Financial Analysis & Derivatives Management QAN & SIA

Financial Evaluation and Risk Strategies of Qantas Airways and Singapore Airlines
October 17
2014




Lecturers: Mr. Damian Bridge
Mr. Ka Wai (Stanley) Choi

Mr. Sebastien Azzam 41791789
Note: Words 2,776 excluding footnotes, reference list and tables.




In the successive report one shall analyse and evaluate the Variance (VR) inherent in the airlines industry; respectively in Qantas Airways (QAN) and Singapore Airlines (SIA). The report affirms Qantas' and SIA's variance and exposure in relation to the Foreign exchange FX with the mitigating factors of interest rates and US currency thus correlated to its natural variance in regards to the entity's purchase of fuel and the costs associated. As of consequence, QAN and SIA incorporate the use of derivatives to hedge its risk/variance in regards to the risk inherent in fluctuating oil prices. Consequently as one examines further, the report Evaluates the Financial position of QAN and SIA in terms of their respective profitability, liquidity, leverage, activity ratios, country risk/VR and how QAN and SIA funds themselves on the primary and secondary money and capital markets.
As one delves deeper; exploring the scope of the foreign exchange (FX) risk of a currency regarding the corresponding transactions correlated with the relative effects such as the cost of crude oil in consanguinity to the effects on Qantas Airways'(QAN) EBITDA. Not to mention the variance – VR (risk) Qantas is exposed to, due to the underlying differences in interest rates, inflation and so forth thus influencing their principal currency - Australian dollars (AUD) in comparison to for instance the US currency and its relative factors influencing the rate respectively.
Therefore in the interests of elucidating the aforesaid statement, a strong AUD currency (as observed in the figure 1.0, 1.1 below during the period of 2012 with the AUD/USD spot rate: 1.0283 2013-05-01) would decrease costs designated in foreign currency; prominently in American Dollars (USD) in correlation to fuel, aircraft purchases and so forth borne by the Qantas group resulting in an indirect cost benefit as witnessed on its income statement with a net profit of 6million in FY13. As of consequence this results in Qantas group's various costs explicitly falling by more than their corresponding revenue given other factors are unchanged affecting EBIT, henceforth having a positive impact on the company. Howbeit in correlation to QAN's 2014 fiscal year earnings, amounting to a loss of 2,800M notwithstanding other mitigating factors amounting to Qantas' statutory loss asides from a highly volatile FX (USD/AUD spot rate of 0.8679 as of 10-15-14) and West Texas Intermediate (WTI) commodity.




Figure 1.1(XE source)


Howbeit a strong AUD currency would reduce foreign denominated currency revenue as witnessed on QAN's company website invoicing clients in their respective domestic currencies be it Euro, British pound, US dollar or Yuan and so forth. As these airfares are not predominantly adjusted for FX movements due to cost ineffectiveness this would inherently result in diminished AUD revenue to Qantas' detriment increasing currency exposure. One may also deduce it is also due in part to the fact that Qantas' suppliers pay for services denominated in foreign currency and its freight services are vastly tied to US currency along with Qantas freights' revenue.
Figure 2.0

Henceforth observing the data provided in figure 2.0 regarding the volume of international passengers; one deduces that the greatest amount originates to/from the USA. As of consequence, a beneficial approach for QAN would consist of switching its principal/functional currency to US dollars, charging its international clientele using its new found principal currency of USD, hence permitting Qantas to hold enough US dollars to cover its fuel and other expenditures without currency risk; subsequently QAN charges the latter Australian market with AUD, covering its expenditures in AUD. Qantas would enjoy several advantages from such a perspective; mainly reducing exchange rate exposure and its correlation risk regarding the cost of hedging fuel, positively altering Qantas' competitive position due to the change in values of its assets and liabilities unlike its current state of affairs.
'…foreign currencies, and or monetary assets and liabilities are translated to the functional currency of the Group at the spot rates except where hedge accounting is applied with resulting FX changes brought to account as exchange gains or losses. '


