Section 1 Company Profile British Airways Plc example essay topic

Global Economic There is increasing confidence that the world economy is enjoying a classic cyclical recovery. Global economy is on a recovery path aided largely by the quick end to the Iraqi war, which generated positive outlook among markets and built up business and consumer confidence. GDP growth rate was 0.2% in the first quarter of 2003 in UK, growth rate for the second and third quarter went up to 0.6%, pointing to a growth rate of 2.0% end 2003. Unemployment rate has been decreasing to a rate at 4.7% according to the National Statistics with Inflation falls (September: CPI now 1.1%, RPI 3.1%) in 2004. UK government increases the interest rate to avoid inflation during past years.

HM-Treasury in November 2003 forecast ed the economy to grow by 2.6% form 2004 to 2005 and slow down marginally to 2.4% from 2006 to 2007. Section 1 Company Profile British Airways Plc (BA). The Group's principal activities are the operation of international and domestic scheduled and charter air services for the carriage of passengers, freight and mail and the provision of ancillary services. The Group's global alliance includes new code share arrangements agreed with Finnair, Iberia and Cathay Pacific. The Group operates in such geographical areas as The United Kingdom, Continental Europe, The Americas, Africa, Middle East, Far East, Australasia and Indian sub-continent. For the fiscal year ended March 2004, the company generated revenues of lb 7,560 million.

This figure represented a decrease of 1.7% on the lb 7,688 million in revenues posted by the company for fiscal 2003. Net profit was lb 130 million in fiscal 2004, up 80.6% from lb 72 million in fiscal 2002.1. 1 Position in the sector British Airways (BA) is one of Europe's largest international airlines and a FTSE 100 company. BA's worldwide route network covers about 220 destinations in over 90 countries. The airline also carries freight and mail and ranks as one of the biggest cargo airlines in the world. The company is classed as the world's second largest international airline, but because its US competitors carry so many passengers on domestic flights, BA is ranked as the fifth biggest airline in the world in overall passenger carryings.

The airline's fleet is comprised of around 310 aircraft, which is one of the largest fleets in Europe. BA vs. Airlines in the UK Although the UK airlines market performed poorly in the 1998-2002 time frame the market is predicted to recover looking forward to 2003, experiencing the third strongest growth in the region. As the leading airline in the UK, British Airways worldwide network covers over 156 destinations in 75 countries and gained revenues of $12.1 billion in 2002. Recently BA signed a global marketing alliance with American Airlines and a number of other airlines.

Named Oneworld it aims to become a transnational airline, and in its first phase will introduce more than 100 new destinations to the BA network later this year. In order to maintain its position as the UK's market leader the company has also established a highly developed Internet site. BA vs. Global Airlines Compare to Global airlines, British Airways still hold one of the strongest position in this sector. The airline industry has performed inconsistently over the last five years, with a 7% rise in value in 2000 followed by a fall of 5% in 2001. The fall was caused by the September 11 attacks impacting industry sales. However, since then the industry has started to recover, with passenger numbers slowly increasing and driving the market's value.

The global airline industry grew by 1.8% in 2003 to reach a value of $254 billion. Europe accounts for a further 29.4% of the industry's value, making it the second largest market globally (the largest market globally for the airline industry is the US). For the fiscal year ended March 2003, British airways generated revenues of lb 7,688 million (proximally $1.3 billion). This figure represented a decrease on the lb 8,340 million in revenues posted by the company for fiscal 2002. BA's total revenues can be split into four main revenue streams - scheduled passenger revenues, non-scheduled passenger revenues, cargo and other, each of which accounted for 85.1%, 0.6%, 6.3% and 8% of 2003 revenues respectively. The company's other activities include its range of aircraft maintenance, package holiday and airlines service offerings.

1.2 Competitors Porters 'five forces' competition model New Entrants Threat of new entrants Industry competitors Suppliers Buyers Bargaining power Intensity of rivalry Bargaining power of suppliers of buyers Substitutes Threat of substitutes Source: Porter (1985) British Airways PLC (BAY-LN) focuses on international and domestic scheduled and charter air services for the carriage of passengers, freight and mail. The Group's is globally allied and holds code share arrangements agreed with Finnair, Iberia and Cathay Pacific. In an attempt to compete backwards in order to better control competition. Analysis of the Airline Industry In order for a company to be able to compare itself with its rivals in terms of competition intensity and profitability, the five forces model can be used.

