6. Financial analysis
6.3 Profitability analysis
Figure 22: Development in turnover rate
Source: Own creation
6.3.1 WACC
In the previous section, return on invested capital was considered positive. To assess whether the return on invested capital is considered at a satisfactory level, the return on invested capital can be compared with the weighted average cost of capital (Petersen, Plenborg, & Kinserdal, 2017, p. 143).
The weighted average cost of capital is abbreviated as WACC. The theoretical formula is shown below.
𝑊𝐴𝐶𝐶 = 𝑁𝐼𝐵𝐷
𝑁𝐼𝐵𝐷 + 𝑀𝑉𝐸∗ 𝑟! ∗ (1 − 𝑡) + 𝑀𝑉𝐸
𝑀𝑉𝐸 + 𝑁𝐼𝐵𝐷∗ 𝑟"
But before the WACC can be estimated, the capital structure, required rate of return on equity and required rate of return on debt must be found. These will be discussed below and finally the calculation of WACC, and EVA will appear at the end of the section.
6.3.2 Capital structure
In order to calculate WACC, Wizz Air's capital structure must be estimated, as it is an important variable in the equation. As Wizz Air is listed on the stock exchange, it has been determined to use the market values rather than the book values, as it is believed to give a fairer and truer picture of the capital structure. To be able to estimate the capital structure, the number of outstanding shares, share price, market value of equity, NIBD and the company value must be found. The number of outstanding shares has been found by reviewing the annual reports, where Wizz Air for each year indicates how many ordinary shares there are as of March 31st in the year in question. Since Wizz
1,08
0,85 0,86 0,91
0,74
2016 2017 2018 2019 2020
Air's financial year ends on March 31st, the share price on this date has also been applied for the last five years. The market value of equity is then found by multiplying the number of outstanding shares with the share price. NIBD has already been found in the reformulation and is included in the analytical balance sheet. The company value is found by multiplying the market value of equity with NIBD. Based on the calculations of the capital structure, that appear in Appendix 12, it can be seen that the share of equity has been 63% on average over the last 5 years, while the corresponding share of debt has been 37%. This gives an average financial ratio of 0.58 over the last five years.
Hence, Wizz Air's capital structure is estimated to have an equity ratio of 63% and a debt ratio of 37%.
6.3.3 Required rate of return on equity
In order to estimate investors' required rate of return, the Capital Asset Pricing Model (CAPM) has been used as a starting point, as many textbooks in finance recommends this approach (Petersen, Plenborg, & Kinserdal, 2017, p. 345). The equation for the required rate of return is shown below:
𝑟" = 𝑟#+ 𝛽"∗ (𝑟$− 𝑟#)
To calculate the required rate of return, the risk-free interest rate, systematic risk on equity and return on market portfolio must be found. In relation to the risk-free interest rate, it is assessed that government bonds provide the most realistic picture of an interest rate that is risk-free, as the assumption is that government bonds are risk-free (Petersen, Plenborg, & Kinserdal, 2017, p. 346).
Therefore, a 10-year government bond will therefore be used to calculate the risk-free interest rate.
Since Wizz Air is headquartered in Budapest, a Hungarian 10-year government bond will be used.
The average yield for a 10-year Hungarian bond was 2.99% in 2019 (Appendix 13). Hence, the risk-free interest rate is estimated at 2.99%.
To estimate the systematic risk on equity, which is also referred to as the levered beta, several different methods can be used. In this thesis, it has been decided to estimate the unlevered beta and then subsequently calculate the levered beta. In order to do that, it has been decided to include
the ten largest airlines in Europe measured by number of passengers. The unlevered beta of the ten largest airlines in Europe is shown in figure 23.
Figure 23: Unlevered beta for the ten largest airlines in Europe
Source: Own creation / (Infront, 2020)
In figure 23, the 10 largest airlines in Europe have an average unlevered beta of 0.75. It is seen that Wizz Air's peer group has a higher unlevered beta than Wizz Air, while the other two low-cost airlines in figure 23, Norwegian and Pegasus Airlines, have a lower unlevered beta. In addition to that, it is worth noting that all five full-fare airlines have a lower unlevered beta than Wizz Air, Ryanair and EasyJet. By comparison, Damodaran has conducted an analysis of 39 airlines in Europe and found an unlevered beta of 0.61 (Damodaran,2020A). The unlevered beta found by Damodaran is considered to be low as it could be seen from figure 23 that the three largest low-cost airlines have a higher unlevered beta than the five largest full fare airlines. It is therefore estimated that a benchmarking of the 10 largest airlines' unlevered beta provides a better picture of Wizz Air's unlevered beta, as it includes the largest five low-cost airlines and five largest full fare airlines in Europe. This is believed to provide a good combination of airlines. Which is why Wizz Air's unlevered beta is estimated at 0.75. The systematic risk on equity, which is the levered beta, can now be found.
In the formula, which appears below, it has been decided to use the market value of equity instead of the book value of equity, as it is considered to give a better picture of Wizz Air's levered beta.
