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Free Cash Flow
Free Cash Flow
To better understand Frontier Airlines and its long-term attractiveness to investors, a free cash flow valuation was conducted to glimpse where the company stands—forecasting for ten years from the proforma statements in 2022 to 2032. The primary data source for the Free Cash Flow valuation derived from the official financial statements of FY 2018 – 2021. The cost of capital from the previous section allowed for the WACC to be used to understand the models better. Data were mainly derived from Fact and S&P Capital IQ; unfortunately, no value line consists of Frontier Airlines.
The McKinsey Free Cash Flow Model allowed for the findings of an accurate value for Frontier Airlines. The Free Cash Flow model below will enable us to measure the profitability that excludes non-cash expenses listed on the business's income statement. This method allows investors to determine whether the stock is overvalued.
The figure below allows the analyst to calculate free cash flow as they need to determine the present value of future cash flows. Deriving the numbers from the balance sheet and income statement into the proforma allows for a better projection.
Figure 3.1: ULCC Proforma Inputs. Source: Excel
The Pro Forma Statement for Frontier Airlines focuses on four concepts. The first concept is determining the forecast period. The figure above used ten years from FY 2022 to 2032. Analysts choose a ten-year time horizon to allow for an accurate growth period. The pandemic drastically changed the company's income and balance sheets, allowing for a more stable outlook with the pandemic factored out. Over the past few years, Frontier Airlines has been decreasing tremendously in growth, but this was a result of the pandemic on the airline industry and underlying factors within the company itself. The growth calculation was executed using the Factset outlook and the sales number for the fiscal year 2022. This allowed for the sales outlook number to be divided from the revenue on the income statement for the fiscal year and subtracted by one. From Fiscal Year 2025 to 2032, the growth rate was calculated using the previous year's growth rate + 1/8 multiplied by the long-term growth rate minus the last year's growth rate, which led to 1% in 2032. The company's growth rate decreased drastically from FY2022 to FY 2023; however, from FY2023 to FY 2032, the company increased and decreased by 2%. From a growth standpoint, the company shows somewhat stable financial health; however, more outliers make it a risky investment.
The cost of goods sold percentage was calculated by taking the four years average of the COGS from the income statement. Frontier Airlines had a loss in the last two years, making some numbers low for operating income, so using the four years average was a better variable.
SG&A percentage was calculated using data from the income statement and averaging the four years of SG&A, ultimately going with the FY2020-2021 data, so it was more accurate for the Proforma Statement chart.
NOA as a percentage for Frontier Airlines was executed by taking the average from 2020 to 2021 without outliers. This led to a value of 13.62% that remained throughout all Fiscal Years. The 13.62% is a warning to investors that Frontier is not investing in operating assets and is liquidating more than spending.
Figure 3.2: ULCC Proforma Statements 2022 to 2032. Source: Excel
The figure above allowed for the creation of the pro forma statement. The data used to forecast Frontier Airlines was derived from the income statement. The first step was to multiply the total revenue from the previous fiscal year by one and then add the forecasted growth rate for the current fiscal year. From FY 2022 to 2032, Frontier Airlines is expected to grow on average by $8,000. Now with the current state of the company, that could be unlikely, but these were the finding for the pro forma.
COGS was forecasted by using the current fiscal year predicated COGS % of sales multiplied by the total revenue for the current fiscal year.
The Gross Profit in the figure above was calculated by using the total revenue minus COGS for the current fiscal year. Gross Profit over the ten years is expected to grow steadily, around $200 on average by 2032. That slight growth in Frontier Airlines GP should concern investors.
SG&A was calculated by multiplying the total revenue for the current fiscal year by the SG&A percentage.
The Depreciation and Amortization came from taking the total revenue in that year and multiplying it by the average of FY 2020-2021 percentage of Depreciation & Amortization.
In conclusion, Frontier Airlines Operating Income is projected to grow in red, showing the company's current and future standing as not profitable. With such a slight gross profit increase YOY, it is another red flag for investors about ULCC. The current state of their financial health is a warning to investors, and they should remain cautious.
Figure 3.3: ULCC Free Cash Flow Valuation. Source: McKinsey Model via Excel
The figure above focuses on the free cash flow model combined with both models. For the ten years of FY 2022 to 2032, the total free cash flow was forecasted by taking operating income minus taxes at a statutory rate minus an increase in NOA. The total free cash flow explains how much Frontier has after limiting its operating expenses and capital expenditures. This leads to Frontier having money left over to spend back into the business on areas such as planes, new initiates, hiring, etc. However, the increase in cash has been relatively small through the years, which shows the poor health of the company. It is good that they are increasing cash on hand YOY, but the small amount is a concern. They will most likely be bankrupt if they can’t pay any debt obligators back because of the low amount. In 2031, Frontier Airlines has matured and will be worth about $8,740. Compared to Frontiers competitors, this is alarming.
Figure 3.4: ULCC NPV & Final Valuation per Share. Source: Excel
The last area of focus for determining the financial health of Frontier Airlines was by converting its value into a value per share. The first component of this model was the enterprise value of ULCC, which was calculated as an NPV calculation of all Total Free Cash Flow values for fiscal years 2022 to 2031 and WACC. The second component was taking the value of excess assets, which consisted of the excess cash on the balance sheet for FY 2021. The third component was calculating the value of debt which comprised all the long-term debt accounts on the Balance Sheet for Frontier Airlines. This focused on Frontier’s leases and the current portion of leases.
The fourth component was determining the value of equity. To calculate the fourth component, I took the enterprise value at $5,662 and added it to the value of excess assets at $918. This provided a value of $6,580, then subtracting the value of debt of $2,845. This provided a value of equity at $3,735. The number of shares outstanding came directly from the Cost of Capital section, which was initially derived from Factset. The equity value of $3,735 was divided by the number of shares outstanding of 217 million. This allowed the last component of value per share for Frontier Airlines to being calculated at $17.15 per share. According to the model, this value per share indicates a discount because the stock price is around $13, and investors should purchase because the shares are worth more. However, with continuous analytical research throughout this project, caution should be high when purchasing Frontier Airlines for the underlying factors mentioned throughout.
The Free Cash Flow Valuation allowed us to determine the financial standing of Frontier Airlines. The model has Frontier in a stable condition with a slow ten-year growth forecast. Still, the level of caution should remain uncertain within Frontier’s business model and daily activities. The stock is around $13, so it is not entirely undervalued, but there is some money to be made for investors with a value per share of $17.15. The value per share does not factor in the daily activities nor assets being sold present day but allows investors to make a strong foundation and understanding of the current standing.
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