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The Airline of the Future? A Business & Financial Appraisal of Airblue For A Three Year Period From July 2007 to June 2009
ACCA OXFORD BROOKES DEGREE PARTNERSHIP RESEARCH & ANALYSIS PROJECT
ABCDEFGHI ACCA STUDENT REG # 123456789 Words =
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The Airline of the Future? A Financial & Business Appraisal of Airblue - 2
Table of Contents
Project Objectives & Overall Research Approach ..................................................... 3
Information Gathering................................................................................................... 6
Results, Analysis, Conclusions & Recommendations............................................... 6
Results, Analysis, Conclusions & Recommendations............................................... 9
Bibliography ................................................................................................................ 29
The Airline of the Future? A Financial & Business Appraisal of Airblue - 3 Part 1 Project Objectives & Overall Research Approach The commercial airline industry has been the centre of attention for political, business and academic pundits for quite some time now. While the first decade of the previous century came with the invention of the aircraft and the commencement of air travel thus giving birth to an industry, the first decade of this century brought with it the attack on the twin towers at the World Trade Centre in New York City in September of 2001, political chaos, the threat of terrorism, heightened security around airports, cut throat competition (from no frills airlines) pushing down air fares and profitability, record high fuel prices (peaking at $147 a barrel) and recently, atmospheric disturbances in the form of volcanic ash clouds over Northern Europe and the United Kingdom causing disruption of thousands of flights and cause an estimated $17 billion in revenue loss to the industry. All this plus, loads of strikes and civil commotion over pay, security and job concerns have been there to greet the industry into the 21st Century. Globally, the aviation industry is undergoing a wave of consolidation with significant mergers and acquisitions being reported as many airlines in the West opt for business combinations as the perceived synergies are said to be enormous. The threat from no frills airlines is also enormous with the Virgin Group backed Air Asia a significant competitor in the Asian region. In this respect, it can be argued that the airline industry is undergoing certain systematic changes that warrant a survival strategy with only the fittest surviving the downturn. Unfortunately, as can be inferred from the above, the first decade of this century has proved troublesome for the airline industry. This has important implications for investors as making investment decisions regarding the airline sector in view of a high risk industrial outlook make any potential investor uneasy from day zero. To add to this, the airline industry has a terrible survival record with many upstarts perishing within their infancy which further precludes investment in this sector. What fascinates me then, as an avid aircraft lover and of all things to do with aeronautics, is what will be the future of the airline industry going forward. Surely, investors cannot continue to pump money into the old established airlines that have become white elephants or too big to fail nor can new investors be readily willing to invest in new upstarts that follow the same old business model which as we know has failed time and lost its resilience to changing times which calls for a new appreciation of risk, return and the business model itself for the airline of the future. Indeed, my concern is what business model would the airline of the future need to follow for it to attract investor confidence?
The Airline of the Future? A Financial & Business Appraisal of Airblue - 4 For this purpose, I sought an airline which had been established post 9/11 and had been able to stem the storm over the past decade, hence using it as a proxy for analysis. It is my belief that by conducting a business and financial analysis of such an airline over the past three years, I would be able to make enough inferences as to whether the business model of the company can be attributed to be the success behind its financial and business success. Building on the same, one can make suggest changes etc that would make it more adaptable for other airlines to follow and hence, would be a prototype of one such solution to the airline of the future. Fortunately, my search for such an airline started from my native Pakistan and ended there only. Airblue Limited (airblue) was incorporated as a public company in 2003 with the aim to provide commercial air travel services for the Pakistani market covering local as well as international destinations. By all accounts it is now the largest private airline in Pakistan having established itself as a key player on the local sector as well as garnering significant market share internationally within a short period of time. The airline operates 156 local and international flights linking Karachi with Lahore, Islamabad & Peshawar and various cities in Pakistan with Dubai, Abu Dhabi, Sharjah & Manchester and boasts revenues of over PKR 10 Billion (Annual Report, 2009). The airline, although registered as a public company, is closely held with a majority stake held by a Pakistani expatriate (Mr. Tariq Mehmood Chaudhary) who has a strong background in IT and software from his Silicon Valley experience and his family interests. The other major shareholding comprises of JS Group, a leading conglomerate in Pakistan, and Mr, Shahid Khaqan Abbasi, a politician, former Chairman and Managing Director of Pakistan International Airlines (the national carrier), former advisor to the Prime Minister on aviation and presently the chief operating officer of the airline (Annual Report, 2009). Going forward, the airline plans to embark on an ambitious growth strategy which includes a fleet up gradation and expansion plan as well as an increase in the number of destinations it flies to along with weekly flights (Annual Report, 2009). Research Questions 1. Undertake a financial analysis of the airline. Has the airline been financially successful from an investor perspective? 2. What business decisions have allowed it to achieve this financial success, if it has indeed been successful? 3. How have competitors to the business model of Airblue i.e. other airlines fared over the same period?
The Airline of the Future? A Financial & Business Appraisal of Airblue - 5 4. What further improvements would one suggest to the business model to make it more efficient and adaptable for other airlines? Overall Research Approach 1. Set objectives 2. In light of the objectives, conduct a financial analysis. 3. Use the information generated above and test it through a business appraisal of the airline & check results of the analysis against other airlines 4. Conclude & recommend further improvements for the sake of standardization and adaptability.
The Airline of the Future? A Financial & Business Appraisal of Airblue - 6 PART II Information Gathering & Choice of Business & Financial Analysis Techniques By virtue of Airblue being an unlisted public company, information about it was always going to be hard to get. However, the enormity of the task nor its difficulty deterred me. I understood that there were two types of information that I was looking for; financial information and business information. Financial information basically refers to the audited financial statements / annual report of the company, while business information is more tilted towards company strategy, performance vides the industry and competitors etc. Having decided what I required, I set in motion. My first stop, during my information gathering process, was a friend at a foreign bank dealing with big corporate clients and, fortunately, covering Airblues account as well. After clearance from his compliance officer and a company official, I was provided with financial statements of the airline for the years 2008 & 2009. The next stop was to another senior colleague at a local investment bank covering large syndications. Sometime back he had told me about working on aircraft acquisition syndication and was fortunate enough for he, after necessary clearance from his supervisor / senior manager, allowed me to take a brief information memorandum on the airline industry as well as other research materials. I focused my attention to some field research next and a visit to few travelling agents and a long drive to the Karachi International Airport to speak with an Airblue staff member (a distant relative) and officials of the civil aviation authority (who I am glad were willing to help me despite their hectic schedules) allowed me to gain a better perspective about the airline and the industry as a whole. Bear in mind, I did not design a proper questionnaire nor were these formal interviews. The manner of meetings was more inclined towards an informal chat over tea or a soft drink, the typical setting of a meet in this part of the world where informality serves better although one should not lose track of professionalism. I think this cultural approach served me well because I was able to get up close and personal with many of these individuals and extracted more from them than what I would have if I would have stuck to a more formal approach. Having gathered the financial information (secondary source) and having made sense of it / added to it through interaction with other individuals (primary source),my next step was to take my search in the 21st century, that is, online. The world wide web is a wealth of information, a sea that has no bed. With that spirit in mind, the research online contributed a significant amount to my stock of information. The websites of Airblue, Pakistan International Airlines, the Economist newspaper, the Daily Dawn Newspaper, the State Bank of Pakistan, International Association of Travel Agents, Bloomberg,
