Level 3 AccountingInternal Assessment 2004Achievement Standard 90504Introduction:Who the report is prepared for:This report is being prepared for a potential shareholder and would includemy advice as to whether or not they should purchase shares in Air NewZealand Ltd.
Purpose of report:The purpose of this report is to fully analyze and interpret the company’sannual financial statements and other relevant information to derive theadvice for the potential shareholder. Analysis and Interpretation aims toassess the profitability, liquidity and financial stability and marketanalysis of Air New Zealand.
Company information:Air New Zealand is a company that focuses on the operation of Domestic andInternational passenger transport and cargo. Express Class launched on 1November 2002 and with this success Air New Zealand is turning it’sattention to the short haul international (Tasman and South Pacific) andlong haul international products and services.
Interpretation:ProfitabilityThe overall profitability of Air New Zealand shows positive trends during2002 and 2003.
The interest expense percentage, which measures the interest expense persales dollar decreased from 2.57% in 2002 to 1.05% in 2003.
This fall in interest expense percentage contributed to the increasing NetProfit percentage as net profit increases when expenses decrease.
The declining interest expense percentage has been caused by a decrease inboth current and non-current liabilities(no use ) as the business paid backsome of its borrowings and finance lease liabilities which means lessinterest expense was required to be paid on those borrowings.
In this situation, the decrease in interest expense is a good trend.
Although the total revenue of Air New Zealand decreased to $807,605 in 2003the effect was eliminated by a more significant decrease in interestexpense as the company paid back some of its debts causing the interestexpense percentage to decrease by 1.52%.
The net profit percentage which measures the net profit per sales dollarincreased from -7.23% in 2002 to 4.58% in 2003. The net profit hasincreased in 2003 as borrowing substantially decreased causing the interestexpense percentage to decrease.
Although the net profit percentage became positive in 2003 it was still nota great percentage of total revenue because even the year of 2002 beginwell as traffic recovered from the September 2001 terrorist attacks, theoperating of Domestic Express Class in November 2002 was quite successfuland improved profitability of the business and the lower fares alsoresulted increase in traffic the business was not that well off. There wasa decline in air travel and hence revenue due to the war in Iraq andoutbreak of SARS which resulted in many passengers delayed or canceledtravel plans.
However, the increase in Net Profit Percentage is a good trend.
The increasing net profit percentage is caused by the decline in operatingexpenditure (down by $848,291) which is a greater decrease than the declinein operating revenue (down by $807,605) due to better expense control andmostly the strengthening of the New Zealand Dollar against the UnitedStates Dollar as the expenses are predominantly United States Dollardenominated and the strong New Zealand Dollar provided exchange benefit.
Nevertheless, the revenue fell from 2002 to 2003 because there was lessdemand for the airline service in the second half of the financial year dueto SARS outbreak and war in Iraq thus the net profit was not as high as itcould have been.
The Rate of Return on equity percentage which measures the Net Profit perdollar invested by shareholders has risen from -45.72% in 2002 to 17.33% in2003. This measure increased by 63.05% as a result of a 151.79% increase inNet Profit.
The Rate of Return on equity percentage has increased as a result of thesignificant increase in net profit while the numbers of shares remained thesame as Air New Zealand decided not to issue more shares to the public.
The increase in the Rate of Return on equity percentage is a satisfactorytrend as this means the return to shareholders for their investment wasmore in 2003 than 2002.The reason for this positive trend is due to anincrease in net profit and the funds used to buy the large and expensiveaircraft required for the long distances of international business andother property and equipments was mostly funded by borrowing rather thanshare issue.
The Rate of Return on equity percentage increased in 2003 because netsurplus after tax increased by $485,706 while the number of shares remainedthe same.
The return on Total Assets which measures how effectively a company usesits assets has increased from -0.54% in 2002 to 6.15% in 2003.
The return on Total Assets increased by 6.69% as a result of the 151.79%increase in Net Profit which resulted from the decrease in operatingexpenditure. An increase in net profit before interest and tax (up by$265,942) and a decrease in average total assets the company holds (down by$2207,211) as it disposed some property, plant and equipment and the saleof some investment also contributed to this.
The return on Total Assets has a good trend as it indicate the improvedearning capacity of Air New Zealand (In other words, more efficient use ofCompany assets).
The selling of redundant assets is quite wise as the sale of redundantassets helped to improve Profitability.
