Continental Airlines 2007

Forest David: Francis Marion University Charles Byles: Virginia Commonwealth University

A.

Case Abstract
Continental Airlines (www.continental.com) is a comprehensive business policy and strategic management case that includes the companys fiscal year-end December 2006 financial statements, competitor information and more. The case time setting is the year 2007. Sufficient internal and external data are provided to enable students to evaluate current strategies and recommend a three-year strategic plan for the company. Headquartered in Houston, Texas, Continental is traded on the New York Stock Exchange under the ticker symbol CAL. Continental owns 366 mainline jets and 272 regional jets and serves most of the world. Amazon has over 45,000 employees and is led by CEO Lawrence Kellner. The firms major competitors are Delta, United and many smaller low cost companies.

B.

Vision Statement (proposed)

To be the superior airline company in the industry, both internationally and domestically.

C.

Mission Statement (actual)

Our goals are simple they are our customers goals. We continue to deliver a high-quality product each and everyday, getting our customers where they want to go, on-time and with their bags, while providing pre-flights and in-flight service that is globally recognized for consistency and excellence. (proposed) Continental Airlines mission is to provide domestic and international air travelers with excellent transportation services through rational innovation and productivity improvements (1, 2, 3). In doing so, Continental will use the most advanced technology to increase efficiency, which will optimize the long-term return to our shareholders and ensure financial stability (4, 5). We proficiently follow strict security precautions to promise safe and punctual flights for our customers and employees (8, 6). We create a comfortable environment where our employees can

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be fulfilled in their work, which allow us to maintain our #1 ranking for customer satisfaction in the airline industry (7, 9). 1. 2. 3. 4. 5. 6. 7. 8. 9. Customer Products or services Markets Technology Concern for survival, profitability, growth Philosophy Self-concept Concern for public image Concern for employees

D.

External Audit
Opportunities The airline industry has grown 18 percent in the last two years. U.S. airline traffic has risen 3.3 percent from 2005-2006. U.S. passenger traffic showed an 8.8 percent growth comparing May 2004 to May 2005 4. In 2005, there was a nearly 5 percent increase in passenger miles flown. 5. U.S. has a stronger passenger demand since September 11, 2001. 6. United Airlines, Delta, and American Airlines raised their fares in the 1st quarter of 2007. 7. There is a greater demand for air travel during summer months, which result in higher revenues in the 2nd and 3rd quarter of years. 8. Internet use for travel arrangements is increasing; 95 percent of tickets were sold via E-tickets. 9. Revenue passenger mileage (RPM) in the industry increased 4.4 percent in 2005. 10. United Airlines has a reputation for bad customer service and frequent customer complaints.
1. 2. 3.

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Threats In 2005, the airline industry spent over 25 percent of revenues on fuel. Delta adds two more Bahamian destinations to the growing Caribbean line up. More security regulations may increase cost of operations. The U.S. has become a target for terrorists attacks, elevation of national threat warnings by the Federal Government can negatively affect the airline industry. United Airlines partners with world renowned Chef Charlie Trotter; elevates customers dining experience. AMR starts 2007 off by increasing advertising expenses in the New York area market by $2 million. Insurance costs are rising causing the costs of tickets to rise also. Bad weather leads to flight delays and cancellations which raise expenses. U.S. airlines in international markets are subject to economic regulations by foreign government (example- European Commission) U.S. airline industry is one of the most heavily taxed of all industries. CPM Competitive Profile Matrix
Critical Success Factors Market Share Price competitiveness Financial Position Consumer Loyalty Advertising Management Security Precautions Organizational Structure Customer Service Total Weight 0.13 0.10 0.12 0.10 0.15 0.10 0.09 0.06 0.15 1.00 Continental Rating Weighted Score 3 0.39 3 0.30 3 0.36 4 0.40 3 0.45 3 0.30 3 0.27 3 0.18 4 0.60 3.25 American Rating Weighted Score 4 0.52 2 0.20 1 0.12 2 0.20 4 0.60 3 0.30 3 0.27 3 0.18 3 0.45 2.84 Rating 3 2 1 2 2 2 3 2 1 United Weighted Score 0.39 0.20 0.12 0.20 0.30 0.20 0.27 0.12 0.15 1.95