The Airline of the Future? A Financial & Business Appraisal of Airblue - 7 Reuters and a host of online journals and publications expanded my knowledge of the airline sector and the subject company in question, broadening my horizon. It is worth mentioning here that much of the information that I gained through my primary sources and online mechanisms helped in better understanding the financial statements. At the same time, many assertions of the primary data gathering process were checked through secondary data sources and vice versa. This allowed me to keep the final set of information as authentic as possible. It is also deemed appropriate to mention here that the use of the mosaic theory helped me all along the way (Schweser, 2009). My interaction with the staff of the civil aviation and Airblue provided me with bits of NON MATERIAL NON PUBLIC INFORMATION (for example the kind of aircraft that the airline uses and its benefits etc) which combined with the rest of my information allowed me to bring more clarity and depth to my analysis. Please note that no instance of ethical or professional misconduct took place. Choice of Financial & Business Analysis Techniques However, turning this information and processing it was going to be no easy task and I understood that I would require a coherent set of financial and business analysis tools that allow me to process the information in such a manner that it closely links with my research questions and allows me to test my thesis statement. Hence, the following tools and techniques, after much deliberation, were chosen: Financial Analysis Analysis Over Time & Against Competitors Covering Key Areas of Sales, Profitability, Cost Structure, Liquidity & Solvency Business Analysis Porters Generic Strategies Business Analysis Porters Five Forces Analysis Business Analysis SWOT Analysis Hence, while the financial analysis portion would ideally explain the financial success of the firm and the reasons attributed to it, the ensuing discussion on company strategy would be tested using the two models of determining source of competitive advantage, with the SWOT analysis preceding any recommendations, that is, acting as a conclusion or presentation of findings. Unfortunately, perfection eludes mankind and hence none of the above tools and techniques used are free of limitations. Financial Analysis has an inbuilt bias to consider past information as an indicator of future performance while the financial statements themselves need to be looked at carefully as management might play around reporting
The Airline of the Future? A Financial & Business Appraisal of Airblue - 8 rules which are themselves very complex (Schweser, 2009). Business analysis techniques, on the other hand, fail to provide a comprehensive answer and serve as mere guiding rules with too many models being competed against by others, building on totally different premises and approaches to answer the same question (BPP, 2008).
The Airline of the Future? A Financial & Business Appraisal of Airblue - 9 Part III Results, Analysis, Conclusions & Recommendations Financial & Operational Analysis
Note: Due to the depth of information available in the annual report, many graphs have cover upto five years of information, just to make the analysis more deep. At times, the figures and snippets of information also relate back to as far as 2005. These are for depth and breadth of information only. Relevant Extracts of the financial statements have been made part of the analysis section only. The Section has been titled financial and operational analysis as there is significant overlapping in the discussion between business and financial matters and hence provides better insight and structure.
Income Statement Extract & Comments on Key Items & Cost Breakdown (SourceAnnual Reports 2007, 2008 & 2009)
Income statement (PKR mm) Revenue Revenue - net Cost of operations Gross profit Other income Selling & marketing expenses Admin & general expenses EBITDA Financial charges Profit before tax Tax Profit after tax EBITDAR margin EBITDA margin Net profit margin
Major expenditures (PKR mm) Revenue Fuel As a %age of revenue Aircraft lease rental & MRV As a %age of revenue Landing & handling As a %age of revenue Salary & benefits As a %age of revenue Repair & maintenance As a %age of revenue Passenger service As a %age of revenue Sales commission As a %age of revenue Financial charges As a %age of revenue Depreciation & amortization As a %age of revenue Total (as a %age of revenue)
FY 2005A FY 2006A FY 2007A FY 2008A FY 2009A 1,574 4,153 6,257 8,533 10,311 1,516 3,972 5,942 8,040 10,024 1,452 3,524 5,416 7,564 8,804 64 448 526 476 1,220 3 11 20 176 395 36 86 123 117 131 81 171 276 359 434 (27) 253 200 249 1,116 24 30 19 54 189 (74) 173 127 122 860 8 20 37 70 301 (82) 153 90 52 559 19.8% 19.0% 17.0% 18.3% 29.8% -1.7% 6.1% 3.2% 2.9% 10.8% -5.2% 3.7% 1.4% 0.6% 5.4%
FY 2005A 1,574 519 33.0% 407 25.9% 58 3.7% 105 6.7% 4 0.3% 183 11.6% 58 3.7% 24 1.5% 24 1.5% 88% FY 2006A 4,153 1,475 35.5% 916 22.1% 308 7.4% 200 4.8% 152 3.7% 283 6.8% 181 4.4% 30 0.7% 50 1.2% 87% FY 2007A 6,257 1,958 31.3% 1,705 27.3% 436 7.0% 396 6.3% 329 5.3% 395 6.3% 315 5.0% 19 0.3% 54 0.9% 90% FY 2008A 8,533 3,263 38.2% 1,799 21.1% 694 8.1% 718 8.4% 394 4.6% 478 5.6% 492 5.8% 54 0.6% 73 0.9% 93% FY 2009A 10,311 3,527 34.2% 2,615 25.4% 1,035 10.0% 826 8.0% 324 3.1% 279 2.7% 287 2.8% 189 1.8% 66 0.6% 89%
The Airline of the Future? A Financial & Business Appraisal of Airblue - 10 Revenue The Companys top line (net of fixed excise duty and other taxes) has grown from PKR 6,257 (FY 2007) million to PKR 10,311 million (FY 2009). Whereas, the EBITDAR margin during the corresponding period has posted a CAGR of 17%. The aforesaid impressive growth is the result of the following factors: 1) Impact of Fuel Prices: The Company has successfully demonstrated its ability to manage the impact of increases in fuel prices; this can be gauged from the fact that during the time of record high fuel prices it managed to retain its EBITDAR margin. During FY 2009, the EBITDAR Margin jumped to 30% due to the fuel price collapse. Furthermore, other cost saving measures adopted by the Company has also contributed thereto. Nevertheless, the Companys ability to pass on the fuel price during peak time was partially compromised; however, airblue improved its EBITDAR margin through cost cutting measures during the corresponding period. 2) Capacity Addition: Number of available seats has been increased from 570 thousand (FY 2005) to 1,206 thousand (FY 2009). 3) Footprint Enlargement: The Company strategically placed more focus on enhancing its footprint outside Pakistan, which has resulted in high passenger yield and provides a synthetic hedge against PKR depreciation. Currently 55% (86) of total weekly flights are being operated on international sectors.
Rev enue (PKR mm) EBITDAR (PKR mm) EBITDAR Margin (PKR mm) 20% 8,533
10,311 30%
19%
6,257 18% 17% 3,075
4,153
1,574 312 790 1,065
1,564
FY 2005A
FY 2006A
FY 2007A
FY 2008A
FY 2009A
(Annual Report , 2007, 2008 & 2009)
Sales Commission Sales Commission is paid on basic fare, which usually constitutes 50% of the total fare price. The Company pays 5% and 8% sales commission on domestic routes and international routes respectively. Approximately 75% sales are being generated through travel agents. Sales commission increased steadily during FY 2005 2008 due to an increase in the number of flights on international routes. However, during FY 2009, the Company changed its sales commission policy and restricted sales commission to basic fare only and excluded the fuel surcharge component of the total fare from the ambit of sales commission. Subsequently, PIA and other regional airlines followed suit and slashed sales commissions (Dawn Press Report, 2008).
Sales Commission (PKR mm) As a %age of Rev enue 5.0% 4.4% 3.7% 2.8% 5.8%
58 FY 2005A
181 FY 2006A
315 FY 2007A
492 FY 2008A
287 FY 2009A
(Annual Report , 2007, 2008 & 2009) Passenger Growth and Yield The number of revenue passengers has grown, in tandem with capacity additions, from 450k to approximately a million. Seat factor has also increased from 74% (FY 2007) to a record high of 82% in FY 2009. The average seat factor for the period covered is 78% (compared to PIAs average of 69% for the corresponding period).

