British Airways Performance Analysis - Assignment Example

 British Airways 1. Performance analysis The performance of British Airways (BA) for the previous two years is analyzed under profitability, liquidity, and efficiency categories with the help of ratios calculated as under: The above ratios reveal the comparative performance of BA for the two years under consideration. Profitability- wise operating profit ratio has registered a commendable performance in 2008 as compared to 2007. In fact ‘the operating profit margin measures the percentage of each sales dollar remaining after all cost other than interest, taxes, and preferred stock dividend are deducted. It represents pure profits earned on each dollar.”(Lawrence J Gitman, page 67)1 The performance of BA has been excellent raising its operating profit ratio from 7.09% in 2007 to 10% in 2008 despite the fact that rise in revenue is merely 3%. In the year 2007 total revenue was £ 8492m and that has risen only to £ 8753m. The extremely good profitability performance is again corroborated by the fact that return on equity has gone up from mere 8.39% to 21.74%. Such a large increase in return on equity is remarkable when the total equity has risen from £ 2411m in 2007 to £ 3233m. Overall BA has performed extremely well on profitability front. Liquidity has been a problem for BA in both years. Liquidity reflects the short term solvency situation of a company. Liquidity position provides an idea about whether company is in a position to meet its short term obligations when those become due. Liquidity of a company is aptly reflected by its current ratio. Current ratio of 2:1 is considered optimum for any industry, but this standard again differs from industry to industry. BA has a current ratio of 0.95: 1 in 2007 and 0.97:1 in 2008. By any standard the current ratio is much lower than the required standard. BA is facing a liquidity crunch and if it continues like this BA might face difficulties in meeting its short term obligations. Current ratio change in 2008 when compared to 2007 is not even noticeable. The contributing major factors to deteriorating liquid position of BA are current interest bearing deposits that have depleted from £ 1642m in 2007 to £ 1181m in 2008. Liquidity is certainly a cause of concern for BA. The activity performance of BA can also be judged through its assets turnover ratio. ‘The total asset turnover indicates the efficiency with which the firm uses its assets to generate sales.’(Lawrence J Gitman, page 67)2 The performance on this front in 2008 has remained almost similar to 2007. Though rise is slender from 0.75 times to 0.79 times, but the important factor is that increase in revenue from £ 8492m in 2007 to £ 8753m in 2008 has been achieved when total assets have actually decreased from £ 11384m to £11123m.Accordingly the exploitation of total assets for raising revenue by BA is praiseworthy in view of recession in the airline market during this year. Overall BA has performed well particularly on profitability front as it has certainly added some value to shareholders’ wealth. That is why EPS (basic) per share has improved tremendously from 25.5p in 2007 to 59.0p in 2008, and this speaks volumes about the performance of BA up till 31 March 2008. 2. Potential financial implications of recent events and effect on share price Reacting to current economic crisis being faced by airline industry, Mr. U K Richard Tams, the General Manager of British Airways termed this as ‘ a lot worse than 9/11. 9/11 was sharp shocked but the underlying economic environment was far better. Now we have rocketing fuel prices and weakening demand. It will be fatal for a lot more businesses.”(Travel weekly, 23 September, 2008)3 This clearly reflects that BA like other airlines is facing two major problems. The first problem relates to rising fuel prices, and the second is weakening demand of air traffic. Air traffic decline has direct impact on revenue. Like any other business the management of revenue in an airline industry is the prime factor affecting its profitability. Under such conditions the airline has to juggle out with air fare settings and controlling seat inventory. Incidentally these factors of rate adjustments and controlling seat inventory are interdependent. The idea is that the airline cannot make heavy adjustments with air fare in order to increase revenue. Excess reduction of or discounting of air fare will ultimately result into decrease in revenue and the problem of low revenue from depleting air traffic remains unresolved. As per a report published in Travel-Mole(4 December 2008)4, an online travel magazine, ‘the first and business- class traffic at British Airways has got on progressively worse for three months, with a 9.2 % decline in October and 8.6% decline in September. Economic class traffic declined 3.3 percent in October.’ British Airways has tried its best to reduce the capacity for superior first and business classes and increasing the capacity of economic class., But chances of increase in revenue in near future with these traditional airline management techniques seem difficult. As per airline management theory when more discount seats are made available the overall yield will get reduced. BA is facing serious liquidity crunch as stated in performance analysis for last two years. The decline in air traffic resulting in lowering of revenue will immediately affect the ability of BA to control worsening liquidity. With current ratios going further down, BA will find difficulty in meeting its short obligations as those falls due. Financial impacts suffered by BA due to the current economic crisis are enormous as has been reported by the company. The first half of 2008-09 results announced by the company shows a fall in profits of around 90% when compared with similar period of 2007-08. As per Interim management report5 the company has shown the following financial highlights that clearly reflect the financial downfall of BA in first six months ending 30th September 2008: Operating profits have come down to £140m when the figure for first 6 months ending 30th September 2007 was £ 567m – reflecting a comparative decrease of 75.3% over 2007 performance of first six months. Profit before tax has been declared at £ 52m as compared to £616m in the same period in 2007 - a fall of 91.55% revealing an awesome fall out of the economic crisis on air line industry. Surprisingly BA has managed an increased revenue in this period to the tune of £ 4754m as compared to £4470m in 2007. This of course was the result of efficient management by effectively controlling and redesigning the seat inventory. Despite this efficiency the profits before taxes have shown an unprecedented dip of 91.55%. Fuel costs rose by 52% as compared to costs in the comparative period of 2007. The interim management report states that this happened despite the fact the company covered the fuel costs by fuel hedging profits of £329m. An inflationary impact of 73% over the market price of comparative period of 2007 has created such a scenario. Another factor that contributed to such heavy slide in profitability is big hike in landing fee and en- route charges due to effects of exchange on non- UK costs, and airport charges in UK. As per interim management report these costs increased by 13.4% over previous comparative period. Interim management report also pointed out that other costs inflated approximately by £ 200m and half of that was the result of currency effects of exchange. Dividend has not been declared by the company looking at the slide in financial performance during six months since April 2008. The impact on financial performance can be assessed from the fact that earning per share (both basic and diluted) came down to minus (-) 4.3p from an imposing 42.5p (restated figure in interim results) for the year ending March 31, 2008. Current ratio has gone down to 0.81:1 as at 30 sep. 2008 from 0.97:1 on March 31, 2008 reflecting further deteriorating liquidity position of the company. Despite such an imposing impact on financial performances there is surprise element with regard to its share prices. Share prices of BA were maintained well till Aug 31, 2008. The monthly average share price for August 2008 as per Yahoo.com was £ 251 as compared to £226.08 for April 2008, but after that it slide down to £ 168.20 for September’08 and lowest to £136.20 for October’08. Thereafter the share prices have rallied back to £155.10 for November ’08 and to £ 177.50 for December’08. The following chart reveals the behavior of average monthly market prices of BA shares: Date Average monthly market price 2008 £ April 226.50 May 232.50 June 215.25 July 255.25 August 251.00 September 168.20 October 136.10 November 155.10 December 179.70 These fluctuations indicate the BA may recover the lost ground in share price because of its effective management of policies, that effected the rise in revenue during six months ending 30 September 2008 despite adverse economic conditions. Gulf News (November 9, 2008)6 reported that Willie Walsh, BA’s chief executive while reacting on the drastic financial impacts of economic crisis stated in Financial Times dated November 8, 2008, that “group had achieved a good performance given the incredibly difficult trading conditions amid the surge in fuel costs and falling traffic volumes. The six months period will be remembered as one of the bleakest on record.” 