PART I

Financial ratios can provide a great deal of insight into a company’s performance, they can also be
used to monitor key trends over time and compare a firm’s performance to that of peers
(Alexander, 2018) The purpose of this report is to assess performance of three aviation companies:
Ryanair Holding PLC, EasyJet PLC and Flybe PLC by analyzing and comparing financial and
non-financial ratios that are relevant to the aviation industry. The ratios are selected and grouped
into six main categories: liquidity, efficiency, profitability, solvency, market value and non-
financial. For reference, formula for each ratio is detailed in Table 1.

Criteria Ratio Formula

1 Current Ratio Current Assets/Current Liabilities
Liquidity Days inventory outstanding +
2 Cash Conversion Cycle Sales collection period - Credit
period
Revenue/(Total Assets – Current
3 Net Asset Turnover
Efficiency Liabilities)
Operating Revenue per Revenue/Number of employees
4
Employee
5 Net Profit Margin Net Income/Revenue *100%
Profitability
Return on Capital Employed P/L before tax/(Total Assets –
6 Current Liabilities) *100%
using P/L before tax
7 Solvency Gearing Ratio Total Debt/Total Equity
8 Interest Cover EBIT/Interest Expense
(market capitalization + preferred
9 Enterprise value to EBITDA ratio shares + minority interest + debt -
Market Value total cash)/EBITDA
Market cap to cash-flow from Market capitalization/ operating
10 cashflow
operation ratio
Number of flights arrive within
11 On-time performance 15 minutes of scheduled time/
Non-financial total number of flights*100%
(Number of carried passengers *
12 Load factor distance)/ (Number of available
seats* distance) * 100%

For each ratio in consideration, the companies will be assigned score based on the ranking of their
performance: the best performer will earn 3 mark, while one with worst performance earn 1. Scores
will be summed up to determine the company with best and worst overall financial health.
1. Liquidity Ratios

Liquidity Ratios are a measure of a firm’s ability to meet its short-term financial obligations.
(Agarwal, 1982) Most commonly-used liquidity ratios are current ratio and quick ratio. However,
aviation companies, as providers of transportation services, have low levels of inventories,
therefore these two ratios are nearly equal in value. A current ratio greater than 1 indicates that
company has sufficient current assets that can turn into cash to cover short-term liabilities, whereas
current ratio lower than 1 implies that company are struggling to meet its obligations.

Cash Conversion Cycle (CCC) indicates the amount of time that elapses from the point when a
company invests in working capital until the point at which the company collects cash. (Robinson,
2015) CCC comprises of three components: days inventory outstanding, sales collection period
and credit period. Since inventory is not a significant activity in the airline business, it could be
disregard in this case. Thus, the CCC is calculated using the following formula:

CCC = collection period – credit period

 1.1. Current Ratio

Figure 1

2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 1.72 1.43 1.53 1.56 3
EasyJet 0.72 0.92 1.04 0.89 1
Flybe 1.2 1.06 0.96 1.07 2
Source: retrieved from Financial Statements

Among the three airlines, EasyJet has the lowest average current ratio of 0.89, indicating difficulty
in meeting its short-term obligations. Other two companies both have average current ratio greater
than 1, meaning they both have sufficient current assets to pay off short-term liabilities. However,
EasyJet has improved its liquidity by 2017 to the safe level of slightly more than 1, while Flybe
dropped to slightly less.
 1.2. Cash Conversion Cycle:
Figure 2

6
4
2
0
-2
-4
-6
-8
-10
-12
-14
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair -9 -9 -13 -10.3 3
EasyJet -4 -6 -8 -6.0 2
Flybe 4 5 3 4.0 1
Source: calculated from Financial Statements

Figure 2 shows negative CCC for both Ryanair and EasyJet, indicating that they generate revenues
from customer before they have to pay their vendors. This could be explained by the traditional
practice of pre-booking tickets by conventional airline customers, sometime weeks to months in
advance. As the result, the availability of cash can be utilized by airline companies to finance
operation and growth at lower cost than that of borrowing or issuing equity.

