Reflections on Ratios for China Southern Airlines
Sales:
The first thing I looked at with China Southern Air (CSA) was
what is happening with sales. Sales have been steadily increasing over the past
4 years. To me, this means that customer numbers are growing, more airfares,
more cargo and freight are being sold…and are expected to be increasing. So, it
makes me curious if sales are increasing, why is net profit decreasing? Net
profit after tax was steadily increasing from 2015 to 2017, then there was a
dramatic dip in profits in 2018, from $6,898 mill RMBs to $3,364 mill RMBs.
What happened to cause this drop? What else affects profits besides sales? My
immediate assumption was an increase in expenses, but what expenses and why?
Profit Margin:
I didn’t really understand what profit margin meant or what a
good measure is supposed to be. So, I did a quick Google search and found that it
tells you how well a firm uses its income. In a nutshell, profit margin shows
how much profit is generated per each dollar of sales. A high profit margin is considered
to 20%, or 20cents of profit is made from each dollar of sales, 10% is about
average or ‘good’ and 5% is low. CSA has a terrible profit margin over the past
4 years but, currently it is the worst. In 2015 at a rate of 4.3%, CSA slowly
increased its margin in 2016 at 5.1% and 5.4% in 2017. However, something
triggered a dramatic drop in 2018 to create a profit margin of just 2.3%. Yes,
last year they were only making 2.3cents of profit to each dollar of sales.
Why??? Again, I began thinking about the cost of operations, expensive new
planes, increasing fuel prices and load factors from passengers and cargo.
Looking at the financial statements revealed so many factors that potentially
could be influential.
NOA and ATO:
I then chose to see what’s happening with assets. CSA has progressively
increased NOA over the past 4 years. The most recent increase occurred recently
from $168,478 mill in 2017 to $192,005 mill 2018. The total asset turnover
ratio is high, holding steady at 0.6 over the past 4 years. Their current asset
turnover is even higher, from 8 in 2015 and 2016, slowly declining from 7 in
2017 to 6 in 2018. ATO has ratios from 77% - 80%, I interpret this to mean the
company is good at generating sales from its assets, or in other words, use
their assets very efficiently. But what does that mean in terms of
profitability?
RNOA:
The return on net operating assets (RNOA) reveals very low
percentages, which doesn’t look good for efficiency. Rising
from 4.3% 2015 to 4.9% 2016 to 5.3% 2017 and then another dramatic drop in 2018
to just 3.1%. I will need to compare
other ratios in the airline industry to see if this is normal or not. If anyone reading this has an airline, please leave your comparisons in the comments or feel free to contact me via email. There is
no doubt in my mind that assets are a major factor of the economic and business
drivers for CSA, but I also know that there is more to the story.
Hi Sharon,
ReplyDeleteI enjoyed reading your post about the ratios for your firm. My firm is Autoneum, which develops and produces equipment for car manufactures, so the comparison of our ratios will be quite indirect, due to the different industries our firms operate in.
Sales:
I had the same issue with my firm. Revenue/sales has been steadily increasing; however, profit has been declining. I also put this down to increasing expenses.
Profit Margin:
Profit margins can't be viewed in a vacuum, which I think you may have done, when you commented on your firm saying the margins were very slim, compared with what your online search yielded you. Profit margins for airlines are renowned for being slim. For example, Qantas's net profit margin for FY 2019 was only 5.06% and 3.35% for American Airlines.
My firm has also been slowly increasing its NOA. I think this is simply a sign of a mature firm. In regards to your ATO ratios, I would argue they are actually quite inefficient. You have stated your firm’s ATO is between is between 77 and 88%. This means, that for every $1 of assets, it is generating between 77 and 88 cents. This really is not much (unless of course you are calculating the ratio backwards, that is, dividing assets by sales). A quick online search suggests that ATO’s between 1 and 3 are healthy. 0.77 and 0.88, would therefore be quite low, unless again, this is normal for airlines. Qantas’s ATO looks to be very low at 0.44 for the quarter ending June 2019.
RNOA
I think you are right when you said that it might be possible that CSA’s RNOA might be low simply due to the industry in which it operates.
Conclusion
In summary, I enjoyed reading about the ratios of your firm. It would have been good to read some more about the ratios of your firm. On a final note, I would recommend continuously comparing your firms with its competitors, simply because airlines are inherently a hard business to run and are quite unique in that way. Perhaps that is one of the reasons why Allan Joyce, the CEO of Qantas, was the highest paid CEO in Australia for the 2019 financial year.
If you got the chance, I would appreciate some comments in return. You can find my post at https://itsacrrualworld.wordpress.com/2019/09/29/step-3-ratios-commentary/.
Kind regards,
Daniel
Thanks for your insights Daniel. There are some industry norms I wasn't familiar with and I appreciate the research comparisons. I'm beginning to understand the relationships with big ticket assets such as million dollar aircrafts and how complicated the success of turn around is to achieve. I think perhaps Allan Joyce earned his remuneration and accolades keeping Qantas thriving.
