Air travel facilitates business, visits to family and friends, and fast transportation of goods and people around the world.
According to the U.S. Department of Transportation (DOT), the aviation industry has four basic categories: international, national, regional, and cargo. Regional flights only stay in one area, and cargo airlines carry goods, not passengers. International flights usually carry more than 130 passengers from one country to another. Domestic flights can accommodate approximately 100 to 150 passengers and can fly anywhere in the United States.
According to government data, in 2020, domestic airlines lost more than 35 billion U.S. dollars, mainly due to the impact of the COVID19 pandemic. Air travel and profits are expected to rebound in 2021 and 2022, as vaccination inspires hopes for a recovery in travel, although the emergence of new variants seems to hinder the recovery of airlines.
- The aviation industry is highly competitive and highly seasonal. Profits may also be affected by energy prices and economic recession, which is unpredictable.
- Investors use certain financial indicators to analyze airlines’ short-term liquidity, profitability, and long-term solvency.
- The key financial indicators analyzed by investors are quick ratio, ROA and debt capitalization ratio.
The competition among airlines is fierce. The aviation industry has a strong seasonality, and fluctuations in energy prices or economic recession can severely affect profits. Investors cannot predict environmental or market factors when assessing the future health of an airline, but they do use certain financial indicators to analyze the stability of the airline. These indicators include short-term liquidity, profitability and long-term solvency.
The key financial indicators that market analysts or investors usually consider are quick ratio, return on assets (or ROA), and debt capitalization ratio.
Environmental and market factors will affect the future health of airlines, neither of which can be predicted. However, certain financial indicators are used to assess the stability of airlines.
Analysts use quick ratios to measure airlines’ short-term liquidity and cash flow. Essentially, the quick ratio reveals whether a company can use its current assets, which are defined as cash or quick assets, to pay all its short-term debts. Quick assets can be quickly converted into an amount equivalent to their current book value.
The calculated quick ratio formula divides the company’s current assets by its current liabilities. This indicator is an indicator of the company’s overall financial strength or weakness. If a company cannot meet its short-term debt obligations with readily available liquid assets, it may go bankrupt. This financial ratio is particularly useful for analyzing airlines because they are capital intensive and have a lot of debt. The higher the quick ratio, the better. Any value below 1 is considered unfavorable. In addition to the quick ratio, other indicators include the current ratio and working capital ratio.
Return on assets (ROA)
Return on assets (ROA) measures profitability because it represents the profit per dollar a company receives from its assets. Since the airline’s main asset, aircraft, generates most of its revenue, this indicator is a particularly suitable measure of profitability.
The formula used to calculate ROA divides annual net income by the company’s total assets. The result value is expressed as a percentage. Because airlines have a lot of assets, even if the ROA is relatively low, it also represents a considerable absolute profit. The alternative profitability that investors may consider is the operating profit rate and the profit before interest, tax, depreciation and amortization or the EBITDA profit rate.
Debt capitalization ratio
The total debt to capitalization ratio is an important indicator for analyzing airlines because it can fully assess the debt status and overall financial soundness of companies with large capital expenditures. For analysts and investors, this financial indicator evaluates companies in the industry, these companies usually have to withstand a long period of economic or market downturn and the resulting period of loss of revenue or decline in profitability.
The debt-to-capitalization ratio is calculated by dividing total debt by total available capital. Analysts and investors generally prefer to see ratios below 1 because they indicate a lower level of overall financial risk. Alternative ratios for assessing long-term financial solvency include the ratio of total debt to total equity and the ratio of total debt to total assets.
In addition to these key financial ratios, investors will also check some specific aviation industry performance indicators. These performance analysis indicators include available seat mileage, cost per available seat mileage, break-even load factor and revenue per available seat mileage.