Examining Key Financial Ratios amongst scheduled carriers

George Loizides gloizides@cyprusair.com

November 2011

Executive Summary
This paper examines and compares two major airlines in the Southeast European area. The financial health of these airlines has been examined.

This paper is outlined as follows:

A brief discussion at the airline industry and especially at the Europe area. A presentation of the main financial ratios for the airlines Aegean and Cyprus Airways compared to the of airline industry average of Europe area which incorporates the two giants, Goliaths Lufthansa and British Airways and the David, Air Malta.

A discussion of the financial ratios of the aforementioned airlines

Introduction-Background of the airline industry

The airline industry is a major economic force for each country in terms of its own operations and its influence on tourism and aircraft manufacturing. The main leading force shaping the industry is the liberalization that comes into effect after the deregulation in 1978, USA and has spread to most of the world. The principal driver of air travel demand is economic growth. In periods in which there is instability economic and political- the market plummets and the airlines required to leave the market. For instance Cyprus Airways has ceased its operations in Syrian and Egyptian routes.

General Characteristics of Airline Industry

Airline industry is an industry which is main characteristic is the intense competition well known as cut throat competition. This peculiar competition among airlines creates an environment for the flourish of low cost carriers such as Ryanair, that offer low fares damaging their ability of full service carriers (scheduled airlines) like Cyprus Airways to cover mainly the fixed costs.

Factors which play a significant role to the airlines operations are the followings: A. Revenue This one of the main factors of airlines and it is used by the revenue management in which incorporates the price differentiation because each passenger has a different willingness to pay for his/her ticket. The pricing policy becomes more complex since the low fares have more restrictions such as non-refundable ticket and advanced purchase requirements in order to fence passengers for willingness to pay high out of low fare passengers.

B. Cost It is one of the largest issues for airlines. The control of operating costs has become critical to airline profitability. Labor Cost

It is the most significant cost for airlines, the number 1 according to Air Transportation Association (ATA). Extremely high salaries of pilots, flight attendants, baggage handlers, customer service, etc. Fuel Cost

According to the Air Transportation Association (ATA), fuel is an airline's second largest expense. Fuel makes up a significant portion of an airline's total costs, although efficiency among different carriers can vary widely. Short haul airlines such as Cyprus Airways typically get lower fuel efficiency because take-offs and landings consume high amounts of jet fuel. Cyprus Airways fuel attributes to 30-35% of the total cost. C. Technology Popularity of websites and web-based fare availability force airlines to compete solely in price. Airlines in order to monitor competitor fares they use advanced power software systems.

D. Weather It is an unpredictable factor, that heavily costs to the airlines a lot o money from cancellations etc. (e.g. recent volcano ash April 2010) With the bankruptcy of Eurocypria, the one and dominant carrier in Cyprus is Cyprus Airways. By the end of 2010 Cyprus Airways suffers from losses for the two

consecutive years and its dramatically decreasing trend in its sales revenue has a negative impact on its profitability. From the analysis it is emphatic to see that the only company that makes profit, has a positive profit margin is Aegean for 2009. The struggle between Aegean and Cyprus Airways especially the last two years, both fierce competitors, has dramatically increase on the routes LCA-ATH-LCA, LCALHR-LCA and LCA-CDG-LCA (from July 2011 onwards).

Presentation of the Ratios

The Key Financial Ratios are demonstrated below for the companies Aegean and Cyprus Airways. The results are for the recent three year period (2008, 2009, 2010) and are obtained from the annual reports for the companies.