Seats Av ailable ("000') Rev enue Passenger ('000') Seat Factor 1,043 80% 79% 1,260 1,234 1,206 82%
570 76% 74%
452 FY 2005A
810 FY 2006A
918 FY 2007A
969 FY 2008A
952 FY 2009A
(Annual Report , 2007, 2008 & 2009) The seat factor came under pressure in FY 2006 and 2007, when airblue commenced flights on the Pakistan UAE sector. Competition from national and Middle-Eastern airlines, and low business class occupancy were the major underlying reasons. The main reason for low business class occupancy was the unsuitability of single aisle fleet to compete with broad bodied aircraft being operated by national and regional airlines. Therefore, in late FY 2007, the management of airblue decided to convert all aircraft from double cabin to a single class, i.e. all economy. The aforesaid decision resulted in an increase in seat factor that jumped from 74% to 82%.
Av erage Fare per Passenger (PKR) 8,689 6,717 5,079 3,410
10,662
FY 2005A
FY 2006A
FY 2007A
FY 2008A
FY 2009A
(Annual Report , 2007, 2008 & 2009) The growth in number of passengers and seat factor was also accompanied by an increase in passenger yield, which increased from PKR 6,717 (FY 2007) to PKR 10,662
The Airline of the Future? A Financial & Business Appraisal of Airblue - 13 (FY 2009). The increase in yield is mainly due to the deployment of aircraft on international sectors. Fuel Cost This is the single largest component of the Companys total cost. The surge in fuel price began in FY 2005 and continued till mid of CY 2008 when it peaked to USD 147 per barrel in July 2008 (The Economist, 2010). Subsequently, fuel prices collapsed due to the global economic recession and traded at the USD 3035 level per barrel in December 2009. Nevertheless, with the signs of economic recovery now visible, fuel prices have climbed to the USD 70 per barrel level.
Rev enue (PKR mm) Fuel Cost (PKR mm) Fuel Cost - as a %age of rev enue EBITDAR Margin (%) 31%
38% 8,533
10,311 34% 30%
36% 33%
6,257 20% 19% 17% 4,153 18% 3,263 1,475 519 1,958 3,527
1,574
FY 2005A
FY 2006A
FY 2007A
FY 2008A
FY 2009A
(Annual Report , 2007, 2008 & 2009) It is pertinent to mention here that during the period covered above, fuel cost grew at a CAGR of 61%, whereas the top line recorded a CAGR of 60%, which demonstrates the Companys ability to pass on the increase in fuel price. Furthermore, in FY 2008, fuel cost as a %age of revenue increased by 7% (i.e. from 31% (FY 2007) to 38% (FY 2008). The Companys EBITDAR margin grew from 17% (FY 2007) to 18% (FY 2008) due to increase in seat factor. During first half of FY 2009, airblue slashed sales commission and curtailed passengers service cost be replacing hot meals with cold snacks, The aforesaid measures along with a significant reduction in fuel prices lead to higher EBITDAR margins in FY 2009.