This model is consisted of three 'horizontal's ources of competition these are the threat of substitutes, the threat of new entries and the competition among rivals. The other two 'vertical's ources of competition are the power of suppliers and also the power of buyers. These forces can be further grouped into the following areas: Porter's Five Forces 1.2. 1 Competition from Substitutes The willingness of a customer to buy a product is partially expressed on the availability of substitute products. British airways (BA) as one of the largest airline companies flying to over 220 destinations and is covering 90 countries. (web 2/11/04) The existence of many airlines on a global spectrum, since this is where the BA is flying can be translated to the existence of close substitutes on the basis of services these companies are offering.

In this case, can be translated as a relation between the price is being charged with the type of service, that is being offered. As a result of the high levels of competition, the existence of many substitutes, forces airlines traditionally being perceived as, world class-high price, to charge low prices for their services. It follows that profit margins are lowered, within the industry. This can be derived from the average of the last 5 years average of net profit margin just -0.722, apparently implying that the profits are heavy lowered because of the substitution effect in Europe. However, this may also be the result of the liberalization of the scheduled airline transport industry within the 17 states of the European Economic Area that was completed in 1 April 1997 aiming for fair competition in the airline industry and ensure that the end user (travelers) are getting right treatment from airlines. 1.2. 2 Threat of Entrants Due to the nature of the industry, make a potential entrant to the industry nearly impossible, as the barriers for entering are high.

The extent of the barriers for entering, are determined from the capital required, on the economies of scale. The airline industry itself does require a huge amount of investment to get into. But still, setting up a small airline one of the so called (used to be called) low budget airlines and start flying to one ore two destinations, is the easiest part. The hardest part is improving and ensuring that the niche you exist in is the one that it exists at all times. Being good airlines even a low budget one, requires investments on different areas, such as branding which makes the operation certainly frilled. The Effectiveness of Barriers to Entry As the industry is capital intensive, efficiency requires large-scale operation.

The required capital for starting up an airline is huge. A potential entrant will have as a result to wait in the long-term to break even in the aggressive airline industry. The effectiveness of the barriers to entrants depends on the resources of the entrants. As Grant (2000), argues in today's changing environment, businesses have to concentrate on themselves, on their resources and capabilities in order to be able to gain market share.

Governments and the regulations they have the power to impose can act very effectively to make the operation of airlines hard or even impossible by sometimes blocking potential players entering the market. These activities can be grouped to governmental and quasi-governmental, and these will include more specifically changes in the laws or policies of any country in which the company operates. As a result, profits can be squeezed of an airline in a particular country. This is not usually the case within the European Union, since the European Act sets out a framework for operation.

But it may not be the case on a global basis, where a particular country may impose greater tariffs to foreign airlines. 1.2. 3 Rivalry between Established Competitors In the airline industry the oversupply of flights, makes it hard to compete with the rivals. Therefore, because of the oversupply, companies go for massive price cuts in order to cover their costs by the big volume of sales. But the trade off for airline is the overcapacity that always have to deal with by avoiding occurring. Since, if over capacity occurs companies may suffer to break even, and is usually the case for the airline industry.

British Airways is constantly adjusting its price range of flights, in an attempt to overcome overcapacity issues that have already been proven a barrier for breaking even for the company. This is depicted from the Geographical Analysis that follows. 1.2. 4 Bargaining Power of Buyers The two vertical sources of competition are the Bargaining Power of Buyers and the Bargaining Power of Suppliers. The transactions included in both sources have as a common point, the transaction between the two parties involved that aims to create value for both parties (buyers and suppliers).

How the value is shared, is relative to their economic power. British Airways operates in the market for outputs since, it simply sells its services to the customers. The strength that the customers have as the buyers can be subdivided into two main parts, the buyer's price sensitivity and the relative bargaining power. Buyers' Price Sensitivity The willingness of buyers to switch from one supplier to another is greatly affected from the price of the products if the products do not have any main difference. ' The greater the importance of an item as a proportion of total cost, the more sensitive buyers will be about the price they pay. ' Grant, R. (2002).

Relative Bargaining Power British airways have the capacity to integrate vertically. As a result, in order to get more control over their supply chain of big volume products and most importantly strengthen their brand they have started marketing their own products, such as holiday packages. 1.2. 5 Bargaining Power of Suppliers " Analysis of the determinants of relative power between the producers in an industry and their suppliers is precisely analogous to analysis of the relationship among producers and their buyers. The only difference is that it is now the firms in the industry that are the buyers and the producers of inputs that are the suppliers. The key issues are the ease with which the firms in the industry can switch between different input suppliers and the relative bargaining power of each party. ' Grant, R. (2002) 1.3 British Airways: PEST Analysis PEST Analysis is a helpful tool to take a closer look at the macro-environment factors such as political, economical, social and technological aspect of the economic as whole and the industry itself.

