Fundamental Analysis Of Airline Industry And Selected Companies

Top-Down Analysis

Question:

Discuss About The Structural Position In The Financial Market?

The aim of this report is to provide an understanding of fundamental analysis of airline industry as well as the selected companies that are Virgin airline and Qantas Airways. In addition to this, the report conducts a top-down analysis of the overall economic environment of the selected companies that includes the fundamental impact on the performance of selected industry and companies. For this, the report analysis the current Gross domestic product, inflation rate, interest rate, exchange rate and personal disposable income in Australia. On the other hand, the report also conducts bottom down analysis of the financial situation of the companies and airline industry. The ratios analyze the performance of the selected companies. The bottom down analysis helps in the comparative analysis and to finding out the more profitable company.

One of the strong industries is air travel industry in Australia. The air travel industry facilities the economic growth, international investment, tourism and world trade and it will increase by 7% per year. In addition to this, business travel has been developed the companies on an international level in terms of supply and production chain and investment that will also contribute to the economic growth. In terms of value, airlines industry shows a valuable growth with $14.2 billion from 2012 to 2017 and annual growth rate 0.4%. The air travel industry exists in the increasing competitive market that was affected by recent trend by expanding domestic as well as international service ((IBIS, 2016).).

The Virgin Atlantic was founded in 1984 in the UK and headquarter of this company is in Crawley and England. The company has a great goodwill and popularity so it enjoyed various trade awards across the world. The mission statement of the Virgin Atlantic is “to embrace the human spirit and let it fly”. After the expansion of the company, the Virgin Atlantic sold its 49% share to Singapore Airlines in £600.25 million (Virgin Atlantic, 2016).

The Qantas Airlines is one of the oldest airlines in the world that was founded in 1920 at Queensland. Initially, the Qantas Airways operates the service of Airmails that has been subsidized by the Australian government. It was the largest company, which provides transportation service to the different countries. The company holds 65% shares of the domestic market in Australia (Qantas, 2017). The mission statement of this company is that the company is dedicated towards work to being best and become an Australian leading premium airline company. In addition to this, the company wants to meet the expectation every time when passengers fly.

Bottom-Up Analysis

Top-down analysis is used to look for the big picture firstly and after that it will analysis the other small component in detail. In addition to this, the investor has calculated the share in the market by determining the total market (Mao et al., 2013). The investor starts the analysis with the help of economic indicator like interest rates, inflation, energy price, gross domestic production and exchange rates, which helps the investor for choosing the right stock. Some of the economic indicators are described as below-

To measure the economic activity of the nation gross domestic production is an effective indicator. In June quarter of 2017, the GDP rate of Australian is increased .80% in compare to previous year and stronger than first quarter of the same financial year. The contribution of all the service industries including the airline industry in gross domestic product is 52% (Trading Economics, 2017). In the economic environment, the revenue from the airways is increasing day by day, which means the Australian economic activities rises. The disposable income of the Virgin Atlantic and Qantas Airways is increased that means the demand for air travel is increase for business as well as leisure purpose.

The interest rate is an amount that was expressed as a percentage of principal by the loan taker to the borrower for using the assets. In addition to this, it was the amount that has been paid by the borrower to a lender for a specific period of time with the particular percentage. The interest of Australia in 2017 is 1.5%, which is unchanged (Reserve Bank of Australia, 2017). The value of Australian dollar is decreased as compare to 2016 therefore, the airline’s industry take the benefit of the decreased value of Australian dollar. In favor to this, due to the implementation of current interest rate the cost of ownership is reduced by $7.4m. Hence, it supports the Australian airlines such as Virgin Atlantic and Qantas Airways.

In the present context, the value of 1AUD is equal to 0.77US Dollar. It analyses that the value of Australian dollar is lower as compare to US dollar (Parliament of Australia, 2016). There is positive and negative impact on the airline’s industry with the fluctuation in currency. There is a need in airline industry to translate the cash flow in the different currencies so it will affect the decision of customer, airline decision and the financial accounts of the airlines. The lower value of the exchange rate has created a problem for both companies such as Qantas and Virgin airlines related to fuel hedging.

