CONTENT

(i)
(ii) (iii) (iv) Air Asia and MAS Profitability Performance Analysis Air Asia and MAS Liquidity Management Analysis Air Asia and MAS Gearing Ratio Analysis Air Asia and MAS Investment Ratio Analysis

Appendix A: Air Asia 2009 and 2008 Financial Statements

Appendix B: Air Asia 2007 and 2006 Financial Statements

Appendix C: MAS 2009 and 2008 Financial Statements

Appendix D: MAS 2007 and 2006 Financial Statements

Appendix E: Ratio Definition

Financial and Management Accounting

Assignment 1 Select two companies that operate in the same industry. Analysing two companies will enable you to judge the performance and financial position of the companies better as you will be able to compare and contrast the performance and financial position of each company. The annual reports of most companies can be obtained from the company websites. In selecting the companies, avoid financial institutions and any company that has been involved in a major acquisition or merger in the past three years. It is strongly recommended that the companies are based in the same country as this will reduce your problems in terms of different legislation and accounting practices. Required:(i) (a) Calculate ratios which will assist you to assess the performance of the companies over a period of three to five years. (8 marks)
Below are 4 profitability ratios that help to access Air Asia and MAS Airline company performance, and understanding their profitability in relation to other relevant cost in 2006 to 2009 financial year.

1. Gross profit Percentage (GP%)

*Note: MAS Gross Profit is calculated as follow:

2. Net Profit Percentage (NP%)

3. Return of Capital Employed (ROCE)

*Note: MAS 2009 EBIT is calculated as below to enable comparable comparison, because Air Asia takes their derivative gain/loss value into their Operating Expenses account. This enables fairer judgement, between the two airline companies, else they be compared on unequal basis and thus do not provide true picture to possible investor MAS 2009 EBIT= (Loss)/Profit From Operations + Derivative Gain = -628,260+ 1,163,133 = 534,873

4. Return on Shareholders Fund/Equity (ROSF/ROE)

(b)

Compare the performance of the two companies, explaining the likely reasons for the differences between their performance over the period. (16 marks)

MAS airline have high revenue comparatively to Air Asia. However, gross profit percentage and net profit percentage calculated above indicates Air Asia generates better return than MAS from 2006 to 2009 financial year, except year 2008. One reason is Air Asia has better operation efficiency, which generate gross profit more than 20% with its leaner operation expenses, in all years except 2008. MAS with business strategy Going Beyond Expectations had over run their operation cost to the extent that is non-sustainable by core operating revenue income. Thus the negative (or low positive in financial year 2007) gross margin performance. However, MAS could rely on Other Operating Income and Derivative Gain to generate positive net profit, ROCE and ROSF/ROE between financial year 2007-2009 as shown in analysis in section (i)-(a). Unfortunately the incomes gained for MAS from the non-core service business (generated from sales of plane, properties, gain from hedging against fuel and currency, and etc) are not consistent. Therefore, ROCE the fundamental measure of business performance fluctuates irregularly from -5.25 in year 2006, moving up to 10.01 in 2007, dropped to 3.26 in 2008, and finally increase to 6.85 in 2009.

Air Asia on the other hand, generally shows a consistent positive ROCE with growth from 2006 to 2009 (except 2009, to be explained later) comparatively with MAS, most likely because of their growing and profitable core airline service operation. There is an exceptional in 2008, where Air Asia had performed poorly against MAS in all four profitability ratio, computed in section (i)-(a). Looking at Air Asia 2008 income statement, Aircraft Fuel Expenses was exceptionally higher than 2009 fuel spending, despite other operating expenses remained lower, in lined with the financial year revenue. One reason is due to crude oil price fluctuation. Crude oil price in 2008 had climbed at significantly pace, resulted to Air Asia taking position to hedge against the rising fuel cost. Shortly after this, crude oil price plummet to low value, resulting Air Asia operating with high fuel cost. Worse, when the quantity of fuel hedge at high price would flow over to following financial year, Air Asia decided to write off the high cost fuel against market price of the time, in 2008 financial year as Loss on Unwinding of Derivatives, eroding the operation profitability, thus the loss reported in year 2008. This is also done to allow Air Asia to compete competitively for new financial year, instead of carrying the burden from wrong decision in fuel price hedged. MAS, may or may not have taken any position in fuel price hedging. But the any decision made at that time gave them the benefit of performing better than Air Asia in financial year 2008. Nonetheless, MAS after adopting new Financial Reporting Standard 139 (FRS139) that establishes the principles for recognizing and measuring financial assets, financial liabilities and certain contracts to buy or sell non-financial items, had to write-off contingency losses in the balance sheet resulting to drop in equity to 0.74billion in 2009, from 4.19billion recorded in 2008. This adoption makes the ROCE and the ROE computed difficult to compare against Air Asia return to investor. Base on the computed figures, Air Asia can be said to perform better than MAS in ensuring consistent return to the shareholders.