Although the PEST analyses rely on past events and experience, it can be used as a forecast of the future. 1.3. 1 POLITICAL FACTORS British Airways welcomes the opportunity to comment on the Commission's review of the third package. The package of measures has been in effect for ten years and has largely been successful in liberalis ing air transport in Europe. BA supports liberalization and has led the calls for its implementation.

That included abandoning the old collaborative business methods and the transition to the highly competitive industry we have today. BA continues to argue for a more liberalized approach with the objective of maximizing commercial opportunities for airlines and minimizing government intervention to the greatest extent possible. According to Data Monitor report (BA, 2004) the long awaited White Paper, 'The Future of Air Transport,' published in December, as an effective, long-term aviation policy. During the consultative process we emphasised the vital strategic importance, now and for the future, of Heathrow as the UK's only global gateway.

BA was pleased that the Government recommended a third runway and sixth terminal at Heathrow within 15 years, subject to meeting certain environmental concerns. The airline has pledged to work with the Government, the BAA and local authorities in addressing the Heathrow environment issue so that this country's leading position in world air transport is assured. We also support the Government's plans for new runways at Birmingham, Edinburgh and Stansted, so long as the cost of development is not subsidized from operations at other airports. 1.3. 2 ECONOMICS factors British Airways makes a substantial contribution to economic in the UK and other countries where they operate. In the UK and other markets that they serve their activities make economic through boosting GDP, employment, and trade, and facilitating travel and cultural exchange. International airlines provide communication links vital to the global economy, supporting trade and investment.

As the global economy develops, these links become increasingly important. The British Airways network is particularly important to the UK. No other airline provides such a comprehensive UK based network. One indicator of the economic contribution made by British Airways is the value of the revenue generated by its activities.

In real terms, British Airways revenues have been falling in recent years as global economic slowdown, the terrorist attacks of 11th September 11th tragedy, war in Iraq, competition and the SARS epidemic. However, because of successful restructuring programme, British Airways has overcome the difficult years since 2000 and is now to benefit in the air travel market over the next few years. 1.3. 3 SOCIAL FACTORS The short-term affect that the social factor has on the airline industry is that; people have cut down on using flying as a mean of travel after the September 11th incident. Many of the flights have been cancelled from America, this resulting to financial difficulties for British Airways. The long-term affect that is going to have is that if there are not as many passengers, then the amount of staff that the companies have hired are no longer needed. For example, British Airways announced it would cut 7,000 jobs on Sep. 20, 2001.

In fact... however there are some people that have not been affected by the September 11th incident, many people have taken this as an advantage. 1.3. 4 TECHNOLOGICAL FACTOR In technology, British Airline focuses on two parts, which are developing new technologies on different parts and improving existing technologies such as: o British airway selects Amadeus technology o Airline distribution and sale so Self-service check-in British airways e-commerce solution New technology offers opportunities for operating efficiencies and improved customer service, such as increasing the fuel efficiency of their aircraft and buildings. They are targeting a 30% improvement in their aircraft fuel efficiency between 1990 and 2010 and a 2% per annum reduction in energy consumption in their buildings. Apart from that, over the long-term, they support the incorporation of aviation into an international system of emissions trading for greenhouse gasses. They already participate voluntarily in the UK Emissions Trading Scheme and support the inclusion of aviation into EU emissions trading from 2008.1. 4 SWOT Analysis Strengths Size and brand Network presence Cost cutting Customer loyaltyWeaknesseso Damaged reputation Debts Labor relation so Reliance upon particular revenue streams Opportunities Terminal 5 Shifting customer needs Further alliances Industry recovery Threats Strong competition Interest and foreign currency exchange rates Fuel costs Decline in airline industry Environmental issues 1.4.

1 Strength: Size and brand According to Data Monitor (2003), British Airways is classed as the world's second largest international airline, but because its US competitors carry so many passengers on domestic flights, BA is ranked as the fifth biggest airline in the world in overall passenger carryings. The company's size means that it can benefit from significant economies of scale in order to reduce costs. The size of the company also means that BA will benefit from such things as increased brand awareness. An increase in brand awareness will result in increased sales if associated with favourable brand perceptions.

BA flies to more than 156 destinations in 75 countries. The company's global coverage will enable BA to tap into most of the main regions of the world where demand for air travel is present. Network presence BA enjoys a strong network presence both in its domestic market and internationally. The company's network presence incorporates two of the major airports in the UK, as well as major international airports such as John F. Kennedy International Airport in New York. Having a strong network presence means that BA can generate traffic feed for both its domestic and international flights. Cost cutting BA has had some success in implementing cost cutting procedures.

