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CAL AT A GLANCE

P/E ► -2.92   EV/EBITDA ► 106 VERY HIGH ROA ► -2.1% AVG ROE ► -82.4% AVG Debt to Equity ► 27.2 HIGH Current Ratio ► 0.965 AVG Interest Coverage Ratio ► -0.717 LOW

 

 

 

 

 

 

Continental Airlines (NYSE: CAL) is the world's fifth largest airline by Revenue Passenger Miles.^[1] CAL serves over 241 destinations worldwide, offering 2,800 daily flights.^[1] Continental's Cost per Available Seat Mile (CASM) of 12.44 cents is among the lowest in the airline industry and is the lowest among the legacy carriers, like United Airlines (UAUA) and American Airlines (AMR).^[2]

As with all airlines, volatile oil prices hurt the company's financial performance. In 2008, CAL's average price per gallon of fuel increased by 50% to $3.27 per gallon.^[2] Furthermore, its minimal fuel hedges make Continental even more vulnerable to fuel prices as it has only 23% of its expected fuel consumption hedged for 2009.^[3] However, CAL is also vulnerable to devalued hedging contracts because of declining oil prices, and moreover, the company posted a $125 million loss because of hedging contracts it had with Lehman Brothers in 2008 after the firm declared bankruptcy on September 15, 2008 .^[4] As of January 2009, all open contracts with Lehman Brothers had been settled.^[4]

Because of higher fuel costs and declining consumer demand for travel, Continental announced a 6.5% workforce reduction and the early retirement of 67 planes in June 2008, marking a 16% reduction in capacity or Available Seat Miles (ASM).^[5] Furthermore, CAL expects its capacity to decrease an additional 4%-6% in 2009 because of slumping consumer demand.^[6]

Business Overview

Continental Airlines is the world's fifth largest airline by Revenue Passenger Miles.^[1] CAL operates through the hub and spoke system, with major hubs in Newark, Houston, and Cleveland.^[7] Continental operates a fleet of 632 aircraft^[8], offering 2,800 daily departures to over 241 destinations worldwide.^[1] Continental provides service to 39 cities in Mexico and Central America, more destinations than any other U.S. airline.^[1] In addition to its own flights, CAL also earns revenue through its code-sharing alliances, particularly its SkyTeam Alliance with airlines like Air France-KLM (AFLYY) and Delta Air Lines Inc. (DAL).^[9] In 2008, Continental had an average fare of $232.26, up from $214.03 in 2007.^[10]

CAL's key operating metrics are shown below:

Financial Analysis

CAL earned $15.2 billion in revenue in 2008, an 7.1% increase from 2007.^[2] Furthermore, CAL's 2008 revenue marks a 9.01% compounded annual growth rate (CAGR) in revenue since 2004 as the company has increased its capacity or Available Seat Miles (ASM) 21.1% during the same period.^[2]

• In 2008, the company's increase in revenue was driven by 6.0% growth in Revenue per Available Seat Mile.^[10]
• Despite an overall decline in Continental's capacity of 0.2%, Trans-Atlantic and Latin American flights grew by 8.9% and 2.5%, respectively, in 2008, compared to 4.9% domestic contraction.^[12]
• Continental's operating expenses reached $15.555 billion in 2008, a 14.8% increase from 2007.^[2]
  • The increase in operating expenses was primarily attributed to a 46.2% and 15.6% increase in fuel costs and regional capacity purchase, net, respectively.^[12]
  • The increase in fuel costs was primarily attibuted to rising fuel costs as CAL's average cost per gallon of fuel jumped by 50% to $3.27 in 2008, up from $2.18 in 2007.^[2]
• Because of higher operating expenses, CAL's Cost per Available Seat Mile (CASM) increased by 14.9% in 2008 to 12.44 cents.^[2]

Overall, Continental had a net loss of $585 million in 2008 after earning $459 in net income in 2007.^[2] However, Continental hedges much less fuel than its competitors, which makes the company vulnerable to volatile oil prices. For example, CAL hedged only 23% of its 2009 fuel needs^[3], compared to American Airlines (AMR)'s 34% of fuel needs hedged.^[13]