Fuel Consumption (million liters) Av erage Fuel Price per liter - PKR 47.35 48.86
36.04
34.35
22.04
23.5 FY 2005A
40.9 FY 2006A
57.0 FY 2007A
68.9 FY 2008A
72.2 FY 2009A
(Annual Report , 2007, 2008 & 2009) Relationship between Revenue and Fuel Cost One of the best measures to assess the Companys financial and operational performance is Available Seat Kilometers (ASK) and Revenue Passenger Kilometers (RPK) statistics. ASK represents the numbers of seats available for passengers multiplied by the number of kilometers the seats are flown and RPK represents the number of kilometers flown by revenue passengers.
ASK & RPK growth (million KMs) Avaialable seat kilometers Revenue passenger kilometers FY 2005A FY 2006A FY 2007A FY 2008A FY 2009A 682 1,394 1,780 2,330 2,425 544 1,053 1,319 1,852 1,982 CAGR 37% 38%
(Annual Report , 2007, 2008 & 2009) The above table indicates that RPK has grown relatively faster than ASK, which means that the fleet expansion plan undertaken by the Company during the period covered has resulted in an increase in seat factor, i.e. increased optimal utilization of aircraft. The following table summarizes the relationship between fare and fuel prices on a per RPK basis and calculates contribution margin. Contribution Margin per RPK represents the amount available to cover all other costs of the airline after deducting fuel cost from revenue on a per RPK basis.
Revenue and fuel cost per RPK Average fuel price per barrel - USD Revenue per RPK - USD Fuel cost per RPK - USD Contribution margin per RPK - USD FY 2005A FY 2006A FY 2007A FY 2008A FY 2009A 43.0 57.9 60.4 91.6 67.6 0.048 0.066 0.078 0.074 0.066 0.016 0.023 0.024 0.028 0.023 0.032 0.042 0.054 0.045 0.043 CAGR 12.0% 8.3% 9.3% 7.8%
Note: USD is being used to adjust the impact of PKR depreciation, (Annual Report , 2007, 2008 & 2009).
The Airline of the Future? A Financial & Business Appraisal of Airblue - 15 Revenue per RPK has increased by 8.3%, whereas fuel cost per RPK has grown by 9.3%. This demonstrates airblues ability to completely pass on fuel price during the period of record high fuel prices was partially compromised. However, contribution margin which was USD 0.032 cents per RPK in FY 2005 has increased to USD 0.043 cents per RPK in FY 2009, which means that the Company now has more resources to cover all other costs. Lease Rentals & Maintenance Reserve Variable (MRV) Charges The Company is obligated to pay lessors under dry leased contracts the following charges on a monthly basis: 1) Monthly Fixed Rentals 2) MRV charges MRV charges are paid to lessors on the usage of the aircraft. These charges are paid on a per hour and a per cycle basis and used to build reserves for repair and maintenance expenditures that will be incurred during the tenor of lease. Typically, airlines opt for low monthly fixed lease rentals and high MRV charges as it limits the airlines monthly liability to lessors during times of economic downturn (Annual Report, 2009). The following table summarizes the monthly fixed lease rentals and MRV charges being paid by airblue on its existing fleet of seven aircraft:
# 1 2 3 4 5 6 7 8 Aircraft A320 A320 A320 A321 A321 A321 A319 A319 Registration No. MSN 760-APBGW MSN 394-APBGU MSN 443-APBGV MSN-1199 APBJA MSN-1218 APBJB MSN 1008-APBRJ MSN-3385/APBIE MSN-3388/APBIF Manufacturing Date Nov '97 Oct '93 Oct '93 Mar '00 Apr '00 Apr '99 Mar '08 Feb '08 Monthly Fixed Rentals 261,000 145,000 145,000 300,000 300,000 310,000 280,000 280,000 Per Cycle Charge 230 256 248 165 165 222 190 190 Per Hour Charge 260 537 379 233 233 408 159 159
(Annual Report, 2009)
Repair and Maintenance Cost This represents the repair and maintenance cost incurred by airblue for the day to day maintenance of its aircraft. It also includes the cost being paid by airblue to lessors in case actual expenditures incurred exceed the MRV built with lessors. The repair and
The Airline of the Future? A Financial & Business Appraisal of Airblue - 16 maintenance cost as a %age of revenue has declined in FY 2009 due to the induction of two six month old A319 aircraft in August 2008.
Repair and Maintenance Cost (PKR mm) As a %age of Rev enue 5.3%
3.7%
4.6%
3.1%
0.28% 4 FY 2005A 152 FY 2006A 329 FY 2007A 394 FY 2008A 324 FY 2009A
(Annual Report , 2007, 2008 & 2009) Landing and Handling Cost Landing and Handling cost consists of overflying charges (paid to different countries for using their air jurisdiction) airport parking, landing and takeoff fees and ground handling charges. During FY 2009, landing and handling costs have increased by 49% as airblue added 4 international sectors to its network and PKR depreciated by 20%.
Landing & Handling Cost (PKR mm) As a %age of Rev enue 8% 7% 7%
10%
4%
58
308 FY 2006A
436 FY 2007A
694 FY 2008A
1,035 FY 2009A
FY 2005A
(Annual Report , 2007, 2008 & 2009) Salary and Benefits Due to heavy reliance on the IT system, airblues salary and benefits cost structure is one of the lowest in the aviation world. As a %age of revenue, salary and benefits cost
The Airline of the Future? A Financial & Business Appraisal of Airblue - 17 is a mere 8%, compared to the industry benchmark of approximately 15% - 18%. 50% of the total payroll cost is attributed to cockpit and cabin crew.
Salary & Benefits (PKR mm) As a %age of Rev enue
8.4%
8.0%
6.7% 4.8%
6.3%
105 FY 2005A
200 FY 2006A
396 FY 2007A
718 FY 2008A
826 FY 2009A
(Annual Report , 2007, 2008 & 2009) Passengers Service Cost Passengers Service Cost mainly includes meals, newspapers and other consumable items served to passengers. In response to record high fuel prices the Company curtailed the aforesaid cost by adopting cost-cutting measures such as replacement of hot meals with cold snacks. Cost per passenger has been slashed from PKR 493 (FY 2008) to PKR 292 (FY 2009).
Passenger Serv ice Cost (PKR mm) As a %age of Rev enue 11.6% 478 395 283 183 6.8%
279 6.3%
5.6%
2.7%
FY 2005A
FY 2006A
FY 2007A
FY 2008A
FY 2009A
(Annual Report , 2007, 2008 & 2009)
The Airline of the Future? A Financial & Business Appraisal of Airblue - 18 Balance Sheet Extract & Comments on Key Balance Sheet Items
Balance sheet (PKR mm) Paid-up capital Shareholders' equity Non-current liabilities Aircraft financing loan Current liabilities Short-term financing Current portion of aircraft financing Unearned Income Trade & other payables Shareholder's equity & total liabilities Fixed assets - Net book value Long-term deposits Current assets Inventory Trade debts Advances, deposits, prepayments, receivables Cash and bank balances Total assets FY 2005A FY 2006A FY 2007A FY 2008A FY 2009A 172 371 445 445 445 7 363 527 579 1,195 27 36 64 159 226 0 491 523 1,137 2,226 2,778 206 48 500 628 9 58 382 583 566 262 400 736 1,110 1,399 598 996 1,746 2,964 4,304 0 131 165 290 417 512 111 206 241 326 480 294 581 1,174 2,190 3,051 4 27 47 106 282 166 314 350 271 369 107 17 598 185 54 996 488 281 1,746 1,554 210 2,964 2,077 196 4,304
(Annual Report , 2007, 2008 & 2009) Equity The Companys capital base is very thin due to its business model where the revenue generating asset, i.e. the aircraft, is being operated on a dry leased contract basis. The Company has built equity over a period of time from its profits and since the commencement of operations; all profits have been reinvested into the Company. During FY 2009, PKR 56 million was injected into the Company by Mr. Tariq Mahmood Chaudhary, CEO of the Company. A further induction of equity of USD 56M is planned in FY 2011 (Annual Report, 2010).
Shareholer's equity (PKR mm) Paid-up Capital Accumulated Profit & Loss Equity FY 2005A 178 (171) 7 FY 2006A 382 (19) 363 FY 2007A 456 71 527 FY 2008A 456 123 579 FY 2009A 512 683 1,195
(Annual Report , 2007, 2008 & 2009) Unearned Income The value of unutilized tickets and airway bills is shown as Unearned Income. Unearned Income is determined as the difference of tickets sold and boarding passes issued during the year.

