3 Financial Analysis: Operational Performance of easyJet and its Peers
3.7 Asset and Liability Ratios
52 Norwegian consistently shows a negative net borrowing cost
of -0.04, which is driven by its fleet investment, which was mainly financed by capitalized leases, and therefore increased its net interest bearing debt (i.e. the financial liabilities).
Southwest’s development in 2015 is mainly driven by its increase in financial liabilities. However, Ryanair’s NBC significantly decreased in 2014151, due to an increase in its non-current borrowings and the fleet expansion, and then leaped back to previous levels.
53 Furthermore, in 2014 easyJet raised GBP 308 m via in capital increase, and correspondingly its equity. As of 2016 easyJet has the lowest equity multiplier within the peer group, which speaks for a solid financing. The low multiplier enables easyJet to raise more debt in the future, if necessary, and/or allows paying out dividends152, if necessary, c.p. without directly affecting operations.
3.7.2 Working Capital
Working capital describes to what extent a company’s short term assets cover its short-term obligations.
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Equation 19: Working Capital
A high negative working capital signals that the company has a constant need to raise funds short-term (by increasing debt or equity). In a situation, in which (sufficient) financing is not available in the Market, such companies quickly face financial constraints, and in extreme scenarios even the risk of failure (Berk & DeMarzo, 2013)153. easyJet and Ryanair show a very comparable development in terms of working capital: during the first five years it goes down, in 2016 it increases again, but only slightly. As both have similar business models and serve similar markets, the reason for the increase is similar, too: they
increased their current assets, based on favorable mark-to-market adjustments of their derivative contracts.
Based on the numbers, easyJet should be able to finance more of its current operations with debt in the future, which c.p. would in turn allow increasing investments to drive further growth (or to pay back equity instead, if it does not believe in its future). In the case of Ryanair, the development also corresponds with a step-up in the value of its stake in Aer Lingus154. Southwest experienced a strong decline in working capital; it has almost tripled its working capital in seven years, from USD -1,532.28 m in 2010 to USD -4,188.95 m in 2016. The two main drivers are: (i) new aircraft and flight equipment financed by short term debt, and (ii) writing down the residual value of its fleet, due to accounting changes in 2012 (based on current and expected future market conditions and assuming, a reduced utilization of (too) large fleet going forward)155.
152 Section 2.2.3 provides more details regarding easyJet’s dividends.
153 Even though working capital is a member of the asset-and-liability-ratios-family, it also is linked to solvency. Section 3.9 provides more details regarding solvency ratios.
154 Ryanair now values Aer Lingus with a share price of EUR 2.33 compared to a former EUR 1.64 (Ryanair, Annual Report 2016, 2016).
155 Notwithstanding the high negative working capital, looking at the entire picture (i.e. current news, the published financial reports, profitability ratios etc.) nothing suggests, that Southwest runs an increased risk of financial trouble.
Figure 33: Working Capital Development
54
3.7.3 Current Ratio
Like working capital, the current ratio gives an indication for a company’s ability to pay current obligations, by using the available short-term assets only (Berk & DeMarzo, 2013)156.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Equation 20: Current Ratio
The higher a current ratio, the higher c.p. the ability to repay short-term debt, by cash generated from current assets, e.g.
inventory or cash. Airlines face higher current liabilities than current assets as a rule of thumb, as input ressources tend to be paid beforehand and tickets on average later (Petersen &
Plenborg, 2012). Consequently, the peers’ current ratio is to be expected to come below 1 and this is the case. Over the review period current ratios for easyJet, Ryanair, and to some extent Southwest, too, are similar. The current ratio of Norwegian,
however, is approximately eight times higher at the end of the review period, which is to be expected following the analysis of the net working capital157. However, Norwegian’s ratio declined from 2011 to 2012 from 2.8 to 2.0, driven by (i) an increase in its short-term borrowings in 2012, and (ii) the high value of financial instruments in 2011158.
3.7.4 Cash Ratio
Narrowing in, this section analyzes the ability to pay back total current liabilities solely by using existing cash reserves.
𝐶𝑎𝑠ℎ 𝑅𝑎𝑡𝑖𝑜 =𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Equation 21: Cash Ratio
A cash ratio close to 1 or above c.p. indicates a strong cash position that allows repaying the current debt, without selling any current assets needed to continue operations (Berk & DeMarzo, 2013). None of the peers
156 Even though the current ratio is a member of the asset-and-liability-ratios-family, it also is linked to solvency. Section 3.9 provides more details regarding solvency ratios.
157 Section 3.7.2 provides more details.
158 Section 3.8.1.2 provides further reasoning for these findings and details on the peers’ days’ sales uncollected ratios.
Figure 34: Current Ratio Development
55 has such a strong cash ratio in 2016. One reason being, that companies usually try to keep non-interest bearing (cash) positions low and rather use cash to finance operations, as this is a cheap way of funding. However, it also mirrors the vast capital requirements of the industry.
Norwegian’s last reported cash ratio equals 0.31; Southwest comes in at 0.29 in 2016, a cash ratio that remains almost constant across all review years. Norwegian shows a decrease, similar to Ryanair’s but less strong. With almost 0.5 easyJet and Ryanair are the two with the highest cash ratio. Ryanair’s ratio decreases year by year, coming from close to two in 2010. The development indicates Ryanair is now using cash more efficiently to fund operations. easyJet has been experiencing both, ups and downs, however shows an improvement in the last two years. In 2011, its cash ratio even came above 1, better than Ryanair’s in the respective year. As cash is used, to fund current operations, as well as to pay out dividends to shareholders, no potential tricky issues can be identified159.
3.7.5 Accounts Receivables Turnover
To investigate the ability to collect revenues early, the account receivables turnover is analyzed, which usually comprises of the net credit sales, but as they are not publicly available, total revenues are used as a proxy (Chen
& Shimerda, 1981).
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 𝑇𝑟𝑎𝑑𝑒𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
Equation 22: Accounts Receivables Turnover
Debtors have an incentive to pay their bills late, if they are not forced to pay interest on amounts outstanding and the more of them pay their bills late, the lower the accounts receivables turnover (ratio) c.p. is. In other words, every time, a flight passenger for instance pays a ticket late, the carrier effectively loses money (i.e. interest either paid actually or in terms of opportunity costs). Ryanair collects money the most efficiently, also based on the policy of online sales (accounts receivable turnover: 86 on average). Southwest, too, operates efficiently, having an accounts receivable turnover of 39 on average. In
2016, however, its ratio goes down to 24. This may be due to its co-branded credit card agreement with Chase
159 Section 3.8.1.2 provides further reasoning for these findings and details on the peers’ days’ sales uncollected ratios.
Figure 35: Cash Ratio Development
Figure 36: Accounts Receivables Turnover Development
56 Bank, which may on average lead to later payments160,161. Over the years, easyJet kept its accounts receivables turnover at around 20; and only Norwegian is lower with an average of 9. Comparing easyJet’s to its peers indicates easyJet has ample room to improve.