Companies Key Financial Ratios

Aegean (AEE) 2008 2009 2010
1.57 2.25 2.09 1.06 1.19 1.08 1.07 1.10

Cyprus Airways (CYP) 2008 2009 2010

Airline Industry Average 2008 2009 2010

0.98

Liquidity Ratios

Current RatioCurrent Assets/Current Liabilities

Asset Management Ratios 1.39 1.35 1.32 1.43 1.33 1.29 1.20 1.18 1.09

Total Assets TurnoverRevenue/Total Assets

Debt Management Ratios 51.5% 51.4% 55.1% 93.6% 94.9% 95.8% 76% 81% 80%

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4.8% 6.7% 13.8% 10.3% -11.6% 5.0% -5.2% 3.7% -3.9% 0.6% 0.8% 12.6% 4.8% 1.39 2 13.8% 3.7% 1.35 2 10.3% -3.9% 1.32 2 -11.6% 0.6% 1.43 16 12.6%

Debt RatioTotal Liabilities/Total Assets

-1.8% -2.4% -46.7%

-0.7% -0.9% -20.1%

3.9% 4.3%

-2.6% -3.6%

-1.6% -2.2% 19.2% -15.1% -7.2%

Profitability Ratios Profit MarginNet Income/Revenue ROANet Income/Total Assets ROENet Income/Common Equity

DuPont Analysis Profit Margin Total Assets Trunover Equity Multiplier ROE

-1.8% 1.33 20 -46.7%

-0.7% 1.29 24 -20.1%

Table 1. Key Financial Ratios

Discussion
Liquidity Ratio This ratio indicates that if it is greater than 1 the company is able to cover its short term liabilities using its current assets. The short term assets are cash, accounts receivable prepaid expenses, etc and the short term obligations is the bank debt, accounts payable, deferred revenue such as advanced ticket payments, derivative financial instruments (Jet fuel swaps), borrowings and bank overdrafts.

Aegean is in better position compared to Cyprus Airways because it has the potential to cover its liabilities almost two times whereas Cyprus Airways having this ratio above 1 but closed to one the ability to meets its short-term obligations is jeopardized. An interesting fact is that both companies for the last two years have downward trend on their current ratio. Asset Turnover This ratio shows how well the company utilizes its assets to produce revenue. Both airlines, Aegean and Cyprus Airways have a similar pattern over the three years an average of 1.35 which exceeds the industry average 1.16, a slight downward trend, with Aegean to perform slightly better over the last two years.

Debt Ratio For Cyprus Airways the debt ratio is extremely high and indicates that the proportion of its liabilities relative to its assets is 95% -an average over the three years-and this is a sign of bad things to come for the next two years. Looking at Aegean, this ratio is stable and around 50%, indicating that the company has a good portion of its assets to be attributed to its liabilities and does not face any leverage risk as Cyprus Airways does.

Return On Sales (Profit Margin) This ratio demonstrates how much is the companys profit per 1 euro sale.

For the last two years Cyprus Airways has a negative profit margin -1.8%, -0.7% due to losses, whereas Aegean only the last year has suffered from losses with -3.9% profit margin. Generally, for both airlines profit margin has declined dramatically. It is worth mentioning that Cyprus Airways has a financial boost from the EU for 2010 amount to 20m. euro in order to return to profits.

Return On Assets (ROA)

This ratio reflects the return which is generated by 1 euro of asset. It illustrates how the airlines utilized their assets and the efficiency of this utilization. The acquisition of aircraft instead of leasing creates high capitalization costs and this is the reason why this ratio is so important for airlines.

Return On Equity (ROE)

This ratio shows the return on the investments of the shareholders. Most investors see this ratio in order to know where to invest. It is very useful tool since it is easy to calculate. From our analysis it is easily seen that ROE are very low for airlines and makes it difficult for a value investor and a risk averse investor to invest on them since there are other companies at other sectors which have 15% ROE and more.

Airline Specific Ratios

In airline industry there have been adopted a set of specific Key Performance Indicators so called KPIs which are most used by the airlines in order to monitor their financial health and viability. Below we provide these airline specific ratios for the companies examined for the last two years, 2009 and 2010.