Liquidity Analysis

The inflation rate is the measurement of the increase in the price of goods and service over a particular period of time that is replicated as a percentage. It is usually measured on monthly and annually basis in the Australia. The inflation rate in Australia has been increased 1.9% in the June quarter of 2017 (Trading Economics, 2017). It was increased the price of food and housing offset in Australia. The Airlines industry is not able to take benefit because of the high inflation rate. It will impact on the demand for airlines services that is provided by the airline’s companies such as Virgin and Qantas Airlines.

Personal disposable income is the amount of money that has been available for households for spending and saving that has been calculated after paying income tax to the government. It is known as the economic indicator that is used to provide a framework the overall state of the economy. In addition to this, the personal disposal income increased to 287837 AUD million in 2016 third quarter from the second quarter of 2016 that is 287139 AUD million (Trading Economics, 2016). It analyzed that personal disposable income of Australian people is increased that makes a positive impact on the Airlines industry. The oil price carries an effective improvement for Airline companies like Virgin and Qantas Airlines; it will reduce the fair of air traveling. With the increasing personal disposable income, it will increase the spending power of customers.

In finance and accounting, bottom-up analysis is a defined as an investment approach which is used to analyze an individual stock on the basis of different factors. These factors involve an organization’s overall financial statements, financial strength and other individual indicators of performance (Sternberg, 2013). In this way, bottom-up analysis of Qantas and Virgin through different ratios is as below:

These ratios are used to analyze the ability of a company to pay debt obligations or current liabilities through the calculation of current ratio, acid test ratio, and cash ratio (Rist et al, 2014).

Name of the ratio	Formula of the Ratio	Qantas (30/6/2016)	Virgin (30/6/2016)	Industry average
Current ratio	Current assets / current liabilities	3458/7028 =.49	656.14/489.27 =1.34	.59
Acid Test ratio	(Current assets – Inventory)/ Current Liabilities	(3458-336)/ 7028 =.44	(656.14-0)/ 489.27 =1.34	.54
Cash Flow Ratio	(Cash+ Marketable securities)/ Current liabilities	(2209+0)/7028 =.31	(601.09+0)/489.27 =1.22

From the above calculations it is analyzed that current ratio is presenting the relationship between current assets and current liabilities. It measures the liquidity of an organization and widely used to discover the short-term liquidity position of the organization. The current ratio of Qantas is .49 and Virgin is 1.34 in 2016. It means that Virgin airline has high solvency and using much their funds in comparison of Qantas. As well as, acid test ratio is also presenting the relationship between liquid assets such as current assets and current liabilities of the company. As well as, acid test ratio is used to measure the ability to current liabilities of the company (Fridson and Alvarez, 2011). The above calculations presenting that acid test ratio of Qantas is .44 and Virgin is 1.34. It means Virgin is much capable to pay current liabilities in compare of Qantas airlines. Furthermore, cash flow ratio measures that how well the current liabilities are enclosed by flow of cash from the company’s operations. Here, cash flow ratio of Qantas is calculated .31 and Virgin’s cash flow ratio is 1.22. It means that Virgin has covered its current liabilities well in compare of Qantas. Moreover, the above calculations are presenting that liquidity ratios of Qantas is less than industry average but these ratios of Virgin company is higher than industry average. It presents that Virgin is much capable in paying debt obligations in compare of industry average and Qantas Company.

Profitability Analysis

In accounting profitability ratio is used to compare the income to expanses during a specific time of period. This ratio focuses on return of a company’s investment on assets and inventory. In other words, profitability ratios are important element to compute overall efficiency of the company which may be either in relation to investment or sales (Nelson, 2014).

