Using Statement of Intermediate Balances - Case Study Example

CORE Analysis of Ryanair Holdings plc and easyJet plc Introduction This report presents a CORE financial analysis of two competitive low-cost airlines, easyJet and Ryanair. The CORE appraisal framework as described by Moon and Bates (1993) consists of four stages: A description of the Context, an Overview of the companies being assessed, an analysis of Ratios relevant to the strategic and environmental contexts of the companies, and an Evaluation of the outcomes. For easyJet and Ryanair, the external profile of the context is the same – the competitive low-cost carrier (LCC) air transport sector. Each company, however, has a slightly different internal context, slightly different strategic objectives, and of course, different financial states. Nevertheless, the companies are sufficiently similar in overall aspects to make a precise comparison possible. Most of the information presented in this report is taken directly from the annual reports of easyJet plc (for year-end 2011) and Ryanair Holdings plc (fiscal year ending 31 March 2012). Supporting information, particular on the background and current state of the LCC sector, is provided by a number of articles from academic journals. Context: External Profile Ryanair and easyJet are competitors in the low-cost carrier (LCC) market in Europe. LCCs differ from traditional airlines in that they offer lower fares (or fares that are at least perceived to be lower) than traditional airlines, offer fewer ‘frills’ – on-board services to passengers – operate in hybrid networks that combine the hub-and-spoke and point-to-point route models, and generally have lower unit costs than traditional airlines (Abda, Belobaba & Swelbar, 2011, p. 21). Ryanair and easyJet have different analyses of their competitive environments. easyJet’s assessment focuses primarily on the overall economic environment in Europe, and gives a great deal of attention to regulatory concerns that affect the airline’s business. easyJet notes that the number of holiday travellers in the UK declined in 2011, but that the threat that posed to the airline’s business was compensated by declining business amongst its competitors. For example, easyJet was able to increase its frequency of flights from Bristol, Glasgow, and Milan after the withdrawal or significant reduction of service by Ryanair, BMI, and Lufthansa from those airports (easyJet, pp. 13-14). In terms of the regulatory environment, easyJet makes it clear in no uncertain terms that it is very unhappy with the British government’s decision to not convert an Air Passenger Duty tax into a per-plane tax, and instead reduce taxes charged to passengers on long-haul flights while raising those charged on short-haul flights; the latter tax, of course, directly affects virtually all of easyJet’s customers. In addition, easyJet has concerns about increasing airspace and airport fees in several European countries, such as the UK, Germany, France, Spain, the Netherlands, and Italy (easyJet pp. 10-11). Ryanair by contrast takes a more general view of its external environment. The company explains that the LCC market is highly competitive, particularly because there are so many competitors in the market; one point Ryanair makes in its discussion – and by doing so, implying that the company is quite displeased with the circumstances – is that the EU-US Open Skies Agreement in place since 2008 allows American carriers to provide intra-Europe services, adding even more competition to the market. Ryanair also acknowledges that it is competing not only with other airlines, but with alternative forms of transportation such as high-speed rail and ferry service (Ryanair, p. 44) Context: Internal Environment In an analysis of major airlines’ competitive strategies published in the mid-1990s, the University of Strathclyde’s Jim Hamill identified three basic strategies that all airlines can pursue: The Competitive Positioning Strategy, the Marketing-Customer Orientated Strategy, or the Cost Control Strategy (Hamill, 1993, pp. 335-336). In a broad sense, the basic LCC model of Ryanair and easyJet is already a competitive positioning strategy, presenting the airlines as an alternative to traditional carriers. From the narratives in each company’s annual reports, they are both clearly pursuing a cost control strategy. Ryanair provides more descriptive details about its perspective with regards to controlling costs than does easyJet. Both airlines practise extensive financial hedging activities against future fuel costs and foreign currency exchange fluctuations; Ryanair goes one significant step farther than easyJet in cost control, in that it grounds a part of its fleet on a seasonal basis to maintain a favourable level of unit costs (Ryanair, p. 43). Looking at the financial statements of