British Airways Stock Price Analysis - Essay Example

Introduction British Airways plc is one of the top companies in the British airlines industry. This report provides insightful analysis of the financial position and performance of British Airways plc over the four years 2002-2005 and compares it against the benchmark of the performance of its major industrial competitor Air France-KLM plc which is also from the airlines industry. The report also presents prediction of the financial position and performance of British Airways plc for the year 2006. It provides estimation of fundamental value of equity price per share at the end of fourth year i.e. 2005 with the help of Earnings Price Ratio model. A: Financial Performance and Position Analysis The financial performance and position analysis of British Airways can be done with the help of profitability, leverage and liquidity ratios in comparison with one of its major industrial competitors i.e. Air France-KLM (banker.thomsonib.com). The analysis of Air France-KLM would serve as a benchmark for the evaluation of performance and position of British Airways plc. Profitability Analysis: Profitability Ratios British Airways Air France-KLM 2005 2004 2003 2002 2005 2004 2003 2002 Return On Assets 2.63 2.46 2.87 3.66 2.94 3.23 3.76 4.41 ROCE 3.70 3.32 3.78 4.80 4.54 5.01 5.84 6.80 Gross Profit Margin 5.64 4.49 4.42 4.85 26.41 27.70 23.18 18.61 Operating Profit Margin 4.23 2.99 2.91 3.09 1.58 1.60 1.88 2.28 Net Margin 1.08 0.39 0.51 1.38 1.64 1.96 2.35 2.78 The profitability ratios presented in the above table highlight both the companies i.e. British Airways plc and Air France-KLM for the last 4 years 2002-05. The return on assets ratio for British Airways reveals that the company has been generating a declining return on its various assets over the last four years. This ratio has decreased by about 39% in 2005 as compared to the year 2002. For Air France, this ratio also shows that the return generated by the company on its various assets has been consistently declining over the four years. The ratio has decreased by about 50% in the year 2005 as compared to 2002. Despite this fact, Air France's return on asset ratio is about 12% higher than that of the British Airways plc for the year 2005. This suggests that Air France has been more successful in utilising its assets towards the generation of profit. The return on capital employed ratio indicates the extent to which a company generates return on the funds invested by its investors. According the above table, British Airways' return on capital employed ratio has been on the declining trend for the last four years suggesting a significant plunge in the company's net profits. The ROCE for British Airways has declined by about 30% in the year 2005 as compared to 2002. Approximately, the similar situation has been with its competitor Air France plc; its ROCE has also been declining but at a higher rate than British Airways i.e. 50% if the figures for the year 2005 are compared with 2002. Still, Air France's ROCE is much higher than that of the British Airways. The three profit margin ratios depicted in the above chart i.e. the gross profit margin, operating margin and net profit margin provide an insight into these companies' general profitability. The gross profit margin shows the revenue that is left with the company after accounting for various production and distribution costs. The operating margin reveals the extent to which a company loses its sales revenues in meeting its various operating expenditure. Despite the fact that British Airways plc's return on assets and ROCE have been declining, the company's gross, operating and net profit margins are significantly improving. The company's gross profit margin has increased by about 14% in 2005 as compared to the year 2002. An analysis for all the three ratios for British Airways suggests that the company loses most of its sales revenues in meeting its cost of sales. Air France, on the other hand, loses most of its sales revenues in meeting its operating expenditures. Although the company's gross profit margin has been increasing considerably over the four years its operating and net margin are decreasing, showing that the company is unable to manage its operating costs effectively. Thus the overall profitability analysis suggests that British Airways plc stands strong against its major industrial competitor Air France-KLM. Long-term Solvency Analysis: Leverage Ratios British Airways Air France-KLM 2005 2004 2003 2002 2005 2004 2003 2002 Debt to Equity 278.11 285.99 272.70 237.76 118.03 108.47 115.26 130.01 Debt Ratio 68.81 70.03 69.32 66.59 47.60 45.95 47.53 50.77 Fixed Charge Coverage 1.45 1.05 0.98 1.20 1.60 1.62 1.76 1.83 The leverage ratios displayed in the above chart show the long-term financial strength or gearing position of these two companies. The debt to equity ratio for British Airways plc exposes that the company relies on more debt financing than equity funds as compared to Air France. Also, the trend for increased debt financing in British Airways has been on the rise for the last four years. British Airways plc's debt to equity ratio rose by about 14% in 2005 as compared to the year 2002, whereas the same ratio for Air France-KLM decreased by about 10% in 2005 as compared to the year 2002, which means that the company has been reducing its reliance on debt financing. Debt ratio for British Airways shows that the company's capital structure contained about 68% of debt finance in the year 2005 which has