DeleteHi Sharon,
ReplyDeleteFirstly, it was great for me to read your ratios considering I also have an airline. This insight is great to see how others are performing within the same market.
Sales: Great interpretation of what you predict is happening within China Southern Airlines. You have included some thought provoking questions in regards to what you found from your sales ratio.
Profit Margin: I really enjoyed that you included a definition of profit margin before diving in to what you found for your company. My company has the same thing when it comes to high expenses due to fuel etc. It is great to that we are in the same boat when it comes to profit margin. Well done.
NOA & ATO: Great interpretation of how CSA has been going through what appears to be a good trend. Once again, I liked how you questioned how NOA and ATO is affecting other things.
RNOA: In comparison to Aeroflot, there is a big difference. In 2015, Aeroflot was sitting at -27.8% and then went up to 14.8 in 2016 and 16.1% in 2017. However, due to some issues it dropped again to -7.7% in 2018 and is even worse in the valuation. So, it might be something to worry about due to how unpredictable it can be in this market. I think you are very right to question its low percentages and comparing with others is hopefully going to be helpful in finding your answer.
In conclusion, I think you have done a really good job in evaluating your ratios for CSA. You have shown that you have an understanding along with plenty of questions on what somethings actually mean. I hope my insight/comparison will be helpful!
Kind regards,
Hannah Lewis
(I have this saved in a word document in the feedback table but decided that this was the easiest way to get it to you!)
DeleteThanks Hannah. I've found the uniqueness of my airline is the support of their government. I'm yet to decide if this is advantageous or not. Digging deeper into the assets and operating expenses I am beginning to uncover some connections. Such as the grounding of the Boeing Max 8 due to fatal crashes (from other airlines)til 2020, sky rocketing fuel prices (which may worsen with the attacks on oil refineries) and subtle changes in accounting policies. The chinese also increased the retirement age of pilots to compensate for the lack of trained pilots in the future. Does your company have difficulty in expanding the number of aircrafts and finding appropriate employees? Since CSA have decided to focus on brand image, the expense for selling and promotions have increased, but I'm not sure how they are spending that money. How on earth does Aeroflot advertise? What do you think is happening with the accounting numbers and have you made any links?
DeleteHi Sharon. I don't think Aeroflot has any issues with their expanding since they lease quite a lot and they mentioned in their annual report for 2018 that they have a goal of having more women in their work place so I assume this means they are not having any issues finding employees.
DeleteAeroflot advertises a lot through social media from what I can see. I actually uploaded this post yesterday about that: https://hannahcqu.wordpress.com/2019/10/02/aeroflots-new-strategy/
They're making losses in 2018 mainly due to the growth of the business which means adding more planes but they also made losses due to the fuel prices and crashes from early in the year. I do believe that they might be working on improving this in the future as they have many goals that include many things that need improving.
Hi Sharon
ReplyDeleteI also have an airline and have found it interesting reading what you have to say about your firm!
I have found with my airline, El Al Israel Airlines, that their sales have also been quite steady but have increased during the 2018 year, however their net profit has decreased. I believe mine is mainly due to the increase of jet fuel prices as this is something that they mentioned continuously in their annual reports. Could this be the same for yours?
I appreciate your explanation on profit margin as this is something that I didn't understand either before having to discuss my ratios. My firm is only making 0.06 & 0.04 cents in the 2015 and 2016 years respectively for every dollar they make, and from then on it continues to decrease to a negative 0.01 in the 2018 year, so your firm is doing better than mine! Again, jet fuel prices? What else?
My firm's NOA has remained steady over the years and like yours, had its greatest increase in the 2018 year from the 2017 year. They dropped to 544,536 in the 2017 year and had an increase up to 978,913! I think this is what has been the biggest driver of my firm's positive economic profit in the 2015 and 2016 years.
Comparing RNOA with your airline, mine has RNOA's of 19%, 14% and then decreasing to 4% and then to -3% in the 2018 year.
Let me know if you find anything else with your firm! I am still currently in the process of my draft, but when I am complete if you are happy to give me feedback let me know! :)
Thank Kaidesha. Wow, a negative RNOA, that can't be good. Is there any indications of what is the increased spending in operating expenses? I took a deeper look into the annual reports to discover the number of kms flown in comparison with the number of new aircraft purchased or leased, which looks like a promising lead. Has your company changed the type of aircrafts they use? CSA have purchased aircrafts with better fuel economy and larger passenger seats with larger cargo space. I think that will affect their future earnings but I'm not sure how to factor it in as a part of the calculation for RINOA.