Moreover these advantages correspondingly include a reduction in FX costs, currency risk and exposure thus causing a total reduction regarding the operating exposure. The Airline industry endures high degrees of operating exposure due the cost of crude oil or the price airline tickets being extensively sensitive to FX and interest rate changes. In connection, a reduction in the need to continuously hedge foreign currencies using FRA's and the need to convert its functional currency to that of the USD in order to purchase oil which is designated and traded only in US currency/petrodollar. QAN's crude oil (WTI) expenditure is an outstanding 26% amounting to 4,220M as observed in the in figure 2.2 below; as such it would be beneficial for senior management to consider such an approach notwithstanding the fact that the US currency rate has been traditionally greater in comparability to Australia's currency rate ranging from 0.66 US cents/AUD to 0.88cents/AUD on average upon observation of figure 2.1 consequently such an approach would increase their revenue and stabilize their fuel/aircraft lease expenditure in terms of Qantas Airways' foreign currency risk, excluding the need to hedge the cost of WTI and the inherent currency exposure denominated with acquisition of crude oil using AUD crossed with USD in order to hedge. It is important for Qantas to adapt to business cycles and externalities affecting its profitability and competitiveness.
Figure 2.1



Figure 2.2


In comparison Singapore Airlines - SIA utilises policies of matching its receipts and payments in each currency in order to manage its foreign exchange exposure due to SIA's foreign currency denominated operating revenues and expenses.
"For the financial year ended 31 march 2014, these accounted for 53.1% of total revenue (FY 2012/13: 56.4%) and 66.9% of total operating expenses (Fy2012/13: 68.7%). The group's largest exposures are from United States dollar, Euro, UK sterling pound, Swiss Franc, Australian dollar, New Zealand dollar, Japanese yen, Indian Rupee, Hong Kong dollar, Chinese Yuan, Korean won and Malaysian Ringgit."


SIA's operating costs include but are not limited to capital expenditure, fuel costs and aircraft leasing predominantly denominated in USD as the case of QAN. However SIA usually faces a deficit in USD. Thus, the weakening of the USD will reduce their operating expenses, improving their profit margins similarly to QAN. Consequently SIA implements a hedging strategy using forward and option foreign currency contracts to hedge a portion of its future foreign exchange exposure with settlement dates that range from a month up to a year without the view to make speculative gains from currency movements as per QAN.
Howbeit as of late SIA in association with RBS (Royal Bank of Scotland) implemented an FX Micro-pay monetary management solution allowing customers to lock in their fares in the currency of choice based on the rate of FX presented to them; allowing them to pay in six denominated currencies: the Australian dollar, Euro, British Pound, Yen, Singapore dollar and the US dollar. Prior to implementation of the new solution, clients waited for their card companies to determine the FX rate before affirming the amount their fare was converted into in correlation to the domestic currency of their credit card several days later. Howbeit, such a solution translates to a win-win situation for clients and SIAs' treasury. Soon Fong Goh, treasurer at Singapore Airlines said:
"Although it's not treasury-driven, we play a supporting role in the set-up of the solution and, as and when the transaction volume grows into a meaningful value, we'll factor that into our foreign exchange (FX) hedging program."

QAN utilizes derivatives i.e. options and swaps on aviation fuel and crude oil (WTI and Brent proxies) to hedge its exposure to fluctuations in the price of aviation fuel; hence QAN's hedging strategy involves hedging up to 80% of estimated fuel consumption out to 12 months and up to 40% in the successive 12 months. QAN does not permit speculative trading in accordance QAN's Board approved Treasury Risk Management Policy.