𝛽%"&"'"! = 𝛽()%"&"'"!∗ 51 +𝑁𝐼𝐵𝐷
𝑀𝑉𝐸6 = 0.75 ∗ 51 +2210.7
2216.56 = 1.5
Unlevered beta 1-Year 2-Year 3-Year Average
Wizz Air 1,13 1,1 1,05 1,09
Ryanair 1,29 1,28 1,26 1,28
Easyjet 1,79 1,62 1,53 1,65
Norwegian 0,11 0,1 0,11 0,11
Pegasus N/A 0,67 0,69 0,68
Air France-KLM 0,19 0,18 0,17 0,18
Lufthansa 0,60 0,59 0,56 0,58
IAG 1,00 0,91 0,85 0,92
Aeroflot 0,88 0,77 0,65 0,77
Turkish Airlines N/A 0,23 0,22 0,23
Average 0,75
Based on the calculations, it can be seen that Wizz Air's levered beta is estimated at 1.5. A beta value of 1.5 indicates that the Investment has a greater risk than the market portfolio. In addition to that, it is also assessed that a beta value of 1.5 is considered as a reasonable estimate, as the Financial Times estimates that Wizz Air's beta value is 1.53 (Financial Times, 2020B), while Reuters on the other hand estimates a beta value of 1.51 (Reuters, 2020C). Hence, Wizz Air's beta value is estimated at 1.5.
Before the required rate of return can be calculated, the return on the market portfolio must be estimated. For that the market risk premium in Hungary will be used. In the period between 2011 and 2020, the average market risk premium has been 8.04% in Hungary (Appendix 14). This is however considered to be high, which is why it has been decided to use the average market risk premium in 2020, which was 7.4% (Appendix 14). Hence, the market risk premium is estimated to 7.4%. Since all values in the formula are found, it is possible to calculate the required rate of return with the CAPM model.
𝑟" = 2.99% + (1.5 ∗ 7.4%) = 14.09%
As it can be seen from the calculations, the required rate of return is estimated to 14.09%. This result is based on a risk-free interest rate of 2.99%, a beta value of 1.5 and a market risk premium of 7.4%.
6.3.4 Required rate of return on debt
To calculate the required rate of return on debt, three different variables must be found. The three variables are the risk-free interest rate, credit spread and tax rate (Petersen, Plenborg, & Kinserdal, 2017, p. 363). The three variables are then inserted into the formula below, after which the required rate of return of debt can be found.
𝑟! = @𝑟#+ 𝑟*A ∗ (1 − 𝑡)
In relation to the risk-free interest rate, the risk-free interest rate has already been set at 2.99% in connection with the calculation of the required rate of return on equity. Hence, an interest rate of 2.99% is used as the risk-free interest rate. The credit spread is based on the credit rating of Wizz Air, which is carried out by credit rating agencies. Moody's rates Wizz Air as having a “Baa3” rating (Moody's, 2020), while Fitch rates Wizz Air with a “BBB-“ rating (Fitch, 2020). This corresponds to a spread of 1.56% (Damodaran, 2020B). As the credit rating is made by highly recognized credit rating agencies, the credit rating is assumed to be valid. Hence, the credit spread is estimated at 1.56%.
The tax rate that will be used is Hungary's corporate tax rate, as Wizz Air's headquarters are in Budapest. The corporate tax rate in Hungary was 9% in 2020 (Deloitte, 2020). It is not estimated that the tax rate will change, which is why a tax rate of 9% is used in the calculation.
𝑟! = @𝑟#+ 𝑟*A ∗ (1 − 𝑡) = (2.99% + 1.56%) ∗ (1 − 9%) = 4.14%
Since all variables are found, the required rate of return on debt can be estimated. The calculations show a required rate of return on debt of 4.14%.
6.3.5 Calculation of WACC
After all sub-calculations have been performed, the WACC can be estimated. This leads to Wizz Air’s weighted average cost of capital is estimated at 10.41%, as shown by the calculations below.
𝑊𝐴𝐶𝐶 = 0.37 ∗ 4.14% ∗ (1 − 9%) + 0.63 ∗ 14.09% = 10.41%
The calculation of the WACC also means that it is possible to estimate the EVA from the Du Pont model, which is the last financial ratio that needs to be calculated, as all other ratios were calculated in section 6.3.
6.3.6 EVA
In figure 24 it appears that EVA has been positive in all the historical financial years that have been analysed. This means that Wizz Air has created value from the investments that have been made.
In other words, it also means that Wizz Air's management has made good investments decisions in the last five years, as evidenced by the positive EVA value.
Figure 24: Development in EVA (in millions)
Source: Own creation
6.3.7 Summary
Wizz Air has performed really well in the last five years, with positive ratios, but a downward trend has been observed in several ratios. However, Wizz Air is still a profitable airline. The capital structure was estimated to have an equity ratio of 63%, while the debt ratio was estimated at 37%.
The beta value was estimated at 1.5, which was considered a fair estimate, but also indicates that the investment has a higher risk than the market portfolio. The required rate of return on equity was estimated at 14.09%, while the required rate of return on debt was estimated at 4.41%. Based on this, the WACC was estimated at 10.41%. Finally, EVA proved to be positive, which means that value has been created based on the investments made.
169.11
284.77
388.28
461.02
343.54
2016 2017 2018 2019 2020