On Shorting Stocks, Double Dips and the UAL/CAL Merger
In continuing with our search for bankrupt potential short candidates, we came across a couple of airline companies (reference Non-Financial Companies to Short in 2010, as well as BoomBustBlog Bankruptcy Search: Focus on British Petroleum and Collateral Damage and The BoomBustBlog Pan-European Sovereign Debt Crisis Bankruptcy Search). Since these companies have such a high sensitivity to fuel prices, we decided to review them separately and with additional detail. I have decided to release the results of the cursory research on the two companies (UAL US Equity [UAUA Listed] and CAL US Equity) that were shortlisted yesterday to the public since I don't feel it will be of use to the majority of my subscribers.
Overview
In April, UAL proposed a merger with CAL through a share swap under which each share of CAL can be exchanged for 1.05 shares of UAL. In anticipation of the deal, the share prices of the two companies are moving hand in hand with each other. The merger is yet to receive the regulatory approval and the deal is expected to be completed by the end of the year.
Interest coverage
We had shortlisted these companies primary owing to the very low interest coverage and very high debt levels ( Non-Financial Companies to Short in 2010). However, the recent uptick in sales in 1Q10 and has substantially improved the outlook for 2010 and have substantially improved the interest coverage of the companies. We verified the analyst estimates for full year 2010 with the trends witnessed in 1Q10 and estimated increase in revenues and fuel cost is in line with trends witnessed in 1Q10. However, the airline business is largely linked to the economic growth and a double dip recession can bring down the estimated sales levels substantially. The bouhaha in the Gulf Coast drilling area may also serve to increase fuel prices to the detriment of these companies.
Without considering the benefits accruing from synergies, and by simply adding revenues and costs, we have prepared a brief income statement of the combined entity.
| Key ratios | 2006 | 2007 | 2008 | 2009 | 2010 |
| Sales | 32,474 | 34,270 | 35,435 | 28,921 | 33,576 |
| Y-o-Y growth | 5.5% | 3.4% | -18.4% | 16.1% | |
| Operating expenses | |||||
| Personnel | 7,007 | 7,230 | 7,263 | 6,910 | 7,124 |
| Fuel | 7,832 | 8,357 | 12,627 | 6,722 | 8,290 |
| Aircraft rentals | 1,405 | 1,400 | 1,385 | 1,280 | 1,245 |
| Depreciation | 1,279 | 1,338 | 1,370 | 1,396 | 1,364 |
| Other | 13,991 | 14,357 | 14,745 | 12,401 | 13,118 |
| Total | 31,514 | 32,682 | 37,390 | 28,709 | 31,140 |
| Operating profit (loss) | 960 | 1,588 | -1,955 | 212 | 2,436 |
| Add: Depreciation | 1,279 | 1,338 | 1,370 | 1,396 | 1,364 |
| EBITDA | 2,239 | 2,926 | -585 | 1,608 | 3,800 |
| Margin | 6.9% | 8.5% | -1.7% | 5.6% | 11.3% |
| Add: Aircraft rentals | 1,405 | 1,400 | 1,385 | 1,280 | 1,245 |
| EBITDAR | 3,644 | 4,326 | 800 | 2,888 | 5,045 |
| Margin | 11.2% | 12.6% | 2.3% | 10.0% | 15.0% |
| Interest expense | 1,138 | 1,097 | 947 | 944 | 1,087 |
| Interest coverage | 2.0 | 2.7 | -0.6 | 1.7 | 3.5 |
Valuation
Without considering the benefits accruing from synergies, and by simply adding the current EV and the projected EBITDAR of the two companies in 2010 (based on analyst expectations), the combined entity is trading at EV/EBITDAR multiple of 3.3x. Most of the analyst are using EV/EBITDAR multiple of 5-6x to fair value the stock and are giving a potential upside.
Cash flow position
The combined entity has cash in hand of nearly $6.0 billion and can meet the debt obligations over the next three years. We have therefore excluded these companies from our final shortlist. BoomBustBlog enthusiasts should reference the "free" accompanying spreadsheet here.
As stated in the company filings....
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Author: Reggie Middleton
Reggie
Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/
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