Travel by air is now an integral component of modern lifestyles. Air travel facilitates business, visiting family and friends, and rapid transportation of goods and people to locations worldwide.
According to the U.S. Department of Transportation (DOT), the airline industry has four basic categories: international, national, regional, and cargo. Regional flights stay local to one area, and cargo airlines transport goods, not passengers. International flights typically carry more than 130 passengers from one country to another. National flights seat approximately 100 to 150 passengers and fly anywhere in the United States. According to Statista, in 2017, total operating revenue for domestic airlines was over $220 billion. The leading U.S. airlines, Southwest Airlines, had an income of over $21 billion U.S. dollars.
Analyzing Airline Companies
Competition is fierce among airline companies. The airline industry is highly seasonal, and profit can be drastically affected by fluctuations in energy prices or economic downturns. Investors can't predict environmental or market factors when assessing the future health of an airline company, but they do use certain financial indicators to analyze the stability of airline companies. These metrics include short-term liquidity, profitability, and long-term solvency. Key financial metrics commonly considered by market analysts or investors are the quick ratio, return on assets (or ROA), and the debt-to-capitalization ratio.
Analysts use the quick ratio to measure an airline’s short-term liquidity and cash flow. Essentially, the quick ratio reveals whether a company can cover all of its short-term debt obligations with its liquid assets defined as cash or quick assets. Quick assets can be rapidly converted to cash quickly in an amount comparable to their present book value.
The quick ratio formula for calculation divides the company’s liquid assets by its current liabilities. This metric is an indicator of the overall financial strength or weakness of a company. If a company cannot meet its short-term debt obligations with readily available liquid assets, it could be liable to bankruptcy. This financial ratio is particularly useful for analyzing airline companies because they are capital-intensive and have significant amounts of debt. The higher the quick ratio, the better. Any value below one is considered disadvantageous. Other metrics in addition to the quick ratio include the current ratio and the working capital ratio.
Return on Assets (ROA)
The return on assets ratio, or ROA, measures profitability as it indicates the per dollar profits a company earns on its assets. Because an airline company’s primary assets, its planes, generate the bulk of its revenues, this metric is a particularly appropriate profitability measure.
The formula used to calculate ROA divides yearly net income by the company's total assets. The resulting value is expressed as a percentage. Because airline companies own substantial assets, even a relatively low ROA represents significant absolute profits. Alternative profitability ratios investors may consider are the operating profit margin and the earnings before interest, taxes, depreciation, and amortization, or EBITDA, margin.
The total debt-to-capitalization ratio is a vital metric for analyzing airline companies because it adequately evaluates the debt position and overall financial soundness of companies with significant capital expenditures. For analysts and investors, this financial metric evaluates companies within an industry that often must withstand extended economic or market downturns and resulting periods of revenue losses or diminished profit margins.
The debt-to-capitalization ratio is calculated as total debt divided by total available capital. Analysts and investors typically prefer to see ratios that are lower than one as they are indicative of an overall lower level of financial risk. Alternative ratios for evaluating long-term financial solvency include the total-debt-to-total-equity ratio and the total-debt-to-total-assets ratio.
In addition to these key financial ratios, investors examine a number of specific airline industry performance metrics. These performance analysis metrics include available seat miles, cost per available seat mile, break-even load factor, and revenue per available seat mile.