United Airlines multinational finance - Research Paper Example

United Airlines United Airlines (UAL) is the major United s airline with the largest number of destination and passenger flights. It caters to the customers’ demand of maximum luxury and comfort during flight. It is the most in-demand airline for all employees and shareholders to invest. It is the world’s most inclusive set of connections worldwide with first-rate international gateways to Asia and Australia, Europe, Latin America, Africa and the Middle East. United Airlines has its base almost everywhere in the US with non-stop or one-stop services. Its fleets are the most fuel-efficient among all the US network carriers. It has ten most advantageous central locations in the four largest cities in the US (UAL, Factsheet 1). The overseas subsidiaries of UAL are United Express, Ted, Continental Express and Continental Connection carriers. United Express and Ted are premium and low-cost subsidiaries of UAL. With these two subsidiaries, UAL participates in the entire scale of the consumer market. These are regional operators and act as additional services of UAL’s mainline network. These subsidiaries add to UAL’s operations by carrying flights that connect to the mainline service. These subsidiaries also can allow a more number of flights in smaller cities than would not have been economically viable with full sized mainline jet aircraft (UAL, Form 10-K 5). The total number of aircrafts owned and leased by the subsidiaries is 552 (UAL, Form 10-K 29). In 2009, UAL had an operating revenue from mainline passengers of $11,313 million as reclassified and $11,910 million as historical. In the same year, UAL had an operating revenue from regional passengers of $2,884 million as reclassified and $3,064 million as historical. Other operating revenues were $1,602 million as reclassified and $825 million as historical (UAL, Form 10-K 99). Foreign Exchange Risk Management Policy UAL being an international airline garners revenues and makes expenditures in numerous foreign currencies. Some expenses include aircraft leases, commissions, catering, personal expense, advertising and distribution costs, customer service expense and aircraft maintenance. Fluctuations that occur in the rates of foreign currencies exchanges have a major effect on the service of UAL and “cash flows through changes in the dollar value of foreign currency denominated operating revenues and expenses” (UAL, Form 10-K 140). In order to effectively reduce the possibilities of risk, the Company may use foreign currency forward contracts to avoid a part of its vulnerability to changes. UAL does not enter into foreign currency derivative contracts for purposes other than risk management. In 2009 and 2010, United did not have any foreign currency derivatives. Continental had foreign currency derivatives with a fair value of $7 million in 2010 and $5 million in 2009. During these two years, according to financial statements, there were no significant hedge gains or losses (UAL, Form 10-K 140). UAL emphasizes North American and hence is not vulnerable to US$ exchange rate risk. For this, UAL does not have to worry about risk related to foreign exchange while buying fuel because oil is traded in US$. This is one advantage for UAL (Muck and Rudolf 573). Some of the most common foreign exchange transactions of the Company are Canadian dollar, Chinese renminbi, Japanese Yen, British pound and European Euro (UAL, Form 10-K 74). UAL’s foreign currency exchange rate changes were 11 million in 2010 and 8 million in 2009 (UAL, Form 10-K 121). Fluctuations in foreign exchange rates can affect UAL in various ways. The scopes and variations of foreign exchange impact can be immense. Foreign exchange exposure is of significant importance to UAL as the large aircrafts travel into foreign markets (Levi 303). Net cash flows of UAL that include foreign currency cash flows have increased in 2010 by $941 million from 2009. There has been a steady increase in cash flow over the last few years and the principal sources are passenger and cargo services. However, UAL has large expense accounts such as fuel, distribution costs and interest expense which offset the profits from the enhanced revenues. Because of the increase costs of fuel, expenses in fuel have been larger in 2010 for UAL. In the year before, i.e., in 2009, UAL cash flows had increased by $2.2 billion from 2008. This was mainly because during 2009 costs incurred in fuel purchase decreased by $4.1 billion as compared to that in 2008. However, much of the profits from this reduced fuel costs were offset by reduced revenues. The reduction of revenue was by $3.9 billion in 2009 (UAL, Form 10-K 56). Foreign exchange fluctuation is inevitable and can have a great impact on the profitability of UAL. There are two sources of foreign exchange risks. The first one and also the largest