Correspondingly as QAN, SIA's earnings are concomitantly affected by fluctuations in the price of jet fuel. Henceforth SIA's strategy for managing the risk on fuel price aims to provide SIA with protection against sudden, random and significant fluctuations in jet fuel prices. Furthermore SIA hedges between 20% and 60% of its fuel requirements, with a cap of 60% for the second half of its financial year unlike QAN hedging up to a staggering 80%. SIA decisively manages its fuel price risk through the implementation of a hedging strategy encompassing the use of hedges up to eight quarters (2 years) forward using jet fuel swaps, options and collars, Brent and crack swap contracts. SIA's fuel costs before hedging amounted to 4843.7M for FY13/14 with the cost infinitesimally abated to 4772.6M after hedging for the same fiscal year as observed in figure 2.3.
Figure 2.3

Hedging reduces earnings volatility in which markets respond positively to therefore increasing the airline's share price due to a reduction in the entities risk profile which translates to reduced cost of capital; as of consequence this implication deduces that risk has cost in the investment market place, though by how much? Airlines are not hedging to improve profits but to reduce the swings in profits; or more explicitly to make profits stay closer to average. The first inevitable market fundamental is that the expected value of a fuel hedge is zero.


Crude oil is heavily traded, liquid, attracts traders, oil suppliers, portfolio investors and is evenly balanced between sellers and buyers. Divergently, airline purchases such that of SIA and QAN are miniscule, and do not affect the market prices, henceforth they purchase oil at spot or forward spot market prices. Consequently, the expected value of such a hedge is zero; if airlines expect otherwise, they are no longer hedging but speculating in oil.

Subsequently, one deduces that the risk in using derivatives is that SIA and QAN are not able to take advantage of the favourable moves while competitors can. A hypothetical exemplar would be if QAN were to lock in a jet fuel price at relatively high levels, but the jet fuel price falls then Qantas is faced with paying a higher price in correlation to its less hedged competitors i.e. SIA.

Henceforth QAN and SIA should have plans in place to account for trends in oil prices (to date oil has had a downward trend figure 2.4). As a result QAN should implement abated levels of fuel hedging rather than its current 94% of fuel consumption hedged. Not to mention, due to the volatility of oil in the global economy surmises the fact that cost of derivatives inextricably rises.
Figure 2.4



As for Qantas greatest costless protection is that as the price of oil goes up so does the AUD and vice versa. As Qantas' former chief economist Tony Webber stated:
'…this relationship has held true for almost thirty years… when the oil price goes up as a result of global oil demand, the price of other commodities invariably increases, helping Australian jobs, income and wealth, which in turn drives air travel.'
In turn, Qantas needs to convert the strong Australian demand into revenue growth which can be achieved by not overreacting to strong demand growth by adding too much supply, but instead allowing yields to grow to finance higher unit costs and monitor business cycles and seasonal trends.
Moving onto the financial performance analysis of Qantas Airways Ltd. and Singapore Airlines Ltd.; The following figures and ratios are critical in regards to the determination of the current financial performance of each of the said companies. 






Profit Ratios: Both Qantas Airways and Singapore Airlines had similar profit margins in 2014 and 2013. In 2014, Qantas Airways had a profit margin of 22.30 % while Singapore Airlines had a margin of 20.75%. Having a higher profit margin is preferred so Qantas Airways was better than Singapore Airlines overall. The return on assets was also extensively differing for both companies as Qantas had a -16.42% whereas Singapore Airlines had a ROA of 1.9% beating Qantas over three years analyzed with Qantas reporting negative ROA for 2012/2014. Hence Qantas Airways' P/E Ratio was (1.11) or 0 for FY14 compared to Singapore Airlines' P/E ratio of 42.97 for FY14 inferring to growth instead of contraction in profit. Thus, it may clearly be concluded that Singapore Airlines is significantly more efficient when it comes to profitability.
Liquidity Ratios: Singapore Airlines is evidently stronger in terms liquidity ratios but Qantas Airways' ratios lagging over a percentage point. Both Singapore Airlines' current and quick ratios are consistently higher than Qantas Airways. Singapore Airlines has current ratios of FY12-1.37, FY13-1.39, and FY14-1.36, while Qantas Airways has current ratios of FY12-.76, FY13-.75, and FY14-.61. For the quick ratio, Singapore Airlines has FY12-1.31, FY13-1.34 and FY14-1.31, while Qantas Airways has FY12-.71, FY13-.70, and FY14-.61. This means that Singapore Airlines has less current debt than Qantas Airways in relation to their current assets. This might detrimental to Singapore Airlines if it is sitting on its assets instead of investing them.


