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Analysis of financial and business performance of Easyjet PLC
This research report is about analysis of financial and business performance of Easyjet PLC. The report consists of six main parts. Part one explains company overview, reasons for topic and organisation selection, research objectives and framework to achieve objectives. The second part discusses the information gathering process and accounting/business techniques used. The third part is the analysis of quantitative and qualitative information. The fourth part is the conclusion on the result of the analysis and recommendation. The fifth and sixth parts include list of references and appendices.
1.1 Topic Selection
Topic chosen for this research and analysis is topic 8 “An analysis of the financial situation of my choice of an organisation” from the recommended list of topics.
I have selected this topic because of the following reasons:
Undertaking the research project on this topic will provide me a wider scope to apply my existing skills, to interpret financial and business performance of an organisation obtained as an accounting student. Researching on this topic will provide me an insight of financial situation and business environment of a real organization.
This topic gives me the scope to apply my theoretical knowledge in the context of a real organisation. This topic requires me to look at an organization from different perspectives.
Application of my skills in context of a real organisation and obtaining insight of a real organization will enhance my analytical abilities further. This topic will enhance my ability to communicate results of my analysis. Moreover application of theoretical knowledge will further enhance my problem solving skills which would be beneficial for my future studies and career.
1.2 Organisation selection
Easyjet is one of the favourite low cost airlines in Europe. It is widely advertised in public places like tube stations and high street malls. In addition to that news articles and press briefings regarding Easyjet frequently published in newspapers. As a result Easyjet attracted my attention.
Easyjet was established in the year 1995 and ever since it maintained a steady growth and now one of the largest airlines in Europe. Therefore I was interested to see how it performs over a multiple financial periods and how its performance is compared with a key competitor which will be another airline operating on the basis of low cost.
I have chosen Ryanair as key competitor of Easyjet.
Both of the airliners are mainly are low cost airliners focusing on a market segment based of low fare. Moreover both airliners operate mainly in the Europe [Ref.27, LowCostAirlines.org (n.d.)]
Ryanair is the largest carrier in the Europe whilst Easyjet is the third largest in terms of passenger carried. Therefore selection of Ryanair as the main competitor appears most relevant to me [Ref.12 IATA (2010)]
1.3 A brief overview of Easyjet
The airline was founded by Sir Stelios Haji-Ioannou in 1995. He and his family are the major shareholders in Easyjet PLC. Headquarter of the company is based at Luton Airport. The airline operates on the basis of low cost achieved by elimination of unnecessary costs and features which are common to traditional airlines. [Ref. 6, Easyjet PLC (n.d.)] .
The company expanded through setting up new bases and major acquisitions for example purchase of interest in Swiss Charter TEA Basel AG and acquisition of GB airways. [Ref.5, Easyjet PLC (n.d.)].
Easyjet is one of the FTSE250 companies and 3rd largest airlines ranked among 10 IATA listed airlines in terms of passengers carried [Ref.11, 12, FTSE, IATA (2010)].
1.4 Research objectives
In order to see how Easyjet performs in the three financial years from 2006 to 2008 following objectives have been set.
Comparative analysis of Easyjet’s financial and business performance in three different financial years ending 2008, 2007 and 2006.
Comparative analysis of financial and business performance with a key competitor.
1.5 Research framework
In order to achieve the above mentioned research objectives a research framework has been set. The components of the framework are:
Selection of appropriate financial and business techniques to establish comparative analysis of financial and business performance of Easyjet PLC in three financial periods and with the performance of the key competitor.
Collection of relevant information which would facilitate use of financial and business techniques and explain the result of the analysis.
Establish a conclusion on the result of the analysis.
2 Information gathering and accounting/business techniques used
I had access to secondary data in conducting the research. I found secondary data to be adequate in meeting information requirement. Therefore I did not need to obtain any primary data.
2.1 Information requirement
Financial information of Easyjet to compute ratios to establish comparison of financial performance between three financial years.
Financial information of Ryanair to perform competitor analysis.
Statistics to identify reasons for changes in financial and business performance over three years period.
Key events which has affected Easyjet’s performance.
Information regarding financial ratios and business models to be applied.
2.2 Sources of information
Annual Reports of Easyjet and the competitor Ryanair for the financial years 2006, 2007 and 2008.