LiquidityThe overall liquidity of the business has improved over the two years.
The current ratio which measures the ability of the business to meetcurrent debts as they fall due in the next accounting period has increasedfrom 1.15:1 in 2002 to 1.21:1 in 2003.
There has been a decrease in the amount of current assets as well as adecrease in the current liabilities. The current ratio has increaseddespite the decrease in current assets because the decrease in currentassets (down by $65,230 which is a 4.54% decrease from 2002 to 2003) wasless than the decrease in current liabilities (down by $111,018 which is8.90% decrease from 2002 to 2003). The current assets decrease was due toasset sales and the current liabilities decrease was due the fact that thebusiness paid off some of its short term borrowings.
This trend is certainly good but should look for further improvement in theratio as the airline industry is quite unsteady and the ratio need to behigher to indicate the company do have strong ability to pay current debtswhen they fall due even it faces unexpected events.
However, the more urgent need to pay back these current liabilities mayhave affected the decisions of the directors of not giving out a dividend.
Cash ManagementThe overall control over cash seemed to have improved as it reported a netincrease in cash holding of $171,063.
There was a strong improvement in Operating Cash Flow as it increased from$56,247 in 2002 to $523,091 in 2003.Cash receipts actually decreased by$758789 which is a 16.67% change but the net cash flows from operatingactivities still increased due to the greater decrease in cash payments of$1,225,633 which is a significant 27.26% decrease and this proves to be avery satisfactory trend. This increase is due toimprovedtradingconditions, a decrease in net interest paid and an improvement in themanagement of working capital.
The net cash flow from operating activities contributed to the improvingcurrent ratio as the cash from operations was sufficient to repay somepayments to suppliers and employees.
The cash outflow resulted from investing activities was due to the highcapital expenditure of $242,882 and some cash was received from sellingfixed assets and other miscellaneous items (probably form the discontinuedactivities) and thus offset some part of outflow.
The net cash outflow from financing activities increased from -$64,963 in2002 to -$135,031 in 2003. This net cash outflow was due to debt repaymentmade during the year and the coupon payment on Convertible Preference Shareheld by Crown. The repayment of debts helped to improve the both theliquidity and financial stability of the company. Receipts from the issueof Convertible Notes to Qantas on 31 December 2002 offset some outflow.
Conclusion on cash managementFinancial StabilityThe interest cover which measures the times the net operating surpluscovers the interest improved significantly from a very unsatisfactory -0.29times in 2002 to 6.15times in 2003 which the interest expenses is a lotmore manageable.
The interest cover increased in 2003 as net surplus before interest and taxincreased from a deficit of -$32,528 to a surplus of $233,414. The amountof interest expense that has fallen significantly due todecreasedborrowings as shown by the decreased gearing ratio has also contributedfurther to the improved interest cover.
The trend shown is quite satisfactory and indicates the business has theability to meet its interest payments from operating income in 2003.
The equity ratio that indicates how the business is financed increased from0.23:1 to 0.28:1 due to the slight increase in equity and decrease of totalassets. This is good trend but the ratio itself is very unsatisfactory asit is less than 0.5:1(In 2003, the shareholders only contributed 28 centsfor every dollar of assets the company has.) which shows outsider havegreater claim to the business assets than owners which can be also beproved by the high gearing ratio. This made the company quite risky as itmeans the company may be forced to close down (although not very likely)by creditors if it fails repay its debts.
The gearing ratio that measure the proportion of the company’s totalcapital that is borrowed decreased from 3.42:1 in 2002 to 2.59:1 in 2003.
The gearing ratio improved because total liabilities decreased by $363973and total equity increased by $149936.Another contributiontothisimprovement was an increase in New Zealand dollar value against the UnitedStates Dollar as aircraft leases and financing liabilities are denominatedin United States Dollars and the strengthening New Zealand Dollar hasdecreased the value of these liabilities on translation.
This ratio has a good trend as it indicate a lower risk as borrowingdecreased but even the improved gearing ratioin2003isquiteunsatisfactory as its borrowing is still extremely high. The more thecompany borrows the more interest it would have to pay and they have to paythe interest whether the investment is a success or not. As borrowing is arisk and the Air New Zealand borrowed so much, the business is quite risky.
However ,the directors are quite aware of this fact and intends to dosomething to improve it in the future.