External Factor Evaluation (EFE) Matrix

Key External Factors Opportunities 1. The airline industry has grown 18 percent in the last two years. 2. U.S. airline traffic has risen 3.3 percent from 2005-2006. 3. U.S. passenger traffic showed an 8.8 percent growth comparing May 2004 to May 2005 4. In 2005, there was a nearly 5 percent increase in passenger miles flown. 5. U.S. has a stronger passenger demand since September 11, 2001. 6. United Airlines, Delta, and American Airlines raised their fares in the 1st quarter of 2007. 7. There is a greater demand for air travel during Weight Rating Weighted Score

0.10 0.05 0.02 0.04 0.02 0.05 0.01

3 4 3 2 3 2 1

0.30 0.20 0.06 0.08 0.06 0.10 0.01 42

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summer months, which result in higher revenues in the 2nd and 3rd quarter of years. 8. Internet use for travel arrangements is increasing; 95% of tickets were sold via Etickets. 9. Revenue passenger mileage (RPM) in the industry increased 4.4 percent in 2005. 10. United Airlines has a reputation for bad customer service and frequent customer complaints. Threats 1. In 2005, the airline industry spent over 25 percent of revenues on fuel. 2. Delta adds two more Bahamian destinations to the growing Caribbean line up. 3. More security regulations may increase cost of operations. 4. The U.S. has become a target for terrorists attacks, elevation of national threat warnings by the Federal Government can negatively affect the airline industry. 5. United Airlines partners with world renowned Chef Charlie Trotter; elevates customers dining experience. 6. AMR starts 2007 off by increasing advertising expenses in the New York area market by $2 million. 7. Insurance costs are rising causing the costs of tickets to rise also. 8. Bad weather leads to flight delays and cancellations which raise expenses. 9. U.S. airlines in international markets are subject to economic regulations by foreign government (example- European Commission) 10. U.S. airline industry is one of the most heavily taxed of all industries. TOTAL

0.10 0.07 0.07 0.09 0.04 0.03

1 2 1 3 1 2

0.10 0.14 0.07 0.27 0.04 0.06

0.03 0.04 0.04 0.06 0.08 0.03 0.03 1.00

2 2 2 1 2 2 2

0.06 0.08 0.08 0.06 0.16 0.06 0.06 2.05

E.

Internal Audit
Strengths
1.

2.
3. 4.

5.

Continental sold nearly $3 billion of tickets on continental.com in 2006, up 40 percent over 2005. Continental placed highest among U.S. airlines for Best-In-Flight Services in 2006. The company increased their capacity of available seats by 5.2 percent in the 1st quarter of 2007. Profits increased by 126 percent from 2005-2006. Revenue passenger miles increased by 11.3% in the 1st quarter of 2007.
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6. Continental outranked all other U.S. carriers to be chosen as the Best Airline for North American Travel in 2005. 7. Voted one of Fortune 100s best companies to work for from the years 19992004 8. Continental had a profit margin of 2.61 percent in 2006; 1.59 percent more than American Airlines 9. Continental is the leader in the New York area market in terms of available seats. Weaknesses
1. 2.

3.
4. 5.

6. 7.
8.

Worst long term debt-to-equity ratio of 14.0 percent among competitors in 2006. Mainline fuel costs represented 26.7 percent of our mainline operating expenses for 2005. Credit ratings were reduced to CCC+ by Standard & Poors; resulting in Continental having to maintain a minimum of $350 million of unrestricted cash in 2005. Labor costs constituted 23.6 percent of total operating expenses in 2005. There was a 52 percent increase in long-term debt and capital lease payments in 2005. As of December 31, 2006, we had $5.4 billion of long-term debt and capital lease obligations. Our capital expenditures increased by $115 million from 2005-2006. Aircraft fuel and related taxes increased 24.2 percent due to a significant rise in fuel prices.

