Transnational Research Associates

Art Madsen, M.Ed.




Most corporations are sincerely interested in maximizing their share prices and consider that a reasonable overall goal. They utilize a number of tools to achieve that objective and a detailed discussion of how these tools are optimally used is of particular interest to both public managers and corporate managers. There are a multitude of variables affecting share price valuation, such as taxation, regulatory processes and unforeseen contingencies, and these will also be discussed in this comparative analysis. The private airline sector in the United States was selected as a platform for demonstrating certain valuation principles and concepts that might not apply to parastatal airlines such as Air France, British Airways, or Iberia. Due to the inequalities of the privatization process currently underway in Europe, the dynamics of many European airlines are influenced to varying degrees by considerations that fall outside the principal objectives of the present analysis.

The following data, observations and analytical comments rely, in part, on more than three theoretical financial management textbooks under sub-headings such as ‘share valuation’, three annual reports, and several stock-related Internet sites, all of which are duly noted in the Reference section. The Internet information is particularly useful since it brings up to date stock quotes and fiscal data pertaining to Delta and Southwest. All pertinent commentaries, analyses, recommendations and observations are, of course, those of the writer who assumes responsibility for them within the context of this academic report.

Fundamental Theoretical Principles of Valuation

It is important to set forth certain basic theoretical principles of share valuation, showing how the shares of these companies should be valued, before applying them specifically to Delta and Southwest Airlines. The constant growth model can be applied to most firms, but not to all. However, this simple model contains most of the critical variables useful to financial managers. The basic formula for the constant growth model is as follows: V = D/ (i – G). Here, V is the present value of the share and D is the current year’s dividend. Further, "i" is the nominal rate of return on shares and G is the expected annual growth rate of earnings and dividends. G must be constant and must be less than "i". In the markets of the late 20th century, dividends (D) were thought to be of particular importance in determining and maintaining a share’s value. This may be less so in the fast-paced electronic share-trading atmosphere of the Year 2000; yet, dividends are still considered to be of considerable importance in the valuation equation for serious analysts and investors. It is important to note that D appears in the numerator of the model, whereas G (growth rate) is beneath it, as the denominator, and reflects the firm’s asset portfolio. The "i" factor is more complex. This represents the required nominal yield (or rate of return on common stock) and is comprised of such imponderable factors as the return on the market and the risk-free rate. Indeed, "i" is determined by a formula incorporating many fluctuating and unpredictable elements over which the company has little or no influence. These elements result in the Beta (b ) coefficient (essentially, a firm’s risk factor). Only by controlling its choice of assets, can the company influence its risk factor; but it can do so only slightly, given the number of uncertainties in the external market or economy. The nature and extent of risk tangibly impacts the share valuation process.

Typical External Macro-Factors Exacerbating Beta-Risk & Affecting Value

In the case of the United States, and other western-type economies governed by the Central Banking Model the availability of credit is a major factor affecting growth and risk, as well as impacting the market. Directly and indirectly, the degree to which capital is available influences the value of share prices in all industries, airlines included.

The Federal Reserve or Central Banking System of the United States and of other countries, controls two primary variables which affect the availability of credit on a nationwide scale. The funds rate is actually a more meaningful indicator of credit conditions within a country, since it affects a wide range of government and private institutions. If the funds rate is low, money is readily available for industrial growth and projects of all sorts. The same is also true of the second rate controlled by the Federal Reserve, the discount rate. Because the Federal Reserve discourages borrowing at the discount window, except for short-term purposes to cover momentary banking insolvencies, these funds are not always as significant a factor in determining the fate of various industrial expansion projects as the funds rate. However, both of these important interest-sensitive parameters set a "mood" or "climate" in which planning and projection take place. When credit is "tight" and funding is difficult to obtain at reasonable rates of interest, then social opportunity cost (SOC) methodologies can be utilized as strategic approaches to raising capital growth funds. These SOC funds represent "ready-money", raised from the private sector community to underwrite necessary growth plans deemed important by industrialists and executives, often locally or on a statewide basis. Decisions are, of course, geared to the results of careful assessments. When monetary policy is less restrictive, and the discount rate is low, federally or privately available funds can be utilized to capitalize new-growth projects. Under this scenario, the rate of return is optimal and repayment feasible. All of these dynamics affect relative share value of a firm anticipating growth in certain economic climates. Just this month, the U.S. Federal Reserve Bank raised the funds rate by 0.5%, theoretically restricting industrial growth by more than usual, and cooling down the American economy (with implications for Europe), one in which share prices, in the macro-sense, might be perceived as over-valued.