The company has cut more than 10,000 jobs and made annual cost savings of around lb 570 million over the last few years. These programs of cost cutting have proved vital for many European and US airlines, especially in the current industry climate. A number of airlines have failed to implement such cost cutting programs and have since gone out of business. Customer loyaltyBA's frequent fly er and loyalty programs help the company to retain customers.

For example, BA's Executive Club frequent fly er program was established to develop passenger loyalty by offering awards and services to frequent travelers. Membership of such schemes encourages repeat travel on BA flights rather than other airlines, as passengers seek to accrue the benefits given to regular travelers. This enables the airline to retain customers and reduce costs, as the company does not have to spend money targeting new customers to replace those lost to other airlines. 1.4. 2 Weaknesses Damaged reputationBA's reputation may have been damaged by the strikes that affected the company's flights during the summer of 2003. Strikes held by ground staff at London Heathrow's Terminal One forced BA to cancel many flights.

The strikes and cancellations caused a lot of ill feeling among customers towards BA and this could have had the effect of weakening the company's brand. The cancellation of flights also led to a reduction in company profits, while costs also increased due to BA's decision to hand out compensation to customers whose flights had been cancelled. Debts BA has a significant amount of indebtedness. At the end of the last fiscal year, BA had long-term debts of lb 5,149 million, a decrease on the previous years debts (lb 6,283.8 million) but still a significant amount to service. Current and future indebtedness could have important consequences for the stakeholders in the company. For example, debt could impair BA's ability to make investments and obtain additional financing for working capital, capital expenditures, acquisitions or general corporate or other purposes.

Debts could also put BA at a competitive disadvantage to competitors that have less debts and could also increase the company's vulnerability to interest rate increases. Labour relations Relations between management and workers at BA remain strained despite the resolution of the strikes that affected the company earlier this year. The strikes that took place during the summer of 2003 were caused by BA management trying to replace a paper based clocking on system with an electronic one, which was very unpopular with both workers and unions. This summer's strikes were the latest in a number of industrial disputes between management and workers at BA.

Further strikes cannot be ruled out and this will again harm BA's operations, revenues and profits. Reliance upon particular revenue streams Since BA has in recent years tailored some of its network, product, schedule and pricing strategies to the business travel market, the steep decline in demand for business travel has affected the company more than other carriers. BA is also reliant on high transatlantic passenger numbers to drive revenues. This has also affected the company, as transatlantic passenger numbers have yet to recover from the effects that the September 11 terrorist attacks in the US had on passenger numbers. 1.4. 3 Opportunities Terminal 5 The UK government has approved the construction of the new Terminal 5 at London's Heathrow Airport. The new airport terminal is being constructed to meet the anticipated future demand for air travel in the forthcoming years.

The expansion of Heathrow Airport should enable BA to gain more takeoff and landing slots and build up its operations at the airport. The expansion will not only cement BA's position at the airport, it will also give the company an opportunity to increase the number of destinations that it flies to. Shifting customer needs The needs of airline passengers are changing, as they become more and more price sensitive. The effect of this has been that traditional airlines such as BA have struggled, while low-cost airlines such as easy Jet and Ryanair have experienced significant growth despite a turbulent industry, especially in the short haul market in Europe. BA could look at the change in customer needs and attempt to make its prices more competitive with the low cost carriers. If BA was successful in making its prices more competitive, then the company should be able recover some of the market share it has lost to the low cost operators.

BA could also look at some of the ways in which the low cost carriers keep their costs low and retain high levels of efficiency in its service. The company may be able to implement some of the strategies used by the low cost carriers (e.g. electronic ticketing) in an attempt to reduce its costs. Further alliances BA has entered into a number of bilateral and multilateral alliances with other airlines to provide its customers with more choices and to participate in markets worldwide that it does not serve directly. These collaborative marketing arrangements typically include one or more of the following features: joint frequent fly er participation; code sharing of flight operations (whereby one carrier's flights can be marketed under the two-letter airline designator code of another carrier); co-ordination of reservations, baggage handling and flight schedules; and other resource-sharing activities. BA could attempt to extend the number of alliances it has with other airlines in an attempt to increase its global coverage even further by participating in more markets worldwide that it does not serve directly. The company could increase the number of partners in the Oneworld global marketing alliance or agree other partnerships outside of this framework.

Industry recovery Market analysts believe that the global airline industry will experience an upturn in fortunes over the next few years. This represents an opportunity for BA, as it could generate increased revenues and market share if the company capitalizes on any increases in demand. 1.4. 4 Threats Strong competition BA faces strong competition from a number of industry rivals. The company's competitors include companies such as UAL Corporation (United Airlines), Lufthansa, Virgin Atlantic Airways, BMI (British Midland) and Delta.