Financial Ratio Analysis (December 2007)

Growth Rates % Sales (Qtr vs year ago qtr) Net Income (YTD vs YTD) Net Income (Qtr vs year ago qtr) Sales (5-Year Annual Avg.) Net Income (5-Year Annual Avg.) Dividends (5-Year Annual Avg.) Price Ratios Current P/E Ratio P/E Ratio 5-Year High P/E Ratio 5-Year Low Price/Sales Ratio Price/Book Value Price/Cash Flow Ratio Profit Margins Gross Margin Pre-Tax Margin Net Profit Margin 5Yr Gross Margin (5-Year Avg.) 5Yr PreTax Margin (5-Year Avg.) 5Yr Net Profit Margin (5-Year Avg.) Continental 8.60 24.30 1.70 7.92 NA NA 7.4 NA NA 0.21 2.42 3.40 17.8 3.4 3.4 12.9 -1.2 -0.9 Industry 8.60 17.20 114.80 8.17 9.50 8.03 9.0 33.7 10.5 0.47 2.27 5.90 32.4 8.5 6.6 28.0 0.8 -0.4 SP-500 8.30 16.00 6.60 13.34 20.14 10.00 21.9 22.3 5.9 2.38 3.39 10.60 33.8 17.5 12.4 33.5 16.8 11.7 44

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Financial Condition Debt/Equity Ratio Current Ratio Quick Ratio Interest Coverage Leverage Ratio Book Value/Share Investment Returns % Return On Equity Return On Assets Return On Capital Return On Equity (5-Year Avg.) Return On Assets (5-Year Avg.) Return On Capital (5-Year Avg.) Management Efficiency Income/Employee Revenue/Employee Receivable Turnover Inventory Turnover Asset Turnover Adapted from www.moneycentral.msn.com Date 12/07 12/06 12/05 12/04 12/03 Avg. P/E NA 8.70 -13.60 -1.90 30.70

4.20 1.1 1.0 3.5 10.0 12.42 48.4 3.9 6.2 -20.6 -0.9 -1.3 11,317 337,430 19.0 44.3 1.2

1.97 0.6 0.6 4.4 4.2 13.65 18.5 4.8 7.3 4.7 2.3 3.3 5,889 121,114 13.9 61.2 0.7 Price/Book NA 10.91 8.12 5.81 1.48 ROE (%) NA 106.3 -30.1 -263.9 3.9

1.19 0.9 0.7 43.3 4.0 16.25 20.8 5.8 7.7 14.5 5.1 6.8 37,696 343,930 9.5 5.6 0.6 Net Profit Margin (%) NA 2.8 -0.6 -4.1 0.3

Price/Sales NA 0.35 0.13 0.09 0.12

Date Book Value/ Share Debt/Equity 12/07 NA 0.00 12/06 $3.78 15.66 12/05 $2.62 24.79 12/04 $2.33 37.66 12/03 $11.01 8.23 Adapted from www.moneycentral.msn.com

ROA (%) NA 3.3 -0.6 -3.9 0.3

Interest Coverage 1.9 1.2 -0.1 -0.6 0.5

Net Worth Analysis (December 2006 in millions)

1. Stockholders Equity + Goodwill = 347 + 0 2. Net income x 5 = $343 x 5= 3. Share price = $30/EPS 5.21 =$5,75 x Net Income $343= 4. Number of Shares Outstanding x Share Price = 98 x $30 = Method Average $ 347 $ 1,715 $ 1,975 $ 2,940 $1,744

Internal Factor Evaluation (IFE) Matrix

Key Internal Factors Strengths 1. Continental sold nearly $3 billion of tickets on continental.com in 2006, up 40 percent over 2005. 2. Continental placed highest among U.S. airlines for BestWeight Rating Weighted Score

0.08 0.05

4 3

0.32 0.15 45

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In-Flight Services in 2006. The company increased their capacity of available seats by 5.2 percent in the 1st quarter of 2007. 4. Profits increased by 126 percent from 2005-2006. 5. Revenue passenger miles increased by 11.3% in the 1st quarter of 2007. 6. Continental outranked all other U.S. carriers to be chosen as the Best Airline for North American Travel in 2005. 7. Voted one of Fortune 100s best companies to work for from the years 1999-2004 8. Continental had a profit margin of 2.61 percent in 2006; 1.59 percent more than American Airlines 9. Continental is the leader in the New York area market in terms of available seats. Weaknesses 1. Worst Long Term Debt-to-Equity ratio of 14.0 percent among competitors in 2006. 2. Mainline fuel costs represented 26.7 percent of our mainline operating expenses for 2005. 3. Credit ratings were reduced to CCC+ by Standard & Poors; resulting in Continental having to maintain a minimum of $350 million of unrestricted cash in 2005. 4. Labor costs constituted 23.6 percent of total operating expenses in 2005. 5. There was a 52 percent increase in Long-Term Debt and Capital lease payments in 2005. 6. As of December 31, 2006, CAL had $5.4 billion of longterm debt and capital lease obligations. 7. Our capital expenditures increased by $115 million from 2005-2006. 8. Aircraft fuel and related taxes increased 24.2 percent due to a significant rise in fuel prices. TOTAL 3.