Flybe has the worst CCC among the three airlines, indicating difficulties in matching operation
revenue and costs. Flybe’s situation might be due to financial risks that vendors perceive when
entering into business with a company that did not made profit from 2010 until 2016, thus they are
not as willing to extend credit periods for Flybe as they would be for other companies. On the
revenue’s side, Flybe’s targeted customers are business travelers on regional routes, who are less
likely to pre-book tickets far in advance, and more often have contracts with deferred payment
terms with the airline.
2. Efficiency Ratios

As provider of airline services, the main activities of airline companies focus on management of
their high-value aircrafts and human resources to generate sales income. Thus the two important
efficiency ratios are Net asset turnover and Operating revenue per employee.

2.1. Net Asset Turnover

Figure 3

2.5

1.5

0.5

0
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 0.64 0.83 0.74 0.74 1
EasyJet 1.53 1.19 1.17 1.30 2
Flybe 2.28 2.08 1.86 2.07 3
Source: retrieved from Financial Statements

Net Asset Turnover measures the efficiency of a company’s use of its assets in generating revenue.
In airline industry, aircrafts are usually financed by long-term liabilities or equity, thus net assets
is used for better measurement.

Figure 3 shows that Flybe has the highest average Net Asset Turnover of 2.07, which means that
the company generate twice as much revenue as its assets financed by long-term liabilities and
equity. Other two companies are less efficient in generate sales from their net assets, with Ryanair
only generated GBP 0.74 revenue for each GBP 1 of assets financed by long-term liabilities/
equity.
Further investigation into the three companies’ annual reports reveals that by 2017, Ryanair had
the largest fleet of 400 aircrafts, EasyJet 279 aircrafts and Flybe had the smallest fleet of 85. This
indicates difficulties for larger airlines to efficiently utilize their larger-size fleet to generate
revenues.

2.2. Operating Revenue per Employee:

Figure 4

500
480
460
440
420
400
380
360
340
320
300
2015 2016 2017

Ryanair EasyJet Flybe

Operating revenue per

2015 2016 2017 Average Score
employee
Ryanair 429 451 428 436 2
EasyJet 478 454 433 455 3
Flybe 374 317 341 344 1
Source: retrieved from Financial Statements

Operating Revenue per employee is a measure of financial productivity for each employee of the
company. This ratio helps determine how efficiently a company is managing its human resources
and optimizing utilization of available manpower.

The best performer is EasyJet, followed by Ryanair, however these two companies are trending
down from 2016 to 2017 in this criteria, indicating that their staff body might be growing faster
than revenue. Flybe has the lowest performance in this criteria, but has improved since 2016.

3. Profitability Ratios
Profitability ratios measure how well the firm is using its resources to generate profit and how
efficiently it is being managed. (Gitman & McDaniel, 2008)In this broad criteria, three ratios are
brought in comparison for clear understanding of three company’s profitability prospect: net profit
margin, return on equity and return on assets.

3.1. Net Profit Margin

Net Profit Margin measures how much is remained after all expenses including taxes have been
deducted. This is the “bottom line” or earning power of the company.

Figure 5

30%

25%

20%

15%

10%

5%

0%
2015 2016 2017
-5%

-10%

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 17.38% 26.35% 22.12% 21.95% 3
EasyJet 14.62% 10.86% 7.63% 11.04% 2
Flybe -5.22% 0.43% -6.68% -3.82% 1
Source: retrieved from Financial Statements

In this criteria, both Ryan air and Flybe had improvement in 2016 but a strong dip in 2017, whereas
EasyJet saw a continuous decline. Poor performance in 2017 are credited to lower consumer
demand due to terrorist attacks in several European cities and uncertain associated with Brexit in
their annual reports. According to Flybe’s Chairman, an 2010 aircraft order forced them to open
new routes to utilize the fleet, even in the time of low demand, resulting in lower profit margin.
Easyjet’s strong growth strategy also affected their bottom line in short term, but they believed
that improving its leading positions will create long term shareholders’ value.

3.2. Return on Capital Employed using P/L before tax

Figure 6

25%

20%

15%

10%

5%

0%

-5%

-10%

-15%
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 11.95% 22.84% 17.13% 17.31% 3
EasyJet 22.75% 13.28% 9.63% 15.22% 2
Flybe -11.42% 2.21% -11.12% -6.78% 1
Source: retrieved from Financial Statements

Return on Capital Employed (ROCE) ratio measures the efficiency with which the capital is
utilized to generate profit. This ratio is a better indicator of financial health than return on equity
for a high-debt, capital-intensive sector such as airline services.