considerably decreased as compared to the previous years. Air France's capital structure, on the other hand, contains about 47% of debt capital which has been declining for the last 4 years. The above Gearing ratios suggest that the long-term solvency position of British Airways is not as strong as Air France because of the company's over-reliance on debt capital. The fixed charge coverage ratio shows the extent to which a company's earnings are enough to cover its various fixed charges such as interest expenses. British Airways plc's earnings were enough to cover its fixed charges by about 1.4 times, whereas Air France's capacity to pay fixed charges was 1.6 times. Furthermore, British Airways' capacity to bear fixed charges has improved by about 17% over the four years as opposed to Air France where the ratio has declined by about 14% in 2005 as compared to the year 2002. Short-term Liquidity Analysis: Liquidity Ratios British Airways Air France-KLM 2005 2004 2003 2002 2005 2004 2003 2002 Current Ratio 0.87 0.83 0.82 0.79 0.84 0.86 0.91 0.99 Quick Ratio 0.74 0.71 0.69 0.66 0.78 0.80 0.84 0.93 Accounts Receivable Days 38.77 40.46 42.33 44.30 53.79 56.04 57.89 58.66 Inventories Days Held 4.44 4.27 4.08 3.75 9.50 9.98 10.12 9.14 The above liquidity ratios show the short-term solvency of British Airways plc as compared to Air France-KLM. The current ratio for British Airways reveals that the company owns enough liquid assets to pay off only 87p for every 1 of its current liabilities or 87% of its total current liabilities. If the value of stock is put aside in calculating liquid assets, the company's quick current assets will bear the capacity to pay off only 74% of its current liabilities. The company's liquidity position as shown by current ratio, however, has increased by about 9% as compared to the last four years. Air France's current assets, on the other hand, are enough to cover 84% of its current liabilities. The quick ratio shows that the company can pay off 78p for every 1 of its current liabilities after keeping aside stock from total current assets. The liquidity position of Air France, as revealed by the company's current assets, has declined by about 17% in 2005 as compared to the year 2002. The accounts receivable days ratio shows how long a company takes to convert its receivables into cash. According to the British Airways' 2005 annual report, the company collects receivables from debtors in about 39 days which is significantly better than the company's performance with respect to cash collection in 2002 i.e. 44 days. Air France recovered all its receivables in about 54 days in the year 2005 whereas has improved as compared to 2002 i.e. 58 days. Inventory held days ratio shows the number of days it takes a company to convert its stock into sales. British Airways converted its inventory into sales in about 4 days in the year 2005 which is significantly better than that of Air France-KLM i.e. 10 days in 2005. British Airways generates sales out of its stock more quickly than Air France. The liquidity position analysis therefore shows that British Airways has stronger liquidity position as compared to the Air France-KLM. To conclude, British Airways plc's financial position and performance analysis shows that the company has a strong position as compared to its competitor Air France-KLM with respect to profitability and liquidity. However, the company's long-term solvency position can provoke the chances of bankruptcy and credit risk because of the company's over-reliance on debt capital. B: Prediction of British Airways' Financial Position and Performance- 2006 British Airways' financial performance and position for the year 2006 can be predicted with the help of the past data available from its annual report for the year ended 2005. For this purpose, the report provides forecasting of income statement and balance sheet with the help of percent-of-sales method. The primary data that has been used for forecasting the company's financial position and performance is the anticipated or assumed sales level. Income Statement: 2005 2006 2006 Actual Forecasted Actual Sales 7,813.00 8,515.00 8% increase- Assumed 8,515.00 Cost of Goods Sold 6,465.00 7,067.00 83% of Sales 6,502.00 Gross Profit 677.00 1,448.00 1,284.00 Selling, Gen. and admin 121.00 128.00 1.5% of Sales 561.00 Operating Income 556.00 1,320.00 723.00 Interest Expense 218.00 218.00 223.00 Taxable Income 382.00 1,102.00 592.00 Taxes (35%) 136.00 386.00 153.00 Net Income 246.00 716.00 451.00 Less: Dividends 0.00 0.00 0.00 Income Added to Retained Earnings 246.00 716.00 451.00 The above chart depicts the British Airways plc's 2005 actual income statement which has been used to forecast the income statement for the year ended 2006. The actual income statement for 2006 has been used to compare it with the forecasted income statement and evaluate the differences. The level of sales for the year ended 2006 is assumed to have increased by 8% of the previous year's sales. With the help of past data, i.e. the actual financial results for the year ended 2005, it was found out that cost of sales remained about 83% and selling, general and admin expenses remained 1.5% of the total revenues. Therefore these figures have been adjusted with the anticipated sales level. Interest expenses are assumed to have remained the same. It can be easily figured out that despite the fact that the forecasted sales level has been assumed to be the same as the actual sales level in 2006, the projected gross profit and net income figures are