Leverage Ratios: Qantas Airways has a staggeringly higher leverage ratio in comparability to Singapore Airlines. Their debt to equity (D/E) and debt to assets (D/A) is substantially higher than Singapore Airlines. Accordingly, in FY2014, Qantas Airways' D/E ratio was 226% and correspondingly it's D/A ratio was 83.45%, compared to Singapore Airlines' D/E ratio of 10.85 and a D/A ratio of 41.23% respectively). Moreover, Qantas Airways had an E/A ratio of (FY12 27.80%, FY13 29.15%, FY14 16.55% dissimilar to Singapore Airlines of FY12 59.82%, FY13 59.75% and FY14 58.46%. Concurrently Qantas Airways had a D/A ratio ranging from 70.84% to 83.45% thus translating to Singapore Airways having a better return on their assets, being better able to considerably manage their debt and with a correspondingly lower debt to equity in correlation to Qantas Airways which translates to a lower leverage/financial risk/ risk of insolvency.
Activity Ratios: Both Qantas Airways and Singapore Airlines had increasing asset turnovers for each of the three years evaluated (FY12 to FY14). Qantas Airways were generally higher ranging from (FY12 0.74, FY13 0.78, FY14 0.82) comparatively to Singapore Airlines' asset turnover of (FY12 0.64, FY13 0.67, FY14 0.67). The higher this ratio is the better, henceforth this generally means that Qantas Airways is more effective in generating revenues from their investment in property, plant and equipment (PPE) or more commonly known as assets in contrast to Singapore Airlines. When looking at the inventory turnover, a ratio is best not to be too low or too high; too low a ratio implies poor sales/excess inventory; whereas a high ratio would ascertain strong sales or ineffective buying depending on the industrial average. Singapore Airlines' Inventory turnover was higher than Qantas Airways with a ratio of (FY12 38.67, FY13 44.56, FY14 49.28) in contrast to Qantas Airways' lower ratio of (FY12 19.25, FY13 19.51, FY14 22.33) implying stronger sales on the behalf of Singapore airlines.
One should not dismiss the crucial factor of political/country risk in the assessment of the said airlines. Singapore Airlines rreceives tremendous support from the Singapore Government in terms of tax, fuel as their main shareholder is Government of Singapore; concurrently Singapore's' government corporate tax rate is minor 17% in contrast to the Australian governmental corporate tax rate of an astounding 30%, this marks a staggering 13% difference in tax rates between the two nations which would be inadvertently detrimental to Qantas Airways' bottom line/ Net profit for any given financial year. Consequently Qantas Airways is significantly restrained due to the Qantas Sale Act 1992 adding to the airlines woes due to the foreign investment restrictions imposed upon it, thus reducing the scope of potential investors.


Moreover what is also notably important is the lack of Australian government support unlike their counterparts in Singapore which are major equity holders in Singapore Airlines. Recently a government debt guarantee failed to pass in the Australian parliament with Tony Abbot stating:

"It isn't the government's job to run businesses. It's government's business to get it right."
Consequently Qantas Airways has had a tough time issuing debt and raising capital due to its fiscal year loses protracted profitability three years running and high leverage as aforementioned in the above analysis. Qantas Airways latterly used Deutsche Bank AG recently to issue unsecured fixed rate notes/unsecured bonds at 7.75% priced to yield 400 bps – 4% (basis points) more than the swap rate as their cost of insuring debt against non-payment using CDSs (credit default swaps) increased from 165bps to 316.5. Qantas Airways correspondingly raises capital through rights issues and private placements to institutional investors (which are also majority shareholders) i.e. Citi Bank, J.P Morgan Stanley, HSBC, BNP Paribas, MLC investments and National Australia bank among others. Qantas Airways last issued a DRP (dividend reinvestment scheme) in fiscal year 2009 and partially in 2010 wherein the company was last profitable.