Figure 5 show the same trend described in Figure 4, as decreased headline profits and increase
fleet size affect the ratios in the same direction. Ryanair’s highest average ROCE indicates that
they are most efficient in utilizing their capitals to generate profit. However, Ryanair and EasyJet’s
continuing commitment to growing fleet size might result in even lower ROCE in the coming
years, whereas Flybe’s promise to reduce its number of aircrafts might improve this measure.

4. Solvency Ratios
4.1.Gearing Ratio:
 Figure 7

250%

200%

150%

100%

50%

0%
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 128.39% 130.73% 113.29% 124.14% 2
EasyJet 39.97% 48.44% 53.50% 47.30% 3
Flybe 125.79% 106.62% 228.66% 153.69% 1
Source: retrieved from Financial Statements

Gearing ratio indicates the proportion of assets funded by debt. The firm with lower gearing
ratio is less likely to be in danger of over-borrowing, whereas high gearing ratios mean the
firm must allocate more profit and cash-flow to funding debts (Worthington, 2006).

As figure 6 shows, Easyjet have the strongest financial position among the group, as their
assets are funded equally between debt and equity. Flybe and Ryanair are both heavily
leveraged, their assets are financed by much more debt than equity. However, Ryanair’s
gearing ratio improved in 2017 despite a share buyback, which means their debt was reducing
more than their equity. Flybe’s measure shows that the company has increase their debt
significantly to finance their growing fleet size, which would raise concerns over solvency
risks from creditors, making debt even more expensive for Flybe.

4.2.Interest Cover:
Figure 8
 70
60
50
40
30
20
10
-
(10)
(20)
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 14.06 20.54 22.83 19.14 2
EasyJet 62.55 39.46 14.07 38.69 3
Flybe (9.33) 1.73 (10.78) (6.13) 1
Source: retrieved from Financial Statements

The burden of interest on a company’s earning is best described by the interest cover ratio. The
ratio compares the funds available to pay interest, which is earnings before interest and taxes,
with the interest expense. The greater the interest coverage ratio, the better able the firm to pay
its interest expenses. (Peterson & Fabozzi, 1999).

The data and figure show that Ryanair and EasyJet are not having difficulty paying interest
expense with their current level of earnings. Flybe, on the other hand, cannot cover their
interest payments with their negative earnings, and probably has to borrow or issue more stocks
to fund their operation and growth, resulting in higher cost of capitals as both debtors and
investors are concerned with high default risks from such a poor financial leverage position.

5. Market Value Ratios

Market value ratios are measures that investors concern in identifying a stock that may be
overvalued, undervalued, or priced fairly when compared to its peers. These measures also
give an idea of what the market considers of the company’s financial health and its prospect.
5.1. Enterprise value to EBITDA ratio
The enterprise value to EBITDA ratio is a valuation tool to compare value of firms with
different levels of financial leverage, since it compares the total value of the firm to earnings
before interest (DePamphilis, 2007).
Figure 9
12

10

-
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 10.52 11.13 10.67 10.77 3
EasyJet 8.01 5.57 7.44 7.01 2
Flybe 4.00 2.15 n.s 2.05 1
Source: retrieved from Financial Statements

For Ryanair, enterprise value are quite stable at around 10x EBITDA, indicating that both
stockholders and debtors are quite confidence with its growth prospect, despite the significant
increase in financial leverage and a drop in net income in 2017. EasyJet has also seen recovery
in 2017 after poor performance in 2016, indicating that the company had either successfully
convinced stakeholders of its future earnings, or increased the size of its debt to finance growth.
Thus, further investigation into market value of EasyJet’s equity is required to determine the
case .
Flybe’s ratios during the three year period are on a continuous decline trend, implying market’s
doubtfulness of its ability to turn around and generate future earnings. Low enterprise value to
EBITDA means both stockholders and debtors perceive high solvency risk in Flybe, and
 increase in financial leverage coupling with negative income from operation in 2017 only
increase such risks.
5.2.Market cap to cash-flow from operation ratio
As enterprise value and EBITDA can both be manipulated by management’s decision
regarding financial leverage and accounting practices in earning calculation, Market cap to
cash-flow from operation ratio is employed to gain a more objective understanding of how
investors value the company, as market value of outstanding shares are entirely determined by
the stock market and manipulating cash flows are not quite easy. Moreover, this ratios would
be a better measures of market value for companies with low or negative net income such as
Flybe, as cash-flow are seldom negative.
Figure 10
14