BA also faces significant competition from low cost operators such as easy Jet and Ryanair in the short haul market between European destinations. All of these companies will combine to take away sales and market share from BA. Interest and foreign currency exchange rates Fluctuating interest and foreign currency exchange rates will have a significant impact on BA's earnings. For example, BA does business in more than 100 foreign currencies, and generates a surplus in most of these currencies. As a result, BA can experience adverse or beneficial effects arising from exchange rate movements. BA will experience beneficial effects from the strengthening of foreign currencies against the British Pound and an adverse effect from the strengthening of the British Pound.

Fuel costs The price and availability of jet fuel significantly affects BA's operations. Any increase in the price or a reduction in the availability of jet fuel will have a significant effect on the company. Due to the highly competitive nature of the airline industry, BA may be unable to pass on to its customers any increased fuel costs that it may encounter. Therefore, an increase in the price of fuel or reduction in its availability will affect the company greatly. Decline in airline industry number of factors have caused the current decline in the airline industry.

For example, the threat of further terrorist attacks since September 11 and a fall in the number of business travellers have both caused passenger numbers to fall. Other factors may continue to affect demand for air travel in the future, which will then affect the revenues generated by BA. For example, global problems such as an increased threat of terrorism in response to the coalition's war on terrorism could have an adverse effect on BA. The threat of terrorism may discourage people from traveling on aircraft and could have the effect of reducing the number of passengers traveling on international flights. Environmental issues BA, like other companies in the airline industry, is subject to UK, European and international environmental laws and regulations concerning emissions to the air, discharges to surface and subsurface waters, safe drinking water, and the management of hazardous substances, oils, and waste materials. Abiding by these regulations may increase BA's costs.

Any tightening of these regulations especially those concerned with emissions to the air may increase costs further in future years. 1.5 Geographic Analysis Turnover by area of original sale The sales in Europe seem to have slightly been increased, whereas in the Americas seems to be a drop of around 500. At the same time the sales in Africa Middle East and Indian sub-continents seem to be flat, whereas the Far East and Australasia, seem to have a slight decrease of a rate of 2%. Overall as the figures depict the total sales have decreased 1.66%. More precisely the total number of sales has been decreased by 128 millions, but still the sales in Europe did increase by 0.75%Operating Profit by area of destination The total operating profit for the year 2004 has been increased by 37% from the previous year. Still Europe, is an unprofitable segment, possibly because of the oversupply of airlines.

Given also the fact that the number of sales has been increased fully explains that returns are squeezed because airlines are forced into reducing prices for avoiding overcapacity. The Far East sector, has very low returns and for the year 2004 has made a loss for BA, but the effect of global diversification still kept the company having positive total margins. 2. Section 2: Financial Analysis 2.1 Turnover and Profit Analysislbm 2000 2001 2002 2003 2004 Total traffic revenue 8092 8432 7572 7074 6953%change -0% +4% -10% -7% -2% (adapted from: Deutsche bank AG) The above table depicts the amount of total traffic revenue that BA had since 2000 and the percentage change over these five years.

It is worth noting that the company in the year 2000 had no change in its actual number of traffic revenue from 1999, which concerning the high volatility of the business is a healthy aspect. This is also reflected in the year 2001 when there is a increase of 4% But the 9/11 attack certainly influenced the airlines traffic revenue including both passenger and cargo business. The passenger capacity, measured in Available Seat Kilometres, was 0.1 per cent above October 2003, being in line with the capacity that was impacted by 2% as a result of planned reductions that BA has made. The reductions did start in early August, which as the company claims are aiming to cover its overcapacity, by cutting down schedule passenger flights.

Traffic, measured in Revenue Passenger Kilometres, was higher by 1.8 per cent as the company reported for October 2004 in comparison to the same period with last year. lb m 2000 2001 2002 2003 2004 2005 2006 Fuel 1102 1028 842 922 1183 1115 1045% Change 37.06% -6.71% -18.09% 9.50% 28.30% 5.75% -6.27% (source: Deutsche Bank AG) The fuel costs net of hedging are now expected to be some lb 245 million more than last year (up lb 20 million from our last estimate). Passenger and cargo fuel surcharges forecast at lb 160 million for this year according to BA's estimations. As a result of the continued rise in oil, British Airways increased its fuel surcharge from lb 6 to lb 10 per sector on long haul flights and from lb 2.50 to lb 4 per sector on short haul flights. ' (web). This may directly impact the total revenue since demand will drop since a higher price being charged. At the same time the Profit Before Interest and Tax seems to have an upturn maybe because of the sell of its 18.25% Qantas stake. 2.2 Profitability Ratios The Return on Capital Employed (ROCE) ratio, compares the profit with the capital invested.

