Southwest Airlines

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The Examination Module on the Canvas site presents a research report by Rob Barnett entitled

Southwest Airlines: Intrinsically Cheap But Is Now The Time To Buy?”

The report is an example of exceptional equity research. With a few modifications it closely


Course Notes II, Outline for Equity Research

which we have been using (and will

continue to do so) throughout the course.

Your assignment is to carefully read the research report, and thoughtfully and fully address

(word process) responses to the following questions.

1. Describe in 1-2 sentences Southwest Airline’s (ticker LUV) sensitivity to the U.S. economic/business cycle.

2. Is the U.S. airline industry a relatively high or low fixed costs industry (another way of stating this is a relatively high or low operating leverage industry)? What does this mean for airline cost and profitability over the course of the business cycle?

3. What single item, not directly under LUVs control, is a key determinant of its cost and profitability?

4. What is LUVs business model (you may want to read the report before answering this question)?

5. How have LUVs total returns on equity compared to the Industry and overall Market (S&P 500) in recent years, and over longer time horizons?

6. Would you describe LUV’s equity as more of a ‘Growth’ or ‘Value’ stock? Briefly explain.

7. Describe in 1-2 sentences what is meant by a company’s “Operating Margin?” Also, give an equation/formula for Operating Margin.

8. In the report LUV’s Operating Margins are shown to be consistently higher than its peers/industry. Are LUVs higher operating margins caused more by higher revenue growth, or greater cost efficiency, or both? Explain based on the research report.

9. Airplanes are important capital equipment to airlines. How do almost all (U.S. anyway) airlines finance the airplanes they fly?

10. What has been LUVs ROIC over the last ten years?

11. Describe LUV’s moat.

12. In terms of the DCF Model Barnett uses, what are the key assumptions he makes about:

a. Measure of cash flow used in the DCF model?

b. Does he use a one-stage or multi-stage DCF model? Explain his reasoning.

c. RAOCC he uses

13. What does his DCF Model suggest about LUV’s valuation? Is LUV over, under, or roughly properly valued?

14. What “Relative Valuation” metrics does Barnett use? According to these valuations is LUV over, under, or roughly properly valued?

15. BONUS POINTS What is a Monte Carlo simulation?

Here is the article /…

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