12

10

-
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 9.07 9.89 9.61 9.52 2
EasyJet 11.59 10.34 7.29 9.74 3
Flybe 4.18 2.16 4.77 3.70 1
Source: retrieved from Financial Statements

Ryanair and EasyJet both have market cap to cash-flow from operation ratios of around 9x
cash flow of operation. Ryanair’s ratios are much stable than EasyJet, and in 2017 actually
outperformed the competitor, while EasyJet’s ratios show significant decline year after year.
This indicates that investors are increasingly concerned of EasyJet’s risks and require higher
returns from their stock investment.
 Flybe has the lowest market cap to cash-flow from operation ratios, implying high risk level
of its stock. However, market seems more positive for its growth prospect in 2017, probably
as management’s commit to decrease its fleet size in the future.
6. Non-financial Ratios
Two important non-financial ratios in the airline industry is on-time performance and load
factor.
6.1.On-time performance
On-time performance measures the proportions of flights depart within 15 minutes of the
scheduled time. On-time performance is a valuable metric for airlines and is an outward
demonstration of reliability which can affect brand loyalty and ticket sales (OAG, 2019)
Figure 11
95%

90%

85%

80%

75%

70%

65%
2015 2016 2017

Ryanair EasyJet Flybe

Punctuality 2015 2016 2017 Average Score

Ryanair 90.00% 90.00% 88.00% 89.33% 3
EasyJet 80.00% 77.00% 76.00% 77.67% 1
Flybe 84.50% 85.40% 82.70% 84.20% 2
Source: retrieved from Annual Reports

All three companies demonstrated lower on-time performance in 2017, which is credited to the
air traffic control strikes and adverse weather conditions in their annual reports. Overall,
Ryanair has the best on-time performance in the three year period, which are two key elements
 of its customer experience beside lowest fare. Followed Ryanair in this criteria is Flybe, and
EasyJet has the poorest performance.
6.2.Load factor
One of the key efficiency ratios of airline business is load factor, which measures how well the
airlines fill their aircrafts’ seats with passengers. About 65% of an airline’s cost are directly
related to the operation of aircrafts and independent of number of passengers. Thus, higher
load factors mean these costs could be allocated over larger number of passengers, allowing
for low fares for customers or higher gross profit margin for the airlines. (Wells, 2007)
Figure 12
100%

95%

90%

85%

80%

75%

70%

65%

60%
2015 2016 2017

Ryanair EasyJet Flybe

2015 2016 2017 Average Score

Ryanair 88.00% 93.00% 94.00% 91.67% 2
EasyJet 91.50% 91.60% 92.60% 91.90% 3
Flybe 75.20% 75.60% 69.60% 73.47% 1
Source: retrieved from Annual Reports

The leading positions in this criteria is Ryanair and EasyJet with very closed average load
factors. High load factors result in Ryanair and EasyJet’s ability to attract customers with lower
fares, while maintaining profitability. Flybe is the poorest performer, which is explained by
the choice of regional routes, high competition, and growing fleet size. This indicates an area
that Flybe must improve in order to increase their profitability.
7. Ranking of Companies
 To rank the three companies based on the above-mentioned criteria, scores of each company
are summed up in the below table:
Table 2: Score Tabulation

Criteria Ratio Ryanair EasyJet Flybe

1 Liquidity Current Ratio 3 1 2
2 CCC 3 2 1
3 Net Asset Turnover 1 2 3
Efficiency
Operating Revenue per
4 2 3 1
Employee
5 Net Profit Margin 3 2 1
Profitability
Return on Capital Employed
6 3 2 1
using P/L before tax
7 Solvency Gearing Ratio 2 3 1
8 Interest Cover 2 3 1
Enterprise value to EBITDA
9 3 2 1
Market Value ratio
Market cap to cash-flow from
10 2 3 1
operation ratio
11 Non-financial On-time performance 3 1 2
12 Load factor 2 3 1
Total 29 27 16

Based on the results of Table 2, Ryanair holds the position of best overall performance for
outperforming the remaining competitors in liquidity, profitability, on-time performance and
market’s confidence in its future earnings. From an investor’s perspective, Ryanair stocks
would be an attractive investment due to the following reasons:
 Strong competitive advantage driven by high-efficiency, low-cost operations;
 Excellent On-time performance guarantee customers’ loyalty and ticket sales;
 Profitability, even during time of uncertainty, are a result of the above competitive
advantages.