Is a key measurement of managerial performance as it relates pre-tax profit to the long-term investment in a company. It is a good guide as to whether sufficient return is being generated on the long-term funds (retained profits, shareholders' funds and longer-term loans) employed by the business. If a low return is being earned for any length of time, liquidity problems may grow. However, surprisingly a delightful increase in return on capital employed confirms that British Airways efficiently recovered itself and the growth is based on long - term strategy. A number of factors are forcing airlines to become more efficient. In Europe, the European Union (EU) has ruled that governments should not be allowed to subsidize their loss-making airlines.

Elsewhere too, governments' concerns over their own finances and a recognition of the benefits of privatisation have led to a gradual transfer of ownership of airlines from the state to the private sector. In order to appeal to prospective shareholders, the airlines have to become more efficient and competitive. It is worth noting here that BA is the only airline that is fully privatized. Gross Profit Margin Gross profit margin (%) 2000 2001 2002 2003 2004 5 yr Ave British Airways 2.92 6.11 0.59 5.53 7.3 4.49 Sector (Euro airlines) 20.3 21.1 21.42 19.88 17 19.94 The gross profit margin of the sector is clearly much higher than that of British Airways. The gross profit margins of Alitalia airline were considerably high, having an average of 54% during the last 5 yrs, therefore the sector's gross margin had an upturn. Net Profit Margin The net profit margin ratio tells us the amount of net profit per lb 1 of turnover a business has earned.

That is, after taking account of the cost of sales, the administration costs, the selling and distributions costs and all other costs, the net profit is the profit that is left, out of which they will pay interest, tax, dividends and so on. For the sector that has been reviewed (European airlines) the net profit margin is much lower than the gross profit margin and has been fluctuating by the reason of September 11 and SARS and so on. Since 2003 the growth is steady to reach its peak up to 2004. Tax Ratio Tax ratio = Tax Paid / Pre-Tax Profit Tax Ratio (%) 2000 2001 2002 2003 2004 5 yr ave British Airways 47.37 35.71 35.18 25.44 36.96 36.10 Sector (Euro airlines) 19.17 10.58 27.68 -2.44 19.48 14.89 Because of the different government policies and regulations concerning airline carriers and also the accounting standards, the tax ratios seem uncorrelated to each other. The British Airways' tax ratio is considerably higher than the other countries flag carriers implying a potential high taxation levels. Sales to Capital Employed Measures amount of revenue generated in relation to level of investment made.

Referred to as Capital Utilization and when combined with profit margin gives the principal measure of profitability - return on capital. Sales to Capital Employed (%) 2000 2001 2002 2003 2004 5 yr ave British Airways 0.93 0.94 0.95 0.93 1.03 0.96 Sector (Euro airlines) 1.85 1.92 1.64 1.73 1.32 1.69 British Airways sales to capital employed ratio have been steadily increasing at a very low rate. The sales to capital employed ratio of the reviewed European airlines are having a massive decrease when compared with British Airways'. 2.3 Long term Finance - Solvency The capital gearing is concerned with a company's long-term capital structure (the relationship between equity and long term loans). Most companies have to borrow money if they are to have the funds to expand, and invest in new machinery and equipment. Some of the investment can be funded from profits they have made, or from the issue of shares, but often it has to be borrowed.

The more they borrow, the more interest they pay, and the bigger the risk is. We therefore want to assess how big that risk is, and to do this we use a ratio. The ratio is known as the gearing ratio. The higher the gearing ratio, the higher the probability those equity holders will be left with very little residual income. The higher the gearing ratio, the bigger the proportion of the companies' money that is borrowed and therefore the bigger the risk is.

A company with a high gearing ratio is in a very dangerous situation if interest rates are going up, i.e. exposure to financial risks. GEARING RATIO 2000 2001 2002 2003 2004 British Airways 0.754 0.792 0.806 0.531 0.6856 Sector 0.518 0.708 0.498 0.681 0.419 From the above graph, comparing with other four years, we can see that the gearing ratio in 2002 is the highest, 80.6 percentage. There are the interest payment problems and the control problems of having a dangerously high level of long-term debt, mainly due to the increased borrowing, and reduction in total capital (lb 319 million) in 2002, it reveal a high risk to the shareholders. In 2003, it reached the lowest point. One main reason if that the long-term liabilities increased by 18.5 percentages in 2003.

