This report examines the current financial position of British Airways (BA) by examining the performance of the company during the financial years 2007/2008 and 2008/2009, based on their published financial statements.
It will calculate and interpret liquidity, profitability, efficiency and gearing (capital structure) ratios and examine changes in these results during this period.
Consideration is given to the ability of the company to survive the current economic recession and other factors which may impact on its performance, including industrial action, a drop in passenger numbers, fuel price volatility, (an all-time high of $147 barrel was reached in July 2008) and the effect of the Icelandic volcanic eruption, and the poor exchange rate between the £Sterling and the Euro/US$; all may have an impact on both short and long term profit and costs.
The paper concludes that BA is in a reasonably strong financial position, although there have been significant trading losses in the year 2008-2009, and the costs of the disruption and consequent loss of revenues due to the Icelandic volcanic eruption are yet to be quantified, although this will have affected its competitors too.
Introduction
Company Background
British Airways was formed in 1936 by the merger of 3 airlines; in 1936 the company merged with Imperial Airways to become the British Overseas Airways Corporation (BOAC); in 1974 it merged again with British European Airways (BEA). Upon the election of Margaret Thatcher as Prime Minister in 1979 it was earmarked for privatisation, and was privatised in 1987 to become British Airways Plc. Now, British Airways is owned entirely by private investors, including a percentage of the Company's own employees. It is the 'national flag-carrier' airline of the UK.
British Airways is the UK's largest airline by turnover and fleet size and the world's leading airline in terms of transatlantic flights. British Airways flies to almost 170 destinations in 75 countries and has a fleet size of around 245 aircraft. Its main hubs are London Heathrow and London Gatwick, although it operates domestic and European services from London City Airport through its subsidiary BA CityFlyer, and OpenSkies, which operates flights from New York to Amsterdam and Paris, with plans to expand flights to Continental Europe from New York under the 'open- skies' agreement between the EU and USA. British Airways has franchise arrangements with the South Africa-based airline Comair and the Scandinavian based Sun-Air, owns 15% of Flybe and also operates the cargo subsidiary British Airways World Cargo.
(2009 Keynote; Airlines)
British Airways is a member of the 'oneworld' alliance which offers an extended route network of destinations worldwide through code-share and franchise arrangements. (http://www.oneworld.com/)
In April 2010 a new holding company was formed with the Spanish airline Iberia to create the International Airlines Group; BA will own 55%, Iberia 45% of this new company, and both will continue to operate under their own brand. (http://www.newstatesman.com/business/2010/04/merger-airlines-groups-iberia)
Competitors
BA's main UK competitor in the premium market is Virgin Airlines, additionally a number of other European operators such as Lufthansa operate in direct competition with BA in the long haul market.
The emergence of 'Budget/no-frills' airlines in recent years following the Southwest Airlines business model, e.g.; Easyjet and Ryanair, has led to the dominance of the short haul market by them. A number of operators have folded recently; e.g. .Flybe in what is an increasingly tough competitive environment.
(2009, 2008 Keynote Airlines)
Financial Discussion
As noted above, BA is entirely owned by private investors. Investors in organisations are not just individuals; banks, major institutions, pension funds and other organisations will look to increase their share portfolio. Therefore to attract these investments organisations need to look attractive, and offer a secure investment with a good rate of return.
Investor's ratios are a well-used method in corporate finance to assist current and prospective investors to assess the company's performance from a shareholders perspective. These ratios can also be used to assess the effects of proposed financing or in a takeover bid. Ratios are indicators of the effective use of capital by an organisation; the financial achievement of all organisations is dependent on the ability to generate acceptable returns (to investors) on the capital funds they employ. This report will examine the published financial statements of 2007/2008, and 2008/2009 by conducting a ratio analysis in 4 key areas; profitability, liquidity, efficiency, and gearing (capital structure).
Key financial indicators over the 2 years show;
Traffic revenue in 2008/09 was £8,509m, in 2007/08 it was £8,157m; an increase of £352m.
Other revenue; in 2008/09 was £483, in 2007/08 it was £596; a decrease of £113m.
Total revenue shows an increase of 2.7% to £239m in 2008/09; however BA made a pre-tax loss of £401m compared to a pre-tax profit of £883 in 2007/08.
Operating profit was down from a profit of £875m in 2007/08 to a loss of £220m in 2008/09.
Net profit was down from £694m in 2007/08 to a loss of £358 in 2008/09.
Share Earnings;
There has been a fall in total share earnings from a dividend of 0.59p (2007/08) to a loss of 32.6p per ordinary share (2008/09) with no dividend paid.