0.03 0.04 0.12 0.09 0.03 0.01 0.02 0.04 0.03 0.06 0.04 0.10 0.10 0.06 0.10 1.00

4 3 4 3 3 4 3 1 2 1 2 1 2 2 2

0.12 0.12 0.48 0.27 0.09 0.04 0.06 0.04 0.06 0.06 0.08 0.10 0.20 0.12 0.20 2.51

F.

SWOT Strategies
SO Strategies 1. Continue to sell billions of dollars of tickets on continental.com because of increasing Internet use for travel arrangements (S1, O8). 2. Continue to lead the New York market area in available seats by taking advantage of the growing airline industry and rising air traffic (S9, O1, O2). 3. Continue with excellent customer service and advertise more to attract customers who have experienced bad service from competing airline companies (S3, O5).

WO Strategies
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1. Help our regional division improve by increasing advertising during the summer months (W7, O5). ST Strategies 1. Install email alert system to notify customers of flight delays in advance (S2, T10). 2. Use our large profit increase from 2005-2006 to cover for heavy taxes on the airline industry (S4, T10). WT Strategies 1. Find ways ton lower fuel cost and expenses (W2, T1). 2. Avoid raising labor cost in the New York market (W4, T6).

G.

SPACE Matrix

Con

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x-axis: -2.2 + 4.4 = 2.2 y-axis: 3.6 + -3.0 = 0.6

H.

Financial Strength Net Income Competitive Advan Leverage Market Share ROA Product Quality Inventor Turnover Customer Loyalty Income/Employee Technological know-h Control over Supplier Financial Strength
Grand Strategy Matrix

Competitive Advan
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I.

The Internal-External (IE) Matrix

The IFE Total Weighted Score Strong 3.0 to 4.0 I Average 2.0 to 2.99 II Weak 1.0 to 1.99 III

High 3.0 to 3.99

Medium The EFE Total 2.0 to 2.99 Weighted Score

IV

VI

Continental

Low 1.0 to 1.99

VII

VIII

IX

Hold and Maintain

Division Domestic Regional Trans Atlantic Latin America Pacific % Profits 46 18 17 10 7

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J.

QSPM
Merge with an airline company of equal size AS TAS ---------4 3 4 ------2 3 4 ---------0.16 0.36 0.36 ------0.04 0.12 0.12 Acquire and upgrade a smaller airline company AS TAS ---------2. 4 1 ------4 1 1 ---------0.08 0.48 0.09 ------0.08 0.04 0.03

Strategic Alternatives Key Internal Factors Strengths 1. Continental sold nearly $3 billion of tickets on continental.com in 2006, up 40 percent over 2005. 2. Continental placed highest among U.S. airlines for Best-In-Flight Services in 2006. 3. The company increased their capacity of available seats by 5.2 percent in the 1st quarter of 2007. 4. Profits increased by 126 percent from 2005-2006. 5. Revenue passenger miles increased by 11.3% in the 1st quarter of 2007. 6. Continental outranked all other U.S. carriers to be chosen as the Best Airline for North American Travel in 2005. 7. Voted one of Fortune 100s best companies to work for from the years 1999-2004 8. Continental had a profit margin of 2.61 percent in 2006; 1.59 percent more than American Airlines 9. Continental is the leader in the New York area market in terms of available seats. Weaknesses 1. Worst Long Term Debt-to-Equity ratio of 14.0 percent among competitors in 2006. 2. Mainline fuel costs represented 26.7 percent of our mainline operating expenses for 2005. 3. Credit ratings were reduced to CCC+ by Standard & Poors; resulting in Continental having to maintain a minimum of $350 million of unrestricted cash in 2005. 4. Labor costs constituted 23.6 percent of total operating expenses in 2005. 5. There was a 52 percent increase in Long-Term Debt and Capital lease payments in 2005. 6. As of December 31, 2006, CAL had $5.4 billion of long-term debt and capital lease obligations. 7. Our Capital Expenditures increased by $115 million from 2005-2006. 8. Aircraft fuel and related taxes increased 24.2 percent due to a significant rise in fuel prices. SUBTOTAL Weight