Comparing with the British Airways, the European airlines are much better than it; their gearing ratios are between 0.4 and 0.7. There is also another measure we can use to assess whether the company is a bit over-exposed to interest rate changes, and that is a ratio called the interest cover ratio. This measures how easily the company can pay its interest out of its profit. As rule of thumb, the interest cover is that firms should be concerned if this ratio falls below about 5.

Certainly a firm, which has a ratio approaching 1, should be very concerned as it is approaching a situation of financial distress INTEREST COVER 2000 2001 2002 2003 2004 British Airways 0.749 1.15 0.398 1.2699 1.699 Sector 17.35 -12.88 8.47 2.16 5.39 In year 2002, the interest cover is the lowest, because it increased long-term loan. The more they borrow the more interest they pay. Apart from that, the earning before interest and tax of it in 2002 is just lb 149 million. Comparing with year 2001, it decreased by 144 percentage. In year 2004, it reached the highest point.

Because of increasing earnings and decreasing the interest expenses at the same time. The above graph indicates that in year 2001, the interest ratio of the European Airlines decreased to negative 12, 88. The main reason because the Scandinavian Airlines got the negative earnings of 173 million pounds. Thus, the interest ratio of European Airline is volatile. However, the situation in interest of the European Airlines is better than British Airways except year 2001.2. 4 Short term Finance - Liquidity - Ratios CURRENT RATIO: The current ratio indicates the extent to which current asset are available to meet current liabilities.

The current ratio for the year 2003 was 0.94 times and in 2004 it was 0.92 times. Because the company's current ratio is less than 1.0, current asset would not be fully cover short-term debt. And from comparing this ratio with the sector ratio BA still lower by an average of 0.10. And because the airline industry has a high fixed cost, this indicates a bad position for the company. QUICK RATIO The quick ratio or acid test ratio is a measure of a company's liquidity used to evaluate creditworthiness. This ratio works out by taking out stocks from current assets divided by current liabilities.

The quick ratio for BA in the year 2003 was 0.81 times and in year 2004 it was 0.82 and from comparing this ratio with the sector ratio, BA still lower by an average of 0.09 times. Also this ratio indicates a bad position to the company. STOCK DAYS: The higher the investment in stocks the worse, as the money is not available to be used elsewhere. BA comparing to the sector is doing well in the year 2003 the stock days for BA was 4.2 days but for the sector it was 19.02 days. DEBTOR DAYS A ratio used to work out how many days on average it takes a company to get paid for what it sells. Debtors day for BA in 2003 it was 37.16 days while for the sector it was 56.19 days which is a good indicators for BA.

CREDITORS DAYA ratio used to work out how many days on average it takes a company to pay its creditors. Creditors days for BA in the year 2003 it was 37.16 but in year 2004 it decreased to 35.02 while debtors days for the sector it was 56.194, 59.518 respectively. The longer the period the better for the company in reasonable way. Moreover, this is can also be of almost free finance for the company in the short term. It correlates earning after interest and tax divided by the number of issued ordinary shares.

The earning per share in 2001 was 0.11 and in 2002 it dropped to (-0.132) in the year 2002 but after that it started to recover. Dividend cover-dividend yield: this ratio shows what proportion of profit on ordinary activities for the year available for distribution to share holders. However, BA has not paid dividend since 2001. On the other hand, according to the new Chairman the company has intention to resume dividend payment to its shareholders from next year.

P / E ratio: this ratio compares the amount invested in one share with the earning per share. The ratio in BA was 44.34 and started increasing since until 28.35 and the forecast for the next tow years it will decrease also until it hit 10.53. Section 3: Valuations 3.1 Dividend Discount Model (DDM) Dividend Discount Model (DDM) is one of the most straightforward and extensively models of equity valuation. In this model, BA is valued in relation to the cash flows which it generates generally, though focuses on distributed earnings of the firm, that is, dividends. However, BA has not paid dividends since 2002, therefore, under DDM assumptions the retained earnings by BA have been reinvested in the company and thus it would enhance the future dividend payments. Dividend discount models are of greatest use when: o The company concerned actually pays a dividend o There is a clear company policy linking dividends to underlying earnings.

The basis of the DDM, then, is that the price to be paid for equity in the market should reflect the future stream of dividend payments accruing to the equity investor. The advantages of the dividend discount model are: 1. It is very simple to understand and apply 2. It focuses on the most visible form of returns to shareholders (dividends) 3. It relies on only a few parameters, requiring only the observation of the current dividend, the required rate or return on equity, and some projection of the future pattern of dividends. The disadvantages of the model are: 1.

