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No. of Recommendations: 3

UAL valuation and "recovery plan" scenarios

a) 5% bankruptcy probability: value of stock $0
b) 60% probability for 10% cost reduction plan: value of stock $21
c) 30% probability for 15% cost reduction plan: value of stock $30
d) 5% probability for 20% cost reduction plan: value of stock $40

Expected stock value = (.05x0) + (.60x$21) + (.30x$30) + (.05x40) = $23.60
Present value (discounted) = $20 ($23.60/1.17)

Present value of the stock under a 10% cost reduction plan: $18

The discount rate (required rate of return) would decrease as leverage ratios improve under a cost reduction plan and once labor issues are resolved. Using current earnings (first call) assumptions and a 10% cross-the-board reduction in total labor costs, equity (retained earnings) would increase by approximately $1 billion over the 2002 through 2005 forecast period.

Key model assumptions
* Cost of equity capital for first (4 yrs) stage: 17%
* Constant growth stage (terminal value) based on a .016 net profit margin and15% discount rate
* 116.5 million shares outstanding
* across-the-board labor cost reduction program includes work rule changes.
* GDP estimates: 3% to 3.5% in 2003, 2004, 2005
* Revenues increase 12% in 2002 over 2001 and then 5% thereafter
* Revenues do not recovery to 2000 levels until 2005
* net margins for a 10% plan: 2002: -2.5%, 2003: +1.7%, 2004: +3.2%
* net income for a 10% plan: 2002: -$400m, 2003: $300m, 2004: $$600
*forecast market value for a 10% plan: $2.4 billion
*company destroys capital under the 10% when all sources of capital are included
* recovery plan in place through 2005.


The "10% recovery plan" scenario suggest that the current stock price is undervalued by at least 15%. 12 month target price: $20 to $25.
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