Foregoing Share Valuation Concepts Applied to Delta & Southwest Airlines

The above scenario represents only one of the external variables in the complex socio-economic equation determining the value of shares in a given industry or sector. If we turn to the airline sector on which this analysis intends to focus more closely, we see that there are other external variables impacting the perceived value of shares. Surely, the ‘travel climate’ in relation to an airline’s routing system is a factor. If there are riots in Detroit, Baltimore and Chicago, travel may be impacted adversely in those cities. If the Mexican Peso falls discernibly in relation to the U.S. dollar, travel from San Diego or Tucson to El Paso might be affected in that heavily Mexican and Mexican-American market. Similarly, if adverse publicity related to an aircraft crash is overplayed in the press, an airline’s quarterly results could fall sharply. Furthermore, when a firm takes on a risky venture (such as routinely flying into airports with a high incidence of wind shear phenomena), earnings are ultimately negatively impacted, along with dividends, of course, and share value invariably decreases. Obviously, astute managers avoid what could materialize as risky ventures in order to forestall a share price decline.

The externally controlled price of oil, and hence aviation fuel, can also impact the airlines sector and influence the value of common stock. For example, glancing back at the oil-crisis of the 1970s, during which OPEC nations imposed higher price levels on petroleum products, it can be seen that even this major economic shock, causing a momentary dislocation socio-economically, was absorbed by the United States, and by the airline industry, without long-term upheaval. Communication between Gulf Nations and the U.S. avoided an even more serious crisis. A similar price-hike, imposed by OPEC nations this year, occurred. Cautionary statements in the annual reports of Delta demonstrate their Board of Directors’ awareness of this unpredictable element in the share-price equation:

"Our company’s results of operations could be significantly impacted by changes in the price and availability of aircraft fuel. A 10% rise in our jet fuel prices would have increased our aircraft fuel expense by approximately $25 million in fiscal 1999." --Delta Airlines 1999 Annual Report, 34.

Although this statement was simply explaining what would have occurred in 1999, very often these events do occur and adversely impact – by considerable margins – the value of share prices. Southwest, of course, is similarly aware of these variables.

Valuation in relation to Internal Policy Decisions, e.g. Reinvestment of Earnings

The internal policies of airlines companies, over which they have control, also influence their share value. We have seen that as external interest rates rise, capital is restricted and share values usually decline. They can also decline if internal decisions are improperly made, such as not reinvesting a certain amount of earned revenue into the business. There are ways of leveraging the value of shares through manipulation of such factors as the ‘rate a firm expects to earn on reinvested earnings’ and the ‘required rate of return’. For example, if the rate on reinvested earnings is less than the required rate of return, the firm can increase share prices by increasing dividends. These are the types of decisions made by informed and astute financial managers on a regular basis. Occasionally, the Board of Directors is consulted to provide further advice and approval as required by the firm’s structural guidelines.

Narrative and Comparative Analysis of Southwest and Delta Valuation Criteria

At this point in our analysis, let us examine recent Annual Reports of Delta Airlines and Southwest Airlines, and current Internet sources, with a view toward applying the foregoing principles and revealing some of the strategies and decisions that their Boards made during the 1998 Fiscal Year. Share prices for these two companies, return on stockholders’ equity, dividends paid, plus revenue figures, long & short term debt, and various external factors, such as those alluded to above, will assist in evaluating the status of both companies. This analysis will be followed by a comparison of Delta Airlines (1998 Assets: $14.6 Billion) and Southwest Airlines (1998 Assets: $4.7 Billion) and by recommendations as to which firm has the more appropriately valued shares. Figures from 1998, 1999 and First Quarter 2000 will be used in this analysis whenever available. Care will, of course, be taken to analyze and contrast appropriate figures from comparable timeframes.

Let us examine the smaller of the two airlines first. In 1998, Southwest Airlines shares ranged in value from $15.31 to $23.75, a price spectrum that would seem fairly unstable at first glance. Fortunately, the high figure was realized at the end of the Fourth Quarter, and handsomely surpassed the 1997 high of $17.50. In the First Quarter of 2000, Southwest Airlines (LUV) is fluctuating in the area of $20.25 per share as of May 22, 2000. Each share had first quarter earnings of $.14, fairly impressive and somewhat indicative of a properly valued issue, seemingly well appreciated by investors. Naturally, other indicators have pointed in the last three years to key underlying reasons for valuation at this level.

In 1998, long term debt of SW Airlines stood at $623,309,000 and shareholder equity was at about 2.4 billion dollars, while net income was on the order of $433.4 million. This profile, set against the total asset figure of $4.7 billion, makes it seem as if Southwest might not be as stable in some ways as it appears on the surface. Stockholder equity and long term indebtedness were, and seem to have remained, considerable. However, the return on total assets, due to judicious investment and manipulation strategies, amounted in 1998 to 9.7% and return on stockholder’s equity was fully 19.7%. These figures point to attractive medium term investment potential, and stock valuation seems appropriate in the 15 to 23 dollar range, now hovering in the 20 dollar range. Company growth is healthy, as well, with "revenue passengers carried" increasing over four years from 44.8 to 52.6 billion, and trips flown rising by an equally encouraging factor (see section f22 of Southwest’s 1998 Annual Report). By inserting many of these raw figures into the basic ‘constant growth model’ equation quoted earlier, a V-value can be generated that approximates the actual figure with some degree of accuracy. The "i" factor is the most troublesome contingency element in the equation, and is difficult to calculate. Knowing the Beta-risk coefficient would seem essential for proper assessment of Southwest’s overall share valuation.