(ii)

(a)

Calculate ratios that will enable you to comment on the liquidity and management of working capital over the period. (10 marks)

To comment the liquidity and working capital management, we can use liquidity ratios and efficiency ratios to measure the airlines performance over the years. Liquidity ratios measure the ability of the business to meet its short-term financial obligations, while efficiency ratios measure the how are the resources of the business are managed. Liquidity Ratios 1. Current Ratio

2. Quick Ratio

Efficiency Ratios 1. Inventory Holding Days (IHD)

2. Receivables Payment Days (RPD)

3. Payables Payment Days (PPD)

4. Cash Conversion Cycles

(b)

Discuss the likely causes and effects of the changes in the liquidity ratios over the period of two years. (15 marks)

Table ii-b-1: Summary of liquidity calculated from section (ii)-(a) Comparing 2008 and 2009 financial years, Air Asia current ratio and quick ratio had increased as shown in table ii-b-1 above, whilst MAS in the same years experienced dropped in both ratios. Current ratio is comparison of business liquid assets with current liabilities. Hence the increase of Air Asia current ratio

signified increase in company current assets significantly against their current liabilities from 2008 to 2009. This is noticeable for the current ratio computation in section (i)-(b). The major increase was vastly contributed by cash build up, available in form of deposits, cash and bank balances, as we can observe from Air Asia balance sheet attached in Appendix A. MAS current assets on the other hand, dropped from RM6.6billion in 2008 to RM4.7billion in 2009, and had increase in current liabilities, possibly contributed from hedging activities against fuel, currency and interest rates amounting RM584.8million as show in MAS balance sheet in Appendix C. Such movement of assets and liabilities, can be undesirable at some extend, because with ratio of 0.86 means MAS current assets is about adequate to payback 86% of its current liabilities, so the business maybe experiencing some liquidity problem. Air Asia and MAS has a special circumstance in quick ratio computation. Noticeably, its movement trend is similar to current ratio trend. Reason is because both airline companies are service base providers. Thus inventory required to ensure business continuation, comparatively to other current assets, is relatively small, which is observable in the quick ratio calculation. Thus, we can say the quick ratio changes are similar to current ratio changes explanation. Air Asia operation outsource their aircraft major maintenance, while MAS carry many major maintenance internally. This resulted to Air Asia require fewer inventory comparatively to MAS, hence the minor change of Air Asia quick ratio compared to its current ratio, while MAS which carry more inventory for maintenance purposes would have relatively larger drop in quick ratio against its current ratio. Mentioned, service industries usually carry minimal stock. This explained the low number of inventory holding days for both airline companies, because the value to the stocks is relatively low compared to their revenue. Hence the small changes in number of holding days for both airlines. MAS inventory holding days increased from 9.1 to 11.5 days was mainly due to drop in cost of sales, a direct result of drop in 2009 revenue, while its inventory increased slightly in value. Air Asia and MAS passenger flight service would receive advance payment before deliverable. Such practice would inevitably bring down receivables payment days (RPD) quite considerably on average basis, with receivable incomes from cargo freight, advertising, on-line merchandising, and etc. Despite lower in 2009 financial year by MAS, the RPD stand almost the same in both 2008 and 2009 years which could possibly means the receivable as a whole could fall proportionately. The changes in Air Asia receivables would could be due to stronger higher income generated from their passenger airline sector which brings the other income revenue substantially lower by proportion, or Air Asia might had improvement in their collectibles from incomes generated from the non-core service deliverables. Payable payments days (PPD) for both airlines had increased though at different rate from 2008 to 2009. In Air Asia, the PPD increased substantially from 87.2days to 142.9days. Two possibilities, one as mentioned in section (i)-(b), Air Asia was operating with relatively high fuel cost. This commodity product would be paid as used, or be strictly given only short-term payment period. Therefore on average, the hedging activities bu Air Asia would substantially reduce the PPD of year 2008. Else, Air Asia might have choose to shortened payables period in 2008 in return for better savings from other suppliers in order to reduce losses incurred from the hedging activities. MAS circumstances would be similar, and may not be very active in the hedging activities, thus the differentiation within the two years is not as large as Air Asia. The aboves contribute to the cash conversion cycles management, which measures the number of days a company's cash is tied up in the the production and sales process of its operations and the benefit it gets from payment terms from its creditors. The
shorter this cycle, the more liquid the company's working capital position is. Therefore in summary, whatever the circumstances maybe, Air Asia had certainly improved its liquidity vastly from 2008 to 2009, while MAS too made improvement, in the capital management, but in a smaller way compared to Air Asia.

