In this essay, the author is going to take a look at the war between Qantas Airways Limited and Virgin Australia Holdings Limited. Both companies are key players in the aviation industry and dominate the Australian local market. An evaluation of their financial reports reveals that Virgin Australia Holdings Limited posted a $51 million profit that outshines the $42 million profit posted by Qantas Airways Limited in 2010. This is an indication of the intensity of the war between them. Qantas Airways is regarded as a veteran in the industry and has many assets. But it has incurred a lot of expenses and industrial strikes from employees with low levels of motivation. Virgin Australia boasts of committed staff and a reputation for quality services in the market with regard to air transport.
Both firms also have destinations in other continents but Qantas is considering abandoning the Frankfurt route since it has proven to be unprofitable. It is contemplating to partnering with British Airways to cater for its European passengers. The stiff competition has been made worse by the entry of foreign airlines like Etihad and Emirates Airways both from the Middle East. The above-mentioned companies have already signed deals with Virgin Australia Holdings and Qantas Airways respectively. This fact has raised concerns and complaints about increased foreign involvement in air transport and the inefficiency of the Foreign Investment Authority in performing its tasks.
Financial Ratio Analysis
As follows there are ratios that express the results of business activities vis-a-vis the resources used in carrying out the activities. These ratios are an indication of adequate return on capital employed (Bodie, Kane & Marcus 2004). It is also an indicator of the management’s ability to utilise the resources at their disposal efficiently. Some of the profitability ratios will be discussed in relation to Qantas and Virgin Australia Airways.
Gross Profit Margin
This ratio will be analyzed in the two companies. According to Bodie et al. (2004), it measures the “…margin (of)…trading profits on sales” (p. 23). The gross profit margins for Virgin Australia dropped from 9.6 per cent in 2010 to 6.3 percent in 2011. This fact can be attributed to the low sales volume that the airline recorded which were caused by the fears brought about by the rumours that the company wanted to sell its international unit to Etihad Airways.
At the same time, Qantas recorded an improvement of 0.38 percent in its gross profit to hit the 11.38% mark in 2011. That has been attributed to the signing of its long-overdue partnership with Emirates Airways (Australian Financial Review 2012).
Net Profit Margin
Net profit margin measures the proportion of ‘net profit of sales’ covering all expenses. Qantas’ net profit margin increased from 1.24% in 2010 to 1.76% in 2011 due to its plans to reduce its overall expenses which included job cuts, grounding of planes, and illegal selling tickets for services that it was unable to provide (Australian Financial Review 2012).
On the other hand, the net profit margin for Virgin Australia dropped from 0.6 per cent to -1.21 per cent in 2011 because of a reduction in sales. Also, Virgin Australia does not enjoy the economies of scale that Qantas enjoys from its many assets (Australian Financial Review 2012).
Return on Equity
This ratio measures the ‘return of profit in relation to the resources invested’ by the owners. The returns for ordinary shareholders at Virgin Australia dropped by 2.35 per cent to close at -4.28 per cent in 2011. This is attributed to the drop in its net profit for the year. Qantas recorded an increase in its net profits from 2.88% in 2010 to 4.26 per cent in 2011 because the net profit for the company increased at the closure of business in 2011.
Also known as efficiency ratio, it measures the efficiency of the firm in utilising the resources that are at its disposal. It basically helps in assessing the efficiency of the management (Groppelli & Ehsan 2000). Some of the efficiency ratios will be discussed in relation to the two companies.
The turnover ratio measures the rate at which management utilises assets at its disposal to generate sales (Bodie et al. 2004). The assets turnover ratio for Virgin Australia rose to 85.08% in 2011 which indicates the improved efficiency on the part of the Borghetti team (Australian Financial Review 2012). Qantas management team – led by Joyce – saw its assets turnover increase to 71.41 per cent in 2011 from 69.17 per cent in 2010.
This ratio which is computed in days is used in “…measuring the efficiency (of) the team in credit management in terms of conversion to purchase” (Gisick 2012: p.2). It took Virgin Australia 44.2 days to convert its credit into sales in 2010. This fact has been attributed to the crisis that was faced by various economies including the Australian one (Gisick 2012). In 2010, the company used an average of 39.7 days to convert credit into sales.
Due to the large capacity of its production, Qantas drastically reduced its credit turnover ratio by approximately 5.3 days. In 2010, it used an average of 46.4 days to convert credit into sales. This reduced to 42.6 days in 2011.
These are ratios that aim at evaluating the ability of the management to meet both short term and long term obligations. In the general meaning, it involves the short term and long term ratios.
It is a ratio that mainly focuses on the solvency of the business to meet short term obligations (Houston & Brigham 2009) which include the following:
This ratio compares assets which are liquidated within a period of 12 months (Gisick 2012) with liabilities which will be due for payment in the same period of time. Its main objective is to assess whether there are short term assets to meet the short term liabilities. A current ratio of less than 1 is desirable since it indicates the ability of the organisation to meet the current obligations (Houston & Brigham 2009).
Virgin Australia managed to reduce its current ratio by 0.11%. This was attributed to a decrease in its current lending. It closed 2011 at 0.65 per cent. On the other hand, Qantas managed to reduce its current ratio by 0.3% which was attributed to a decrease in some expenses such as salaries, closing the financial year at 0.90 per cent.
This ratio shows whether the creditors and debtors are paid at the same time and whether the business has sufficient liquid resources to meet its current liabilities (Groppelli & Ehsan 2000). It is different from current ratio because it excludes stock and prepayments from current assets. In 2011, Virgin Australia maintained a quick ratio of 0.64 per cent, a difference of 0.12 per cent from the previous year. This was due to the reduction in current liability in the previous year. On the other hand, Qantas reduced its current quick ratio in 2011 by 0.03 per cent to settle at 0.85.