ReplyDeleteIt was interesting to see that another airline service had similar steady increase in sales over the four year period. Perhaps indicating that their is an ongoing increase in people spending their excess earnings on holidays. Sharon proposes that the decrease in net profit is a result of an increased expense. Which I then went to consider the steep decrease in net profit for AirFrance in 2018 I followed a similar train of thought and found that it was a result in an increase in an expense of other comprehensive income in the account of 'change in fair value and cost of hedging transferred to profit or loss' which was a significantly higher expense in 2018 than other years.
ReplyDeleteAlso similarly, China Southern Airlines and Air France both have low profit margins well below the 5% min line. Though unlike China Southern AirFrance's profit margin has increased since its low in 2016. Unlike China Southern which has had a steady increase in NOA my firm's NOA has been decreasing as the operating liabilities have been increasing more than the operating assets. Interestingly, China Southern has a high ATO or sales to NOA ratio of between 77-88% which suggests efficiency in use of assets to generate profit but AirFrance has a far higher ATO with 528% being the minimum in 2016 and 759% being the maximum in 2018 which would tend to indicate an extremly good use of assets for sales? i originally didnt consider viewing this as a percentage but it does put a very positive lean on things when considered in that light since it suggests at worse for every dollar of NOA their is an earning of $5.28 for the lowest amount and $7.59 at the highest.
Apologies for the delayed reply. It took me a while to figure out who you were Sarah! Is there any other indication of increased spending on overseas holidays? Have you had a look at France's GDP rates and fluctuations in the Euro? Does France use Euros?Air France's ATO seems to be extraordinary. Did you read Daniels's comments regarding 'normal' efficiency ratio for ATO? I could understand a decrease in NOA if they are not purchasing new aircrafts or perhaps choosing to lease instead. Would that affect increased liabilites? Or is it the fuel thing too? I discovered that CSA also increased employee incentives which increased liabilities a bit and also promotion and selling. It did take a bit of digging though. There are also some other expected industry norms unique to airlines.
DeleteFuel is more of an increased expense on the income statement for me. it seems to be increased liabilities due to lease debt which could be leasing the new planes since it was never very clear if they where leasing or buying just 'changing' but since lease debt went up i can assume that the new planes are under lease increasing the liability. i found some indication that their has been roughly a 2% increase on holiday spending globally for several airlines, though not sure where the information was based on. i have not looked at exchange rates since it is not as major an element except for fuel expenditures. I looked at the average wage versus the average living costs, which showed a rather different degree of earnings over living cost.
DeleteThis comment has been removed by the author.
ReplyDeleteFrom messenger: Interesting to see how your sales have been increasing and yet your net profit is decreasing. After further surfing the internet I found this article which may explain your net profit decrease. https://asia.nikkei.com/Business/Companies/China-airline-trio-suffers-first-profit-drop-in-5-years It shows that with the high fuel costs and also the decrease in the Yuan that profits were down. With the grounding of the Boeing 737 Max after recent crashes and authorities asking the domestic carriers to sop using the planes in 2019.
DeleteProfit Margin – if any indication of the company having to stop using the Boeing 737 Max and using older airplanes could cause the effect of loss of profit. With high fuel costs, fluctuating tariffs the potential for higher profits is somewhat sombre.
NOA and ATO – Looking at the efficiency ratio here if the company expenses are increasing where were these increases from? This would be where we would analyse how well the company is using its assets and liabilities. I can see that your asset turnover is high and that having a high asset turnover is using its assets effectively.
RNOA – looking at your response in this area and having a low Return on Net Operating Assets looking at why could help. I found that with China Outfitters Holdings Ltd it was due to the company classifying some of their trademark companies as intangible assets with indefinite lives.
You have put a lot of thought into what you have written. You have logically laid out the main point of your discussion. It will be great to see what you have written for Steps 4 & 5. I will finish my evaluation sheet once I have seen the rest of your steps.
Reply: I knew about the grounding of the Boeing Max 8s til 2020 and that they cancelled the contract for 60 odd more to be built. I didn't think to look at the strength of the yuan or tariff fluctuations. There are some minor connections in the financials indicating some changes in exchange rates, but not so significant. I'm feeling that it is difficult to assess the efficiency of the assets due to the nature of the industry. These are big ticket assets, millions of dollars up-front outlay and millions to maintain and operate, all before one cent of sales has been made. And it kind of has to be that way due to the precious cargo of human life. I'm still struggling to find adequate answers to why the economic profit is staggeringly negative and increasing and why anyone would want to invest - which doesn't seem to deter CSA from issuing more shares each year. Still lots of questions yet 🤔
DeleteIris: Thinking about what you have just written once the airplanes are in the air we could think about the landing fees and operating costs of that affect the planes use.
DeleteReply: Yes! of course, taxi fees on runways, hanger fees, gee the airport hub itself! It's stupendously expensive to run an airline. I totally forgot about the airport they've recently opened in Bejeing. I can't imagine these kinds of assets being easliy liquated or resold or properly valued...I was thnking what do they do with obsolete airplanes too
DeleteIris: Also what about your competition especially the new airline Scoot
Delete