(iii) (a)
1.

Calculate gearing ratios for the two companies. ( 4 marks)

Gearing

2.

Interest Cover

*Note: Please refer to the explanation on MAS 2009 recalculated EBIT value, in section (i)-(a), under the ROCE computation table

(b)

Discuss the capital structure of the two companies and the implications of the funding decisions that were made in the past. ( 8 marks)

Air Asia and MAS business operations had been financed by both internally by the shareholders as equity, and externally by loans borrowed. From 2006 to 2009, Air Asia had increased their long term borrowings substantially against equity increased, thus raising their gearing ratio. With the borrowings, Air Asia can leverage on the funds available to finance its business expansions such as acquiring more aircraft, expanding its Low Cost Carrier Terminal facilities, basically to generate higher revenue turnover that cannot be supported by equity alone. Such decisions were made with expectation to generate higher returns to the shareholders, simply because at high gearing, any changes in operating profit will lead to a proportionately greater change in ROSF ratio. The increase in borrowings funded Air Asia activities to generate better return in year 2007 compared to 2006. Thus the ROSF/ROE value increased from 17.56 to 29.97, a favourable return to equity owners. However, with increased borrowings in year 2008, the negative profit incurred from operations, inevitably declined the ROSF/ROE value of Air Asia to -30.93, which would totally devastate the shareholders. Provided the profits before the interest and taxation can cover the interest, as in Air Asia for year 2006, 2007 and 2009, tends to be beneficial to the shareholders. As for MAS, they more or less maintained their gearing ratio from 2006 to 2008, by injecting the same proportion of capital accordance to loans borrowed. The increase in 2009 gearing was mainly due to the incorporation of FRS139 standard required which reduced the equity as a whole. It may also due to such standard adoption, that MAS decided to reduce the borrowings in order to lower its gearing value that may have cut down the 2009 operations size.

MAS has high interest cover ratio 2007 financial year, due to other income from sales of plane and property. As these are non-sustainable, the interest cover can be seen to fluctuate from year to year, and may take away the confidence of investors who analyses this ratio. Undoubtedly, increasing financial loans has another benefit to the shareholders that is the tax-deductibility of loan interest. The higher the loans, the higher the finance cost which is tax-deductable for both airliners, hence the precedence in acquiring higher loans.

(iv) (a) Calculate investment ratios for the two companies. For this purpose, you can use the current share price as the share price on the last day of the financial year may be difficult to obtain. (8 marks) 1. Dividend Payout Ratio (DPR)

2. Dividend Yield Ratio t = dividend tax credit. However dividend declared by MAS in 2007 is tax-exempt of 2.5cents, thus in this aspect, t= 0

3. Earnings Per Share (EPS)

4. Price/Earnings(P/E) Ratio

(b)

Discuss the implications of the investment ratios to existing and potential investors in this industry. (16 marks)

