Qantas Financial Analysis Report

Contents

Executive summary

Introduction

Qantas Ltd

Financial ratios

Financial ratios analysis

Profitability ratios

Asset Turnover

Profit Margin

Return on Assets

Liquidity ratios

Financial stability ratios

Gearing ratios

Times interest earned

Cash flow Statement

Revenue received in advance

Concept of revenue received in advance

Qantas’ revenue received in advance

Recommendations

Conclusion

List of References

Executive summary

The report is prepared to the potential investors of Qantas Ltd, who are concerning about the financial performance and cash flow of the company. The report is conducted using financial ratio analysis and reviewing the cash flow statement. The comparison is made between the financial year 2018 and 2017, as well as the Australian airlines industry to discuss the findings.

Firstly, the main ratios are calculated and analysed are Profitability, Liquidity, and Financial Stability.

• Profitability ratios are low, as a result of the airlines industry requirements with high costs incurred and assets;
• Liquidity ratios are below 1 but still higher than the industry performance;
• Financial stability ratios are acceptable with confident ability to cover the interest charged. The gearing ratio is optimal accordance to the company’s policy.

Secondly, the net cash flow in 2018 is slightly decreased despite higher cash inflow from operating income. It is a result of the company’s reinvestment and reducing finance leverage.

Thirdly, the investors’ concern about high liabilities is discussed using the company’s policy for revenue received in advance. The deferred liabilities are mainly because of the Frequent Flyer Redemption Revenue program, which is an advantage to finance the business’ operation with advanced cash.

Lastly, the recommendation is also made to the investors that they should proceed the share purchasing. However, the expected returns should be set for the long-term because of the current high competition and pressure on unit cost at this time.

Introduction

Qantas Ltd

To give a brief introduction, Qantas was established in 1920, during that time it established itself as a standalone provider of domestic and international airlines throughout Northern Territory and entire Queensland.

This report is prepared to give the potential investors an overview of Qantas Financial Performance, so that it can help the clients in their decision making process of buying shares and investing in Qantas business. We are also going to clarify all the financial aspects of Qantas which can help our clients in the decision making process.

Financial ratios

It is defined as a standard method through which we can compare and analysis any organizations financial ratios, which are a set of number and percentages, showing the relation between two or more items in the financial statement (Altman, 1968).

To support this report we are making three financial ratios:

Profitability Ratios. The ratios of Return on Assets, Profit Margin, asset Turn Over measure the ability of generating income by a favorable result. Using these ratios in combination will reflect an overall analysis of the company’s success in managing their assets and debts (Edmister, 1972).

Liquidity Ratios. Most commonly used ratios to measure the company’s solvency are Current ratio and Quick ratio. They determine the ability of a company to pay off its short-term obligations by turning its non-cash assets into cash easily. Generally, a high liquidity ratio promises sufficient current assets to cover their current ability (Salmi & Martikainen, 1994).

Stability Ratios. Measuring the long-term liquidity of a company, stability ratios include Debt ratio, Equity ratio, Time Interest Earned. By examining the ability to cover the debts and the structure of debt and equity, these ratios estimate how stable the business from collapsing beyond the next 12 months (Chen & Shimerda, 1981).

In reviewing these ratios, it is necessary to compare with benchmark, budget, historical performance, or other competitors’ ratios to interpret the number into useful information (Horrigan, 1965).

Stability Ratios

Measuring the long-term liquidity of a company, stability ratios include Debt ratio, Equity ratio, Time Interest Earned. By examining the ability to cover the debts and the structure of debt and equity, these ratios estimate how stable the business from collapsing beyond the next 12 months (Chen & Shimerda, 1981).

In reviewing these ratios, it is necessary to compare with benchmark, budget, historical performance, or other competitors’ ratios to interpret the number into useful information (Horrigan, 1965).

Financial ratios analysis

Profitability ratios

Asset Turnover

ATO ratio of Qantas in 2018 is 8.02, 10% lower than last year, describing a poorer utilization of assets in generating sales this year. The negative variance can be explained as the new purchasing of six aircraft out of maturing operating leases this year amounted $230mil (Qantas, 2018), which significantly increases the total asset of the company. It is reasonable for an airline company to maintain a high level of assets as its major assets are Building, Plant and equipment, and Aircraft, which are costly and durable.

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Profit Margin

The net profit margin of Qantas is 5.74%, which means per $1 sale generated, the company actually earns $0.05. Although it expresses a high proportion of cost and expenses, the ratio is meaningful when compared with the benchmark. Profit margin of Qantas is exceeding the Australian Domestic Market ratio, which is the core to the company’s successful market leading position.

Return on Assets

As a combination from the inherent low profit margin and a high value of assets, ROA in 2018 of Qantas is 5.46%. The ROA in 2017 is 2% higher than 2018 result, indicating that the company used the assets to generate profit better last year, although the profit is still increased.