Market AnalysisThe earnings per share ratio which shows the amount of earnings for eachordinary share is the most important ratio used by investors. It hasincreased from -10.95 cents in 2002 to a more promising 5.67 cents in2003.However the business does not seem to be a worthwhile investment whencompared to the Qantas’ earnings per share. Qantas reported an earnings pershare of 20.0 Australian cents which can be converted to 21New Zealandcents.(Currencyconversionsbasedonratesupdatedat5:33PM, Thursday 02 September 2004).This is a lot (15.33cents more) higher thanthe earnings per share of Air New Zealand.
The level of earnings per share has increased for Air New Zealand becausethe company did not issue any shares and funded their capitals withborrowing from outside sources. The net surplus after tax have alsoincreased from a deficit of -$319,980,00 in 2002 to $165,726,000 in 2003.
Air New Zealand did not declare any dividend and shareholders shouldprobably look for returns in other forms such as capital gain instead. Butin 2003, the shareholders actually lost 10 cents of share value.
The directors have decided not to declare a dividend for the 2003 year evenit meets the requirements of a solvency test due to the high andunsatisfactory gearing ratio and the business continues to have strongcapital demands.
Due to the fact that Air New Zealand did not pay a dividend, both dividendsper share and dividend yield could not be calculated and analyzed.
Conclusion:I recommend the potential shareholder not to purchase shares in Air NewZealand. The reasons for this recommendation are:1. The equity ratio and gearing ratio are both very unsatisfactory. Theysuggest that creditors have greater control over the company which puts thecompany at risk. The company may find it much more difficult to raisefurther debt finance in the future.
2. Air New Zealand continues to have strong capital demands due to the factthat it is flying both the shortest and longest route in the world. Thisprobably requires further borrowing from creditors and may deteriorate thegearing and equity ratio which is already very unsatisfactory.
3. The earnings per share is unsatisfactory when compared with Qantas.
(15.33 cents less)4. No dividends were issued in both 2002 and 2003 due to high gearingratio. There were also no capital gain (shares value decreased by 10cents)to compensate this.
5. The risk is too high compared to other investments such as a termdeposit. The CEO, Ralph Norris believes that “There are numerous recentexamples of airlines that have been profitable one year and bankruptshortly afterwards.” Air New Zealand may well be one of them!6. Revenue is likely to decrease due the fact that the Trans-Tasman marketmay became even more competitive with new airlines to entering.
7. The proposed alliance with Qantas would certainly make Air New Zealand amore worthwhile investment but the whole alliance needs approval on bothsides of the Tasman. However, many organizations and regulators includingCommerce Commission and The Australian Competition and Consumer Commission(ACCC) opposed this alliance. Expenses associated with pursuing Australianand New Zealand regulator have already been paid in 2004. Increasedexpenses lead to reduced profit. Shareholder should really wait until thealliance is approved before investing in the company.
8. There were actually some improvements in the financial position andperformance of Air New Zealand in the year 2004. However, Air New Zealand’sCargo business was impacted by the strong New Zealand currency which leadsto a revenue 10% lower. Operating cash flow of $466.9 million was 10.7percent lower, as a result of a $62.9 million increase in income taxpayments over the previous period. The investing and financing activitiescontinued to face cash outflow which indicate the company has not fullyrecovered from the outbreak of SARS and war in Iraq. Air New Zealand’sgearing has improved but is still very unsatisfactory.
Therefore I advise the potential shareholder to purchase shares in othercompanies or another form of investment. The shareholder could perhapsconsider a term deposit especially if him/her has a large amount of fundsavailable for investment as a term deposit is much less risky. On September2, 2004, The National bank advertised a term deposit arrangement with a 7%per annum for 2 years return if you invest $10,000 or more which is quite ahigh return and this option could be considered bythepotentialshareholder.
Limitations?Only two years of information was available which makes the conclusionsless reliable.
?No industry averages were available for comparison.
?Only the most important and useful analysis measures were considered.
?The earnings per share ratio is misleading due the fact that theshareholders did not actually receive any return.
? Dividends per share and dividend yield were not analyzed as no dividendswere declared. Thus the market analysis is not fully completed.
?The 2003 annual report was used for the analyses and interpretations whichmeans the information is out of date.
Basically your ass is all rite ! do the conclusion on cash management byyourself I believe you can get the full mark !