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.

Comments

[Eternal Student]

Thanks, Reggie.

Anyone have suggestions on how best to short with a small amount of purely gambling money from a Retirement Account? I can't short these Stocks from there. There are ETFs like SDS Proshares, but those are mostly for daytraders. Does anyone have any other suggestions out there?

[hellboy]

interesting posts from you, thanks!