Name of the ratio	formula of Ratio	Qantas (30/6/2016)	Virgin (30/6/2016)	Industry average
Net Profit Ratio	(Net profit/Sales revenue)*100	(341/7737)*100 =4.40%	(38.1/425.75)*100 =8.94%	5.35%
Gross profit ratio	(Gross profit/ Sales revenue)*100	(2524/7737)*100 =33.59%	(303.55/425.73)*100 =71.30%	36.62%
Operating profit ratio	(Operating profit/Sales revenue)*100	(549/7737)*100 =7.09%	69.17/425.73 =16.24%	9.05%
Return on assets Ratio	(EBIT/Average assets)*100	(549/17105.5)*100 =3.20%	(69.17/1819)*100 =3.81%	4.39%
Return on shareholder Fund	(Net income/Share holder’s fund)	(341/3255)*100 =10.47%	(38.10/885.19)*100 =4.30%

Net profit ratio is used to measure the net earned income of the company through its operational activities and determine that how well a company is effectively managing operating costs in respect to its share (Gay and Simnett, 2015). The net profit ratio of Qantas and Virgin is calculated respectively 4.40% and 8.94%, which presents that there is a significant fall in Qantas’s net profit and there is a need to maintain profitability by cut down its operating expenses. In addition, gross profit ratio and operating profit ratio are presenting that the financial position, pricing strategy, and operating efficiency of Virgin is better in comparison to Qantas and overall airline industry in Australia.

Furthermore, return on assets ratio is used to determine the net earnings that are being produced by average of total assets. This ratio also measures that how effectively a company is managing its assets in generation of revenues in a specific time of period. Hence, this ratio helps the organizations to transform assets into investment. Here, return on assets ratios of Qantas, Virgin and industry average are 3.20%, 3.80% and 4.39% respectively. Therefore, it is interpreted that the profitability of Virgin is quite good in the industry in compare of Qantas but in compare of industry it is not favorable.

The efficiency ratios are used to evaluate that how well a company is using their assets in operational activities to generate income. Efficiency ratios are used by the management to improve the growth of the company as well as outside creditors and investors. Usually, the funds are invested in various assets to generate revenue and sales in the business. These ratios represent that all the generated revenues and profits are dependent upon how the assets are being managed (Kaufman, 2013). Efficiency ratios show the time period in which assets can be converted efficiently into income.

Name of the ratio	Formula of Ratio	Qantas (30/6/2016)	Virgin (30/6/2016)
Trade receivable turnover	(Average trade receivables/ revenue)*365	(808/7737)*365 =38days	(32.18/425.73)*365 =27.58days
Sales to Capital employed ratio	(Sales / Capital employed)*100	(7737/9677)*100 =80%	(425.73/1407.18)*100 =30%

The above table presenting that how the companies are making sales. The trade receivable turnover ratio of Qantas is 38 days, which means that the company will its accounts receivables in 38 days in the financial year 2016. This ratio is also presenting the company’s efficiency of collecting cash from credit sales and analyzing the liquidity flow in a financial year. In addition, inventory turnover ratio of Virgin is 28 days, which presents that the company is much capable in to collect its credit sales in compare of Qantas. On the other hand, sales to capital employed ratio of Qantas is higher than Virgin. It means that Qantas has the higher ability to generate sales by utilizing its assets in compare of Virgin.

These ratios are also called as leverage ratios, which measures long-term structure and stability of an organization. Capital structure ratios are used to analyze the financial statement of an organization by using of different sources of finance. The capital structure ratios are helpful for the investors in making appropriate financial decision in worst position. In this way, debt to equity ratio is use to make a comparison between company’s debt and total equity. This ratio is used to analyze the capital structure of a company and helpful in identifying creditors and investors for the company (Coe, 2011). Lower debt to equity ratio will be more favorable for the financial stability of an organization.

