Was Continental Headed for Bankruptcy Before Merging With United?

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 |  Includes: UAL, UAUA
by: Sudhanshu Jain

The airline industry is a highly competitive industry which generally earns low returns because of the high cost of operation. This can bring disaster when times get tough in the economy.

Continental Airlines (NYSE:CAL) is the fourth largest airline in the US based on revenue passenger miles. It was founded in 1931 and commenced operations in 1934. Continental Airlines had been through Chapter 11 twice. It filed for bankruptcy for the first time in September 1983 and remained under Chapter 11 from 1983 to 1986. Continental filed for its second bankruptcy in 1990 mainly due to the increased jet fuel prices after the Gulf War of 1990. In 1993, Air Canada, Air Partners and Texas Pacific Group enabled Continental to emerge from bankruptcy by investing $450 million in the airline.

Was Continental Airlines heading towards bankruptcy for the third time before merging with United Airlines (UAUA)? Altman Z-score analysis, capital structure analysis, and profitability analysis shows that the company was in distress before the merger was announced.

Altman Z-Score Analysis:

Altman Z-Score decreased to 1.2 in year 2009 from 1.7 in year 2008. At the end of June 2010, the company had a Z-Score of 0.49, which means that the company was in distress zone and chances of financial embarrassment were very high. (Data source: Old School Value)

Zones of Discrimination:

Z > 2.99 –“Safe” Zone

1.8 < Z < 2.99 –“Grey” Zone

Z < 1.80 –“Distress” Zone

Capital Structure Analysis:

At the end of year 2009, the company’s total debt to equity ratio was 1062%. Debt comprised 91.4% of the total capital and equity comprised only 8.6% of the total capital. Also, about 15% of the company’s total debt was due in year 2010 and another 18% was due in year 2011, which would have created problems for the company. The company had approximately $7 billion worth operating lease commitments due in next five years.

Million $

Percent

Debt

6266

91.4%

Equity

590

8.6%

Total

6856

100%

Click to enlarge

Million $

Percent

LT Debt (Incl. Cap Leases) Due 2010

975

15.6%

LT Debt (Incl. Cap Leases) Due 2011

1148.9

18.3%

LT Debt (Incl. Cap Leases) Due 2012

590.9

9.4%

LT Debt (Incl. Cap Leases) Due 2013

656.9

10.5%

LT Debt (Incl. Cap Leases) Due 2014

338.9

5.4%

Total LT Debt (Incl. Cap Leases) Due in next 5 years

3710.6

59.2%

Total LT Debt (Incl. Cap Leases) Due after 5 years

2555.5

40.8%

Total

6266

100.0%

Click to enlarge

Million $

Percent

Total Term Long

350

5.6%

Total Senior Bonds and Notes

5272

84.1%

Total Capital Leases

196

3.1%

Total Trust Preferred

248

4.0%

Other Borrowings

200

3.2%

Total

6266

100.0%

Click to enlarge

Million $

Percent

Operating Lease commitment due 2010

1485

10.5%

Operating Lease commitment due 2011

1432

10.1%

Operating Lease commitment due 2012

1487

10.5%

Operating Lease commitment due 2013

1331

9.4%

Operating Lease commitment due 2014

1285

9.1%

Operating Lease commitment due in next 5 yrs

7020

49.7%

Operating Lease commitment due after 5 yrs

7094

50.3%

Total

14114

100.0%

Click to enlarge

(Source: Capital IQ)

Profitability Analysis:

Continental Airlines had negative operating earnings in the years 2008 and 2009. The company’s ROA and ROE were also negative in the years 2008 and 2009. In year 2009, the company paid around $330 million in interest expenses.

Jet Fuel Price Analysis:

The airline industry is extremely sensitive to costs such as fuel, labor and borrowing costs. Jet fuel price in 2010 increased by about 10.7% compared to 2009.

27 Aug 10

Share in World Index

cts/gal

$/bbl

$/mt

Index Value 2000= 100

vs. 1 week ago

vs. 1 month ago

vs.1

yr ago

Jet Fuel Price

100%

208.2

87.5

689.3

239.1

1.7%

0.8%

10.7%

Asia & Oceania

22%

203.6

85.5

675.5

244.3

-0.6%

-1.3%

10.2%

Europe & CIS

28%

208.5

87.6

690.1

236.0

1.9%

0.3%

10.2%

Middle East & Africa

7%

200.4

84.2

664.2

251.4

0.6%

0.0%

9.9%

North America

39%

210.8

88.5

698.6

235.4

2.8%

2.2%

11.4%

Latin & Central America

4%

219.8

92.3

710.8

255.7

2.9%

3.0%

11.5%

Click to enlarge

(Source: IATA.org)

Disclosure: The author of this article holds no financial interest in the securities of this company. The author of this article knows of no existence of any conflicts of interest that might bias the content or publication of this article. The author is not monetarily or financially compensated in any way for writing this article.