Jun 25, 202310 min read

Dupont Analysis Airlines Case Study: SouthWest Airline & Singapore Airline- Investment Articles

Updated: Jun 26, 2023

South West Airline and SIA Airline Dupont Analysis

Dupont Analysis Introduction

The Dupont analysis is a method relatively unknown to the investment community to understand how well a company is performing and making money. It helps us look at factors contributing to a company's financial success. There are 3 components to this perfect equation for Dupont Analysis, Net Profit Margin, Return on Asset (R,) and Financial Leverage. What is ROE? It is Return on Equity and denotes how effectively a company utilizes the investments given by the shareholders to generate profits.

Dupont Analysis is typically employed to compare apples to apples, namely, companies to other companies in similar industries.

To analyze critically with Dupont Analysis, I typically look at each component individually and evaluate the result by the process of elimination. For example, let us use one case study (Singapore Airlines; SIA), where the stock ticker has already been rampantly flying off. This is to be compared to an airline in the US, Southwest airline in this Dupont Analysis.

1) Net Profit Margin (Dupont Analysis)

The Net profit margin represents the profitability of a company's products. The airline industry's net Profit Margin (Bottomline) is notoriously renowned for being tiny and squeezed as it is a cut-throat industry. I quote Warren Buffet above, and he has knocked down airline company stocks again and again in the past. Intriguingly, he bought into the airlines after the covid situation.

To compare, let us investigate the financials of South West Airline, a famous US airline Buffet amassed in 2020

Net income statement (South West Airline)

The infamed airline industry had relatively low-profit margins compared to other industries for its high operating costs, including fuel, labor, maintenance, and aircraft acquisition expenses. Net Profit Margin ranged around the average in the industry, lower than 10% from 2013 to 2018. Subsequently, it reached a healthy level of above 10% in 2019 and came crashing down in the year of covid again, pressed for margin.

Net income statement (Singapore Airlines)

If we compare Apple-to-apple with Singapore Airlines (SIA), we notice an apparent margin difference (%) from 2013 to 2018. The percentage proportion is by dividing net income over the previous sales.

Notably, the margin was squeezed hard even before covid started at a couple of good years when South West Airline attained more than 10% margins. This could be one of the reasons Buffet was so interested in Southwest Airlines quantitatively. However, one interesting point is the net income margin of SIA has bounced/recovered tremendously to a new height of 12.17%. What may have caused this phenomenon? I dug further into the income sheet and realized they have similar operating expenses of 20%~, which means the root cause lies with the Gross Profit Margin.

South West

SIA

Gross Profit Margin is derived by deducting the Cost of Goods sold from Revenue (Revenue- COGS); gross profit margin in Airlines is typically attributed to central machinery, aircraft maintenance, and lease, airport charges, the distribution cost of tickets, insurance, and especially things like fuel cost & machinery. I then investigate this train of though

Crude Oil Hedges (SIA)

Crude Oil Prices surged dramatically in younger years. Then they declined in 2015 when there was a global oversupply. Hydraulic fracturing and horizontal drilling techniques enabled the US economy to extract previously inaccessible shale oil. As we all know, oil is the primary fuel for airplanes, and the decline has since led to southwest airlines' cost of fuel declining drastically.

However, this oil price movement does not seem to impact SIA. I cite this old article found online "Singapore Airlines Ltd (SIA) on Thursday reported a full-year fuel hedging loss of S$549 million ($416 million) as a result of falling oil prices and also highlighted fierce competition and soft demand on its key routes." on the year 2015, this reflects oil hedges as a double-edged sword in this volatile economy.

SIA Machineries

As can be inferred, machinery (Airplanes) did not significantly increase for SIA after the covid situation. SIA's management has cut down expenditures to expand the flight cautiously, which is a good sign, to be honest.

SW Machineries

On the contrary, southwest airplanes have increased significantly despite covid situation. Is this the case where management should have planned accordingly? I proposed it is likelier due to the covid lockdown situation easing earlier in the US, and revenge travel has rebounded quickly in this? However, this has detriment gross profit margin for SW Airline as the gross profit margin was eaten into.

Nonetheless, since SW Airline embarked on predicting future demands, the future revenue and profit are bound to be increased as the upfront costs have already been paid by the management in this particular predicament with temporary headwinds faced by SW Airline. This is corroborated by the news that it decided to buy 100 Boeing planes in 2021.

Despite SIA being the winner in this Dupont Analysis category, SW Airline Gross Profit Margin is projected to increase in the long run to normalize back to its old 2013 to 2018 good old times. The way to improve gross margin here is multiples; one is to project future oil prices for the airline to propose hedging against higher prices. This is not easy to achieve as oil price macroeconomics events are hard to predict in the first place. The second way is to align the no. of flight consumption with the number of planes, projecting the future demand of travelers. Relatively, this is easier to achieve and model. For now, I can infer that this airline industry's gross margin and COGS are hard to extrapolate. However, let us look at other factors that can enhance its ROE.