Name of the ratio	Formula of Ratio	Qantas (30/6/2016)	Virgin (30/6/2016)	Industry average
Debt to equity ratio	(Total liabilities/ Total equity)*100	(13450/3255)*100 =413.21%	(1011.26/885.19)*100 =114.24%	183.76%
Equity ratio	(Total equity/ Total assets)*100	(3255/16705)*100 =19.48%	(885.19/1896.45)*100 =46.67%	28.7%
Gearing ratio	(Long term debt/ Capital employed)	(4482/9677)*100 =46.31%	(440.88/1407.18)*100 =31.33%

The above calculations are presenting that debt to equity ratio of Qantas is much higher in compare of Virgin and industry average, which means it is risky for Qantas to identify investors and creditors in comparison of Virgin and industry. But it is less risky for Virgin in compare to industry average. In addition, the equity ratio of Qantas is 19.48% and Virgin is 46.67 respectively, which determines that there are there are many potential stake holders for Virgin who are interested to invest in the company. It is also observed that Virgin Company has higher capabilities to attract investors in comparison to whole airline industry. Furthermore, the gearing ratio of Virgin Airlines Company is less than Qantas airlines, which determines that there is low proportion of debt to equity of Virgin in comparison to Qantas.

Market value ratios or market performance ratios are used to evaluate the price of company’s shares that are held publically. Market value ratios are employed by the potential and current investors to find out that whether the company’s shares are under-priced or over-priced (Brigham and Houston, 2012).

Name of the ratio	Formula of Ratio	Qantas (30/6/2016)	Virgin (30/6/2016)	Industry average
Earnings per share (EPS)	Available earnings/ Number of equity shares	49%	7.82%	39.53%
Price earnings ratio	(Market value of each share/ earnings per share)*100	6.71%	7.81%	5.94%

The term earnings per share are defined as net income per share, which is used to measure the earned net income per share. It is a calculation that is used to present how the company is profitable on the basis of shareholders. In the above calculations it is determined that earning per share of Qantas is higher than Virgin and overall industry average. It means that Qantas Company is more gainful and the company has more income to distribute to its shareholders in comparison of Virgin and industry average.

Furthermore, price earnings ratio is used to indicate the probable price of a share that will be based on its earnings. High price earnings ratio presents the value per share in the market and indicates positive future performance. The price earnings ratio of Qantas, Virgin and industry average is 6.71%, 7.81%, and 5.94% respectively. Therefore, it is analyzed that the future performance of Virgin airline is positive and the investors have higher willing to pay more for this company’s share in compare of Qantas and industry.

From the above calculation it is analyzed that both Qantas and Virgin have increased their total assets, but Virgin is presenting a noticeable grow in comparison of Qantas. It is observed that rise in total assets of Virgin is due to increase in cash or liquidity and rise in inventory of Qantas is due to increase in stock. Therefore, it can be determined that the profitability of Virgin has increased by increased liquidity but Qantas has showing an increase in liabilities in comparison of Virgin. Furthermore, it is analyzed that Qantas is arranging funds from debts in comparison to equity which increases the debts and accountability of the company, but Virgin is arranging funds wisely from their equity. Therefore, Virgin has a strong structural platform for the investors in comparison of Qantas in the Australia’s airline industry.

Conclusion

From the above discussion, the report can be concluded that the economic factor of Australia affects the overall profitability of all the companies situated in Australia. The report analyzed that personal disposable income of the individual is based on the overall profitability of the economy. On the basis of ratio analysis of both companies, it is also concluded that the management and financial position of Virgin is much better than Qantas. In contrast, it is analyzed that the Qantas Company has needed to manage their assets in a proper manner to increase the revenue and sales in the industry. Therefore, it is recommended that the company should decrease its debts or current liabilities through utilizing its currents assets effectively. Furthermore, it is also recommended that the companies should manage operating expenses in a systematic manner to increase their profitability ratio. The EPS of Qantas is good in comparison of Virgin, which may attract the stakeholders but there is a need to increase the value of shares in the market that leads to growth of an organization.

References

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