A question about airline stocks and performing financial statement analysis on an airline company:
If you were asked to perform a financial statement analysis for an airline what 5 ratios would you use and why are these the most relevant ones? – Pauline
I wouldn’t. Airlines are notorious commodity-like businesses that require large capital expenditures and generate very little net cash flow adjusted for those outlays. Even at a 5x price-to-earnings ratio, I’m not interested. There are far easier ways to make money. Humans have a tendency to want to value things that were difficult more highly than things that came easily, but $1 of profit spends exactly the same as another $1 of profit. It doesn’t matter if that dollar were generated by a sewage treatment plant or a high-tech start-up.
Unfortunately the prof asked us to perform a financial statement analysis for an ariline. The analysis is limited to only 5 ratios. We have to identify them then say why these are most relevant and important to the airline. I am struggle to answer this question but will try to figure it out.
That’s too bad. I once had a professor who wanted the same thing for Beta. I refused to answer it and instead wrote an essay about why stock beta is a meaningless metric with the exception of short-term option pricing. She gave me 108% on the exam, but not all professors are that rational.
I’m about to attend a regular get-together so if I leave anything out or don’t explain the basics sufficiently, I apologize.
Profitability Ratios: I would take a form of “owner earnings”, which is net income + depreciation + amortization – capital expenditures necessary to maintain current volume – working capital requirements, adjusting for any underfunded pensions or contingent liabilities, and then divide it into average assets (beginning assets + ending assets / 2) and equity (beginning equity + ending equity / 2). That gives you “Return on Owner Assets” and “Return on Owner Equity”, which I find more useful than plain vanilla Return on Assets (ROA) and Return on Equity (ROE).
Airline Industry Financial Ratios: Then, I’d look at the four industry-specific ratios for airlines, ASM, CASM, BELF, and RASM:
- Available Seat Miles (ASM) = Amount of Seats to Passengers on All Flights x Number of Miles Those Seats Are Flown
- Cost Per Available Seat Mile (CASM) = Adjusted Operating Expenses / Available Seat Miles (see above)
- Break-Even Load Factor (BELF) = The total percentage of seats on an aircraft that need to be purchased for revenue to equal expenses, with the assumption that revenue per passenger mile and expenses remain constant.
- Revenue Per Available Seat Mile (RASM) = Total passenger revenue divided by total available seat miles, expressed in cents.