Liquidity ratios

Both of the liquidity ratios in Qantas is below 1, which means it is at a weak position to pay off its current debt liabilities. Although the ratios describe that Qantas have trouble in turning its assets into cash to meet its short-term obligation, the company consider the result as prudent while considering a range of adverse scenarios (Qantas, 2018). Moreover, both current ratio and quick ratio witnessed an improvement of 11% and 8% from 2017 to 2018, respectively. This is a result in the policy of using exceeded cash to reduce gross debt and cost this year (Qantas, 2018).

However, it is necessary to compare the result with the benchmark because the acceptable ratio varies from industry to industry. Average quick ratio of Australian Airlines Industry in 2018 is 0.335 (CSI Market, 2018). Therefore, although Qantas’ liquidity ratios suggest that it may be unable to meet its current liabilities when they are at due, the company is still performing over expectation of the industry.

Financial stability ratios

Gearing ratios

The above numbers mean that 21% of the company’s assets is funded by its owner and the remaining of 79% is funded by external creditors, showing a high dependence on the external financing resource. According to the annual report, this capital structure optimises the Group’s cost of capital, maintains its financial strength, increase the shareholder value (Qantas, 2018).

The gearing ratios are maintained stable with slightly increase of equity and less liabilities. It is explained as the effort of Qantas in reducing financial leverage and minimal near-term refinancing risk this year, especially by a large repayment to borrowings and buying back the shares from the market (Qantas, 2018).

Times interest earned

By dividing the company’s earnings before interest and taxes (EBIT) to the interest expenses incur, the Times interest earned measure its ability to cover its financing cost using pre-tax earnings. The results above show an increase performance of Qantas this year while the EBIT can cover 6.84 times of the interest expense in 2018, and 5.83 times in 2017.

With a high interest coverage ratio, Qantas is able to pay off its obligation easily and regularly and has the advantage in pursuing further borrowings with creditors (White et al. 2005).

Cash flow Statement

Qantas Ltd uses the direct method to prepare their cash flow statement, including the flow of cash in/out the company from operation activities, financing activities, and investing activities (Higgins & Reimers, 1995).

Total receipts from customers this year is slightly increased from previous year at 6.44%, from $16,947mil in 2017 to $18,039mil in 2018. The growth rate represents the stable improvement of Qantas as a front liner in the airways industry. Cash payments to suppliers and employees relating to the operation activities only increases by 2.94%, indicating a success in cost management of Qantas this year. Therefore, net impact to the cash flow is an increase from $ 2,965mil to $ 3,646mil, equal to a growth rate of 22.97%.

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Net cash flows from operating and investing activities in FY17 and FY18 are increasing, indicating the reinvestment strategy of the company. Specifically, in 2017, Qantas earned $2,704mil from operating their business and spent $2,046mil to proceed more assets, equal to 75.67%. Similarly, in 2018, Qantas invests $2,201mil in their assets out of $3,413mil from operation cash inflow, which is 64.49%. It is observable to notice that the major investment of Qantas in two years is Payments for property, plant and equipment and intangible assets amounted to $1,368mil and $1,959mil in 2017 and 2018, respectively, equal to 66.86% and 89% of total cash outflow from investing activities, in that order.

In both 2017 and 2018, Qantas do not receive any investment amount of capital investment. The net cash outflow from investing activities significantly double from $854mil to $1,296mil in this order. The main activities leading to the variance are payments for share buy-back amounted $751mil in 2018 105.19% higher than the payments of $366 in 2017. Besides the borrowings received of $802mil this year, the borrowings payback is $802mil. The value of these items in previous year is $419mil and $453mil, respectively, represents a notable variance of more than 50% in both activities. These negative numbers describe the spending of the company to pay their financing cost instead of raising more. It can be seen that Qantas highly relies on its earnings to reinvest itself and attempt to decrease their dependence on shareholders by the effort to borrow from external debts and buyback the stocks.

In conclusion, Qantas actively exploits its high value of cash income from business operation to reinvest in their assets, and reduce their financing resources. Although the net impact to this year is a slightly decrease by $84mil, the impact to its liquidity is minor as total in cash and cash equivalent held in 2018 is $1,694. Overall, the cash flow statement expresses the business’ stable growth, and the company becoming strong enough to finance itself instead of reducing the financial leverage.

Revenue received in advance

Concept of revenue received in advance

Revenue received in advance is an accounting concept in the companies using accrual basis. The accrual principle requires the revenue to be recognized when the risks and rewards of goods/services rendered are fully transferred instead of the cash transactions (Dechow & Skinner, 2000). Therefore, if the company receives cash from customers for the services it has not provided, this income will be recorded as a liability (Samuelson, 1993).