It is a ratio analysis that mainly focuses on the “…(firm’s) long term solvency to meet the long term obligations” (Gisick 2012, p.12). Also known as gearing ratio, it focuses on the borrowed capital that is used in financing the firm. The ratios include the following:
Debt Equity Ratio
This ratio measures the proportion of capital in terms of preference shares financed by debt (Bodie et al. 2004). An enterprise with high debt ratio has a higher financial risk and pays higher interest rates. Virgin Australia reduced its debt to equity ratio by 14.52 per cent. This is attributed to the agreement that it entered into with Etihad Airways to share some of its assets. The closing ratio for 2012 was 177.04 percent.
Qantas increased its debt to equity ratio from 95.60 per cent to 98.05 per cent. The increase in debt shows that the company sourced additional finance from additional preference shares issued in the capital market (Gisick 2012).
Debt Asset Ratio
These are ratios that measure the portion of assets that is financed by debt. A high debt ratio indicates a higher financial risk and pays a higher interest rate. It can also be interpreted as a high proportion of debt equity ratio, meaning that a substantial part of the capital is borrowed (Byron 2012).
Virgin Australia maintained the ratio at 75.89 percent and the change of 0.1 per cent is attributed to market dynamics during the re-evaluation of the assets. At Qantas, there was a change of 0.57 per cent in the debt asset ratio which is attributed to its increased lending in order to purchase additional assets.
Most of these financial ratios can be interpreted wrongly due to various factors. First and foremost, the operational policies between Qantas and Virgin Australia are totally different. This is also attributed to the fact that Qantas has projected a loss of $200 million. At the same time, Virgin Australia is benefiting from its foreign and local investments.
Secondly, there is a significant difference between the management structures in the two firms in terms of the environment within which the members of staff are operating. Virgin Australia has committed employees who would work for the company even when it’s making losses. The highly motivated employees contributed to its earnings before interest and tax (EBIT) of $35 million. In contrast to that, Qantas’ employees would ditch the company in case their salaries are not paid. The aforementioned situation is caused by the labour conflicts and failure to engage employees in management programs which have brought about resistance to change among Qantas employees (Sharp 2012).
The entrance of foreign players in the market has also changed the views of investors and the prices of their shares. Fearing the liquidation of its shares, Virgin Australia Holdings offered its shares in the new and unlisted Virgin Australia International Holdings Company by way of a special dividend in order to accommodate the desires of its current foreign partner, Etihad Airways, and other prospective partners (Gisick 2012).
On the other hand, after the announcement of the deal between the company and Emirate Airways, the shares of Qantas went up by 6.6% to settle at $1.055 (Financial Times 2012). This shows the volatility and inflexibility of Qantas’ shares which are affected by minor changes in the economy making many investors lose hope in their stock (Tayme 2009).
Other challenges that are faced by the two companies include increased variable costs and high fixed costs. This is a big challenge especially for Qantas because it pays its employees very well in comparison to Virgin Australia. These companies have also not being spared by the effects of the current global economic crisis. This has made Qantas record a 0.5 per cent fall in its international revenues (Kristal 2011). The company is also contemplating closing down its Frankfurt operations which have proved to be extremely expensive to maintain. It will possibly partner with British Airways to provide its customers with such services (Gisick 2012).
Air transport industry in Australia is very vibrant because of the competition. It is also noted that the collaboration between Australian local firms and those from the Middle East will improve the quality of services offered while making them affordable to the consumers because improved management practices and a reduction in expenditure are expected. In other words, financial ratios are going to change for the better. This could also be especially explained due to the efficiency and profitability ratios.
Investors are more likely to trade in stocks that have consistently performed in the market and which have a higher potential for growth. They will also invest in companies with a dedicated management team and staff working towards the success of the company (Australian Financial Review 2012). The motivation of employees in Virgin Australia inspires confidence among investors. The company has recorded high efficiency ratios and continuity is assured because it is a national carrier.
Australian Financial Review. 2012. Aviation. Web.
Bodie, Z Kane, A & Marcus, J. 2004. Essentials of investments, 5th edn, McGraw-Hill Irwin, New York.
Byron, H. 2012. Investing in a tumultuous market, Oxford University Press, Oxford.
Financial Times. 2012. Qantas Airways Ltd. Web.
Gisick, M. 2012. Qantas Airway and Virgin Australia Holdings, Web.
Groppelli, A Ehsan, N. 2000. Finance, 4th edn, Barron’s Educational Series Inc., London.
Houston, F & Brigham, E. 2009. Fundamentals of financial management, South-Western College Publications, Cincinnati, Ohio.
Kristal, E. 2011. Investment management, Free Press, New York.
Sharp, L. 2012. Financial management, Free Press, New York.
Tayme, U. 2009. Management in a crisis, McGraw-Hill, New York.
Appendix 1: Formulae
Gross profit margin = gross profit/ net sales * 100
Net profit margin =net profit/ net sales * 100
Return on Equity = net income/ average shareholders’ equity * 100
Where average shareholders’ equity = total equity/2
Assets Turnover = net sales/ total assets * 100
Credit Turnover = creditors/ purchases * 365 days
Debt Turnover Ratio = debtors/ net sales * 365 days
Inventory turnover ratio = inventory/ cost of goods sold * 365 days
Current Ratio = current liabilities/ current liabilities * 100
Quick Ratio = (current liabilities – inventory) / current liabilities * 100
Debt Equity Ratio = total liabilities/ total equity * 100
Debt Asset Ratio = total assets/ total assets * 100
Source: Houston & Brigham 2009.
Appendix 2: Figures
Source: Gisick 2012.