta estimates we calculated earlier in the cost of equity computation.
The risk characteristics in perpetuity are likely to change as follows:o American Airline – changing debt ratio (going concern
assumption) should reduce risk and hence beta. The beta used in perpetuity is the unlevered average industry beta re- levered to a more sustainable debt ratio
o Ryanair – as the company grows and becomes more mature, the risk is expected to converge with the market
o BAA and Asur – risk is assumed to converge with market risk, although at the low end reflecting stability in cash flows
Growth rate are derived from fundamentals and based on ROC and Reinvestment rates. In perpetuity the growth rate is set at levels below or close to long term sustainable economic growth as we don’t expect these sectors to be the major drivers of economic growth.
Growth phase Capex and Working capital changes have been projected on the basis of historical data. I perpetuity the implied reinvestment rates were used (derived as a function of growth and ROC).
Leverage – we projected that in the long term the companies gradually move to their optimal capital structure, except for BAA,which is already at
57
its optimum.In addition, Asur is assumed to generate a ROC slightly higher than its cost of capital in the future. Therationale behind this is that as the company becomes more mature and moves towards its optimum capital structure the cost of capital is likely to fall. This fall is likely to be supplemented by reduced risk
57
premium for Mexico, as the country becomes less risky place for investors. We believe that Asur could sustain the higher ROC partly because of its most valuable asset – the concession to use the airports. This asset gradually depreciates reducing the book value of the equity of the firm, and on the other hand does not require capital expenditures to replace it. It is also a natural barrier to entry to competitors in the sector and it give Asur the exclusive right of being airport operator. We assumed that in perpetuity the ROC of Asur will move towards the industry average of around 11.0%
3. Valuation resultsThe valuation results are presented in
Figure 65 Valuation resultsAmerican
Airlines Ryanair BAA AsurValue of Operating Assets 13,776.0 5,272.9 7,452.1 848.0Cash & Marketable Securities 148.0 1,447.9 973.9 102.8Firm Value 13,924.0 6,720.7 8,426.0 950.8Market Value of Debt 12,083.8 1,549.1 5,007.1 -Equity Value 1,840.1 5,171.7 3,417.9. 950.8Value of Equity in Options 217.9 71.7 2.45 -Value of Equity in Common Stock 1,622.3 5,099.9 3,415.4 950.8Number of Shares 161.2 754.3 1,060.9 30.0Value per Share 10.06 6.76 3.22 31.69
Source: Analysis
We performed the DCF valuation on the basis of the inputs presented above. The equity values of AA, Ryanair and BAA includes also the equity options outstanding written by the companies. In computing the options values we have used the annualized standard deviation in the log-normal returns
& P1 #on a monthly basis for 5 years ( Ln$
P
! ), the average strike price and maturity of the options.