(The earnings per share ratio is a valuable tool for investors, revealing the amount earned by the organisation in respect of its ordinary shares; a proportion of this amount is paid in the form of dividends to shareholders with the remainder retained by the organisation for future investment.)
Profitability;
In general, the higher profitability ratios are the better. An analysis of the profitability ratios shows the extent of the losses experienced in 2008/09;
- Net return on assets is (-358/10488) x100= (3.41%) from 6.24% in 2007/08
-Net profit margin; (-358/8992) x100= (-3.98%) from 7.92% in 2007/08
-Gross profit margin; (-401/8509) x100= - (4.71%) from 10.09% in 2007/08
-Return on Capital Employed; (-358/10488 x100= (-3.41%) from 7.49% in 2007/08
-Return on Equity; (-358/1646) x100= (-21.74%) from 22.89% in 2007/08
-Earnings per share; no dividend paid; a loss of 32.6p per share in 2007/08
These figures underline the scale of losses experienced in 2008/09.
Liquidity;
Liquidity ratios provide a measure of the working capital management of a business; as with profitability ratios the higher the better. The differences in liquidity between 2007/08 and 2008/09 are;
2008/09;
Current Ratio; 2346/4646=0.56:1
Quick/Acid Test; (2346-127-25)/4142=0.52:1
2007/08;
Current Ratio; 3148/3244= 0.97:1
Quick/Acid Test; (3148-112-19)/3244=0.93%:1
As shown, there has been a deterioration of .41:1 in both measures from 07/08 to 08/09.This indicates a lessening of BA to meet its short-term liabilities.
Efficiency;
An examination of the efficiency ratios for 2007/2008 and 2008/2009 shows that Ba used its assets marginally better in 2008/09; an increase of 0.01 in fixed asset turnover, net asset ratio shows an increase of 0.07, debtors collection period has improved by 2.89 days. These are positive indications in that they show a slight improvement, the debtors collection period being the most marked in this area.
2009;
Net Asset Turnover; 8992/10488=0.85 times
Fixed Asset Turnover; 8992/8142=1.1 times
Debtors Collection Period; (530/8992) x362=21.51 days
2008;
Net Asset Turnover; 8753/11123=0.78 times
Fixed Asset Turnover; 8753/7975=1.09 times
Debtors Collection Period; (586/8753) x365=24.4 days
Gearing/Capital Structure; These ratios examine the balance of debt and equity financing in a business and identify the risk profile of the business. Of these ratios the gearing ratio is perhaps the most important; it measures the percentage of capital employed that is financed by debt and long term finance. Therefore, the higher the gearing ratio, the higher the dependence on borrowings and long term financing; the lower the gearing ratio, the higher the dependence on equity financing. The gearing ratio for 2008/09 shows an increase of 11.46%, indicating an increased dependence on borrowing and long term financing. The ratio analysis for these indicators show significant changes between 2007/08 and 2008/09; interest cover has decreased by 3.56, an increase in liabilities to equity of 2.24, an increase in total liabilities to total assets of 0.11:1, a corresponding decrease in total assets to total liabilities of 0.2:1, and a difference of 0.03:1 in cash-flow to assets. Together with the losses made in 2008/09 this confirms the deterioration in performance.
2009;
Gearing Ratio; (4500+4142=8642) = (8642/10488) x100=82.39%
Interest Cover; -220/-177= 1.24 times
Total Assets to Total Liabilities; 10488/8642=1.21; 1
Total Liabilities to Total Assets; 8642/10488=0.82:1
Liabilities to Equity; 8642/1846= 4.68:1
Cash-Flow to Liabilities; 133/8642=0.01:1
2008;
Gearing Ratio; (7890/11123) x100=70.93%
Interest Cover; 875/-182= 4.8 times
Total Assets to Total Liabilities; 11123/7890=1.41:1
Total Liabilities to Total Assets; 7890/11123=0.71:1
Liabilities to Equity; 7890/3233=2.44:1
Cash-Flow to Liabilities; 303/7890=0.04:1
Conclusion
BA made a significant pre-tax loss in 2008-2009 of £401m, an operating loss of £220m, and a net profit loss of £358.This is in sharp contrast to the profits made in 2007-2008 of £883 pre-tax, £875m operating, and net £694m in 2007-2008. The reasons for this were an increase in aviation fuel prices; between 2007 and 2008, the cost of jet fuel increased by around 80%, (2009 Keynote Airlines) due to the extraordinary high prices of crude oil in 2008 (an all-time high of US$147 barrel was reached in July 2008; BA attempts to negate aviation fuel fluctuations by hedging; that is, by paying a fixed price in advance for estimated fuel needs in an attempt to escape high price rises) the effects of the recession on business travel (a key market segment for BA), consumer confidence falling, and the collapse of the financial sector and the housing market.