both airlines, one would expect that they would have similar profiles. Most of their assets should be “property, plant, and equipment” category, representing the two airlines’ fleets of aircraft – easyJet owns or leases a total of 204 aircraft, mostly Airbus A319 and A320 airliners, while Ryanair has a fleet of 294 Boeing 737-800 aircraft (easyJet, 2012, p. 13; Ryanair, 2012, p. 62). A note in Ryanair’s discussion of risks faced by the company explains that operating margins and revenues are very sensitive to small changes in external conditions, such as fuel prices, exchange rates, or unexpected problems like the disruptions to air travel caused by volcanoes in Iceland in 2010 and 2011 (Ryanair, 2012, pp. 53-54). This suggests that intangible assets should be a small proportion of each company’s asset portfolio. Because a significant part of each airline’s fleet is leased – about 30% in both cases – this should be reflected as a significant entry in the non-current liabilities category, as lease payments on aircraft are typically deferred to near the end of the lease term, with intermediate payments (for interest and other lease maintenance) treated as “other operating expenses” (Baker, Ding & Stolowy, 2005). Finally, derivative financial instruments used as part of airlines’ hedging strategies should be represented by significant entries in both the current assets and current liabilities of easyJet and Ryanair. For reference, the Consolidated Financial Statements from each company’s annual reports are provided in the Appendix. Overview The first problem encountered in making a comparison between easyJet and Ryanair is that the two companies use different currencies in their financial reports; easyJet’s are in Pounds Sterling, while Ryanair’s are in Euros, the respective currencies of their home countries Great Britain and Ireland. In order to make the comparison, Ryanair’s figures are converted to Pounds Sterling below, according to the exchange rate of 1 € = £0.836 at the end of 2011 as published in the company’s annual report (Ryanair, 2012, p. 39). From the discussion in the previous section, the factors from the two financial statements that are of particular interest are: Factors that indicate unit costs, as that is identified as a significant feature of LCCs according to Abda, et al. (2011). This can be looked at in a couple different ways, either as the cost per Available Seat Kilometre (ASK), a common metric in the air industry, or as cost per aircraft, since the number of aircraft in both fleets is known. And of course, the unit costs can be compared to unit revenues on the same basis as an assessment of productivity. The proportions of “property, plant, and equipment” and intangibles in the two companies’ assets. The proportions of derivative financial instruments in assets and liabilities, since these identify hedging activity. The following table sets out the relevant measures side-by-side, with Ryanair’s figures converted to Pounds Sterling as explained above. “Available Seat Kilometres” for Ryanair is actually “Available Seat Miles”; while a kilometre and a mile are obviously not the same thing, the manner in which the measures are used in airline financial statements – i.e., one unit distance per seat – should render the physical difference irrelevant for this analysis. Indicator easyJet Ryanair Number of Aircraft 204 294 ASKs 69,318 million 71,140 million Operating Revenues £3,452.00 million £3,670.20 million Operating Expenses (incl. fuel) (£3,204.00 million) (£3,099.05 million) Assets – Property, Plant, and Equipment £2,149.00 million £4,117.47 million Assets – Intangible £451.00 million £39.12 million Assets – Derivative Financial Instruments (current and non-current assets) £107.00 million £196.63 million Liabilities – Derivative Financial Instruments (current and non-current liabilities) (£79.00 million) (£68.38 million) Current Assets £1,738.00 million £3,240.34 million Current Liabilities (£1,177.00 million) (£1,517.34 million) Total Assets £4,469.00 million £7,524.84 million Total Liabilities (£2,764.00 million) (£4,760.43 million) (Source: easyJet, 2012, pp. 20, 22, 67; Ryanair, 2012, pp. 37, 41, 131) There are a couple of interesting comparisons in the two companies’ financial states. Despite having a fleet almost one-and-a-half times the size of easyJet’s, Ryanair’s operating revenues are very similar, a bit more than £200 million greater, while its operating expenses are a bit more than £100 million lower. There are also great differences in assets and liabilities, which are larger for Ryanair; the larger fleet of aircraft would account for some of this. easyJet, on the other hand, lists intangible assets more than ten times larger than Ryanair’s. Ryanair holds a much larger amount of derivative financial instruments – a net amount of £128.25 million versus £28 