% 0 "On the basis of the valuations results we reached the following conclusionsValuation summary American Airlines Ryanair BAA AsurValue per Share 10.06 6.76 3.22 31.69Current Stock Price 10.20 5.55 5.80 30.45
58
Undervalued / (overvalued) -1.3% 21.8% -44.4% 4.1%Recommendation HOLD BUY SELL HOLD
Source: Analysis
58
59
Appendix IAMR Income Statement 2001 2002 2003 2004 1Q04 1Q05 2004TTMPassenger Revenues 17,208 15,871 15,851 16,897 4,098 4,292 17,091of which American Airlines 15,780 14,440 14,332 15,021 3,678 3,841 15,184of which Regional 1,428 1,431 1,519 1,876 420 451 1,907
Cargo 662 561 558 625 148 151 628Other 1,099 988 1,031 1,123 266 307 1,164Total Revenues 18,969 17,420 17,440 18,645 4,512 4,750 18,883
Labour Costs -8,032 -8,392 -7,264 -6,719 -1,640 -1,644 -6,723Fuel -2,888 -2,562 -2,772 -3,969 -808 -1,097 -4,258Commission and Bookings -1,540 -1,163 -1,063 -1,107 -288 -271 -1,090Maintenance -1,165 -1,108 -860 -971 -231 -235 -975Other rentals and airport fees -1,197 -1,198 -1,173 -1,187 -305 -300 -1,182Food Service -778 -698 -611 -558 -137 -125 -546Other Operating -2,996 -2,715 -2,428 -2,366 -582 -617 -2,401Special Charges -1,466 -718 -407 -11 0 0 -11US Government Grant 856 10 358 0 0 0 0
Ebitdar -237 -1,124 1,220 1,757 521 461 1,697Aircraft Rentals -829 -840 -687 -609 -153 -148 -604Ebitda -1,066 -1,964 533 1,148 368 313 1,093Depreciation and Amortization -1,404 -1,366 -1,377 -1,292 -326 -290 -1,256Ebit -2,470 -3,330 -844 -144 42 23 -163Interest Income 110 71 55 66 14 36 88Interest Charges -538 -685 -703 -871 -212 -235 -894Capitalized Interest 144 86 71 80 18 23 85Other -2 -2 113 108 -28 -9 127Financial Income / (Charges) -286 -530 -464 -617 -208 -185 -594EBT -2,756 -3,860 -1,308 -761 -166 -162 -757Tax Benefits 994 1337 80 0 0Income (Loss)Accounting Change ImpactNet Loss
-1,7620
-1,762
-2,523-988
-3,511
-1,2280
-1,228
-761
-761
-757
-757
60
AA –Balance Sheet 2001 2002 2003 2004 1Q05Current Assets 6,469 4,833 4,562 4,851 5,272Currrent Liabilities -6,740 -6,372 -5,755 -6,212 -6,852Inventory 0 0 0 0 0
Net Working Capital -271 -1,539 -1,193 -1,361 -1,580
Tangible Assets 19,655 19,694 19,460 19,137 19,116Intangible Assets 6,615 5,636 5,188 4,665 4,631Financial Assets (cash) 102 104 120 120 148
Total Assets 26,372 25,434 24,768 23,922 23,895
Termination Indemnity reserves -10,122 -9,760 -9,599 -8,812 -8,758
Net Capital Employed 15,979 14,135 13,976 13,749 13,557
Total Debt -10,606 -13,178 -13,930 -14,330 -14,254Total Equity 5,373 957 46 -581 -697
Net Capital Employed 15,979 14,135 13,976 13,749 13,557
61
Ryanair - Income statementLast Twelve
months Dec-04 Dec-03 2004 2003 2002 2001 2000
'000 EUR '000 EUR '000 EUR '000 EUR'000
EUR'000
EUR '000 EUR'000
EUR
Operating revenues 1,238,387 1,015,536 851,373 1,074,224 842,508 624,050 487,405 370,137
Operating expensesDepreciation and amortization (100,623) (70,960) (71,728) (101,391) (76,865) (59,010) (59,175) (44,052) Lease payments (42,018) (23,636) (6,450) (24,832) - (4,021) (7,286) (2,097) Staff, fuel, route charges and others (811,193) (636,753) (509,771) (684,211) (502,169) 398,086) (306,933) (239,933) Total operating expenses (953,834) (731,349) (587,949) (810,434) (579,034) (461,117) (373,394) (286,082)
