Using DuPont Analysis to Analyze Airline Stocks

by: Bennington Investment Ideas

The airline industry is an extremely capital intensive industry that has been struggling to find sustainable profitability. Some of the past recent challenges have included over capacity, surging fuel prices, and high labor expenses. Everyone is well aware of the constant parade of airline companies into and out of bankruptcy.

Using DuPont Analysis is one way to dig a little further into the companies to see what similarities (or differences) there might be. DuPont Analysis is a view of breaking down Return on Equity (ROE) into factors that can be further analyzed. These factors are commonly a profitability measure, a turnover measure, and a leverage measure. DuPont Analysis was created by E. I. du Pont de Nemours and Company (DD) in the 1920s. For this analysis, I looked at a three-factor analysis:

Factor Calculation
Asset Turnover Revenue/ Average Assets
Profitability Net Income/ Revenue
Leverage Average Assets/Average Equity

However, companies have become more focused on tax reporting, and this increases the overall complexity. While leverage is calculated in the Asset to Equity ratio, the cost of the leverage is lost in the profitability margin. Possibly one company has obtained lower cost debt than another, and that financial engineering is different from how it runs its day to day operations.

Using this simplified DuPont Analysis creates some challenges, since the Profitability measure captures the impact of several concepts ranging for tax efficiency to also touching on leverage impact. The higher the leverage, the higher the interest, the lower the net income. DuPont Analysis can also use a five-factor model that includes a profitability measure based on EBIT/Revenue, a tax efficiency measure and then an interest rate adjustment measure. Previously, I used a five-factor model to look at The Coca-Cola Company (NYSE:KO) and PepsiCo Inc. (NYSE:PEP) in this article. The airline stocks that I will consider for this article are listed below and represent primarily Western Hemisphere companies as well as Ryanair (NASDAQ:RYAAY).

Select Airline Companies
Ticker Name Market Capitalization Last Fiscal Year Revenue
LFL Lan Chile S.A. $ 9,229 4,391
RYAAY Ryanair Holdings plc $ 9,014 4,043
LUV Southwest Airlines Company $ 8,780 12,104
DAL Delta Air Lines Inc. (New) $ 8,035 31,755
UAL United Continental Holdings, Inc. $ 7,460 23,229*
CPA Copa Holdings, S.A. $ 2,773 1,415
ALK Alaska Air Group, Inc. $ 2,321 3,832
TAM TAM S.A. $ 2,051 6,855
JBLU JetBlue Airways Corporation $ 1,686 3,779
GOL Gol Linhas Aereas Inteligentes S.A. $ 1,614 4,204
SKYW SkyWest, Inc. $ 783 2,765
HA Hawaiian Holdings, Inc. $ 278 1,310
RJET Republic Airways Holdings, Inc. $ 214 2,654
Source: Data is provided by services as of June 17, 2011.*From UAL 2010 10-K. showed a $34 billion figure. GOL, RYAAY, CPA and TAM revenues are from Yahoo Finance.

I then pulled the data more detailed financial data from Yahoo Finance for 2010 through 2009 for the key statistics required. For 2009, I will look at the DuPont Analysis for United and Continental as individual companies based on their SEC Filings. Applying the DuPont Analysis for 2010 gives the following table:

2010 Airline DuPont Analysis
Ticker Asset Turnover Profitability Leverage Implied ROE
DAL 0.73x 1.9% 76.2x 104%
HA 1.22x 8.4% 4.7x 48%
TAM 0.85x 5.9% 7.3x 37%
LFL 0.70x 9.8% 5.2x 36%
ALK 0.77x 6.5% 5.1x 25%
CPA 0.60x 17.0% 2.3x 24%
RYAAY 0.43x 10.2% 2.6x 12%
GOL 0.80x 3.1% 3.2x 8%
LUV 0.81x 3.8% 2.5x 8%
SKYW 0.63x 3.5% 3.2x 7%
JBLU 0.58x 2.6% 4.1x 6%
RJET 0.60x -0.5% 7.8x -2%
Source: Author Calculations

The interesting observation is that I'm used to reading about LUV's great operations, which it shows in having the third-best asset turnover; however, relatively low profitability and limited leverage result in a lower ROE than many other companies. The other interesting note is the risk of Leverage. The two most-leveraged companies had the highest and lowest calculated ROE. However, after that, there appeared to be some correlation between leverage and ROE. The following table will look at the results for 2009.