Company websites e.g. www.easyjet.com, www.ryanair.com
Online newspapers eg. Aviationnews (www.aviationnews.eu)
Financial websites e.g. www.thisismoney.co.uk
Text books e.g. P3 Kaplan Publishing
Online financial encyclopaedias e.g. www.investopedia.com
Statistics provides by trade, national, regional bodies and associations e.g. IATA and Eurostat.
2.3 Rationale for sources selected
In order to compute ratios necessary for analysis of financial performance I have used Annual reports of Easyjet’s related to three financial years for the purpose of establishing comparative analysis of Easyjet over three years period. In addition I have collected annual reports of the main competitor Ryanair for competitor analysis.
I have used statistics obtained from the above mentioned sources to identify reasons for changes in financial and business performance.
Information from newspapers helped me to identify key events which had impact on the performance of Easyjet.
Company websites provided me with an overview of business of Easyjet and its competitor Ryanair.
Text books and financial encyclopaedias provided me with ratios and business models based on which the research has been carried out.
2.4 Limitation of information gathering
Limitation of information gathering was negligible because Easyjet had limited product/service range and most of the relevant information was publicly available. However information from the sources other than the company itself had to be verified to test reliability.
2.5 Accounting and business techniques used
Accounting techniques used mainly consist of ratio analysis. In addition to that some trend analysis has been performed (e.g. revenue trend).
Academic business models have been used to assess external, internal environments and business strategy of Easyjet PLC.
List of accounting and business techniques used.
Area of analysis
Operating expense ratio
Fixed asset turnover
Return on equity
Earning per share
Debt to equity
Long term debt to capitalization
Cash flow analysis
Analysis of cash slow statement
Porter’s Generic strategy
2.5.1 Operational performance
Revenue trend analysis: This tool helps to identify changes in revenue pattern over time.
Operating margin: A company’s pricing strategy and operating efficiency is measured by operating margin. It is a measurement of the proportion of a company’s revenue left after payment of operational cost.
An increasing margin over time indicates the company in question earning more per pound of sale and vice versa. It can be also used to measure the company’s earning capabilities against a competitor. [Ref.19, Investopedia (2010)]
Net margin: This ratio measures the proportion of net profit to revenue.
This ratio can be utilized to see the performance over time as well as it can be used to assess the performance of the business concerned with a competitor. [Ref.20, Investopedia (2010)]
Operating expense ratio: This analysis helps identify trends in operating expenses incurred over time.
A smaller increment in operating expense ratio compared to a significant growth in revenue over time indicates the management is efficient at managing expenses. [Ref.28, Moneyzine.com (2010)]
2.5.2 Resource management
Asset turnover: This measures the amount of sales generated by a company’s assets.
This ratio indicates a company’s ability to use assets efficiently. An increasing trend in the ratio over time indicates enhanced asset utilization. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover and vice versa. [Ref.13, Investopedia (2010)].
Fixed asset turnover: Fixed asset turnover measures the amount of sales generated by the fixed or non-current assets.
A higher ratio indicates the business has less resources tied up in fixed assets (e.g. property, plant and equipment). In other words the business is utilizing the fixed asset effectively. A declining ratio indicates the fixed asset utilization is ineffective or the business is over-invested in fixed assets [Ref.3, College-cram.com (2010)].
Cash turnover: This ratio measures efficiency of cash utilization by a business organization [Ref. 4, Credit Research Foundation (1999)]
Current ratio: This ratio is used to assess to show relationship between current assets to current liabilities. This ratio assesses safety of current debt holder’s claims in case of default as well as going concern prospect of the entity. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. [Ref.14, Investopedia (2010)]
2.5.4 Investment return
Return on equity: This is profitability measure which indicates a company’s ability to yield a return to the shareholders’ fund. [Ref.21, Investopedia (2010)].
Earning per share: Company’s net profit allocated to each share. When investment potential of two companies is compared the one with higher EPS would be more attractive and have higher share price as result. However it has to be considered that two companies may have same EPS but one which can generate same level of EPS with less equity is considered to be more efficient [Ref.16, Investopedia (2010)].
2.5.5 Financial leverage
Debt to equity ratio: It is a measurement of a company’s financial leverage. It indicates the proportion of equity and debt the company is using to finance its assets.