The losses continued through 2Q09, as Continental posted a $213 billion net loss, as compared to a $5 billion net loss in 2Q08.^[14] This is despite a 40.2% decline in average price per gallon of fuel to $2.07.^[14] With airline travel falling in the recessionary environment, operating revenue for CAL fell by over 22%, from $4.044 billion to $3.126 billion between 2Q08 and 2Q09.^[14] In fact, passenger travel revenue decline by a larger degree than did overall revenue, with a 24.2% drop to $2.767 billion.^[14] During the first half of 2009, CAL has begun to address these issues by downsizing its fleet, with a net decrease of 1 plane and plans to remove 9 and sell 12 Boeing 737-500 aircraft over the remainder of the year.^[14] Moreover, there was a 7.8% decrease in Available Seat Miles (ASM) to 28,007 million, but a 130 basis point increase in Load Factor to 82.7%.^[14] However, more importantly than the fall in demand was that CAL became less efficient at earning revenue on a per customer basis, as the 18.3% fall in average yield per revenue passenger mile suggests.^[14] This was due, in part, to 15.6% cuts in average passenger fare during 2Q09 to attract travels.

Although Continental reported operating income of $61 million in 3Q09--a $213 million improvement as compared to 3Q08--the company nonetheless had a net loss of $18 million for the quarter.^[15] Like many of its competitors, CAL benefited from relatively low oil prices, which led to a 51% decrease in its airline fuel expense, from $1.8 billion to $881 million in 3Q09.^[15] The company did have operating cash flow of $187 million in 3Q09, though its current cash debt coverage ratio is only .0407, which suggests that the company will have difficulty meeting its current obligations with cash flow earned through operations.

Business Segments

Mainline Operations (73% of revenue^[16])

Continental Airlines distinguishes between its Mainline and Regional operations based on the number of seats in the plane. For a flight to be considered part of its Mainline operations, it must have more than 50 seats for a jet and more than 78 seats for a turboprop.^[16] In 2008, the Mainline operation had 102,527 ASMs, Revenue per Available Seat Mile of 12.51 cents, and Cost per Available Seat Mile of 12.44 cents. Overall, there were 350 aircraft in the fleet and 48,682 passengers. Moreover, 50% of mainline operations consisted of international travel.^[16]

Regional Operations (27% of revenue^[16])

As previously mentioned, Continental considers flights with less than or equal to 50 seats for jets and less than or equal to 78 seats for turboprops to be a part of its Regional Operations. The airline does not directly operate this segment, but instead has agreements with ExpressJet, Chautauqua, CommutAir and Colgan to operate and manage these flights.^[16] However, Continental still maintains significant control of these operations, and for example, it sets passenger fares and pays revenue-related expenses, such as terminal rent at airports.^[16] The Regional Operation consists mostly of domestic flights with 103 destinations in the United States, whereas there are flight to 26 cities in Mexico, eight cities in Canada and one in the Caribbean. This resulted in 18,010 passengers, 12,984 ASM, and revenue of $18 million during 2008.^[16]

Trends and Forces

Volatile Oil Prices Hurt Profitability

Although CAL hedges less of its fuel than competitors, Continental is still vulnerable to devalued hedging contracts as a result of declining oil prices. In 2008 after oil prices had climbed to about $150/barrel in July, Continental and many other airlines entered into hedging contracts at prices well over $100/barrel. However, oil prices have since plummeted, sliding to about $40/barrel in December 2008 and approximately doubling to about $80/barrel in December 2009.^[17] Because of declining oil prices, CAL has been hurt by devalued hedging contracts- for example, in 2008 CAL posted a $125 million fuel-hedging loss with Lehman Brothers because of lower oil prices.^[18]

Because of higher fuel expenses, CAL cut capacity and jobs in 2008. Continental retired 67 aircraft and laid-off 3,000 employees in 2008 to reduce its operating expenses and because of declining consumer demand for travel.^[19] This decrease in aircraft represents a 16% reduction in capacity.^[19]

Fuel expenses represent the largest operating expense for airlines. In 2008 for example, fuel expenses represented 31.5% of CAL's overall operating expenses, a significant increase from 25% of operating expenses a year earlier.^[20] During 2008, CAL's average price per gallon of fuel increased 50%, reaching $3.27.^[21] Furthermore, CAL's 2008 price of fuel marks a 175% increase from $1.19 per gallon in 2004.^[22] Because of higher fuel prices, Continental's Cost per Available Seat Mile increased by about 14.9% in 2008, driving a 14.8% growth in operating expenses.^[23] Unlike many other airlines however, Continental hedges much less of its annual fuel needs, hedging only 22% of its projected fuel needs for 2009.^[13]