significantly different from actual figures. This has been due to the fact that the cost of sales and selling, general and admin expenses figures have not moved with the level of sales as anticipated. The cost of sales has been estimated to remain at 83% of sales whereas in actuality it stood at about 76% of the sales level. Furthermore, the SG&A have been estimated to be 1.5% of sales whereas these expenses were 7% of sales at the end of the year 2006. These significant differences in the forecasted and actual figures have caused the forecasted net income to be different from that of the actual results for the year 2006. Balance Sheet: 2006: 2006 Forecasted Actual Cash* 1,873.00 Accounts Payable* 936.00 Cash 2,440.00 Accounts Payable 752.00 Accounts Receivable* 766.00 Other Current Liabilities* 1,618.00 Accounts Receivable 929.00 Other Current Liabilities 2,126.00 Inventory* 85.00 ST Debt 559.00 Inventory 83.00 ST Debt 479.00 Other Current Assets* 340.00 Taxes Payable 36.00 Other Current Assets 214.00 Taxes Payable 75.00 Total Current Assets 3,064.00 Total Current Liabs. 3,149.00 Total Current Assets 3,666.00 Total Current Liabs. 3,432.00 Plant & Equipment* 8,856.00 L-T Debt 4,045.00 Plant & Equipment 7882.00 L-T Debt 3,602.00 Other Assets* 255.00 Other Assets 373.00 Minority Interest 219.00 Minority Interest 213.00 Common Stock 1,861.00 Common Stock 1,861.00 Retained Earnings* 1,893.00 Retained Earnings 589.00 Additional Financing Required 1,008.00 Total Assets 12,175.00 Total Liab. & Equity 12,175.00 Total Assets 12,174.00 Total Liab. & Equity 12,174.00 The above chart displays the two balance sheets; actual and forecasted for the year 2006. The actual balance has been included so as to simplify the comparison of forecasted balance sheet with it. For the preparation of forecasted balance sheet, percent-sales-method has been used with the help of data for the year ended 2005 (actual). The figures for items like cash, accounts receivables, inventory, other current assets, fixed assets, other assets, accounts payable and retained earnings move in direct relation with sales level. Therefore, these figures have been calculated with the help of past balance sheet's figures and sales level.1 All other figures are assumed to be constant or unchanged. A comparison of above two balance sheets show that the total assets figures are almost the same in forecasted balance sheet as the actual results of British Airways plc for the year ended 2006. Items like long-term and short-term debt, minority interest and common equity do not move with the sales level, but even the items that generally reflect the changes in sales level have not moved according to increase in sales. It can also be found that most of the items in balance sheet have not moved in relation with sales level as predicted. The forecast for British Airways plc has not been accurate but it provides an estimation of how the financial position of the company moves with the level of sales. C: Equity Valuation British Airways plc's fundamental equity value per share has been done with the help of earnings price ratio model. Because of the fact that the company has not disbursed any dividend payments to its shareholders for the last 4 years, other equity valuation models such as dividend growth model and discounted cash flow model could not be used. Earnings Price Ratio Model P0 = E1 = 0.33 = 334p1 Re 0.098 The earning per share according to the financial statements for the year 2005 was 0.23, whereas the company's earning growth rate was 45% according to the past financial data. The required rate of return on equity was about 9.9%. All these figures were applied to the Earning Price Ratio model which priced the company's equity at 334p per share. The Earnings Price Ratio model with growth suggests that the British Airways plc's fundamental was valued at 334p per share at the end of the year 2005 based on the information obtained from 2005 annual report and accounts. The company's actual share price as at 30/12/2005 was 334.00p per share in the London Stock Exchange (uk.finance.yahoo.com). This further explores that the price of British Airways' shares in the market was accurately valued according to the Earnings Price Ratio model. Appendix I Cash = 1,682.00 = 22% * 8,515.00 = 1,873.00 7,813.00 A/R = 720.00 = 9% * 8,515.00 = 766.00 7,813.00 Inventory = 84.00 = 1% * 8,515.00 = 85.00 7,813.00 Other C.Assets= 304.00 = 4% * 8,515.00 = 340.00 7,813.00 Fixed Assets= 8,152.00 = 104% * 8,515.00 = 8,856.00 7,813.00 Other Assets= 244.00 = 3% * 8,515.00 = 255.00 7,813.00 A/P= 897.00 = 11% * 8,515.00 = 936.00 7,813.00 Other C.Liab.= 1,488.00 = 19% * 8,515.00 = 1,618.00 7,813.00 Ending Retained Earnings = Beginning R/E + Net Income - Dividends = 1,177.00 + 716.00 = 1,893.00 Appendix II Earnings Price Ratio Model: P0 = E1 = 0.33 = 334p Re 0.098 E1 = E0 (1+g) = 0.23 (1+0.45) = 0.33 E0 = Current earnings per share = 0.23 (2005) g = Growth rate of earnings = 45% or 0.45 Re= expected return on equity= Earnings per share Book value per share Book Value per share= Book Value of Shares (Total Assets- Total Liabilities) Number of Shares Outstanding = 2,684 = 2.33 1151.47 Re= 0.23 = 9.9 2.33 References British Airways Stock Price Data- 2005 from http://uk.finance.yahoo.com/q/hps=BAY.L&b=30&a=11&c=2005&e=30&d=11&f=2005&g=m Brealey, R.A., Myers, S.C. and Marcus, A.J. (2001), "Fundamentals of Corporate Finance", 3rd ed., The McGraw-Hill Companies: NY Financial Ratios- British Airways plc and Air France-KLM from http://banker.thomsonib.com Read More