0.08 0.05 0.03 0.04 0.12 0.09 0.03 0.01 0.02 0.04 0.03

0.06 0.04 0.10 0.10 0.06 0.10 1.00

---3 4 4 ---2

---0.12 0.40 0.40 ---0.20 2.28

---1 2 3 ---1

---0.04 0.20 0.30 ---0.10 1.44

Key External Factors Opportunities 1. The airline industry has grown 18 percent in the last two years.

Weight

Merge with an airline company of equal size AS TAS -------

Acquire and upgrade a smaller airline company AS TAS ---50 ----

0.10

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2.

U.S. airline traffic has risen 3.3 percent from 20052006. 3. U.S. passenger traffic showed an 8.8 percent growth comparing May 2004 to May 2005 4. In 2005, there was a nearly 5 percent increase in passenger miles flown. 5. U.S. has a stronger passenger demand since September 11, 2001. 6. United Airlines, Delta, and American Airlines raised their fares in the 1st quarter of 2007. 7. There is a greater demand for air travel during summer months, which result in higher revenues in the 2nd and 3rd quarter of years. 8. Internet use for travel arrangements is increasing; 95 percent of tickets were sold via E-tickets. 9. Revenue passenger mileage (RPM) in the industry increased 4.4 percent in 2005. 10. United Airlines has a reputation for bad customer service and frequent customer complaints. Threats 1. In 2005, the airline industry spent over 25 percent of revenues of fuel. 2. Delta adds two more Bahamian destinations to the growing Caribbean line up. 3. More security regulations may increase cost of operations. 4. The U.S. has become a target for terrorists attacks, elevation of national threat warnings by the Federal Government can negatively affect the airline industry. 5. United Airlines partners with world renowned Chef Charlie Trotter; elevates customers dining experience. 6. AMR starts 2007 off by increasing advertising expenses in the New York area market by $2 million. 7. Insurance costs are rising causing the costs of tickets to rise also. 8. Bad weather leads to flight delays and cancellations which rise expenses. 9. U.S. airlines in international markets are subject to economic regulations by foreign government (example- European Commission) 10. U.S. airline industry is one of the most heavily taxed of all industries. SUBTOTAL SUM TOTAL ATTRACTIVENESS SCORE

0.05 0.02 0.04 0.02 0.05 0.01 0.10 0.07 0.07 0.09 0.04 0.03

---------2 ---------------3 -------

---------0.04 ---------------0.27 -------

---------1 ---------------4 -------

---------0.02 ---------------0.36 -------

0.03 0.04 0.04 0.06 0.08 0.03 0.03

-------

-------

-------

-------

3 3

0.09 0.09 0.49 2.77

2 4

0.06 0.12 0.56 2.00

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K.

Recommendations
The QSPM strategies assessed merging with another airline or acquiring a smaller firm. Although both options are viable in the future, for now it is recommended Continental increase advertising by $100 million.

L.

EPS/EBIT Analysis
$ Amount Needed: 100M Stock Price: $30 Tax Rate: 35% Interest Rate: 7% # Shares Outstanding: 98M

M.

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EBIT Interest EBIT EBT Interest Taxes EBT EAT

Epilogue

The epilogue is organized around the subject areas of the summary questions at the end of the case and will include an update of events since the writing of the case in summer 2007.