PKR mm Revenue Unearned Income As a %age of Revenue FY 2005A 1,574 9 1% FY 2006A 4,153 58 1% FY 2007A 6,257 382 6% FY 2008A 8,533 583 7% FY 2009A 10,311 566 5%
(Annual Report , 2007, 2008 & 2009) Fixed Assets The Company has incurred capital expenditures very cautiously and used the savings to fund PDPs. The most significant head of capital expenditure is Engineering and Flight Equipment, which enables the Company to earn revenue. All offices of the Company are on rental premises; however, during FY 2009 airblue acquired office space in the Islamabad Stock Exchange Building to build its head office.
Fixed Assets (PKR mm) Leasehold improvements Building Operating ground & catering equipment Engineering & flight equipment Office equipment, furniture & fixtures Computers & accessories Sub-total Leased vehicles Total Cost 36 78 88 253 23 45 522 177 699 Accumulated Depreciation 7 17 57 7 32 120 67 187 Net Book Value 29 78 71 196 16 13 402 110 512
*As of June 30, 2009, (Annual Report , 2007, 2008 & 2009) Intangible The Company incurred PKR 70.2 million on software development that has been fully amortized during FY2009. Trade Debts The Company successfully exploited its revenue management system to keep Trade Debts within control. The Sales Agents submit their collections on fortnightly basis and in the case of delay, airblues Revenue Management System blocks them from making further sales (Annual Report, 2009).