Secondly, Delta Air Lines, Inc. requires brief valuation analysis and commentary. On Appendix A, it can be seen that Delta share prices have fluctuated roughly between 43 and 63 dollars per share in the last year (June 99 to May 00). These shares are priced at approximately three times the value of Southwest’s. A current Delta share (DAL) is being sold at $55.19, according to Stock Master’s May 23rd quotation, inthe mid-range of this year’s performance.

A fast glance at the net worth of these two firms reveals a similar disparity (with a SW/Delta asset ratio of 5:15 Billion Dollars, one to three). Certain assumptions can be made as to the probability of equal risk factors in the airlines industry affecting both SW and Delta. Nonetheless, other indicators must be reviewed to see if Delta has properly valued its shares, account being taken of unforeseeable market dynamics and other variable factors. Shares of common stock outstanding at the end of 1998 amounted to 75.2 million, with shareholders’ equity standing at $4.023 billion (recorded as a liability), representing more than 20% of the firm’s net value. Historically, share values were on the order of $129 in last fiscal quarter of 1998 and have obviously fallen to approximately half that value in the year 2000. Analysis of the number of shares issued, in the interim, and other variables, would have to be made to determine if the current valuation is appropriate. From an investor’s standpoint, of course, the share value is geared to market conditions and even to external subjective perceptions as much as it may be to internal financial fundamentals of the company. Growth of Delta Air Lines, Inc. seems to have been healthy; yet their 1998 annual report does not highlight these figures as enthusiastically as Southwest. Delta has extensive route patterns inter-linked with European carriers in addition to heavy market saturation quotients domestically in the United States. In 1997 and 1998, Delta entered into formal pay scale mediation proceedings with employees and this caused some concern in management circles. With all other risks inherent in this business, labor problems and industrial actions are clearly not something looked upon with favor. Somewhat amazingly perhaps, long term indebtedness of Delta totaled 1.9 billion on June 30, 1998, representing precisely the same percentage of net worth (13%) as Southwest (13%). So, when looking at comparative share valuation in light of these parameters, a 'wash' seems to emerge, demonstrating to analysts that similar patterns of banking, financial and managerial decisions are being made at the upper echelons of these two major civil aviation firms. Delta’s cash liquidity position was also quite realistic, at 1.6 billion in 1998, indicating adequate cash flow patterns and astute managerial operations.

Growth was on the order of only 3% in Revenue Passengers Flown between 1997 and 1998; however, this factor was not negative and would be considered basically upbeat from an investor’s perspective. Share valuation [using the constant growth formula, such variables are plugged into the G rating] tends to reflect these types of parameters, as well.

Concluding Recommendations and Observations

Southwest Airlines has proven to be consistently profitable over at least seven years. Its share valuation mechanism is comparable to that of Delta and to other major carriers in the industry. Several major criterion indicators, in spite of SW’s smaller size, seem to point to excellent managerial decision-making and wise fiscal administration. Neither Delta nor SW has exceeded a 13% ceiling on long term indebtedness in relation to their net worth, basically a debt-equity indicator. Stock issues are proportionate to assets in both cases, and it appears as if both of these airlines are expected to continue dominating their respective markets. Under these circumstances, the writer of this analysis would tend toward purchase of Southwest Airlines, as opposed to Delta, but only for fairly subjective reasons related to personal preferences associated with potential growth of a smaller company. Delta is a ponderous and somewhat ‘lumbering’ firm, whereas Southwest seems to be managed more adroitly and with a visionary streak of enthusiasm reflected both in the tone of its corporate literature and in its performance record.

All of the many hundreds of input variables and fluctuating risk factors used to arrive at proper share valuation could not be fully analyzed in this report. Nonetheless, many highly significant factors entering into the calculation and assessment of share prices and related financial valuation criteria were validly and accurately portrayed.


[Note: All statistical data and figures quoted in the body of this report are available at the hyperlinks provided herein below.]

DAL (Delta Air Lines Inc) Stock Quote Site:

Delta Air Lines, On-Line Annual Reports (1998, 1999, First Qtr. 2000)

Delta Air Lines 1998 Annual Report, Atlanta, Georgia, 1999.

Delta Air Lines 1999 Annual Report, Atlanta, Georgia, 2000.

Friedland, S. Principles of Financial Management: Corporate Finance, Investments and Macrofinance, Winthrop Publishers, Inc., Cambridge, Massachusetts, 1978.

Gup, B., Principles of Financial Management, Second Edition, John Wiley & Sons, New York City, 1987.

Hartl, R., Basics of Financial Management, W. C. Brown Publishers, Dubuque, Iowa, 1986.

Hicks, J. Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, Second Edition, Oxford University Press, 1978.

LUV (SW Airlines) Stock Quote Site:

Southwest Airlines Company 1998 Annual Report, Dallas, Texas, 1999.

Southwest Airlines Company, "Southwest Airlines Reports First Quarter (2000) Earnings; Exceeds First Call Consensus Estimate",


Recent Stock Price History of Delta Air Lines, Inc.

(Courtesy of