It does not deal well with a required rate of return which is equal to or lower than the growth rate of dividends 2. It does not enable us to value firms which do not pay dividends 3. It concentrates on a very narrow range of parameters and may not capture the fundamental determinants of firm value. Assume that British Airways has 7 growth years and 10 transitional years. Long term growth rate of this company is 11.377%.

The theoretical present is 116.73 which is significantly lower than current price of 224.50. According to DDM model the current stock price is obvious overvalued. 3.2 Price Earning Model Ratios Company / Sector 2004 2005 (E) 2006 (E) EPS British Airways 0.12 0.1694 0.20859 Airline sector 0.3 0.4481 0.5894 P / E Ratio British Airways 9.13 13.30 10.80 Airline sector 8.145 9.9045 7.1325 Estimated EPS are optimistic for the next two years since they indicate that the British Airways will further improved its position. The industry's P / E ratios are lower than the company; it is assumed that the investors confident less than the industry's average.

Furthermore, the Price Earning Model has utilized to forecast the future share price of the British Airways: The forecasting price of 224.48 is slightly higher than the current price, which indicates that the current price is overvalued. However, EPS seems slight optimistic. If the future EPS decreased, the theoretical price will continue to lower than its current price. 3.3 Risk Analysis R 2%British Airways 2.663 15.79 Industry 1.9485 16.55 FTSE 1.00 100 Beta is the measure of systematic risk. Systematic risk is variability of returns that is due to macroeconomic factors that affect all risky assets. Because it affects all risky assets it cannot be eliminated by diversification.

Macroeconomic factors include things such as economic growth, inflation, and exchange rate changes and business risk. Beta measures the volatility of the security in comparison with the market as a whole, in this case estimated by the FTSE 100, i.e. how many changes in the stock can explained by index changes. The industry beta is above 1.00, which suggests that it is highly sensitive to the market movement and the business cycle. British Airways has a beta of 2.663, which suggests that it is very sensitive to the whole economic and the FTSE market even more volatile than the industry.

R-Square is a correlation measure between daily returns on the stock and the index average returns. It fluctuates between 0 and 1; values close to zero show little or no correlation between the stocks. On the other hand, figures close to 1 show a strong parallelism between both performances. In our case the R-Square is 15.79% which indicates that the Beta only explains 15.79% of it price movement.

However, there are other significant factors that affect British Airways. 3.4 Residual Valuation Thus our residual income figure is negative (-2.58) which implies that British airways, whilst producing healthy accounting earning, i.e. is profitable from an accounting viewpoint especially during last 12 months, however, failed to cover the cost of equity capital (failed to cover the opportunity costs of shareholders). Therefore, British Airways in this sense is destroying value as shareholders could get a far better return investing their money elsewhere. The advantages of the residual income model are: 1. It uses readily available accounting data 2. It can be used to value a company even when that company does not pay dividends 3.

It focuses on economic profitability rather than accounting profitability. The disadvantages of the model are, however: 1. It is based on accounting data which can be subject to creative accounting 2. The model requires 'clean surplus accounting' to hold, which means that it requires all gains and losses to be shown in the profit and loss account (income statement). In many countries such as the UK, there are gains and losses to the firm which do not pass through the income statement and go straight to the capital account on the balance sheet. Good examples are exchange rate losses and property revaluation gains.

Section 4: Prospects and Summary As the second largest airline in Europe and the market leader in the airline industry, British Airways has been strengthening its position in the industry. Despite the Iraq war and the oil crisis in one hand and fierce competition both nationally and internationally, BA amazingly has managed almost double its operating profits compared to the previous year. However, this achievement has done through its remedial Future Size and Shape Strategy in order to deliver significant savings and manpower reduction. Moreover, BA has a plan to resume its dividends payment to its shareholders after a delay of almost three years. According to Rod Eddington, BA's Chief Executive, results for 2003-04 show, that BA have risen to all the challenges that have come its way and have emerged a stronger, fitter company. They give us every cause for confidence, and provide a sound foundation for investing in the new products it will need if they are to remain competitive and lead the way, rather than follow it.

British Airways is obviously struggling to strengthen its balance sheet, a profound example is the effort they make to better handle their overcapacity issues. The risk and financial ratios analysis suggest that despite the recent increase in its net profits, the volatility of the stock price is the main weakness for the British Airways. Moreover, uncertainty of the future oil prices on one hand and high debt and borrowing on the other are main issue and concern for the management at the BA. These are the main concerns for the management at the BA: o Oil price so High debt and borrowing and repayment (very high gearing) o Competition Staff's strike so Shareholders (dividends) o Customer services and recovery Our conclusion that derived from our financial analysis for BA is HOLD. (i.e. because of its overvalued share price and the present stock price risk fluctuation).