million for easyJet – indicating a much higher level of hedging activity. Ratios The first ratios to be examined are unit costs, which are operating expenses per aircraft and operating expenses per ASK. easyJet’s unit costs are £15.71 million per aircraft and £0.046 per ASK; Ryanair’s unit costs are much lower at £10.54 million per aircraft, but only slightly lower on a per-ASK basis at £0.044. In terms of unit revenues, easyJet earns £16.92 million per aircraft and £0.050 per ASK, while Ryanair earns £12.48 million per aircraft and £0.052 per ASK. Ryanair therefore has better net revenue per unit than does easyJet: £1.94 million per aircraft versus £1.21 million for easyJet, and £0.008 per ASK versus £0.006. The second set of ratios to be examined are the ratios of intangible and tangible assets to total assets: easyJet Tangible Assets (Property, Plants, and Equipment): £2,149 million/£4,469 million = 48.09% Intangible Assets: £451 million/£4,469 million = 10.09% Ryanair Tangible Assets (Property, Plants, and Equipment): £4,117 million/£7,525 million = 54.71% Intangible Assets: £39 million/£7,525 million = 0.52% Taking this one step further to assess the companies’ ability to absorb losses, the respective debt-to-asset ratios of easyJet and Ryanair are 0.62 and 0.63, roughly equal, but with very different asset profiles. Finally, the net hedging level for both airlines – which is a description of their ability to manage future costs, and as a consequence maintain margins – can be determined by a ratio of net derivatives to net assets. For easyJet this ratio is 0.016 (£28 million net derivatives/£1,705 million net assets), and for Ryanair this ratio is 0.046 (£128 million net derivatives/£2,765 million net assets). Evaluation A general conclusion that can be drawn from this analysis is that Ryanair is on the whole more efficient and more financially-sound than easyJet. Despite earning less per aircraft – an outcome that can be explained by the seasonal grounding of a part of its fleet – Ryanair has lower unit costs and higher net revenues. It also has a very good debt-to-asset ratio with a much higher proportion of tangible assets than easyJet. This assessment is also confirmed by other studies; a study that conducted a data envelopment analysis and total factor productivity analysis on a large number of global airlines put Ryanair at or near the very top of the list using both methodologies (Barbot, Costa & Sochirca, 2008, p. 272), although it must be said that easyJet also performed very well in the same study. As Ryanair is a larger airline than easyJet, the results of the above analysis at least anecdotally confirm the conclusion of Barbot, et al. that economies of scale directly correlate to better airline financial performance. Ryanair’s financial profile with comparatively low levels of intangible assets and higher levels of hedging activity reflects the company’s caution to its investors about the sensitivity of airline revenues and margins to small changes in the cost environment (Ryanair, 2012, p. 53). Although easyJet’s debt-to-asset ratio of 0.62 indicates the company is well-protected against losses, its position is a bit more tenuous because of the inclusion of a large amount of intangible assets of uncertain value; if those were disregarded, then the debt-to-asset ratio would become 0.69, still not necessarily a bad indicator, but not as favourable as Ryanair’s 0.64 under the same conditions. This perhaps partly explains why fees and taxes are a significant area of concern for easyJet, while they appear to not be as big a priority in cost-cutting strategies for Ryanair. References Abda, M.B., Belobaba, P.P., and Swelbar, W.S. (2011), ‘Impacts of LCC growth on domestic traffic and fares at largest US airports’, Journal of Air Transport Management, 18, pp. 21-25. Baker, C.R., Ding, Y., and Stolowy, H. (2005), ‘Using “Statement of Intermediate Balances” as Tool for International Financial Statement Analysis in Airline Industry’, Advances in International Accounting, 18, 169-198. Barbot, C., Costa, Á., and Sochirca, E. (2008), ‘Airlines performance in the new market context: A comparative productivity and efficiency analysis’, Journal of Air Transport Management, 14, 270-274. easyJet. (2012), europe by easyJet plc: Annual Report and Accounts 2011. easyJet plc. Hamill, J. (1993), ‘Competitive Strategies in the World Airline Industry’, European Management Journal, 11(3), pp. 332-341. Moon, P. and Bates, K. (1993), ‘Core analysis in strategic performance appraisal’, Management Accounting Research, 4, pp. 139-152. Ryanair. (2012), Annual Report. Ryanair Holdings plc. Appendix A: easyJet plc Statement of Financial Position (Source: easyJet plc 2011 Annual Report, p. 67) Appendix B: Ryanair Holdings plc Consolidated Balance Sheet (Source: Ryanair plc 2012 Annual Report, p. 131) Read More