Air Tran Airways Is a Term Paper
- Length: 13 pages
- Sources: 7
- Subject: Transportation
- Type: Term Paper
- Paper: #24119577
Excerpt from Term Paper :
Another is high labor productivity, yet another is high asset utilization. The net result is that AirTran has one of the lowest levels of cost per ASM in the industry.
In terms of weaknesses, one major weakness is that AirTran has no discernable source of sustainable competitive advantage. Its success to date has been based on its ability to combine many small sources of advantage into a single airline. Yet, none of these sources can be considered sustainable in the long run. The industry is highly competitive. Competition comes from all manner of airlines both domestic and international. Any or all of these competitors and potential competitors, including new entrants, could replicate AirTran's success factors.
AirTran also has a high level of debt, the bulk of which derives from debt and lease obligations on their fleet. They presently hold over $800 million in debt on their balance sheet. The debt-to-equity ratio is 3.18, up from 2.25 a year ago. The company has invested in these airplanes with an eye to expanding their service, but it exposes the company to several significant risk factors. Should their business be adversely affected by either industry-wide issues such as a dramatic spike in fuel prices or additional regulation, or by company-specific issues such as the entrant of a strong new competitor to the marketplace, AirTran's profitability will be negatively affected by these long-term obligations.
One of the major threats to AirTran is that of competition, in particular new entrants. The industry is highly competitive, but also in a state of flux. Existing players frequently shift strategy. The market is open to new entrants, some of whom could be existing airlines seeking to make better use of existing aircraft. AirTran's long-term contracts with their key airports lends them a certain degree of protection against direct competition entering these markets, but much of AirTran's current or potential market is subject to the strong threat of new entrants.
Another major threat is that of rising fuel prices. Already fuel accounts for more than one-third of AirTran's operating expenses.
The existence of the discount airline industry is dependent on the ability of companies to offer flights at a low enough price to entice consumers to fly. Most of this form of travel is discretionary rather than essential. For many routes, driving can be substituted. For all routes, electronic means of communication, ranging from e-mail to virtual meetings, can replace air travel should the price of jet fuel render the service prohibitively expensive. This is an especially strong threat to AirTran, given that their target customer is, in their terms, "cost-conscious."
There are, however, some strong opportunities for growth. In this industry, market share is perpetually up for grabs. The main driver for consumer decision-making remains price. To this point, AirTran has demonstrated steady growth while operating within a fairly narrow market both in terms of geography and customer base. In particular, geography offers many opportunities for growth. AirTran management has stated that there remain many routes and markets that they feel are either underserved or served but overpriced.
The use of the B737 has given further opportunities for AirTran to grow. This aircraft has a longer range than their first aircraft, the B717. They now have the capability to servicing coast-to-coast routes. Furthermore, this aircraft gives them the ability to enter international markets such as Canada, Mexico, Central America and the Caribbean.
As a relatively young, growing airline, AirTran is highly leveraged. The debt/equity ratio was 3.183 in 2006, compared with 2.257 the year previous. The bulk of increase in debt is directly related to the purchase of additional airplanes. Taking a look at some of the basic debt analysis ratios, interest coverage was 2.6 in '06, 2.24 and 2.3 the two years previous respectively.
However, interest expense does not reflect the total debt burden of AirTran. The airline industry is characterized by a high amount of obligations beyond interest-bearing debt. These obligations are essential to the conduct of business, such as airplane leases and landing fees. So in this case the best measure of coverage is the Fixed Charge Coverage, which was 1.07 in 2006 and 1.045 in 2005, a modest improvement.
In terms of raw performance measures, AirTran improved last year. Cash flow from operations was $112, 834, 000 versus $87,338,000 the year previous, an improvement of 29%. Operating income was up 79% to $42,133,000. Net income was up 92% to $15,514,000. This was due to improvements in both gross and net profit margin. The performance in 2005 was largely growing pains due to expansion, and both profit margin figures were better in 2004 than in either of the past two years.
In spite of this, the additional debt they've taken on has caused their liquidity to worsen. Their current ratio dipped from 1.435 in 2005 to just 1.057 in 2006. Worse yet, their quick ratio dipped from 1.253 to 0.888 in the same period. Not surprisingly, cash flow was negative in 2006, following a modest increase in cash in 2005. This liquidity issue, while not major given the airline's growth trajectory and the high cost of incremental growth in this industry, indicates that AirTran is exposed to a high degree of risk relating to their high debt load.
As a portfolio manager, I would want to own equity in AirTran. It is not suitable for all types of portfolios, however. AirTran is a growth company. They have demonstrated the ability to increase their market share consistently throughout their history. They have a strong management team that has been able to demonstrate consistent results over time. The industry is highly competitive, and yet AirTran has been able to differentiate itself sufficiently, and make shrewd enough business decisions to enjoy a significant measure of success.
AirTran does not pay dividends, and does not expect to do so in future. Because of this, it is only suitable for growth portfolios, where the only source of expected income is capital gains, and where a high degree of risk is accepted.
The firm's liquidity issues increase its financial risk, but they are increasing their profitability. Their return on total assets is 2.29%, their return of total equity is 8.58%, so they are making good use of what they have.
The time horizon for an equity position in AirTran would be long-term, for two key reasons. One, the airline industry is somewhat cyclical. There is strong long-term demand but this demand wanes occasionally due to strong external influences. Also, AirTran is on a strong growth trajectory. The airline industry is characterized by long leads times for growth. New aircraft can take years to arrive after an order is placed, and after that the right routes and schedules must be found. A market must be built for each individual flight, as each route can be considered its own business unit in terms of the revenues per flight mile.
The airline industry is not typically considered a long-term investment, for the simple fact that slowdowns are inevitable and the highly-leveraged structure of the industry means makes airlines very vulnerable. However, AirTran represents one of the better bets in the industry because of its growth component. In holding it, I would be willing to take profits should the opportunity arise.
The debt of AirTran, however, does not interest me as a portfolio manager. AirTran's current growth trajectory, as applied to the airline industry, means that it is inherently going to be highly leveraged. Debt today makes up 76% of total capital, up from 69% a year ago. The structure of the debt is also an issue. Most of AirTran's current debt is related to airplane purchases. Other obligations, such as landing fees and airplane leases, make up a significant portion of operating expenses. These are necessary for AirTran's survival in that they ensure continuing operations.
Liquidity is a further issue. At present, AirTran remains liquid, but their liquidity position is not one that I would be comfortable with. The low level of liquidity and high level of leverage exposes the company to downturns. If they were operating in a business where they had some protection from downturns, I could accept their current figures. However, they are in a highly-competitive industry with few barriers to entry, and they have little in the way of sustainable competitive advantage.
Cash flow is not certain. In the discount segment, there is a delicate balance between ticket prices and load factors, which puts a soft ceiling on their revenues. Their high level of fixed obligations puts a soft floor on their costs. When you consider the structure of their expenses, AirTran only has control over about one-third of those, plus a modicum of control over fuel costs through their hedging program. Ultimately, AirTran could easily come into liquidity problems should any adverse conditions materialize.
AirTran does not pay dividends, and does not expect to. They do not have the free cash…