Operating profit before exceptional costs 284,553 284,187 263,424 263,790 263,474 162,933 114,011 84,055
Reorganization costs - - (3,012) (3,012) Other exceptional costs - - (9,491) (9,491) Amortization of goodwill (2,287) (1,702) (1,757) (2,342)Total exceptional costs (2,287) (1,702) (14,260) (14,845) - - - -
EBIT 282,266 282,485 249,164 248,945 263,474 162,933 114,011 84,055383 350 340 222 173 128
Financial charges -Interest expenses (53,254) (40,992) (35,302) (47,564) (30,886) (19,609) (11,962) (3,781) Other financial income/(charge) 25,981 17,368 18,486 27,099 31,962 29,050 21,339 9,820Total (27,273) (23,624) (16,816) (20,465) 1,076 9,441 9,377 6,039
Profit before tax 254,993 258,861 232,348 228,480 264,550 172,374 123,388 90,094
Taxes (23,680) (24,257) (22,446) (21,869) (25,152) (21,999) (18,905) (17,576) -
Net income 231,313 34,604 209,902 206,611 239,398 150,375 104,483 72,518
62
Balance sheetLast Twelve
months Dec-04 Dec-03 2004 2003 2002 2001
'000 EUR '000 EUR '000 EUR '000 EUR '000 EUR '000 EUR '000 EUR
Fixed assetsIntangible 30,872 30,872 45,085 44,499 - 36Tangible 1,845,452 1,845,452 1,611,127 1,576,526 1,352,361 951,806 613,591 315Total fixed assetsCurrent asetsCash and liquid resources
1,876,324
1,447,850
1,876,324
1,447,850
1,656,212
1,124,671
1,621,025
1,257,350
1,352,361
1,060,218
951,806
899,275
613,627
626,720
315
355Receivables 14,467 14,467 11,478 14,932 14,970 10,331 8,695 21Prepayments and other receivables 18,608 18,608 22,977 19,251 16,370 11,035 12,235 6Inventories 27,160 27,160 24,183 26,440 22,788 17,125 15,975 13Total current assets 1,508,085 1,508,085 1,183,309 1,317,973 1,114,346 937,766 663,625 397
Total assets 3,384,409 3,384,409 2,839,521 2,938,998 2,466,707 1,889,572 1,277,252 712
Current liabilitiesPayables 89,439 89,439 82,491 67,936 61,604 46,779 29,998 22Accrued expenses and others 317,049 317,049 223,679 338,208 251,328 217,108 139,406 107Current portion of long term debt 106,841 106,841 79,545 80,337 63,291 38,800 27,994 9Short term borrowings 2,325 2,325 4,454 345 1,316 5,505 5,078 3Total current liabilities Long term liabilities Provisions
515,654
107,741
515,654
107,741
390,169
97,915
486,826
94,192
377,539
67,833
308,192
49,317
202,476
30,122
143
Other creditors 22,958 22,958 268 30,047 5,673 18,086 15Long term debt 1,046,546 1,046,546 893,285 872,645 773,934 511,703 374,756 112Total long term liabilities Shareholders equity Share capital
1,177,245
9,652
1,177,245
9,652
991,468
9,637
996,884
9,643
847,440
9,588
579,106
9,587
404,878
9,194
127
8Share premium 562,015 562,015 559,717 560,406 553,512 553,457 371,849 248Profit and loss 1,119,843 1,119,843 888,530 885,239 678,628 439,230 288,855 184Total equity funds 1,691,510 1,691,510 1,457,884 1,455,288 1,241,728 1,002,274 669,898 441
Total liabilities and equity 3,384,409 3,384,409 2,839,521 2,938,998 2,466,707 1,889,572 1,277,252 712
63
BAA - Income Statement 2002 2003 9M 2003 2004 9M 2004 2004LTMRetail (incl. World Duty Free) 866 755 802Airport/traffic charges 677 690 734Property/op. facilities 260 266 282Other 60 49 59
Total Airports 1,863 1,760 1,452 1,877 1,589 2,014Rail 58 64 50 67 51 68Other 51 58 18 26 15 23Total Revenues 1,972 1,882 1,520 1,970 1,655 2,105