one is sale of tickets in foreign denominations and receipt of the prices in dollars. There is a usual gap of 15 to 45 days between sale of tickets and receipt of revenue by UAL. If in the interim the foreign denomination value diminishes, then there will be loss from the sale of tickets, and vice versa. The second source of foreign exchange risk is the impact of foreign exchange fluctuation on anticipated future cash flows. Since it is not viable to adjust prices of tickets in short intervals, the fall of foreign denomination values will effect future transaction when again dollar value reduces considering foreign currency price and the load factors are stable (Levi 303). Since a bulk of financial transactions (revenues and expenses) occur in various foreign currencies, exchange rates of foreign currencies have a major impact on the cash flows and the company’s operations. For this reason economic exposure, i.e., vulnerability of the company to foreign exchange rate, is measured and managed by using foreign currency forward contracts (UAL, Form 10-K 140). After incurring all the expenses in relation to various operations, the excess cash is invested in short-term, highly liquid investments. Investments that mature within three months are considered as cash revenues. Investments that are made in debt securities and are distinguished as available-for-sale are stated at fair value. All the profits gained and losses incurred from the change of fair value of such debt securities are included in other comprehensive income. The profits are reflected in other comprehensive income and losses are reflected in other comprehensive loss (UAL, Form 10-K 101). UAL accumulated other comprehensive income of $387 million at the end of 2010 and $35 million at the end of 2009 (UAL, Form 10-K 82). As of December 31, 2007, other comprehensive income included net change in unrealized losses on financial instruments of $37 million, and net change related to employee benefit plans of $11 million. Both figures were in losses. On December 31, 2008, net change in unrealized losses on financial instruments was $15 million, which was a gain, and net change related to employee benefit plans was $73 million, which was a loss. On December 31, 2009, net change in unrealized losses on financial instruments was $204 million, which was a gain, and net change related to employee benefit plans was $148 million, which was a loss (UAL, Form 10-K 84). On December 31, 2009 and on December 31, 2010, UAL did not have any foreign currency hedges. On December 31, 2010, UAL had outstanding forward contracts to hedge 24% of its projected Japanese yen-denominated cash inflows, mainly from sale of tickets to passengers during 2011. In the consolidated balance sheet as on December 31, 2010, current liabilities included $7 million, which was the fair value of those hedges. UAL is involved in hedging transactions as defense against rising fuel costs. However, UAL’s “hedging programs may use significant amounts of cash due to posting of cash collateral in some circumstances, may not be successful in controlling fuel costs and may be limited due to market conditions and other factors” (UAL, Form 10-K 19). Moreover, if there is a considerable rate of decline in fuel prices, then the costs in relation to UAL’s fuel hedging arrangements may increase to the extent the company has entered into swaps or collars. Swaps and sold put options (as part of a collar) force the company to make payments to the counterparty upon settlement of contracts. This will happen if the price of commodity hedged reduces below the amount previously agreed upon. There can be no guarantee that the hedging arrangements made by UAL will ensure protection against fluctuations of fuel costs or that its counterparts will succeed under the hedging arrangements. In addition, if the company’s financial condition weakens, then UAL may not be able to enter into new hedge contracts in the future. This may result in that UAL will have to post increased amounts of collateral under its fuel hedging agreements (UAL, Form 10-K 19). Derivative Financial Instruments Under suitable conditions, UAL “accounts for its fuel derivative instruments as cash flow hedges” (UAL, Form 10-K 138). All derivatives selected as hedges that fall under certain categories are granted special hedge accounting treatment. In general, taking advantage of the special hedging accounting, all intermittent changes in fair value of derivatives selected as hedges that are significant are recorded in accumulated other comprehensive income (loss). Hedge becomes ineffective when the “change in the fair value of the derivative instrument exceeds the change in the value of the Company’s expected future cash outlay to purchase and consume fuel” (UAL, Form 10-K 138). This ineffectiveness is considered as other non-operating income or expense. All cash transactions