Increased Competition on International Routings

Continental has long been one of the most internationally oriented U.S. carriers. In 2008 for example, 50% of the company’s routings were to international destinations^[24] These high revenue flights have helped Continental weather decreased domestic demand - in 2008, CAL's revenue from Trans-Atlantic flights grew by 11.6% compared to a 1.2% increase from domestic flights.^[25] However, the higher margins on these routes could be pushed downward by increased competition from other U.S. legacy carriers, which have announced expanded international routings as a key component of their post-bankruptcy operational plans-in 2008 for example, DAL announced plans to add 15 new international routes in the summer of 2009.^[26]

Bankruptcy by Legacy Airlines

Numerous U.S. legacy carriers like Delta, US Airways, and United have been forced to declare bankruptcy due to price competition from discount airlines and overall decreased demand for air travel. While Continental’s relatively healthier finances allowed it to avoid bankruptcy, the company is now at a competitive disadvantage to others in the industry. The carriers that declared bankruptcy have cut costs and restructured under Chapter 11 protection. As a result, these airlines have emerged as stronger and more serious competitors, more capable to discount prices because of their lower costs.^[27].

Competitors

Continental's closest competitors are legacy carriers like United Airlines (UAUA), American Airlines (AMR), and Delta Air Lines Inc. (DAL) but also includes low-cost carriers like Southwest Airlines Company (LUV). Because of rising operating expenses and falling consumer demand, CAL has followed other airlines, implementing a $15 fee for the first piece of checked baggage and $25 for a second bag.^[28]

Market Share

Notes

1. ↑ ^{1.0 1.1 1.2 1.3 1.4} CAL 2008 10-K, Item 1, "Overview"
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7} CAL 2008 10-K, Item 6, "Selected Financial Data"
3. ↑ ^{3.0 3.1} CAL 2008 10-K, Item 7, Outlook
4. ↑ ^{4.0 4.1} CAL 2008 10-K, Item 7, "Aircraft Fuel"
5. ↑ Reuters
6. ↑ "BRIEF-Continental Airlines sees mainline capacity down in 2009" Forbes.com 12/11/2008
7. ↑ CAL 2007 10-K, Item 1, "Domestic Operations"
8. ↑ CAL 2008 10-K, Item 2, "Flight Equipment"
9. ↑ CAL 2007 10-K, Item 1, "Alliances"
10. ↑ ^{10.0 10.1 10.2 10.3 10.4 10.5 10.6 10.7} CAL 2008 10-K, Item 6, "Selected Operating Data"
11. ↑ ^{11.0 11.1 11.2 11.3 11.4 11.5} CAL January 2009 8-K  
12. ↑ ^{12.0 12.1} CAL 2008 10-K, Item 7
13. ↑ ^{13.0 13.1} "FACTBOX-U.S. airlines' fuel hedging positions" Reuters.com 12/23/2008
14. ↑ ^{14.0 14.1 14.2 14.3 14.4 14.5 14.6} CAL 2Q09 10-K, Part I
15. ↑ ^{15.0 15.1} 2009 3Q09 CAL 10-Q
16. ↑ ^{16.0 16.1 16.2 16.3 16.4 16.5 16.6} 2008 CAL 10-K, Item 6
17. ↑ "OPEC drops crude oil prices again" Phoenix Business Journal 12/19/2008
18. ↑ CAL 2008 10-K, Item 6
19. ↑ ^{19.0 19.1} "Continental becomes latest U.S. airline to cut service" International Herald Tribune 6/5/2008
20. ↑ CAL 2008 10-K, Item 8
21. ↑ CAL 2008 10-K, Item 6
22. ↑ CAL 2008 10-K, Item 6
23. ↑ CAL 2008 10-K, Item 8
24. ↑ CAL 2008 10-K Overview
25. ↑ CAL 2008 10-K Selected Financial Data
26. ↑ "Delta to Offer Customers Service to More Unique International Destinations in 2009" Delta.com 11/12/2008
27. ↑ Continental 2006 Annual Report, Item 3, pg. 5
28. ↑ Continental.com
29. ↑ ^{29.0 29.1 29.2 29.3 29.4 29.5 29.6} Air Transport Association 2009 Economic Report Pg. 23
30. ↑ Wikinvest Fuel Cost per Gallon Page
31. ↑ Summary 2008 Airline Traffic Data