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Key Financial Ratios

1. Key financial ratios

This section will analyse Easyjet’s performance over the past five years.

Key ratios to be used for Easyjet are short-term liquidity, profitability and long-term solvency. Efficiency and investment ratios are to be analysed as well.

1.1 Profitability

Profitability ratios are used to assess company’s ability to generate earnings relative to its expenses. Key ratios include ROA, ROE, ROCE and profit margins. ROA of EasyJet increased by 16% in 2015. ROE increased by 15%. EasyJet reported a record £581m profit in 2015 which is attributable to falling oil prices and a favourable pound to dollar rate. Profit margins continued to increase at a steady pace of around 15%.

In the next two years, however, net profit fell by 44%. This is reflected in lower ROA and ROE which declined sharply in 2017. Gross and net profit margins also fell by 33% and 49% respectively.

Decline in gross profit margin (gross profit/revenue) indicates that there has been a significant increase in operating costs since total revenue of the company has actually increased to a record high £5,047 million in 2017 and load factor has reached 92.6%.

Cost per seat, however, increased by 11% as a result of negative foreign exchange impact which cost EasyJet over £308 million (£3.56 per seat). Disruptions in the airline industry

Rising revenue indicates strong demand and

According to Air Transportation Association (ATA), fuel is airline’s second largest expense and one that fluctuates the most.

demonstrating strong demand in a competitive environment.

ROCE is particularly useful when analysing capital-intensive companies. ROCE has fallen from 16.89 to 8.95. The ratio accounts for debt and long-term liabilities and provides a better image of company’s financial state.

Revenue per seat remained broadly flat at £58.23. Headline cost per seat increased by 2.4% to £53.52 driven by an adverse foreign exchange impact of £308 million (£3.56 per seat) and the costs of disruption, which remains a major industry challenge.

1.2 Liquidity and Capital Structure

Current and quick ratios are used to assess short-term liquidity. Current ratio of Easyjet has improved over the past five years and has reached 1.04 in 2017. Quick ratio has also increased to 0.85 in 2017. Low figures suggest liquidity problems and inability to cover short-term liabilities. Insufficient liquid resources leads to higher issuance of debt and higher leverage -> risk.

WHY?

Debt-to-capitalisation metric is vital for long-term valuation of Easyjet’s solvency. Debt to capital ratio increased by 33% over the past five years. Debt to equity, however, has increased by 25%. This is an indication of higher leverage.

Ratio might not include leases and shows as more liquid than really is. (operating leases- dominant source of financing

1.3 Efficiency

EasyJet is committed to maintaining its structural cost advantage in the markets where it operates, primarily against the legacy airlines. The Lean programme has been able to deliver sustainable cost reduction: £400 million of savings have been achieved over the last seven years, with £85 million saved last year.

Currently EasyJet operates an efficient fleet of Airbus A320 family aircraft equipped with CFM56 engines. This year easyJet started to operate the new generation Airbus A320neo aircraft. There will be 100 of these aircraft in the fleet by the end of 2022. These aircraft, equipped with CFM LEAP-1A engines and wingtip ‘Sharklets’, are 15% more fuel efficient than current generation aircraft. These will significantly reduce the operating costs and have a positive impact on operating profit.

Asset turnover ratio shows how efficiently assets are used to generate sales.

Receivables turnover

1.4 Investment

Investment ratios are used to assess the performance of company’s shares. Earnings per share have fallen to 77.40p (32% drop).

Price to earnings ratio, however, fell to 9.29 in 2016 and reached 15.72 in 2017. Current P/E is 10.48.

Price-to-earnings to growth ratio can be used for a more complete picture of Easyjet’s stock valuation. PEG fell from 0.95 to -0.55.

Dividend payout ratio has increased from 40 to 70.16.High number suggests that retained earnings are not being reinvested and returned to shareholders. Dividend yield of Easyjet is higher than the industry average. Easyjet might not be able to maintain further EPS and dividend growth given the operating environment which it is facing.

Overall, however, dividends paid were well covered by earnings in 2017 (2.7x coverage)

1.5 Dupont

ROE is measured against cost of equity in order to determine the efficiency of easyJet’s equity capital deployed. Easyjet’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy. This is not the case for easyJet. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. Even though easyJet returned below the industry average, its ROE comes in excess of its cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of easyJet’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

ROE = profit margin × asset turnover × financial leverage

ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)

ROE = annual net profit ÷ shareholders’ equity

Profit margin indicates effectiveness of cost management. Asset turnover shows how much revenue can be generated from Easyjet’s asset base. Since financial leverage can artificially inflate ROE, we need to look at how much debt easyJet currently has. Conclusion

Easyjet operates in a highly capital intensive industry which is easily affected by economic downturn, fluctuating energy prices and seasonal demand. Capital intensive also indicates high operating leverage which in turn leads to high swings in profitability.

Lack of capacity, strikes and disruption across Europe has led to this summer’s delays that highlight structural problems afflicting the European airline sector. European airspace might become more disrupted if in the next few decades if action is not taken.