A high debt/equity ratio indicates that a company is financing most of its growth placing high reliance on debt. This can result in volatile earnings as a result of the additional interest expense [Ref.15, Investopedia (2010)]
Long term debt to capitalization ratio: The capitalization ratio measures the debt component of a company’s capital structure. A company is financially healthy if it capital structure has an appropriate proportion of equity and debt [Ref.18, Investopedia (2010)].
Solvency ratio: It measures a business organization’s ability to meet long term obligation. Acceptable level of solvency depends on the industry the organization operates in. However the general pre-assumption is a solvency ratio greater than 20% is considered financially healthy [Ref.22, Investopedia (2010)].
2.5.6 Debt servicing
Interest coverage: A ratio used to measure a company’s ability to meet interest expense on outstanding debt. When a company’s interest coverage ratio is 1.5 or lower, its ability to meet debt obligations is weak [Ref.17, Investopedia (2010)].
2.5.7 Cash flow analysis
Analysis of cash flow can be done using information obtained from cash flow statement. Following tools can be used to analyse
Operating Cash Flow / Net Sales: This ratio measure the company ability to earn cash from revenue generated. [Ref.26 Loth (2010)]
Analysis of investment activities:
This analysis is performed to see how cash was used in investment activities.
Analysis of financing activities:
This analysis is performed to see how cash was generated from financing activities.
2.5.8 Business environment
SWOT analysis is used to assess internal and external environment of a business environment.
Strengths and weaknesses relate to resources and capabilities.
Opportunities and threats relate to external factors.
Strengths are the key competencies of an organization.
Weaknesses are the flaws within the organization.
Opportunities are the favourable external variables which can be exploited,
Threats are the external adverse variables.
An analysis is performed to see how a business organisation
Converts threats into opportunities
Matches strengths with opportunities
[Ref.23, Kaplan publishing (2009)]
2.5.9 Business strategy analysis
Porter’s generic strategy: A business model used to define competitive strategies adopted by a firm.
Cost leadership: The organization aims to be the lowest cost producer in the industry by producing products or providing services at lowest cost possible.
Differentiation: The firm creates a product/service which has unique features.
Cost focus: This involves selection of a specific market segment or a niche. By focusing on this niche cost saving takes place which is passed to the consumer.
Differentiation focus: Selection of a particular niche and concentrate on competing on that niche on the basis of differentiation.
[Ref. 23 Kaplan Publishing (2010)]
2.6 Limitation of accounting and business techniques used
Most of ratios applied used historical cost information to analyse past performance. However results of ratio analysis cannot be projected to assess the future performance as the conditions existed which affected past result may not exist in the future.
Two companies may have same ratio but their implication will vary according to the size of the companies.
Business models such as SWOT and Porter’s generic strategies tend to oversimplify the situations factors and strategies into categories in which they always do not fit.
[Ref. 23 Kaplan Publishing(2010)]
3.1 Operational performance analysis
Operating expense ratio(%)
Easyjet increased its fleet by 35 new aircrafts in 2007 [Ref.25, Leeuwen (2007)].
This enabled it to increase capacity to accommodate growth in passenger traffic by 7.3% in the EU leading to revenue growth by 11% in 2007 [Ref.24, Layos (2009)].
However Easyjet was not able to capture the growth in the market to the same extent as Ryanair.
Easyjet’s total revenue increased by 31%. This is because recession had driven market to low cost air travel. Being a low cost airliner Easyjet was in a favourable position [Ref.33, Travel Daily News (2009)].
Ryanair’s growth in revenue was maintained but when compared to Easyjet’s growth it appeared less promising. However this occurred because of Ryanair’s decision to reduce average fare by 1% when the passenger traffic increased by 20% . A higher fare could have increased Ryanair’s revenue [Ref.29 Ryanair annual report (2008) pg.4].
Gross margin improved. This was achieved by increase in revenue and fall in operating expense ratio. This meant Easyjet was improving its earning potential at the same time managing operating expenses effectively.
Compared to Ryanair Easyjet’s gross margin was low. This was because Ryanair had comparatively better revenue growth and lower operating expense ratio.
Operating profit plunged significantly in 2008 compared to other two financial years.