Trade Debts (PKR million) Trade Debtors Day s 350 314 38 271 369
166
28 20 12 13
FY 2005A
FY 2006A
FY 2007A
FY 2008A
FY 2009A
(Annual Report , 2007, 2008 & 2009) Liquidity: The company's current assets grew from PKR 1.1 billion to PKR 3.1 Billion during the period under review. This growth is primarily based on an increase in advances to Airbus S.A. in lieu of Pre Delivery Payments. Accounts receivable and inventories have also increased which is in line with the growth in sales. At the same time, current liabilities increased from PKR 1.13 Billion to PKR 2.78 Billion with the only non operating factor being the growth in short term financing as a result of pressure on internally generated cash flows due to cash outflows as a result of PDP's and BFE's.
Overall, the company has been able to maintain a sound current ratio of 1:1 or close to it over the review period. The cash conversion cycle has worsened from -16 days to 4 days but is still under manageable levels and hence no major liquidity risk is witnessed.
Solvency: On the leverage side, 100% profit retention ensured that the total debt to Equity ratio improved from 80: 20 to 72:28 from an year earlier. The financial leverage at the start f the review period was roughly the same only. However, going forward, the acquisition of three aircraft on an ownership basis is set to increase financial leverage with a proposed strategy of 100% profit retention to aid in keeping this under manageable levels. Similarly, a USD 15 Million equity injection is planned for FY 2011 to help the company reduce financial leverage.
The Airline of the Future? A Financial & Business Appraisal of Airblue - 21 Competitor Analysis Pakistan International Airlines Corporation (PIA) was incorporated on January 10, 1955 under the Pakistan International Airlines Corporation Ordinance 1955, which was subsequently repealed and replaced by the PIAC Act, 1956. PIAs shares are quoted on all stock exchanges of Pakistan (PIA Website, 2010). Massive Losses PIA is facing mounting financial pressure. During CY 2008, PIA incurred a net loss of PKR 35,880 mm (CY 2007: PKR 13,399 mm), resulting in accumulated losses of PKR 72,534 mm (CY 2007: PKR 37,160 mm). In addition, PIAs CY 2008 current liabilities exceeded its current assets by PKR 56,669 (CY 2007: 38,798 mm). The aforesaid situation led to an external auditor report, which included a mater of emphasis para explaining that PIA accounts have been prepared on a Going Concern basis due to the Government of Pakistans support to PIA.
Income Statement Revenue Cost of services Gross profit Distribution costs Administrative costs EBIT Finance costs Other provisions Exchange loss Other operating income Profit/(loss) before tax Taxation Loss after tax Depreciation & Amortization EBITDA Fuel cost Staff cost Repair and maintenance CY2005 64,074 58,941 5,134 3,809 4,326 (3,001) 2,787 (34) 110 1,242 (4,513) (102) (4,412) 3,797 796 26,463 10,049 5,005 CY2006 70,587 69,882 705 4,395 4,887 (8,577) 4,768 856 504 986 (13,215) (452) (12,763) 3,481 (5,097) 33,370 7,943 6,654 CY2007 70,481 66,556 3,924 4,449 5,257 (5,781) 7,136 433 720 (999) (13,071) 328 (13,399) 5,652 (129) 30,515 12,050 3,583 CY2008 89,202 85,562 3,639 5,390 5,818 (7,569) 8,352 1,521 24,119 (1,831) (39,729) (3,849) (35,880) 8,039 471 45,854 14,415 4,206
Balance Sheet CY2005 CY2006 CY2007 CY2008 Property, plant and equipment 51,264 78,964 95,497 115,010 Intangibles 112 98 103 113 Total fixed assets 51,376 79,062 95,601 115,123 Long term investments 310 4,528 4,540 4,498 Other long term assets 8,441 4,948 5,381 5,009 Total non-current assets 60,127 88,538 105,522 124,631 Current assets 12,770 18,353 13,251 15,039 Total assets 72,898 106,892 118,774 139,670 Share capital 17,981 19,474 20,878 21,423 Reserves 4,281 4,281 (32,782) (68,125) Unrealized gain / (loss) on (15) 21 97 73 remeasurement of investments Accumulated losses (11,800) (24,563) (37,160) (72,354) Total equity 10,446 (788) (11,904) (46,702) Surplus (revaluation of fixed 926 972 14,193 assets) Non-current liabilities 41,214 65,728 77,656 100,471 PROVIDED BY :MUHAMMAD HATIF SAJJAD DAR GROUP :https://www.facebook.com/groups/accaglobeextended Current liabilities 21,237 41,025 52,050 71,708 PAGE:- https://www.facebook.com/AccaGlobeExtended EMAIL 106,892 :- hatifdar@yahoo.com Total equity and liabilities 72,898 118,774 139,670
FACEBOOK:- https://www.facebook.com/HaTiFDaR
Metric Revenue passengers (mm) Passenger load factor (%) Revenue per passenger (PKR) Jet fuel prices (PKR per liter) Jet fuel prices (USD per liter) Average employees
CY2005 5.5 69.7% 11.7 27.0 0.45 19,263
CY2006 5.7 68.5% 12.3 32.6 0.54 18,282
CY2007 5.4 67.4% 13.0 35.1 0.58 18,149
CY2008 5.6 71.3% 15.9 57.1 0.81 18,036
Source: Annual Report 2008 Fuel Cost Furthermore, the price of crude oil rocketed in 2008 to its highest ever level of USD 147 per barrel in July that caused an additional expenditure of PKR 15.5 bn in fuel costs over the year. As a percent of revenue fuel cost constitutes 51% of total revenue compared to the global average, which stands at 31% for CY2008. The aforesaid difference is mainly due to PIAs ageing fleet.
47.3% 41.3% 43.3% 45,854 33,370 30,515 26,463 51.4%
FY2005
FY2006
FY2007
FY2008
Fuel cost (PKR mm) As a % of rev enue
(Annual Report, 2008) Seat factor PIAs seat factor fell continuously from CY2005 to CY2007. Some of the reasons that can be attributed to this fall are the bans imposed in 2007 on PIA flights to EU member countries. . A detailed review of the network was carried out to identify economically non-viable flights; as a consequence to this, a number of routes were shelved and frequencies were curtailed based on the contribution of the route over and above its variable operating cost (VOC) and direct operating cost (DOC). The upshot to route
The Airline of the Future? A Financial & Business Appraisal of Airblue - 23 rationalization was simple: decisions were taken to close down some stations and cut down expensive foreign/overseas staff.
71.3%
5.7 69.7%
5.6 68.5% 5.5 67.4% 5.4
FY2005
FY2006 No. of passengers (mm) Seat factor
FY2007
FY2008
Annual Report, 2008
As at the time of writing, the financial statements of PIA show further decline with the national flag carrier depicting a loss of 5.2 Billion rupees due to a loss on cost control even though fuel prices have fallen depicting a declining efficiency trend for the airline (Annual Report, 2009). .
The Airline of the Future? A Financial & Business Appraisal of Airblue - 24 Business Analysis As the financial analysis proves that the airline has been financially viable, we now turn our attention to identifying the business model that allows the airline to enjoy this growth. In other words, the plan is to identify the source of competitive advantage for the firm. Airblue Operating Model, Revenue Management System & the Target Market Observations (Annual Reports 2007 2009 & Company Press Reports 2006-2009) Single Aircraft Type - Airblue operates the A320 family aircraft and benefits from cost efficiencies in employee training and maintenance. A single type of aircraft fleet ensures a cost efficient and productive workforce. Point-to-Point Networks - Point-to-point networks are cost effective. This is because airlines that have connecting flights routinely pay airport taxes when they stop at connecting hubs. Furthermore, refueling at connecting hubs causes extra fuel costs to be incurred. In addition, flight delays and luggage losses are common occurrences in routes that have stopovers, which cause further costs to be incurred. Point-to-point service enables the Company to make more round trips per aircraft per day, maintains low turnaround times and achieves high utilization rates on its fleet. Maximum Capacity Utilization - Maximum capacity utilization means filling up the maximum number of seats available on an aircraft. This is achieved by forecasting demand and supply of a particular route and adjusting fares accordingly by offering discounts or charging premiums. Low Distribution Costs - Airblue has low distribution costs through its sale agents, company maintained sales offices, the internet and call centers. The Company has the lowest sales commission structure in the industry and seeks to increase sales through its sales offices, internet and call centers, which will further reduce distribution expenses in the future. It is pertinent to mention here that the Company has the credit of introducing E-ticketing in Pakistan. Single Passenger Class - Airblues fleet is all coach class. The Company strategically adopted a single passenger class strategy as it would not be feasible for the company to compete on business class with a fleet of single aisle aircraft. The aforesaid strategy resulted in high seat factors despite the current economic recession. Revenue Management System - The airline has developed a unique airlinewide, web-based system that provides reservations, check-in, weight & balance,
