Easyjet and Ryanair Companies: the Symptoms of Tremendous Growth - Research Paper Example

BE 316 Interpretation of financial ments Introduction Two competitive companies, ly Easyjet and Ryanair in the air transporation sector havebeen selected for comparative assessment of their financial performances. The comparative study is made on financial analysis using ratio analysis. The areas of performances analyzed are profitability, liquidity, financial risks undertaken, and investment ratios. These ratios have been used to bring out the growth undertaken by the respective companies. The figures used in growth trends have been taken from annual reports 2008. Also the financial statements analyzed of the companies are for the year 2008.The areas covered are profitability, liquidity, financial risks, investments attractions and overall growth of the companies. Profitability The ratios employed to assess the profitability of two competitive airlines are Operating profit margin, Net Profit Margin, ROCE, and earnings per share. Gross profit margin cannot be employed as the airline business is not a goods trading business. Operating Profit Margin “measures the percentage of each sales dollar remaining after all costs and expenses other than interest and taxes are deducted. It represents the pure profits earned on each sales dollar.”(Lawrence J. Gitman, page 144)i Easyjet operating profit margins are mere 3.85% as compared to massive 19.78% of Ryanair. The reason for such difference is the efficiency employed by Ryanair in operating expenses to reach a turnover of $27138222000. On the other hand the turnover of $2362.8m has been achieved by Easyjet at huge operating cost of $2271.8m. Net profit margins take into consideration all expenses including depreciation and finance expenses before taxes. It will be noted that Easyjet has shown improvement in net profits margin of 4.66% when compared to its own operating profit margins of 3.85. The reason is that Easyjet has net finance income and not the expenditure. It is because of this reason Ryanair/s net profit margin of 16.17% is lower than its operating profit margin of 19.79 as it has finance expenses are higher than finance income. But Ryanair’s net profit margin is certainly higher than Easyjet because of its efficiency shown in controlling the expenses. Return on capital employed (ROCE) is more realistic ratio of profitability “if the assets are stated at current value rather than at historical cost; that is, there is a revaluation reserve included in the capital employed.” (Philip Ramsden, page 42)ii Taking this limitation into account, Easyjet has a very poor ROCE of 3.81% as compared to 8.19% of Ryanair. This shows that Easyjet is not employing its resources as effectively as the Ryanair. Earnings per share may be basic or diluted. Diluted earnings per share are calculated in complex capital structures. Diluted EPS “shows shareholders the maximum potential effects of dilution on their ownership position.”(Belverd E Needles and others, page 675)iii For comparison of profitability between the two companies we have used diluted earnings per share as has been calculated in each company’s respective annual return. Accordingly though Easyjet though is not performing badly but its EPS (diluted) is much lower than that of Ryanair. Ryanair is providing its shareholders a diluted EPS of $ 25.62 as compared to $ 19.4 diluted EPS of Easyjet. Taking into account all the ratios of profitability discussed above, it is clear that Ryanair has performed very well on profitability front despite the fact that there have been heavy effects of recessions particularly on airline industry. On the other hand the performance of Easyjet is also appreciable but it is not as remarkably good as that of Ryanair. On all profitability ratios Ryanair has excel over Easyjet and that makes us to believe that Ryanair is exploiting its assets or resources more effectively to generate extra profitability for its shareholders in comparison with Easyjet. Liquidity Liquidity status is the nerve center of any company. In fact it reflects a short term solvency position of the company. That is why liquidity of an entity is measured by its ability to meet the entity’s current obligations that are payable within a period of twelve months. The ratios used to analyze liquidity status of both airlines are Current ratio, average collection period, and average payment period. Quick ratio has not been considered because airline business does not involve inventory trading. Current ratio is a very common ratio that measures company’s ability to meet short term obligations. Normally current ratio of 2 is considered optimum for any type of industry. “A current ratio of 2.0 is occasionally cited as acceptable, but a value’s acceptability depends on the industry in which the firm operates.”(Lawrence J. Gitman, page 133)iv Current ratio of Easyjet 1.56: 1 and that of Ryanair is 1.53: 1. As both the companies have current ratio of less than the optimum ratio of 2:1, it is believed that both companies are facing liquidity problems. Both the companies might be finding it difficult to meet their current obligations. The liquidity status for both the companies is not comfortable and to make the situation acceptable, the companies have to resort to resources whereby short term liquidity is able to meet short term obligations as and when those become due. It is very important to note here that whenever the ratio is 1.0, the net working capital is zero as at that stage current liabilities are exactly the same as current assets. The companies have to make efforts to increase the ratio as any depletion will lead to short term solvency problems. Average collection period is another ratio that assesses the current liquidity status. Average collection period indicates the amount of time required to make collections from accounts receivables. In simple language it indicates the average credit period granted to customers. Average collection period for Easyjet is 36 days which is much higher than 4.53 days of Ryanair. The short collection period shows the efficiency of the management. The working capital of Easyjet on sales remains blocked for 36 days that create problems for the liquidity of the company. On the other hand Ryanair average collection period of mere 4.53 days is helping the company’s liquidity to be recouped very fast and thereby enabling the