Financial Performance of Low-Cost and Full-Service Airlines in Times of Crisis, The

In a long-term study of historical market risk premiums, Ibbotson and Sinquefield (1976) find that the average risk premium for the S&P 500 index during the period 1929-76 was about 8.4%. During our sample period from January 1996 to April 2003, we find a similar market risk premium of 8.15%. A closer examination reveals, however, that the market risk premium pre-9/11 was 14.9%, influenced in part by the booming economy during the 1990s and the 1999/2000 stock market bubble, and that it dropped to -19.4% after 9/11.

If we square the correlation coefficient ρ^sub i,m^ we can observe that the term ρ^sup 2^^sub i,m^ is equivalent to the R^sup 2^. Again, all three approaches may be used interchangeably and yield the same results. As noted above, the R^sup 2^ and (1-R^sup 2^) simply provide a proportional decomposition of a firm's total variance σ^sup 2^^sub i^ into its two risk components, β^sup 2^^sub i^ σ^sup 2^^sub m^ and σ^sup 2^^sub e^sub i^^, and may be interpreted as percentage weights.

Results

Accounting Performance

The first part of our analysis focuses on the relative performance of Southwest and its competitors from an accounting standpoint, by comparing various accounting measures and financial ratios for the three firms over time. An analysis of the stock performance and return volatility of the three airlines follows in the next section.

The accounting figures and financial ratios in the following table are based on quarterly 10-Q filings from January 2000 to March 2003. As we can see, despite the 9/11 events, Southwest managed to remain profitable on slightly declining sales, while Continental and Northwest registered significant losses on falling revenues.

Southwest's current ratio is initially below the current ratios of Continental and Northwest, but improves significantly post-9/11.

A comparison of the activity ratios paints a similar picture for all three airlines: each experiences a decline in its asset turnover ratio. The decline is particularly strong for Continental and Northwest, and relatively mild for Southwest.

A look at the financing ratios paints a very different picture for our sample airlines. Although Southwest's interest coverage ratio drops significantly during our sample period (from 15.6 in 2000 to 5.4 in 2002), the firm remains in a good position to cover its interest expenses. On the other hand, the impact of 9/11 on the interest coverage ratios of Continental and Northwest is tremendous: both airlines have negative ratios in 2002, indicating that they experience significant difficulties in making their interest payments. Both Continental and Northwest had a significantly higher debt ratio than Southwest prior to 9/11. The high leverage and the accompanying financial risk are likely to be one of the reasons for the quick deterioration of their financial ratios. By the first quarter of 2003, the debt ratio of Southwest remained relatively stable around 50%. In comparison, Continental's debt ratio increased to 92.6%. Even more interestingly, Northwest's debt ratio rose above 100%, accompanied by a deficit in shareholders' equity. The profitability ratios (ROA, ROE, and profit margin) of Southwest are comparatively healthy after 9/11, although they remain below the profitability levels that Southwest showed in 2000. In contrast, Continental and Northwest show very strong signs of weakening post-9/11.