Labour Costs (443) (420) (475)Retail Expenditure (276) (167) (176)Operating Leases Expenses (45) (43) (44)Other Operating Costs (401) (407) (401)Total Costs (1,165) (1,037) (829) (1,096) (882) (1,149)Share of operating profit in Joint Venture 6 11 5 9 15 19
Ebitda 813 856 696 883 788 975
Depreciation and Amortization (257) (258) (191) (258) (213) (280)
Ebit 556 598 505 625 575 695
Interest Income 34 60 52Interest Charges (134) (176) (143)Net Interest (100) (116) (66) (91) (63) (88)Other Financial Income 49 42 2 2 9 9Financial Income / (Charges) (51) (74) (64) (89) (54) (79)
EBT 505 524 441 536 521 616Taxes (152) (161) (137) (162) (153) (178)Minority Interests (2) (2) (1) (1) (1) (1)Income (Loss) 351 361 303 373 367 437
64
BAA - Balance Shteet 2002 2003 2004 Dec-04
Trade Receivables 183 218 270 314Trade Payables (125) (143) (152) (150) Inventory 34 27 23 53
Net Working Capital 92 102 141 217 O t h e r C urr e n t A s s e t s / ( L i a b i l i t i e s) (576 ) (669 ) (792 ) (810 )
Total Net Current Assets (484) (567) (651) (593)
Tangible Assets 6,975 7,802 9,074 9,997Intangible Assets 10 10 10 10
Share of Gross Assets 51 75 60 62Share of Gross Liabilities (39) (72) (46) (48) Loans 39 30 17 18
Investments in JVs 51 33 31 32Investments in associates 6 7 49 42
O t h e i nv e s t m e n t s 8 0 14 2 12 2 8 0 Total Fixed Assets 7,122 7,994 9,286 10,161
Other Liabilities (267) (971) (901) (941)
Net Capital Employed 6,371 6,456 7,734 8,627
Gross Financial Debt 2,567 3,029 3,598 4,169 of which Convertible Debt 311 730 838 838 of which Bonds 1,842 1,873 2,266of which Bank Loans 350 378 447 other financial debt 34 48 47
C a sh & M a rk e t a b l e S e c ur i t i e s (939 ) (1 , 156 ) (890 ) (849 ) Net Debt 1,628 1,873 2,708 3,320Minority Interest 6 8 8 9Total Equity 4,737 4,575 5,018 5,298
Net Capital Employed 6,371 6,456 7,734 8,627
ASUR 1999 2000 2001 2002 2003 2004
65
Income StatementRevenues:
Aeronautical revenues 94.2 112.6 107.8 92.7 102.8 132.9Non-aeronautical revenues 15.8 19.4 19.1 22.1 27.7 44.4
Total revenues 110.1 132.0 127.0 114.8 130.5 177.2Operating expenses:
Cost of services 25.4 30.8 31.4 31.8 32.9 41.9Technical assistance fee 6.6 6.0 4.2 3.5 4.1 6.0Concession fee 5.6 6.6 6.3 5.7 6.5 8.9General and administrative 12.6 11.5 10.9 9.9 10.8 9.5Depreciation and amortization 29.9 33.1 33.0 31.0 31.6 35.8
Total operating expenses 80.1 87.9 85.8 81.9 85.9 102.1Operating income 30.0 44.1 41.1 32.9 44.7 75.1
Interest income 3.8 6.0 8.6 4.5 4.8 0.0Interest expense (1.8) (1.8) (0.1) (0.1) (0.1) 0.0Exchange gain/(losses), net (0.1) (0.4) (0.6) 1.1 0.5 0.0Chages in monetary position (0.1) (5.5) (4.1) (2.9) (3.1) 0.0
Comprehensive financing cost 1.7 (1.6) 3.8 2.5 2.2 (2.6)EBT 31.8 42.4 44.9 35.4 46.8 72.6Provision for asset tax 0.0 0.0 0.0 (2.9) (4.0) 0.0Income tax and profit sharing (13.4) (18.6) (16.7) (11.3) (16.6) (16.5)Income before extraordinary items 18.3 23.9 28.3 21.2 26.2 56.0Contract termination fee 0.0 0.0 (0.7) (0.4) (1.5) 0.0Other special items 0.0 0.0 0.0 (0.3) (0.1) (1.6)Net income 18.3 23.9 27.6 20.4 24.6 54.4
