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Table 7.DuPont System Analysis – Five Year Averages, lists the averages for five years

DuPont System Analysis from FY02/03 to FY06/07 for the four airlines. The average figures

are advantageous for the analysis process as each airline is potentially in a different strategic phase and each year new strategic decisions are made. The five year average gives a good reflection of the overall expertise and success of the respective company Boards.

DuPont System Analysis – Five Year Averages

Air New Zealand Easy Jet Qantas Virgin Blue

Income Statement

Net Profit Margin (NPM) 4.38% 4.54% 4.56% 9.2%

Balance Sheet

Total Asset Turnover (TAT) 0.89 0.78 0.70 1.07

Financial Leverage Multiplier(FLM) 3.04 1.90 3.07 2.94

Return on Total Assets (ROA) 3.94% 3.46% 3.19% 10.1%

Return on Common Equity (ROE) 12.0% 6.78% 9.71% 29.53%

Table 7. DuPont System Analysis – Five Year Averages The comparative observations are:

 The five year average NPM for Virgin Blue is over twice that of each of the other three

airlines

 Virgin Blue has a considerably higher TAT than the other three airlines

 The two flagship airlines, Air New Zealand and Qantas, have the highest FLM

 Easy Jet has the lowest FLM followed by Virgin Blue.

 Virgin Blue has over twice the ROA of each of the other three airlines

 Easy Jet’s ROE is approximately twice that of its ROA whilst the other three airline’s have an ROE of approximately three times their respective ROA

The Total Asset Turnover (TAT) compares sales against assets which would indicate that Virgin Blue is using its assets more effectively than the other three airlines. This is also supported by Virgin Blue’s considerably greater Return on Total Assets (ROA) and Return on Common Equity (ROE). It is important to recognise that the total book value of the assets may differ from the true market value if inadequate allowances for this have been made in the financial reporting process. For the calculation of the FLM the total assets include the total liabilities and the total assets which include capital investments which are supported by debt. In other words, some of the assets are liabilities.

Despite a similar NPM to Air New Zealand and Qantas, Easy Jet has the lowest Financial Leverage Multiplier (FLM) and therefore has a low ratio of total assets to stockholder equity (Net Assets). This indicates that Easy Jet has managed to achieve a similar NPM to Air New Zealand and Qantas with less financial risk. Easy Jet also has one of the lowest ROA and by far the lowest ROE despite the announcement by the Board that ROE is to be its key

financial measure for the benefit of the shareholders. This is possibly due to new capital investments such as the purchase of additional new aircraft. Aircraft are the primary assets which are required to create cash flow and an improved NPM. Different financial reporting standards could also play a part in this variation.

It is possible that Easy Jet’s total asset to stockholder equity ratio is low due to a number of leased aircraft which are not classed as assets. These leased aircraft were being returned off lease from 2006 onwards. Easy Jet’s Board has declared that no dividends will be paid and that all profits will be reserved for reinvestment. Easy Jet is now purchasing its aircraft. Despite the relatively similar FLM, Virgin Blue has managed to achieve by far the greatest ROE and ROA of all four airlines. Virgin Blue’s Total Asset Turnover (TAT) is approximately 20% greater than the other airlines and its NPM is twice that of the other airlines. This is possibly due to lower operating costs, high load factors and the use of cash or debt to finance its ongoing operating assets to support the airline’s expansion.

3.3.1 Comparison of Airline Risk and Return Analysis

Air New Zealand and Qantas are both flagship airlines and well entrenched as their respective country’s primary airlines. The low cost airlines, Easy Jet and Virgin Blue, are initially perceived as the ‘under dogs’ which generally means that the competition will not see them as a competitive threat. Both Easy Jet and Virgin Blue have started with ‘clean slates’ which has enabled them to customise their strategies and operations to the current market.

Comparison of Capital Asset Pricing Models (CAPM)

The Intercept of Regression (Alpha) measures the price volatility. The difference in return of

stock that exceeds or lags beyond its Slope of Regression (beta) is the Intercept of

R-Square is the square of the correlation coefficient and is the proportion of the variability in one

provides a measure of the quality of fit. 100% R-square means perfect predictability. (Financial Dictionary. 2009).

TheCorrelation Coefficientis the standardized statistical measure of the dependence of two random variables, defined as the covariance divided by the product of the standard deviations of the two variables. (Financial Dictionary. 2009).

Regressionis a mathematical technique used to explain or predict. The general form is Y = a + bX + u, where Y is the variable that we are trying to predict; X is the variable that we are using to predict Y, a is the intercept; b is the slope, and u is the regression minimize the squared sum of the residuals. The ability to fit or explain is measured by the (Financial Dictionary. 2009).

Residuals are(1) Pa

return). Residuals measure the impact of (Financial Dictionary. 2009).

Expected Returnis the return that is expected to be earned on a given asset each period over an infinite time horizon. (Gitman. L. J. 2007). An investor would be expecting the expected return to be at least equal to the required return. If this is not the case then a price adjustment will occur.

Table 8. Comparison of Airline Capital Asset Pricing Models (CAPM), records the results of

the regression of returns analysis of airline stocks against the market index using fifty-four months of observations up to May 2008.