3. Potential financial strategy to counter negative effects of credit crisis The present credit crisis being faced by BA and other airlines is unprecedented and accordingly the solutions required to counter will have to be extraordinary. Take the case of fuel price hedging where every move now seems counterproductive. Oil prices have come down from $ 147 a barrel in June 2008 to $ 55 a barrel in November 2008. This is an indication of an all round credit crunch and not merely confining to airline industry. Under such circumstances the hedging policies earlier adopted by airlines to keep price hedged around $90 a barrel flew out of window like thin air. The extent of problem can be understood from the fact that despite such a drastic fall down in oil prices the profitability situation of airlines has worsened; and it is being said that 2009 will prove hard to bear by the airlines. Such unprecedented fall in oil price has not helped airline industry to recover the lost grounds. It seems there is no other way out to shield any upward fluctuations (and that are likely to happen) in oil prices except the traditional tool of hedging. This is because the crisis is not only for airlines but also for oil industry as well. The oil industry will also be tactically planning to come out of the crisis and for oil industry the only way is to bring back surge in oil prices. Oil prices are bound to rise. Therefore airline industry has to be well prepared for that. British Airline has already brought out a hedging strategy, as stated in next paragraph, and that is quite compatible with present oil price situation. This is one area where well planned and careful moves are required. Experts are of the opinion that hedging market is very liquid at present, and it may be difficult to secure new hedging deals from banks. Banks and other players will also change their strategies with regard to hedging and accordingly the airlines have to move as per changed policies of these institutions. It is a question of survival not only for airlines but for financial institutions as well. As per a report in The Age (November 14 2008)7 ‘British Airways has had 35 percent of next year fuel bill hedged at $100 a barrel since the summer, but as its half year results last week said it remained hedged at less than 40 percent despite the changing conditions.’ This may be an aggressive strategy but a carefully planned move keeping in view the expected surge to come in oil price. Quoting Finance Director Keith William the report further stated that ‘if oil averaged out at $75 a barrel and dollar at 1.65 to sterling, the carrier would lower its fuel bill to 2.8 billion pounds in 2009/10 from around 3 billion this year.’ and this sounds encouraging. The next important method to avert credit crisis is to increase revenue and reduce operating costs. Many airlines have so far tried traditional methods like reduction in fares, and increasing the number of flights on busy sectors. Some even tried to switch to more fuel efficient aircrafts to reduce the fuel costs. These are effective measures no doubt but this time crisis is different and traditional methods may not make enough dents in overcoming the gap between the revenue and the costs. IBM Global Business Services has suggested a Smart Aviation Model to overcome the present credit crisis. As per this model there are three “key attributes that can positively influence the aviation operating model: 1. The passenger experience, 2. Development of variable, and 3. Agile infrastructure and organization, and partner collaboration.”(Charles Vincent and others, page 7)8. Though British Airlines has already started working on partner collaboration methodology, it must also extend its horizons to other two parameters as well to attain the potential gains from such measures. Development of variable involves outsourcing of certain non- core activities. This will not only reduce the cost but also increase the operational efficiency particularly when the competition among the airlines is intense. In this category a trend that is catching up is to launch a sort of reduced service airline in order to meet the regional competition. Further, the British airline should also develop and encourage passengers’ self- service solutions in order to further reduce the operating costs. Under these solutions the passengers of all airlines will be using one set of infrastructure at the airport. These days airlines and airport use separate systems for managing customer touch points and channels. Certainly some collaborating efforts are required by the airlines at airports to reduce these costs, and that would matter a lot in ultimate analysis. BA should follow the following three steps as suggested by IBM Global Business Services in its above referred write up by Charles Vincent and others: 1. Provide range of self service solutions to customers and provide customers more choice, flexibility and control through their own maneuverings. 2. Develop a variable infrastructure where under core business is focused more effectively and non- core business is outsourced in order to bring flexibility in costs as per demand of services. 