EBITDA 59.9 77.1 74.2 63.9 76.2 111.0
ASUR 1999 2000 2001 2002 2003 2004
66
Balance SheetCash and marketable securities 63.7 95.8 46.0 63.2 102.8Trade receivablesRecovarable taxes and other current assets
10.9
2.1
14.1
6.7
15.4
5.5
15.2
12.5
19.0
2.8Total current assets 76.7 116.6 66.9 90.9 124.6Property, plant and equipment 30.7 65.4 79.4 103.8 149.4Airport concessions, net of amortization 827.9 806.1 703.4 683.8 704.2Right to use airport facilities, net 233.6 225.1 194.4 187.8 192.7Total assets 1,169.0 1,213.3 1,044.0 1,066.3 1,170.9Trade accounts payable 1.3 0.1 0.2 0.9 1.0Accrued expenses and other payables 7.3 8.7 11.1 13.0 14.9Total current liabilities 8.6 8.8 11.4 13.9 15.9Long term debt 0.0 0.0 0.0 0.0 0.0Other 0.0 0.0 0.1 0.1 1.3Deferred income tax and profit sharing 24.2 40.7 36.0 42.6 48.1Total liabilities 32.8 49.5 47.4 56.5 65.3Capital stock 1,082.2 1,082.2 970.6 970.6 1,029.0Legal reserve 1.4 7.3 3.6 4.6 20.5Retained earnings 52.5 74.2 22.5 34.6 56.0Total stockholders' equity 1,136.2 1,163.7 996.7 1,009.8 1,105.5Total liabilities and stockholders' equity 1,169.0 1,213.3 1,044.0 1,066.3 1,170.9
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Appendix II
Analysis if returns - Ryanair1-Year
Horizon2-Year
Horizon5-Year
Horizon10-YearHorizon
Compounded Annual Return 19.8% -3.1% 20.22% n.aMarket Index Compounded Annual Return 4.61% 10.96% -5.70% n.aBeta 1.34 1.16 0.73 n.aRisk-free Rate 2.07% 2.52% 5.20% n.aStock Treynor Measure 13.2% -4.9% 20.6% n.aMarket Treynor Measure 2.54% 8.45% -10.90% n.a
(U nd er ) / O u t p er f o rm a n c e 10 . 68 % -13 . 33 % 31 . 48 % n . a . Source: Bloomberg, Ryanair's's annual report, Eurostat
Analysis of returns - BAA1-Year
Horizon2-Year
Horizon5-Year
Horizon10-YearHorizon
Compounded Annual Return 12.8% 12.6% 9.4% 3.3%Market Index Compounded Annual Return 4.61% 10.96% -5.70% 8.99%Beta 0.2 0.32 0.35 0.23Risk-free Rate 4.83% 4.52% 4.73% 5.71%Stock Treynor Measure 39.7% 25.3% 13.2% -10.4%Market Treynor Measure -0.22% 6.45% -10.44% 3.28%
(Und e r) / Ou t p e rfor m a n c e 39 . 95 % 18 . 89 % 23 . 66 % -13 . 72 %
Source: Bloomberg, BAA's annual report, Bank of England
Analysis of returns - American Airlines1-Year
Horizon2-Year
Horizon5-Year
Horizon10-YearHorizon
Compounded Annual Return -18.3% 59.0% -21.21% -3.03%Market Index Compounded Annual Return 2.34% 13.71% -4.36% 8.49%Beta 4.71 3.54 4.67 2.02Risk-free Rate 4.27% 4.25% 5.11% 5.57%Stock Treynor Measure -4.8% 15.5% -5.6% -4.3%Market Treynor Measure -1.93% 9.46% -9.47% 2.92%
S to c k (U n d er ) / O u t p er fo r m a n c e -2 . 87 % 6 . 00 % 3 . 84 % -7 . 18 % Source: Bloomberg, AA's annual report, Fed reserve bank
Analysis of returns - Asur1-Year
Horizon2-Year
Horizon5-Year
Horizon10-YearHorizon
Compounded Annual Return 52.5% 65.3% 21.4% N/AMarket Index Compounded Annual Return 2.5% 12.4% -4.8% N/ABeta 0.82 0.87 0.81 N/ARisk-free Rate 4.2% 4.2% 4.3% N/AStock Treynor Measure 59.0% 70.6% 20.9% N/AMarket Treynor Measure -1.7% 8.2% -9.2% N/A
S to ck (U n d er) /Ou t p erfo r ma n ce 60.8% 62.4% 30.0% N /A
Source: Bloomberg, Asur's annual report, Mexican Central Bank
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