What investors want is to gain profitable return from investment made, and investment ratios are tools that savvy investors would use to help analyse the position of stock price and whether is dividend payout favourable. Generally, there are investors who look for capital gain in share price, and investors who underlie the importance of dividend payout. Air Asia is on the verge of continual expanding its business, thus retained all profits for reinvestment into their operation. MAS on the other hand does not generate strong profitability from its core operation, thus not in good position to announce dividend payout to their shareholders. Undoubtedly, both airline companies will unlikely attract investors who focus on the dividend return. On the other hand, there are investors that that might be interested in long-term capital share price gain as mentioned above. These investors would not only focus on the dividend payout and yield, but also on the EPS that measure the fundamental share performance. From 2006 to 2009, EPS value of Air Asia generally increased and sustained with earnings of RM0.21 per share in 2009, which most certainly would make existing investors satisfied with company performance while attracting new investors with its lower P/E ratio that indicates the share price is not overly overvalued. As for year 2008, the year with many unforeseen circumstances such as crude oil price fluctuation, economy crisis, spread of H1N1at year end and etc, the EPS and P/E ratio reflected poorly. In this year and beginning 2009, there were many transactions of Air Asia share, with existing investors disposing the shares in order to cut losses as they dropped, while new investors taking opportunity to buy and keep the lower share price with expectations of gaining share price value towards future. MAS that has lower issued of ordinary share compared to Air Asia, tend to performed better in calculated EPS value. By right, existing investors would be satisfied with MAS EPS achievement. However analysing the P/E ratio, the high value in 2008 would imply either the public had high confidence over MAS future business, or could be an indicative of share price being overvalued. Unfortunately, the market had higher stringer perceive of second scenario of MAS share price being overvalued in 2008, which probably explain the dropped in share price in year 2009. Hopefully, with the better EPS and lower P/E ratio in year 2009, MAS can retain the existing investors confidence as well as attracting new investors.

(v)

Discuss the problems that are faced by people who wish to assess the performance and financial position of a public company if only the published reports are available. (15 marks)

As third party outsiders, we do not have access to asymmetric information like the internal operation team of the public company has. Without knowing detailed transactions, we have no means to tell whether the company is operating efficiently, and utilising the company funds to the beneficial of the shareholders. For example, MAS airline financial account does not stipulate detailed expenses. Hence, we cannot determine factor that caused the organisation to incurred negative profit. This is common to many public companies whether they often only release information beneficial to them, while keeping the negative information as vague possible. Another limitation is related to quality of the financial statement. Companies often apply particular accounting policies or structure particular transactions in order to portray healthy financial performance. Such creative accounting poses serious problems to outsiders who rely on financial ratios, which are dependent on the quality of the reported statements. Assets declared in the balance sheet, often do not represent actual value or includes inflation influence. The asset values are recorded in balance sheet usually less any formulated amount off for depreciation purpose. These hence understate, or possibly overstate the profits in some circumstances. For example, company A may choose to depreciate Machine Y in 5 years, and company B choose to depreciate the same Machine Y in 10 years. In doing so, the depreciation value for both companies would be different and often not detectable by outsiders. If such circumstances, it would also influence ratios computation like ROCE value. One major problem with published report is the time of release. Rapid changes takes place now like none before, thus by the time published report which is a snapshot of the business at the reported moment, can be considered obsolete when public received it. It is February 2010 now, and the airlines 2010 report may only be released in another few months. It may not be as helpful in analysing the companys todays performances.

References: Air Asia, 2009 Annual Report, Air Asia Berhad, 2010 Air Asia, 2008 Annual Report, Air Asia Berhad, 2009 Air Asia, 2007 Annual Report, Air Asia Berhad, 2008 Air Asia, 2006 Annual Report, Air Asia Berhad, 2007 Atrill, P. and McLanet, E., Accounting and Finance for Non-Specialists (Sixth Edition), Financial Times Prentice Hall, 2008 Ciancanelli, P., Dunn, J., Koch, B. and Stewart, M., Financial and Management Accounting, University of Strathclyde Business School, 2009. Investopedia, Liquidity Measurement Ratios: Introduction, http://www.investopedia.com/university/ratios/liquidity-measurement/, accessed 12th February 2011 Investopedia, Liquidity Measurement Ratios: Cash Conversion Cycle, http://www.investopedia.com/university/ratios/liquidity-measurement/ratio4.asp, accessed 12th February 2011 InvestorWords.com, Working Capital, http://www.investorwords.com/5334/working_capital.html, accessed, accessed 6th February 2011 MAS, 2009 Annual Report, Malaysia Airline System Berhad, 2011 MAS, 2008 Annual Report, Malaysia Airline System Berhad, 2009 MAS, 2007 Annual Report, Malaysia Airline System Berhad, 2008 MAS, 2006 Annual Report, Malaysia Airline System Berhad, 2007