that occur while purchasing and settling derivatives are included in cash flows in the statement of cash flows (UAL, Form 10-K 138). On 2 May 2010, UAL Corporation, Continental and JT Merger Sub Inc. merged together by entering into an agreement. After the merging became complete, UAL Corporation name was altered to United Continental Holdings Inc as it became the parent company of Continental and United. However, until the operations of Continental and United are assimilated, these two companies will operate as separate bodies (UAL, Form 10-K 4). After the merger, “UAL, Continental and the trustees for Continental’s 4.5% Convertible Notes, 5% Convertible Notes and 6% Convertible Junior Subordinated Debentures entered into supplemental indenture agreements which provide that Continental’s convertible debt, which was previously convertible into shares of Continental common stock, will be convertible into shares of UAL common stock upon the terms and conditions specified in the indentures” (UAL, Form 10-K 147). To facilitate Continental’s activities as a separate entity, it is indicated that the embedded conversion options in Continental’s convertible debt are treated as freestanding derivatives. Moreover, according to the contract, UAL is to provide common stock upon conversion of the debt and this common stock should also be treated as freestanding derivatives (UAL, Form 10-K 147). Offshore and Euromarket Funding and Investing Activities UAL has business all over the world and a substantial part of its operations take place outside the United States. These operations in foreign countries garner almost one-third of total operating revenues of the company. This data is included in the report submitted to the Department of Transportation (DOT). UAL’S activities in Asia, Europe, Latin America, Africa and the Middle East are an important part of its global network of airlines. Unstable economic, political and market conditions in these regions can negatively affect the company’s operations and can be a hindrance for achieving its business goals. Moreover, “significant or volatile changes in exchange rates between the U.S. dollar and other currencies, and the imposition of exchange controls or other currency restrictions, may have a material adverse impact upon the Company’s liquidity, revenues, costs and operating results” (UAL, Form 10-K 26). In December 2010, the DOT granted an antitrust immunity approval. Following that United, Continental, Air Canada and Lufthansa entered into a joint venture agreement that included trans-Atlantic routes. The purpose of this venture is to provide efficient flight schedules and reasonable fares and service. This venture has a “revenue-sharing structure that results in payments among participants based on a formula that compares current period unit revenue performance on trans-Atlantic routes to an historic period, or baseline, which is reset annually” (UAL, Form 10-K 7) Conclusion Airlines are always in competition for share of market by increasing or decreasing their capacity including route systems and the number of markets captured. Several other American airlines have increased their international market by sending airlines to destinations previously held only by UAL, thus causing overlap in destinations served. This increases competitions for those destinations. During the global recession both UAL and its competitors have made significant reductions in global capacity. However, several of UAL competitors may not have reduced global capacity and instead, may have increased it. This will further increase competition in both domestic and international markets and can have an adverse effect on the company’s financial condition or its operations. The severe recession in the global economy has resulted in reduced demand of air travel and this has caused extreme financial constraints on US airlines including UAL in 2008 and 2009. There was improvement in the financial condition of UAL in 2010 mostly because of the improving global economy, which has resulted in more air travels. But this cannot guarantee consistent growth in air travel demand and further worsening of economic conditions can damage UAL’S ability to sustain the profit gained in 2010. Works Cited Levi, Maurice D. International Finance. New York: Routledge, 2009. Print. Muck, Matthias, and Markus Rudolf. “International Corporate Risk Management: A Comparison of Three Major Airlines.” Risk Management: Challenge and Opportunity. Eds. Micjael Frenkel, Ulrich Hommel, and Markus Rudolf. Germany: Springer, 2005. 571-590. Print. United, the World’s Leading Airline, Factsheet, 2013. Web. 19 February. 2013. ‹http://www.unitedcontinentalholdings.com/index.php?section=about›. United, the World’s Leading Airline, Form 10-K, 2013. Web. 19 February. 2013. ‹http://ir.unitedcontinentalholdings.com/phoenix.zhtml?c=83680&p=irol-reportsannual›. Read More