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Delta, EasyJet and Iceland

Delta and EasyJet have announced flights to Iceland, which solidifies this island’s position as a desirable destination. It will also increase competition up here quite a bit, forcing airlines to step up marketing activities and strategic market positioning. Airlines, so wonderful yet risky investments.

Warren Buffet once said that if he could go back in time and change but one thing, he would sabotage the Wright brother’s plane to save future investors from bad investments. I have only one response to that; without airlines, the world today would be very similar to 1911. Holidays in the Bahamas or the Alps would not exist, exotic fruit would not be known in Scandinavia, the U.S. would never have gone to the moon, mobile technology would not exist, and our world vision would be severely impaired. Let’s now hope Warren hasn’t invested in a time-traveling machine, for I really love the airline industry and flying. Now let’s see what the Icelandic airlines are up against.

When looking at the financial reports of Delta and EasyJet, the different structure of the two airlines begins to emerge. Since Delta Airlines operates out of the United States and EasyJet from the UK, EasyJet financial reports have been converted to USD using the GBP/USD exchange rate December 31 each year. Financial reports have exchange rates affecting items such as sales built-in and adjusted so there is no need to use the yearly average rate.

EasyJet is significantly smaller than Delta. The company‘s operating revenue 2010 was 14.5% compared to Delta with passenger revenue at 13.7% and ancillary revenue at 19.7%. Assets measure 14.4%.

EasyJet‘s comparative size and turnover is at nearly the same exact levels as in 2005, but the airline has been increasing its share in ancilliary revenue.  Cost of sales are higher than operating expenses when compared to Delta and can be traced to airport charges where Delta‘s size possibly results in better rates. Maintenance also affects EasyJet to a greater extent and is a relatively higher versus Delta than salaries.

EasyJet’s payables measure 75.1% of Delta’s whereas receivables measure only 20.7%. This could create a future problem and may threaten the airline’s net working capital position.

Applying accumulated growth rates on EasyJet using USD instead of the GBP factors in the economic performance of the UK against the US. As such, it must be interpreted with caution.

The difference between receivables and payables is notable; the accumulated growth rates reveal that EasyJet’s receivables position is shrinking while the payables position is increasing. This may result in future liquidity problems.

EasyJet’s net working capital position is strong whereas Delta appears to be heading directly towards bankruptcy. At -4,078 (-9.4% to assets), recovery is questionable.

EasyJet has driven down its credit ratio from 14.7% 2005 to 6.5% 2010 while Delta‘s ratio remains fairly stable at around 5%. In other words, EasyJet has lowered its exposure risk arising from customer default significantly.

A look at some performance indicators give indication as to where the airlines’ operating strengths and weaknesses (i.e. operating risks) lie. Converting EasyJet financial reports to USD has no effect on performance ratios since the conversion merely changes the scale of underlying values but does not change the relationship between them. First some explanation as to what the measures below reveal:

The cash conversion cycle is the difference between outstanding invoices and bills, or receivables less payables. The CCC usually includes inventory, but since airlines do not have inventories it is omitted. A low CCC suggests efficient account management. The interval measure gives indication as to how long a company can operate if cash flows dry up (e.g. in the event of a strike). It is calculated as Current assets / Daily operating cost.

It takes EasyJet 3.6 times longer to pay its bills than Delta but only 1.4 times longer to collect on outstanding invoices. This works in EasyJet’s favor in financial terms, but may cause supplier and creditor problems. Having to wait almost half a year for EasyJet to settle its bills while Delta does so in a little over a month is likely to cause difficulties for EasyJet service providers in the long-term. For such providers, Delta is a better client.

Delta is more at risk in a strike situation and has a tolerance threshold of three months. EasyJet could sustain a strike for nearly 7 months.

Last but not least, the expense breakdown clearly illustrates  how airport charges and maintenance weigh heavier on EasyJet’s expense side than Delta’s. These charges are likely to be a significant factor in EasyJet’s extended conversion cycle and high payables position and are a vulnerability.

So this is what the Icelandic airlines are up against. Of the two, I’d say EasyJet poses a much greater threat.


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