Contrary-wise, the worst performing company is Flybe. The company has the worst results
in most criteria including profitability, solvency, market value, load factor and operating
Revenue per Employee. Recommendations for Flybe to improve its financial performance
are the following:
 Decrease its fleet size to better manage its high-value assets
 Issue more equity to lower gearing ratios and interest burden;
 Improve its cash conversion cycle by encouraging advanced bookings to meet short
term obligations and improve liquidity.
 PART II
Memorandum
To: Chief Financial Officer

From: Investment Specialist

Date: 16 September, 2019

Subject: Capital Investment - decision making process and appraisal method

I. Capital Investment decision making process

Regarding Capital Investment, management is expected to make decisions to allocate

constraint resources to projects that will return positive value to the company within the time
frame dictated by company’s owners or corporate policy. In order to ensure investment
projects’ profitability as well as alignment with corporate policies, Capital Investment decision
must undergo the following five stages:

1. Project Identification: project ideas may come from several contexts and sources. In this
stage, project ideas are chosen based on company’s missions, values, short term and long
term goals. These objectives are widely different from company to company, and may
include but not limited to: increasing revenue, improving profitability, retaining talents or
establishing brand royalty etc.
2. Project Screening: is an assessment of project ideas to screen out ones not suitable for
further consideration. Evaluators conducting project screening utilize criteria and scoring
systems to determine whether projects are suitable to invest limited resources (capital,
manpower and time) to further develop an in-depth business case.
3. Evaluation: in this stage, project’s feasibility and viability is determined using Investment
Appraisal methods (detailed in section II of this Memo).The financial evaluation often
involves various case scenarios and sensitivity analysis. Non-financial benefits of the
project are also assessed to assist the company in choosing the best projects that would help
them achieve their objectives. A detailed project execution plan must be developed at this
stage, ready for implementation upon approval of decision-makers.
4. Approval: At this stage, decision is made by company’s owners or managements to commit
resources to the chosen project. Project execution plan is implemented, and budget are
reserved for costs associated with the project.
5. Monitor and review: at every stage of project execution, several performance indicators are
assessed against the plan to ensure project’s success. Any indication that raises concern or
risk of project’s failure must be responded by management’s actions or adjustment to
execution plan. Upon completion, the project is reassessed of efficiency and performance
for future benchmarking purposes.
II. Investment Appraisal methods

Several methods of Investment Appraisal are employed to appraise the profitability of a new
project, each technique evaluates the project from a different angle and gives different insights.
Thus, utilization of more than one technique is common in order to gain comprehensive
understanding of the project’s feasibility.

1. Payback period: determines how long it takes the project to generate sufficient cash-flow
to cover initial investment. This methods are suitable when management preferred projects
to achieve short term goals. Then, a project with payback period of 2 year is preferred than
one with 5 year payback period. However, this method ignores time value of money and
any financial benefits beyond the payback point. To factor in time value of money,
evaluator may calculate payback periods based on discounted future cashflows in stead of
nominal value of future cashflows.
2. Net present value: the most commonly used method of investment appraisal discounts
future cashflows related to the project by cost of capital invested in the project to calculate
the present-day value of future cashflows. The sum of initial investment and all discounted
future cashflows is the net present value (NPV) of the project, and the company should
accept the project if it has positive NPV. The major disadvantages of this method are: (1)
the calculation of discounting rate is complicated if factoring the effect of future financial
leverage as result of the project, and (2) disregard of the scale of investment.
3. Internal Rate of Return: is the discounting rate that discounts future cash flow to equal with
the initial investment. This method eliminates the problem of calculating discounting rate
of the NPV method, and can be utilized to compare projects of different scales.
Management usually benchmark the IRR with a hurdle rate, and project with IRR higher
than the hurdle rate will be selected. For example, if the company’s guideline specifies that
the hurdle rate is 9%, any project with IRR lower than 9% would be rejected.
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