Cost Control Continental announced that it has reached a new agreement with EDS and GE aviation that will result in cost reductions of $100 million annually when fully implemented. (CO FACTS, 1st Quarter 2008). Continental continued to enhance its fuel efficiency by installing winglets on more aircraft (it now has winglets on 206 of its mainline aircraft). Winglets reduce fuel consumption by increasing

Rece (100,0 Rece (100,0 (100,0 2,10 (35,0 (102,1 (65,0

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aerodynamic efficiency and decreasing drag. (Continental Airlines website, Most Recent Quarterly Earnings, Fourth Quarter 2007). Rivalry Among Legacy Carriers and Possible Mergers The Wall Street Journal reports that preliminary merger talks between United Airlines and Continental Airlines have become more serious. At the same time, merger talks between Delta and Northwest have gained momentum. The article notes that Continental executives have repeatedly stated that they prefer to remain independent, but would do whats best for the company if the competitive landscape changes (i.e., if Delta and Northwest merge). (Airline Merger Talks May Lead to a Double Wedding, February 7, 2008) Regional Jet and Turboprop Service Continental Airlines recently changed its Continental Express regional jet service arrangement from being provided exclusively by ExpressJet Airlines to being provided by both ExpressJet and Chautauqua Airlines (a subsidiary of Republic Airways). Both airlines are all-jet. In the previous arrangement, ExpressJet operated aircraft exclusively for Continental Express. Now, Continental Express service is operated mostly by ExpressJet (205 aircraft), but also by Chautauqua (25 aircraft) according to Wikipedia. In addition, Chautauqua operates regional jet service for AmericanConnection, Delta Connection, United Express, and US Airways Express. A more significant change in Continentals regional service is the addition of Continental Connection operated by Cape Air, Colgan Air, CommutAir, and Gulfstream International Airlines. The different branding reflects the turboprop aircraft used by these airlines, a change from the previous all-jet regional service offered by Continental. Whether the addition of turboprop service will affect the publics perception of Continental is to be seen as travelers tend to perceive turboprop aircraft as less safe than jet aircraft. Service Quality The case suggests that service quality can be assessed in two ways first by the Airline Quality Rating 2007 (which is published annually) and second by the number of awards received by the airline. Since the time of the case, Continental was chosen as the Best Airline for North American Travel in December 2007 by Business Traveler Magazine readers. International Strategy In November 2007, Continental announced the launch of twice-daily nonstop service to London Heathrow from its New York and Houston hubs beginning March 29, 2008. The airline will continue to offer nonstop flights to LondonGatwick (twice-daily) and Houston (daily), as well as Cleveland (daily, seasonal). (CO FACTS, 1st Quarter 2008, Continental Airlines website, Most Recent Quarterly Earnings, Fourth Quarter 2007) According to the Wall Street Journal, Continental is adding service to growth markets such as China, India, and Latin America (Continental Turns a Pretax Profit Despite Fuel Costs, January 18, 2008).
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Fuel Costs Since the time of the case, oil prices have risen as high as $100.00 per barrel. Despite these increases, only Continental and Southwest Airlines have avoided losses in the fourth quarter 2007. Continental has two approaches for addressing high fuel costs. The first is through keeping its fleet of aircraft younger and newer, and adding fuel-saving devises such as winglets. (CO FACTS, 1stf Quarter 2008). The second approach is through fuel hedging. Continental reported on its web site that it hedged approximately 32% of its fuel requirements for the fourth quarter of 2007. As of December 31, 2007, the company had hedged approximately 20% of its projected fuel requirements for the first quarter 2008 and 5% for the second quarter of 2008. Internet Booking The case pointed out that Continental was slow to adopt Internet booking. While data are not available on any changes that have taken place in the last six or seven months, Continental reports that customers can easily book flights through its web site. That web site also offers electronic timetables for PCs, laptops, cell phones, and PDAs. Also, the web sites in a number of countries offer region-specific information. In addition, Continental offers Spanish and German web sites and the ability to purchase tickets online in all countries that Continental serves. (CO FACTS, 1st Quarter 2008) EU-US Open Skies Treaty As the case pointed out, the US-EU Open Skies Treaty allows any EU or US airline to fly between any city in the EU and any city in the US. Continental was one of a few US carriers likely to benefit from this treaty and, as noted earlier in this epilogue, Continental has announced new service to London Heathrow starting on March 29, 2008. The Go Forward Plan The Go Forward Plan is now in its 12th year and still in place. Financial and Operating Results Continental reported the following recent financial and operating results in its CO FACTS, 1st Quarter 2008. Operating Revenues (mil.) Operating Income (mil.) Revenue Pass Miles (000) Available Seat Miles (000) Load Factor (%) 2007 $14,232 $687 84,309 103,139 81.7 2008 $13,128 $468 79,192 97,667 81.1

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