The Airline of the Future? A Financial & Business Appraisal of Airblue - 25 revenue calculation and real-time management information. The airblue intranet system provides requisite functionality to operate the business in a way that ensures a paperless environment, minimizes staff number and provides real time management information to both the functional operating areas and senior management. The Company has a complete record of all flights since the launch of its operations, which has now become an effective tool to estimate demand and tweak fare structure as per demand and supply situation, that is, follow predatory pricing. The aforesaid in-house system has won recognition from industry experts, aviation consulting companies and senior executives of different regional airlines. It is pertinent to mention here that it would not be easy for any airline to replicate this system due to heavy cost of migration. Furthermore, airblue has used a company specific reservation system, which results in huge savings on reservation charges. Synthesis Porters Generic Strategies Judging by the aforementioned discussion, we find that the company employs a cost leadership strategy with a broad market focus as described by Porter in his generic strategy model (BPP, 2008). By not differentiating between business and economy class or targeting a specific market subset, the company has kept its focus broad while its cost saving strategy (as detailed above) has allowed it to become productively efficient. The use of predatory pricing allows for maximum utilization and targeting of available resources which hints at allocative efficiency. Combine the two; you have an airline which is economically efficient (Grant, 2002). Hence, a source of competitive advantage enjoyed by the airline is its ability to undertake predatory pricing and operate through a low cost operating base, thanks to its heavy reliance on information technology, internet based systems and its in house revenue management system. Industry Structure A Source of Competitive Advantage? Many times, industry structure too can be a source of competitive advantage. Porters Five Forces Analysis is a good proxy at ascertaining what drives industry structure and whether the same can be a source of competitive advantage for competing firms (BPP, 2008). The analysis is presented on the next page in the form of an industry review.
The Airline of the Future? A Financial & Business Appraisal of Airblue - 26 PAKISTAN'S COMMERCIAL AIRLINE SECTOR BRIEF REVIEW On the domestic scene, after having made a great start on the international scene, the Pakistani airline industry has waned over the years in terms of presence, market share, number of operators, aircrafts and routes operated. This is the result of many factors including but not limited to fuel costs, lack of investment in new aircraft, lack of strong sponsor support and in the case of PIA (the national flag carrier), massive politicization (Dawn Press Report, 2010). Industry Structure Degree of Rivalry The degree of rivalry in the Pakistani market has dropped significantly as a result of a small number of domestic and international operators. Lack of sponsor support and a failure to curtail operating leverage to manageable levels through increasing load factor per flight has been the prime reason for the withdrawal of local operators while the threat of terrorism and tough competition by Gulf based airlines on traditional destinations of the Pakistani traveller has pushed away European operators leading to a high concentration ratio. However, rivalry on the international scene is higher as compared to the local sector on account of higher number of operators. Threat of new entry remains low as a result of the natural obstacles faced by any potential entrant with regard to the dynamics of the industry where cost control and strong sponsor support is a must for survival. Negative industry trends further these obstacles as the failure of many local operators sets a bad precedent for potential entrants while the law and order situation in the country keeps many foreign operators (particularly European operators) away as the flow of their target market to and from Pakistan remains low. The small number of operators mitigates any consumer choice that may pose a significant buyer power threat. However, the international sector is more competitive and the increased choice does represent elements of moderate buyer power. Supplier power remains high as cost pressures from rising fuel costs are out of the control of the operators.
Threat of New Entry
Buyer Power
Supplier Power
The Airline of the Future? A Financial & Business Appraisal of Airblue - 27 Threat of Substitute Products The lack of widespread technological advancement coupled with lower focus on a quality experience by operators in road and rail travel in the country making threat of substitute products low on the domestic scene. On the international sector, the lack of proximity coupled with the geographic factors of traditional destinations of the Pakistani consumer present a natural hedge for operators against alternative mechanisms.
Nevertheless, the market for air travel in Pakistan is lucrative and opportunistic operators stand to gain much if they are willing to take the risks of operating in such a competitive environment provided they do not repeat the mistakes that their predecessors and colleagues have made. Bear in mind that Pakistan is a capacity constrained market adequate fleet size is not available to serve demand. The market size is 11 million + passengers growing at a 35-year CAGR of 6.4% within which domestic traffic has grown at a 35-year CAGR of 5.5% and international traffic has grown by 7.6% during the corresponding period. This corresponds well when compared to a global average for last the 20 years 4.8% (IATA, 2010). Synthesis As can be inferred from the above, to a great extent, we see that the local industry structure also provides Airblue an edge over its competitors and hence proves that there are significant factors that favor the airline and work in tandem with the factors identified in Porters generic model to help the airline survive. A capacity constrained market, low buyer power, low rivalry and low threat of new entrants coupled with the lack of any formidable substitutes means that any airline which wishes to avoid a loss making situation in this scenario has to hedge supplier costs, that is fuel. As can be inferred from the discussion so far, the efficient operating model of the airline has allowed it to reap significant cost savings with its ability to do predatory pricing and passing on the cost of higher fuel to consumers without impacting brand equity adding to its competitive force.
The Airline of the Future? A Financial & Business Appraisal of Airblue - 28 Presentation of Findings
Perception of low price means compromising safety In case of unplanned repair & maintenance, delays can occur due to high aircraft utilization Strong brand equity Safe and secure
Captive passenger base Relatively young fleet
Unique airline-wide web based system & revenue New LCCs being management software provides established in the a sustainable edge over its region competitors Traffic, landing and overflying rights are dependent on intercountry government relationships Deterioration in geopolitical environment
W T
Pakistan is a supply constraint market Favourable demographic structure; young populace (per capita income is rising) Ethnic population on the rise in UAE and UK Rapid urbanization Strong economic growth
Opening up of Saudi Routes
The Airline of the Future? A Financial & Business Appraisal of Airblue - 29 Conclusions & Recommendations The success of Airblue can be attributed to the following: Low cost productively efficient High Capacity Utilization resource allocation efficiency Predatory Pricing Techniques High Use of Internet & E Commerce systems Favorable Industry Structure
While it would certainly be hard to find such a combination of factors for each and every airline, the airline of the future, in case we talk about it adaptability of Airblues business model, implies that for investor confidence to return, airlines that are in their stages of infancy or mid life should invariably try and adopt an efficient working style focusing on a low cost base as much as possible. The lower the cost base, the more efficient the airline and the more its ability to absorb cost pressures outside of its control. At the same time, airlines should realize that any seat not sold implies output and revenue lost forever (Grant, 2002). Hence, it should be the target of the airlines of the future to ensure maximum capacity utilization. Airblues case also depicts the importance of E systems and E commerce and this too has important implications of any future business model for the airline industry. Specifically, the internet based systems reduce costs and allow wider reach and marketability. On an ending note, I would like to state, that the airline of the future, would also have to take stock of the fact that the industry has become increasingly competitive and has important implications. The favorable industry structure has helped Airblues cause well. The important differentiator between it and the rest of the two players in the local industry, was its strategic positioning as an airline that specifically targeted a market that was looking for cheap air travel and at the same time established itself as a low cost producer. Airlines of the future will also have to look into this factor and see which strategic positioning serves them best in terms of exploiting the maximum amount of benefit available.
The Airline of the Future? A Financial & Business Appraisal of Airblue - 30 BIBLIOGRAPHY Airblue Limited. (2008) Annual Report 2007. Islamabad: Airblue Limited. Airblue Limited. (2008) Annual Report 2008. Islamabad: Airblue Limited. Airblue Limited. (2009) Annual Report 2009. Islamabad: Airblue Limited. BPP. (2010) ACCA Paper P3: Business Analysis. London: BPP Learning Media. Pakistan International Airlines Corporation. (2008) Annual Report 2008. Islamabad: PIAC. Pakistan International Airlines Corporation. (2009) Annual Report 2009. Islamabad: PIAC Schweser (2009) CFA Level One: Financial Statement Analysis. London: Kaplan. Grant, Susan, J. (2002) Stanlakes Introductory Economics. 7th Edition. London: Longman Airblue Limited (2010). Company Information & Press Reports. [Online]. Airblue Staff. Retrieved From: http//: www.airblue.com [Accessed 12th May 2010]
The Economist (2010). Articles: Airlines & Defense. [Online]. The Economist Staff. Retrieved From: http//: www.economist.com/articles/subject.htm [Accessed 12th May 2010]
IATA (2010). Industry Information. [Online]. IATA Staff. Retrieved From: http//: www.iata.org [Accessed 12th May 2010]
PIAC (2010). Company Information & Press Reports. [Online]. PIAC Staff. Retrieved From: http//: www.piac.com.pk [Accessed 12th May 2010]
The Airline of the Future? A Financial & Business Appraisal of Airblue - 31 State Bank of Pakistan (2010). Economic Data. [Online]. SBP Staff. Retrieved From: http//: www.sbp.org.pk [Accessed 12th May 2010]
Dawn Newspaper Press Reports & Clippings, 2006 - 2010