company to meet the short term liabilities as and when those become due. Average payment period is reverse of average collection period. It indicates the average credit period granted by the accounts payable to the company. The longer the average payment period the more beneficial it is for the company. On this account Easyjet’s position is better than that of Ryanair. Average payment period of Easyjet is 111 days and Ryanair has a shorter average payment period of 21 days. It shows that Easyjet is using creditors’ facility into its working capital for a longer time than that of Ryanair; and thereby bringing down the stress and pressure of working capital management. Overall the liquidity position of Ryanair is better than Easyjet because of its better current ratio, though not optimum, and lower average collection period. At the same time Ryanair is suffering from shorter average payment period and thus pressurizing its working capital to an extent. Financial Risks Financial risks from the point of view of a company relate to degree of dependence upon resources other than owned capital, i.e., degree of indebtedness and the company’s ability to serve those debts. These risks are measured through debt ratio and coverage ratios like times interest earned ratio. There is also a financial risk that whether net profits after taxes and other liabilities are capable of meeting dividend declared. Dividend coverage ratio has not been considered as both the companies have not declared dividend for the year 2008. “The debt ratio measures the proportion of total assets financed by the firm’s creditors. The higher the ratio, the greater the amount of other people’s money being used in an attempt to generate profits.” (Lawrence J. Gitman, page 140)v Therefore this ratio shows the gearing or leverage of the capital structure. In the case of Easyjet, the company is highly geared as its debt ratio of 1.7 indicates than debt capital invested in the company is much higher than equities. Same is the case with Ryanair where the debt ratio is 1.65 and thus company is highly geared. The high geared dependence on loan capital brings in a fixed interest liability on the company. The equity holders get the remaining earnings and also share in the capital in a situation like winding up only after meeting such fixed interest liability. This is called trading in equity. In other words even though highly geared capital structure has the risk of meeting fixed interest liabilities; but at the same time it provides an opportunity for the owners to trade in equity. Both Easyjet and Ryanair represent such a situation as both have highly geared capital structure. When the company has loan capital, it has the financial risk of meeting fixed liability of the interest on such loan capital. The coverage of such financial risk can be measured through Times interest earned ratio. “The most popular income statement coverage ratio is the times interest earned (also referred to as the interest coverage ratio). It is designed to measure the company’s ability to meet interest payments.” (Shannon P Pratt and Alina V Niculita, page 165)vi Easyjet has net profits to meet 2.68 times of interest liabilities of the company; and Ryanair has profits to meet 5.53 times of interest liabilities. The Ryanair is certainly better placed because of its better performance on profitability front even though both are highly geared companies having dependence on debt capital more than their equities. Both companies have taken risks for financing total assets but above ratios indicate that both companies have net profitability to generate ability to undertake such financial risks. Even though Ryanair is better placed but Easyjet also possesses the ability to undertake such financial risks as has been proved through the above ratio analysis. Investment ratios Investors always look for certain key information before taking a decision about investing in shares of any company. This information is reflected through financial ratios. The most important of such ratios are Earning per share and Price/ earnings (P/E) ratio. Earnings per share as described earlier in this write up “represent the number of dollars earned on behalf of each outstanding share of common stock.” (Lawrence J. Gitman, page 145)vii Earnings per share may be calculated as basic EPS as well as diluted EPS taking into account weightage of investments into account. Investors observe EPS very carefully and that is why this ratio is very popular among investors. Easyjet is lagging behind Ryanair so far as EPS is concerned. Its diluted EPS is $19.4 as compared to $25.62 of Ryanair. A normal investor will be more attracted towards Ryanair, but a serious investor will observe other ratios as well like P/E ratio. “The price earnings (P/E) ratio shows how much investors are willing to pay per dollar of reported profits.”(Eugene F Brigham and Joel F Houston, page 116)viii In fact this ratio reflects the confidence level that investors place into the future performance of the company. It is believed that higher P/E ratio attracts greater degree of confidence among investors. This is more so because its calculations take into account both market value of share as well as earning per share. Based on these determinants P/E ratio of Easyjet is 16.24 and that is more than P/E ratio of 10.75 of Ryanair. This is clear indication that investors are more attracted in future performance of Easyjet than Ryanair. Growth Trends Both Easyjet and Ryanair are growing companies but Easyjet is more attractive to investors. Gross revenue of Easyjet has grown by 31.5% in 2008 as compared to 2007. Pretax profits increased by 35.7% in 2008, return on equity have shown a growth of 6.00pp in 2008, and basic EPS increased by 45.9%. This growth trend may be cause of attraction of investors. Ryanair is also showing symptoms of tremendous growth. Its traffic has grown in 2008 by 20% resulting into revenue growth. Though operating revenue has grown by 20% in 2008 but its net profit after taxes have declined by 10%. However, adjusted net profit has shown a 20% growth. Basic EPS has declined by 8%, but diluted EPS has grown by 20%. This might be reason for its P/E ratio being lower than of Ryanair. Annexure showing ratio calculations Word count: 2164 Appendix 1. Income Statement and Balance Sheet of Ryanair 1 2. Income Statement and Balance Sheet of Easyjet References Read More