2009 Airline DuPont Analysis
Ticker Asset Turnover Profitability Leverage Implied ROE
TAM 0.82x 12.8% 9.2x 97%
HA 1.21x 9.9% 8.1x 97%
GOL 0.85x 14.8% 3.2x 40%
CPA 0.60x 19.8% 2.5x 30%
United* 0.86x -4.0% -7.4x 25%
LFL 0.66x 6.6% 4.4x 19%
ALK 0.69x 3.6% 6.3x 16%
RJET 0.43x 2.4% 6.5x 7%
SKYW 0.63x 3.2% 3.1x 6%
JBLU 0.52x 1.9% 4.3x 4%
LUV 0.72x 1.0% 2.7x 2%
RYAAY 0.42x -5.8% 2.8x -7%
Continental 0.99x -2.2% 35.6x -79%
DAL 0.63x -4.4% 80.5x -224%
Source: Author Calculations *Reflects a mathematical result.

Here is the clear illustration of the problem with leverage, since DAL negative profitability was magnified through enormous leverage showing the worst ROE. TAM and HA both sit near the top of the table thanks to strong metrics across the board. United also shows a clear demonstration of why it is important to look at the calculations. A 25% ROE might sound good, but it is only positive since both profitability and book equity are negative. As a result, I pulled the Q1 2011 10-Q for UAL to see if things are improving for it:

UAL DuPont Analysis
Metric Q1 2011 2010
Revenue ($ millions) 8,202 23,229
Net Income ($ millions) (213) 253
Average Assets ($ millions) 40,075 29,141
Average Equity ($ millions) 1,820 (542)
Asset Turnover (annualized) 0.82 0.80
Profitability -2.6% 1.1%
Leverage 22.0x -53.8x
Implied ROE -47% -47%
Source: UAL Q1 2011 10-Q and UAL 2010 10-K from

It appears that the combination of two underperforming airlines results in an underperforming airline. However, it appears there is some potential: Merger synergies should help get profitability back to being positive. Both airlines had solid asset turnover ratios before, and UAL continues to show good asset turnover, comparable to LUV. Leverage is also coming down and should continue as retained earnings (assuming 2011 Q2 profitability) help to increase a very low book equity base.

The airline industry is clearly a challenging space. Recent fee increases for baggage and other services that used to be included appear to be helping profitability. The Latin American Airlines (TAM, CPA, LFL) and HA appear to have some of the strongest metrics. However, as the table below shows they have a pretty high P/E as well with the exception of HA.

Airline Price to Earnings
Ticker Current P/E
TAM 23.4
LFL 21.0
JBLU 17.8
LUV 15.8
SKYW 15.3
GOL 13.5
RYAAY 13.3
BRS 11.7
CPA 11.7
HA 11.3
ALK 8.8
DAL 7.1
UAL 5.6
Data provided by services.

Potential Long: Given HA's leading statistics and low P/E, it is a good possible long candidate. It should be noted that this article constitutes a quick survey using one type of analysis. HA is also a relatively small company. According to Yahoo Finance, HA has a very strong cash position with over $300 million in cash and under $200 million in debt. ALK may also be a good long.

Potential Short: When I started writing the article, I had expected to see LUV with leading statistics; however, that was not the case outside of asset turnover. I would be very reluctant to short LUV, but if it fails to improve its statistics this could be an issue. LUV is down about 11% over the past 52 weeks and is about 30% off its 52-week high. In contrast, UAL is up 1% and is only 23% from its 52 week high. UAL sports a P/E about one-third of LUV's. A more aggressive play might be to look at valuation shorts or pairs trades using the Latin American airlines on the argument that, while they have good metrics for DuPont, those metrics do not justify the valuation.

Turnaround (Long): or more adventurous investors, UAL may offer a good return as a turnaround company. Improving prospects and cost savings may provide some medium term returns.

It should be noted that this analysis is very focused around book results and the income statement. A good follow up analysis to this would be a careful cash flow assessment for any prospective investment, either long or short.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HA over the next 72 hours.