Reference List

ASX- Australian Securities Exchange, 'Notice of change of interests of substantial shareholder', http://www.asx.com.au/asxpdf/20140910/pdf/42s44qd0hlw0s2.pdf
ATO- Australian Taxation Office, 'Tax Rates', https://www.ato.gov.au/rates/company-tax/
Australian Business Traveler, 'Qantas loses out on Government debt guarantee', 28th Feb 2014, http://www.ausbt.com.au/qantas-loses-out-on-government-debt-guarantee

Commonwealth consolidate acts; 'Qantas Sale Act 1992 Cth.' http://www.austlii.edu.au/au/legis/cth/consol_act/qsa1992120/
Department of Air Transport, Cranfield University, Bedford, UK, Morrell.P & Swan.W, 'Airline Jet Fuel Hedging: Theory and practice', 6th November 2006, https://dspace.lib.cranfield.ac.uk/bitstream/1826/3029/1/Airline%20jet%20fuel%20hedging%20-%20theory%20and%20practice.pdf ;
Inland Revenue Authority of Singapore, 'Tax rates and tax exemption schemes', http://www.iras.gov.sg/irasHome/page04.aspx?id=410
Inside Story, Webber.T, 'Qantas: a ten-point plan', 2nd November 2011, http://insidestory.org.au/qantas-a-ten-point-plan
Investopedia Website, 'Petrodollars', http://www.investopedia.com/terms/p/petrodollars.asp

Jessica Jaganathan, 'Asia Airlines Raise Hedging Volumes On Oil Price Fall', 25th September 2014, http://www.businessinsider.com/r-asia-airlines-raise-hedging-volumes-on-oil-price-fall-2014-9#ixzz3GNyURSbJ
Lacar F., 'Singapore Airlines: Factors Accounting for Marketplace Success', Chifley / La Trobe University, http://dlibrary.acu.edu.au/research/carpediem/pages/volume4/vol4no1_businessanalysis.htm
Purvis B., 'Qantas Airways Offers First Junk-Rated Bonds in Australia', 12th of May 2014, http://www.bloomberg.com/news/2014-05-12/qantas-plans-australia-s-first-ever-issue-of-junk-rated-bonds.html
Qantas Airways Ltd, 'Qantas Data Book 2014', http://www.qantas.com.au/infodetail/about/investors/qantas-data-book-2014.pdf
Qantas Airways, 'Shareholder Information', http://www.qantas.com.au/travel/airlines/investors-share-holder/global/en

Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf;
Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf

The Sydney Morning Herald, Tony Webber, 'High dollar good for Qantas', February 8, 2013, http://www.smh.com.au/business/high-dollar-good-for-qantas-20130207-2e0zd.html#ixzz3GNpsdhWE
Treasury management international, 'RBS launches multi-currency pricing for Singapore Airlines online sales', 5 June, 2014, http://www.treasury-management.com/news/200/rbs-launches-multi-currency-pricing-for-singapore-airlines.html
Financial Evaluation and Risk Strategies of Qantas Airways and Singapore Airlines
2014

2




The Sydney Morning Herald, Tony Webber, 'High dollar good for Qantas', February 8, 2013, http://www.smh.com.au/business/high-dollar-good-for-qantas-20130207-2e0zd.html#ixzz3GNpsdhWE