Because Qantas’s financial recording and reporting are under accrual basis of accounting, its revenue from ancillary passenger revenue, passenger services fees, lease capacity revenue and air charter revenue is recognized when the services are provided. Receipts for advanced passenger ticket sales or freight sales which have not yet been availed or recognized as revenue are deferred on the balance sheet as revenue received in advance (Qantas, 2018).

Qantas’ revenue received in advance

In the FY17 and FY18, Qantas’s revenue in advanced is $5,168 mil and $5,385 mil, respectively. It increases the current liabilities from $3,671mil in 2017 to $3,870mil in 2018, and the non-current liabilities from $1,424mil to $1,445mil in the same period (Qantas, 2018). The higher liabilities raise the concern in the investors about the debts obligations. However, it is usual for Qantas to maintain these high amount of unearned revenue as it is the value of customer booking in advance, and the program of unredeemed frequent flyer revenue.

Frequent Flyer Redemption Revenue is the program of Qantas to issue the points for further Qantas flight redemption and then recognized in passenger revenue. The revenue received for the issuance is deferred as a liability, or revenue received in advanced until the points are redeemed or the customers are uplifted after flight redemption, the passenger is uplifted (Qantas, 2018). Redemptions on other airlines are recognized in other revenue.

Although the advanced payment from customers represents an obligation of Qantas to the passenger, it is in fact, benefits the company. Firstly, the amount advanced strengthens the company’s cash flow when the passenger pre-book their flights. Secondly, for the points issued, the banks also pre-pay for the right to issue their customer the deals using their credit cards. Therefore, Qantas is beneficial from an upfront amount to fund from the Frequent Flyer program in addition to the traditional pre-booking method.

Recommendations

From the analysis above, Qantas Ltd is generating the shareholders return in the top quartile of the ASX100 and a population of other global airlines companies (Qantas, 2018). The ability of using the assets to generate revenue is exceeding the average industry performance. However, because of the nature of the airlines areas, the high cost of sales and operating cost of company results in a low margin of profit.

It is also the company’s strategy to maintain an optimal capital structure and high interest coverage ratio that highly relies on the external liabilities rather than its own capital. However, Qantas is attempting to reduce the financing leverage by buying back the shares and repayment to borrowings using its available cash exceeded short-term requirements. Therefore, the liquidity ratios of the company are intentionally maintained at 0.49, which is still higher than the industry’s performance. Moreover, the high level of revenue received in advance which increase the liability is due to the company’s program of Frequent Flyer Redemption, which finances further operation with cash (Qantas, 2018). As a result, the cash flow statement witnessed an active movement as the company highly uses the inflow on investing activities and financing activities.

Overall, the financial health and performance of Qantas is exceeding the competitors, proving its leading position in the market. However, the investors still need to consider the inadequate ratios as they indicate the risk of business, although they are claimed to follow the company’s policy. The investment should be proceeded but the expectation would be set for long-term period, given the current intense competition and extremely high cost.

Conclusion

The report provides an in-depth analysis of the financial performance and financial health in Qantas Ltd. It is conducted using the financial ratios from the company’s financial statements as well as reviewing the cash flow statement in the FY2018 and 2017. By which the calculation, findings and comparison are discussed to help the investors in their decision making process. A specific section about the high liability of the company that concerning the investors are also provided to prove the strong position and performance of Qantas as a leading company in the airways market.

List of References

• Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The journal of finance, 23(4), 589-609.
• Chen, K. H., & Shimerda, T. A. (1981). An empirical analysis of useful financial ratios. Financial Management, 51-60.
• CSI Market, 2018. Airline Industry Financial Strength Information. Retrieved from https://csimarket.com/Industry/industry_Financial_Strength_Ratios.php?ind=1102.
• Dechow, P. M., & Skinner, D. J. (2000). Earnings management: Reconciling the views of accounting academics, practitioners, and regulators. Accounting horizons, 14(2), 235-250.
• Edmister, R. O. (1972). An empirical test of financial ratio analysis for small business failure prediction. Journal of Financial and Quantitative analysis, 7(2), 1477-1493.
• Higgins, R. C., & Reimers, M. (1995). Analysis for financial management (No. s 53). Chicago: Irwin.
• Horrigan, J. O. (1965). Some empirical bases of financial ratio analysis. The Accounting Review, 40(3), 558.
• Qantas, 2018. Annual Report 2018. Retrieved from https://investor.qantas.com/FormBuilder/_Resource/_module/doLLG5ufYkCyEPjF1tpgyw/file/annual-reports/2018-Annual-Report-ASX.pdf.
• Salmi, T., & Martikainen, T. (1994). A review of the theoretical and empirical basis of financial ratio analysis (No. _001). Sci. Finance. Abstract.
• Samuelson, R. A. (1993). Accounting for liabilities to perform services. Accounting Horizons, 7(3), 32.
• White, G. L., Sondh, A.