2) Return on Asset (ROA);Dupont Analysis

SW Total Assets

SW Additional paid-in Capital (APIC)

SIA Total Assets

ROA is the 2nd component of our Dupont Analysis. SW and SIA's total assets increased significantly as covid- started raising cash for the distressed debt-ridden industry. The balance sheet story is completed upon seeing its APIC is overwhelmingly high during 2021, denoting the company had sold equity shares for cash to tide through accordingly.

Asset Turnover Ratio: Revenue/ Assets

Generally, long-lead time industries with high-value items such as those with high machinery and CAPEX like airlines will be unable to employ a high-turnover methodology. Nonetheless, let us evaluate whether the turnover ratio is an essential metric in our airline industry Dupont analysis.

From my calculation, the asset turnover rate of SW is higher, indicating it is more efficient in this metric. Why is this so? SIA is one of the best airlines in the world, and its flight routes and seat pricing should be optimized. As of recent events, could there be overly high "Ground Time" for the planes? Let us evaluate further.

I take away cash and cash equivalent to ensure that the asset turnover ratio is clean and free of erroneous calculations; since cash is typically not an asset to generate more cashflow or ROE for airline companies. The historical asset turnover ratio plunged during covid for both airlines as most flights were canceled and airplanes were grounded and rendered redundant.

The asset turnover ratio for SIA has been lower since the past decade, while the SW one has been more efficient than the other. SW has also reverted to its historical median turnover ratio as the US lockdown is completed earlier. It may also suggest it is of higher operating efficiency with good management guidance. This indicates that SW airline is exploiting maximum resources and minimizing inefficiencies in asset utilization. Capacity management is a determinant for improving asset turnover, and implementing dynamic pricing strategies can help SIA Airlines optimize seat allocation and maximize revenue per flight.

The verdict here is SW is clearly the winner of this ROA metric. We can guesstimate by using the number of machinery ratio: to no. of flight tickets to identify if the flight route and ticket seats are well differentiated and optimized. The other way is to look at the flight load to eliminate if this is why SW ROA is significantly higher.

Passenger load factor (%) SIA: 87%

Passenger load factor (%) SW: 77.6 %

Interestingly, the SIA load factor is higher; when linking this piece of evidence to the machinery which SW had bought during covid, it becomes as clear as the skies the load factor has been distributed amongst the new planes and less likely that SW has not been efficient in loading the customers. Nonetheless, there is room for improvement for the SW asset turnover ratio to increase since this load factor is not optimized as of the current state of affairs.

How can SIA then improve the Asset turnover ratio, it is likely to be improved by resource utilization and cost optimization as both airlines are known to have a competitive advantage in the industry. Regardless, there is only visibility in this area for how they employ and allocate their resource once further information is given.

3) Leverage; Dupont Analysis

SIA Deferred Revenue

SW Deferred Revenue

Leverage is the 3rd and final component of Dupont analysis, like when banks borrow to increase their leverage multiplier, subsequently enhancing their ROE.

‌As we all know, airlines receive cash from you first when you purchase an airline ticket from their website. This is known as deferred revenue in the context of airlines which is a liability on the balance sheet that represents an advanced payment from the customers for service yet to be delivered (Flights)

It is split into two segments here yet again, current deferred revenue within the next 12 months and non-current deferred revenue beyond the next 12 months. As illustrated above, SIA has no deferred revenue beyond 12 months, which coincides with the departure date I can select on its official website.

This allows them to use consumers' money for expansion and buying more aircraft. Concurrently, this idea of theirs enhances ROE by increasing liabilities and debts.

SIA, deferred revenue has surged twice and four times the fold ever since covid started; it is evident to our eyes that this is due to revenge traveling and pent-up demand from the co-vid situations. Meanwhile, SW Airlines deferred revenue has increased 1.5 times, which seems pale in comparison. As aforementioned, there was a surge in planes repurchased by SW airlines in 2021 and 2022 in contrast to SIA; why did the deferred revenue differ so widely? Could it be due to the disparity of geographical location, where Singapore Changi Airport reopened its arms to travelers in 2022 and the opening of China borders while the United States lockdown has already reopened since 2021?

b) Right dilution for equity

The equity component is equally as crucial for Dupont Analysis (Leverage multiplier); there was a significant rights dilution event occurring for SW Airlines to borrow cash in trade with equity. Ironically, even when SIA borrowed money, the leverage multiplier was shown to have declined from the year 2021 to 2022, showing a historically lower Equity multiplier.

Compared to SIA Airlines, SW Airline's equity multiplier is significantly higher, leading to a higher ROE overall. This, along with deferred revenue cash flow, is the one and best metric essential to evaluate whether the airline can continue to surge higher in the future.

Conclusion

This 3rd leverage metric's visibility, ease, and usage are high in DUPONT analysis. At the same time, ROA is also essential despite the need for more visibility on how the company allocates their resource other than the passenger load factor and planes it possesses in its arsenal. What other companies would you want to see a Dupont analysis on? Leave a comment on the website contact button or subscribe to my blog!

Disclaimer: This website is not financial advice and is merely for entertainment and reading purposes.

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