The recent strikes, although competitors like Lufthansa experienced industrial action too, will perhaps portray BA in a negative light in the public mind.
The recent disruption caused by the Icelandic volcanic eruption, with the consequent losses to BA (and other Airlines), which have yet to be quantified.
Possible Environmental legislation will add further costs; e.g. the proposed doubling of Air Passenger Duty by the UK Government from 2010. On a positive note, the opening of Terminal 5 at Heathrow (built for the exclusive use of BA), despite the initial problems with passenger baggage will perhaps aid BA to increase efficiency and add to passenger satisfaction. (Baggage problems have improved by 72.3% since 2008) Customer satisfaction rates are up; BA's 'ready to go' performance has improved by 19% in 2009. (BA Annual report 2009)
According to Key Note (2009 Airlines) there will be 'long-term growth in demand for air transport, the rate of increase in the immediate term could be affectedly the general slowdown in the economy. The growth that will be achieved between 2008 and 2012 will, once again, come from the expansion of the low-cost scheduled services sector, while passenger numbers on non-scheduled flights are projected to slide further, as consumers continue to favour independently arranged travel. The problems the industry will continue to encounter up to 2012 include increasing oil prices, government taxation on air travel and rising airport charges'.
Deregulation; e.g. the open skies agreement offers both opportunities and threats as BA can now possibly expand their 'open skies' service to mainland Europe from the USA; however competitors can do so too.
The difficulties facing BA are not unique to them in the present economic climate.
BA, although it experienced a large loss in 200-2009, will continue to operate; the challenge facing it is to reduce costs, improve its staff relations to avert costly strikes, and build upon its existing routes and alliances. The proposed merger with Iberia may yield increased business and profits.
BA has a strong brand image which it will need to emphasise; as competitors offer a similar level of service; such intangible assets may be of increasing importance in the years ahead.
References
Sh313; Class Materials, Handouts, Tutorials, Lectures
Bibliography
DeFranco, A., and Lattin, T. (2007): 'Hospitality Financial Management': John Wiley and Sons Inc.: New Jersey
Guilding, C. (2002) : 'Financial Management for Hospitality Decision Makers': Butterworth-Heinemann: Oxford
Wilson, M. (2009): 'Reading the Financial Pages for Dummies': John Wiley and Sons Ltd: Chichester
Wood, F., and Robinson, S. (2009) (7th edition): 'Book-Keeping and Accounts': Pearson Education Ltd: Harlow
Reports
Keynote Market Report 2009: Airlines
Keynote Market Report 2008: Airlines
Keynote Market Report 2007: Airlines
Keynote Market Report 2007: Airports
British Airways Annual Report and Accounts 2009/2008 pages 77-81
British Airways Annual Report and Accounts 2008/2007 pages 78-81
Internet Resources
[Available from]
http://www.newstatesman.com/business/2010/04/merger-airlines-groups-iberia [Accessed on.28.04.2010]
[Available from]
http://www.oneworld.com/ [Accessed on24.04.2010]
Appendix 1
British Airways Ratio Analysis Workings 2009 (£m)
Profitability
Net Return on Assets; (-358/10488) x100= (-3.41%)
Net Profit Margin; (-358/8992) x100= (-3.98%)
Gross Profit Margin; (-401/8509) x100= - (4.71%)
Return on Capital Employed; (-358/10488 x100= (-3.41%)
Return on Equity; (-358/1646) x100= (-21.74%)
Earnings per Share; no dividend paid
Liquidity
Current Ratio; 2346/4646= 0.56:1
Quick/Acid Test; (2346-127-25)/ 4142=0.52%
Efficiency
Net Asset Turnover; 8992/10488=0.85 times
Fixed Asset Turnover; 8992/8142=1.1 times
Debtors Collection Period; (530/8992) x362=21.51 days
Capital Structure
Gearing Ratio; (4500+4142=8642) = (8642/10488) x100=82.39%
Interest Cover; -220/-177= 1.24 times
Total Assets to Total Liabilities; 10488/8642=1.21; 1
Total Liabilities to Total Assets; 8642/10488=0.82:1
Liabilities to Equity; 8642/1846= 4.68:1
Cash-Flow to Liabilities; 133/8642=0.01:1