Department of Infrastructure and Regional Development, 'International Airline Activity—Time Series - Airline by country of port data—passengers, freight and mail—2009 to current', https://www.bitre.gov.au/publications/ongoing/international_airline_activity-time_series.aspx
Qantas Airways Ltd, 'Qantas Data Book 2014', http://www.qantas.com.au/infodetail/about/investors/qantas-data-book-2014.pdf
Qantas Airways Ltd, 'Qantas Data Book 2014', http://www.qantas.com.au/infodetail/about/investors/qantas-data-book-2014.pdf; Investopedia Website, 'Petrodollars', http://www.investopedia.com/terms/p/petrodollars.asp
Qantas Airways Ltd, 'Qantas Data Book 2014', http://www.qantas.com.au/infodetail/about/investors/qantas-data-book-2014.pdf
Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf
Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf
Treasury management international, 'RBS launches multi-currency pricing for Singapore Airlines online sales', 5 June, 2014, http://www.treasury-management.com/news/200/rbs-launches-multi-currency-pricing-for-singapore-airlines.html
Treasury management international, 'RBS launches multi-currency pricing for Singapore Airlines online sales', 5 June, 2014, http://www.treasury-management.com/news/200/rbs-launches-multi-currency-pricing-for-singapore-airlines.html
Treasury management international, 'RBS launches multi-currency pricing for Singapore Airlines online sales', 5 June, 2014, http://www.treasury-management.com/news/200/rbs-launches-multi-currency-pricing-for-singapore-airlines.html
Qantas Airways Ltd, 'Qantas Data Book 2014', http://www.qantas.com.au/infodetail/about/investors/qantas-data-book-2014.pdf
Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf; Jessica Jaganathan, 'Asia Airlines Raise Hedging Volumes On Oil Price Fall', 25th September 2014, http://www.businessinsider.com/r-asia-airlines-raise-hedging-volumes-on-oil-price-fall-2014-9#ixzz3GNyURSbJ
Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf;
Singapore Airlines, 'Annual report and sustainability report', pg. 177-180, http://www.singaporeair.com/pdf/Investor-Relations/Annual-Report/annualreport1314.pdf;
Department of Air Transport, Cranfield University, Bedford, UK, Morrell.P & Swan.W, 'Airline Jet Fuel Hedging: Theory and practice', 6th November 2006, https://dspace.lib.cranfield.ac.uk/bitstream/1826/3029/1/Airline%20jet%20fuel%20hedging%20-%20theory%20and%20practice.pdf ; Inside Story, Webber.T, 'Qantas: a ten-point plan', 2nd November 2011, http://insidestory.org.au/qantas-a-ten-point-plan
Department of Air Transport, Cranfield University, Bedford, UK, Morrell.P & Swan.W, 'Airline Jet Fuel Hedging: Theory and practice', 6th November 2006, https://dspace.lib.cranfield.ac.uk/bitstream/1826/3029/1/Airline%20jet%20fuel%20hedging%20-%20theory%20and%20practice.pdf ; Inside Story, Webber.T, 'Qantas: a ten-point plan', 2nd November 2011, http://insidestory.org.au/qantas-a-ten-point-plan
Inside Story, Webber.T, 'Qantas: a ten-point plan', 2nd November 2011, http://insidestory.org.au/qantas-a-ten-point-plan
Lacar F., 'Singapore Airlines: Factors Accounting for Marketplace Success', Chifley / La Trobe University, http://dlibrary.acu.edu.au/research/carpediem/pages/volume4/vol4no1_businessanalysis.htm
Inland Revenue Authority of Singapore, 'Tax rates and tax exemption schemes', http://www.iras.gov.sg/irasHome/page04.aspx?id=410
ATO- Australian Taxation Office, 'Tax Rates', https://www.ato.gov.au/rates/company-tax/
Commonwealth consolidate acts; 'Qantas Sale Act 1992 Cth.', http://www.austlii.edu.au/au/legis/cth/consol_act/qsa1992120/
Australian Business Traveler, 'Qantas loses out on Government debt guarantee', 28th Feb 2014, http://www.ausbt.com.au/qantas-loses-out-on-government-debt-guarantee

Purvis B., 'Qantas Airways Offers First Junk-Rated Bonds in Australia', 12th of May 2014, http://www.bloomberg.com/news/2014-05-12/qantas-plans-australia-s-first-ever-issue-of-junk-rated-bonds.html
ASX- Australian Securities Exchange, 'Notice of change of interests of substantial shareholder', http://www.asx.com.au/asxpdf/20140910/pdf/42s44qd0hlw0s2.pdf
Qantas Airways, 'Shareholder Information', http://www.qantas.com.au/travel/airlines/investors-share-holder/global/en
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