Companies Airline Specific Ratios KPIs

Revenue Passenger Kilometers (RPK) Available Seat Kilometers (ASK) Passenger Load Factor Revenue per Available Seat Kilometer (RASK) Yield Cost per Available Seat Kilometer (CASK)* Average Stage Length (Km)

Aegean 2009
53,168,259,508 80,557,968,952 66% 7.73 94.35 6.54 763

Cyprus Airways 2010 2009 2010

2,729,711,250 3,796,726,289 72% 4.43 100.20 5.55 1,762

55,817,072,778 2,779,761,249 82,083,930,556 3,850,988,751 68% 72% 7.20 95.32 6.41 835 4.36 106.90 N/A N/A

Table.2 Airline Specific Ratios

cents in EUR ()
Title Ac fuel Total CASK Total CASK excl. fuel 1.5 6.4 4.9

2010
Aegean Cyprus Airways 1.6 5.6 4.0

2011
Cyprus Airways 1.7 6.1 4.9

Table.3 CASK breakdown by fuel

Revenue Passenger Kilometers (RPKs) Revenue Passenger Kilometers is a measure of passenger traffic and it is calculated as revenue passengers flown multiplied by the distance flown. In 2010, in Cyprus Airways RPKs there is a decrease -2% from 2009 whereas for Aegean Airlines an increase of 5%. This is due to the increase capacity as we see below.

Available Seat Kilometers (ASKs)

This is a measure of total available capacity flown and it is given by multiplying the number of offered seats by the trip distance flown. There is a decraease in ASK of Cyprus Airways about -1.5% however for Aegean an increase of 1.9% a signal that has expanded its network.

Load Factor (LF)

Load factor is a measure of capacity utilization and is obtained by dividing the revenue passenger flown with the total capacity flown. This is also denotes the percentage of empty seats which are lost opportunity for the company and can not be recovered. The load factor of Cyprus Airways has remained at the same levels as 2009, 72%. On the other side, the load factor has increased for Aegean.

Revenue per available seat kilometer (RASK) This is a ratio that represents the revenue generated from each seat flown for 1 kilometer. This measure is relatively stable for Cyprus Airways around 4.4 cents of euro whereas for Aegean has a decrease of 6.9%. This can be explained from the fact that has expand its network and put into the market additional capacity.

Revenue per passenger carried (RPPC) This measurement is also know as average fare and it is calculated by the total revenue divided by the total passengers and it shows how much on average a passengers pays on any trip. For Aegean there is an increase of 1% to the average. The average fare for Cyprus Airways decreased to 100 euro for 2010 down from 106 euro.

Conclusions
The airline industry is a very volatile and challenging industry. The evolution of airline industry began at the late 80s in Europe when the market became liberalized creating innovations and new behavior of entrepreneurial activity. New entrants challenge the status quo of the airline industry with one third of the costs of old full service carriers, offer low fares with price discrimination, second hand airplanes , non trade union labor and point to point routes. Cyprus Airways is the only airline in Cyprus having a fleet of 13 aircrafts. Flying from Larnaca to the most extent to European destinations, connects passengers to

USA in cooperation with Virgin Atlantic. It operates as a full service carrier and is targeting business travellers. Although its financial health is the lower than in its main competitor Aegean there are several factors to explain this. First, Cyprus Airways has one of the highest cost even if it is lower than that of Aegean and mainly due to the sharp rise of fuel prices in recent years. Also Aegean costs is higher than that of Cyprus Airways because of its operating activities in its domestic environment in Greece and creates an average stage length sufficiently lower than that of Cyprus Airways and also another cause is the debt crisis that Greece faces. Second, what is worsening the situation for Cyprus Airways is both the high debt ratio more than the industry average and at the same time the high current ratio which is not usual for other companies to have. Third, Cyprus Airways has a significant problems with its yields sufficiently lower than Aegeans. A revised policy for incentive scheme and service fee is now under consideration in order to incorporate direct method of sales, selling more tickets directly to passengers through its website, bypassing travel agents and reducing the costs associated with the commission incentives.

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