3. Airlines should use shared processes at all airports under a cost sharing programs. It is heartening to note that BA has already started working on these strategies. It is reported by Rebecca Thomson in Computer- Weekly. Com (December 2, 2008)9 that discussions are under progress of possible merger of BA with Qantas, an Australian airline. The said report stated, quoting BA’s Chief executive Willie March, that “merging with Qantas would open new routes to each carrier, enabling BA to explore opportunities in places such as Asia that would be difficult to do alone.” General rule of finance management is not to invest when services are otherwise available. In other words BA should not plan to undertake more investments in planes or renewal of existing fleet and other infrastructure investments even if it is necessary. This is because return from such capital investments will start after a long wait. Whereas, the company has to bear right from start the cost of raising the capital as well as the cost of servicing such capital. Expansion and/ or renewal of infrastructure are certainly not prudent moves under such turbulent period, and this will only add up to existing woes of present credit crisis. BA should also seek more collaboration arrangements where the capital already invested by the collaborators can be effectively utilized on the basis of experience of aviation management of BA. Cartels with other airlines on regional basis should be developed by BA in order to put effective use of already invested capital in the infrastructure. Where such arrangements are not possible, BA should use facilities available in the market of leased aircrafts, particularly in those regions where expansion has become very necessary because of already efficient and effective services provided by BA. In fact approach on all spending fronts, whether capital expenditure or revenue expenditure, should be conservative as has been suggested by Justice Bachmann. According to Justice Bachmann (October 14 2008) airlines should maintain spending discipline because of following four reasons: “1. A need to be conservative about debt as the legacy players too to fleet renewal spending for next few years, 2.Voilatile fuel prices, 3. Low cost rivals enjoy a 20%- 40 % nonfuel unit cost advantage, and 4. Consolidation is still likely in future. The strategies mentioned in this section to avert the present credit crisis are all basics relating to financing and only those are required to be followed in extreme crisis like the present one. BA will certainly come out winning when basics will be adhered to resisting aggressive finance and business polices. 4. Recommendations to potential investors The track record of stocks of British Airlines has been one of the best among other airlines. For a long time till August 2008 its stock remained stubborn and thereafter it stumbled because of huge upheaval in the stock market resulting from an all round credit crunch starting from the bankruptcy of Lehman Brothers in US. It is a fact that now the behavior of stock market is completely unpredictable and any sort of recommendation may not result fruitful because of unprecedented slide in stock market since the end of January 2008. Still there are certain basic rules that will hold well even under unpredictable circumstances like the present one. Investors should follow those basic principles of investment in case they are thinking about investing in the scrip of British Airlines. Certain facts about British Airways in this regard are noteworthy. Revenue has been rising all along for BA. Even as per its interim reporting for six months ending 30 September 2008, its revenue rose to £ 4754m as compared to £4470m in 2007. Efficient and tactical management has enabled the BA to remain in profits for the 6 months ending 30 September 2008, though it is much lower than in the comparative period ending 30 September 2007. It is important to note that many airlines are in red. Few have already declared bankruptcy as they could not bear the effects of credit crisis. Detailed medium term analysis at Yahoo. Com (2nd January 2009)10 is as under: “Medium term price tend British Airways change from bearish to bullish this week. This market keeps a relative behavior lower – 14.6116 than FTSE 100 Index. Volatility has been decreasing during last month daily and weekly indicators alert of the proximity of a market TOP. Keep track of bullish divergences on RSI that will confirm this scenario.” EPS is lowering over the period. Dividends have not been declared as per interim results. Quarterly volatility in prices of BA as per yahoo.com is 101.6607%. Given the above indicators it is very difficult to predict the future of shares of BA even though trend at present has changed from bearish to bullish over the week assessment. But the weak indicator is the volatility factor which is as huge as 101.6607%. Though the scrip is one of the best under present circumstances, but the suggestion to potential investors is ‘wait and watch’ at least for next few weeks. If the trend remains bullish definitely invest the money in BA and if it turns bearish because of volatility factor wait again till there is some sort of bullish tendency again come with stability of few weeks. One has to keep in mind that the year 2009 is very difficult for the airlines. References Read More