Although the revenue growth was excellent it was offset by large increase in operating ratio which can be attributed to increment in fuel cost by 66.6% which was a major component of operating costs. Rise in fuel cost was due to increase in world wide crude oil price in 2008 [Appendix. B,G].
Ryanair’s operating margin declined but not to the extent as Easyjet. This was due to smaller increment in operating expense ratio compared with Easyjet. This indicated that Ryanair was better protected against rise in resource cost fluctuations (for example fuel price hike).
Although the tax payable increased by 41.3% this was offset by an increase in net finance income by 163.7%. As a result net margin increased [Appendix. B].
However compared to Ryanair Easyjet underperformed in terms of net margin which can be attributed to lower revenue and lower gross margin.
The effect of reduction of gross margin trickled down to lower net margin as well. The difference between net and operating margin in Easyjet had narrowed compared to other two years because of reduction of tax payable by 45.6% [Appendix. B].
Ryanair also experienced reduction of net margin attributed to falling gross margin.
3.2 Resource management analysis
Easyjet maintained a consistent asset turnover which reduced slightly in 2007 but increased in 2008. Compared to Ryanair the ratio was higher although Ryanair’s performance was increasing gradually.
It appeared Easyjet utilized its assets more efficiently. However it had to be considered that as mentioned earlier in section 2.5.2 a company with lower profit margin has higher asset turnover ratio and vice versa. Easyjet had lower profit margin therefore the asset turnover ratio was higher.
Fixed asset turnover
Fixed asset turnover reduced slightly in 2007 which is due to addition of 35 new aircrafts through purchase [Ref.25, Leeuwen (2007)]. In addition to that these assets had higher book value because of depreciation had not been provided to the same extent as older fleets in use.
In 2008 fixed asset turnover increased slightly because there is an improvement which is due to large increment in revenue by 31.5% [Appendix. B].
Ryanair’s fixed turnover remained constant. However the ratio was considerably lower comparatively. This indicated Easyjet had less resource tied up in fixed assets and utilizing its fixed assets effectively. This was achieved by a low aircraft turnaround time of 30 minutes [Ref. 6, Easyjet PLC (n.d.)].
Easyjet maintained an increasing trend in cash turnover in 2007 and 2008.
This was achieved by reduction of idle cash by 16.5% and 12.1% in 2007 and 2008 [Appendix. C].
There had been an increasing trend in money market deposit which increased by 19240% and 19.1% in 2007 and 2008. This indicates the excess cash was deposited in the money market [Appendix. C].
Ryanair had a lower cash turnover compared to Easyjet. Excess cash was not utilized as much efficiently as Easyjet.
Easy jet had a lower current ratio compared with a key competitor Ryan Air in 2006 and 2007 which narrowed down in 2008.
Therefore it can be concluded that Easy Jet liquidity position was close to industry average.
In addition to that both the companies had ratio higher than 1 in three consecutive financial years which indicates both were solvent.
However Easyjet and its competitor had a declining current ratio which indicated that their ability to pay for obligation as they fall due was deteriorating.
3.4 Investment return
Return on Equity
From an investor’s point of view Easyjet was comparatively less attractive than Ryanair. However the increment of return on equity in 2007 would have projected Easyjet as a promising company which was making progress.
In 2008 Easyjet’s return on equity dropped to a very large extent.
Ryanair also faced a reduction in return on equity in 2008 but the extent of fall in Easyjet was greater.
Moreover the fluctuations in return on equity in terms of increase and decrease were more severe in Easyjet whereas in Ryanair the changes were smooth and smaller. This would have projected Easyjet as comparatively less stable company to invest.
Earning per share (EPS) in pence
Eaga (Ref 27,28)
[Appendix. A, H]
In 2007 Easy Jet’s EPS increased due to increase in net margin and insignificant issue of further shares [Ref.7, Easyjet annual report (2007) pg.76].Easyjet outperformed its competitor in that year.
Both Easyjet and Ryanair suffered decline in the EPS in 2008 due fall in profit. However the extent of decline in Easyjet was greater than Ryan Air. One of the reasons could be share buy back by Ryan Air which reduced number of shares and thereby increased profit available to each shares [Ref.2, Bowel (2008)]. In addition to that as discussed in earlier section fall in net margin in Easyjet was greater than Ryanair.
Compared to another FTSE 250 company Easy Jet had better EPS which indicated Easyjet yielded better return to its shareholders compared with a similar sized firm [Ref.11 FTSE (2010)]. However it has to be noted the industries were different. Eaga operated in energy industry.
3.5 Financial leverage
Easyjet debt to equity ratio remained similar in 2007 and 2006. It increased in 2008. In theory it indicated Easyjet was taking increased risk to finance growth which could increase interest expense.
However from the financial statement it was found that interest payable reduced by 4% [Appendix. B]. This could be due to Bank of England’s decision to reduce bank rate by 0.25% on 10th April 2008 [Ref.1 Bank of England (2008)].
In 2007 the capitalization ratio decreased slightly because shareholder funds increased by 17.2% compared to increment in non current liabilities by only 8.6%. This was achieved because higher profit in that particular period increased retained earning by 43.2% which increased shareholders’ fund and compared to that long term borrowing only increased by 7.1% which had lead a smaller increment in total non current liabilities[Appendix. C].
In 2008 the ratio increased because the largest item in the non current liabilities ‘borrowing’ increased by 19.1% and profit after tax decreased. The increment in the borrowing can be attributed to finance acquisition of a subsidiary. [Appendix. C,D].
From the analysis it was evident that there was a marginal difference in the debt to equity ratio between the two companies. However the capitalization ratio was much lower in Easyjet compared with Ryanair. This indicated that Easy jet was comparatively taking less risk for its expansion in terms of obtaining long term finance. Therefore it was less aggressive than Ryanair.
According to the 20% rule of thumb, as mentioned in section 2.5.5, Easyjet’s solvency ratio was at dangerous state in 2006. It improved in 2007 but became much worse in 2008. This trend could be the result of consistent borrowing which was greater than operating profit available to cover it. For example the long term borrowing increased by 7.1% and 19.1% in 2007 and 2008 where as operating profit increased by 46% and then declined by 47.1% in those years [Appendix. C, B].
This indicated Easyjet’s capability to meet long term obligation was really deteriorating because of falling earning capabilities coupled with obtaining more long term debt.
When compared to Ryanair the 20% rule seemed less significant in respect of airlines industry since both the companies had the ratio less than 20%. It was surprising that although Ryanair had higher capitalization ratio compared to Easyjet it appeared to be more solvent. This indicated unlike Easyjet Ryanair was utilizing the long term debt more efficiently and profitably and its aggressive approach to finance expansion through obtaining more debt was quite successful.
3.6 Debt servicing
Easy jet had a good interest cover in 2006 and 2007. It had gone down in 2008 because of reduction in operating profit and obtaining more long term finance.
Although interest cover had gone down in 2008 it was still adequate because as mentioned earlier in section 2.5.6 it is considered that if interest cover goes below 1.5 times a company does not have sufficient capabilities to meet interest expenses.
However the fall in the interest cover in 2008 was alarming as it indicated the company was loosing its ability to cover the interest obligation fast.
However Ryanair appeared to have more capacity to meet interest obligation and it maintained its capacity for three years consecutively unlike Easyjet and it was not loosing its ability to meet interest obligation as fast as Easyjet.
3.7 Cash flow analysis
Operating cash flow to sales ratio
Easyjet had experienced minor fluctuations in the ratio over three year period. However its quality of revenue was comparatively lower than Ryanair.
Ryanair’s revenue generated more cash which however plunged in 2008 but yet significantly higher than Easyjet.
Investment activities analysis
In 2006 Easy Jet had a massive investment in the property plant and equipment of £324.6 million which exceeds net cash generated from operation by £99.4 million (£324.6 –£ 225.2). The remaining amount was financed by sale and leaseback amounting £108.6 million. Bank loan of £201.2 was obtained. However it has been observed that there were surplus cash and equivalent amounting £667 million at the beginning of the year which could have been used to finance investment [Appendix. D].
In 2007 there has been a comparatively smaller amount of investment amounting £273.9 [Appendix. D].
In 2008 there has been massive investment through acquisition of GB airways amounting £118 million and addition of property, plant and equipment amounting £324 million which exceeded the operating cash flow of £ 296.2 million. In addition to that net cash flow from financing activities was only £5.9 million. This indicate
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