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ACCA OXFORD BROOKES DEGREE PARTNERSHIP RESEARCH & ANALYSIS PROJECT

ABCDEFGHI ACCA STUDENT REG # 123456789 Words =

The Airline of the Future? A Financial & Business Appraisal of Airblue - 2

Project Objectives & Overall Research Approach ..................................................... 3

Results, Analysis, Conclusions & Recommendations............................................... 6

Results, Analysis, Conclusions & Recommendations............................................... 9

6,257 18% 17% 3,075

1,574 312 790 1,065

(Annual Report , 2007, 2008 & 2009)

The Airline of the Future? A Financial & Business Appraisal of Airblue - 11

The Airline of the Future? A Financial & Business Appraisal of Airblue - 12

570 76% 74%

Av erage Fare per Passenger (PKR) 8,689 6,717 5,079 3,410

10,311 34% 30%

The Airline of the Future? A Financial & Business Appraisal of Airblue - 14

(Annual Report, 2009)

Landing & Handling Cost (PKR mm) As a %age of Rev enue 8% 7% 7%

Salary & Benefits (PKR mm) As a %age of Rev enue

(Annual Report , 2007, 2008 & 2009)

The Airline of the Future? A Financial & Business Appraisal of Airblue - 19

The Airline of the Future? A Financial & Business Appraisal of Airblue - 20

The Airline of the Future? A Financial & Business Appraisal of Airblue - 22

CY2005 5.5 69.7% 11.7 27.0 0.45 19,263

CY2006 5.7 68.5% 12.3 32.6 0.54 18,282

CY2007 5.4 67.4% 13.0 35.1 0.58 18,149

CY2008 5.6 71.3% 15.9 57.1 0.81 18,036

Fuel cost (PKR mm) As a % of rev enue

5.6 68.5% 5.5 67.4% 5.4

FY2006 No. of passengers (mm) Seat factor

Annual Report, 2008

Threat of New Entry

Captive passenger base Relatively young fleet

Opening up of Saudi Routes

Dawn Newspaper Press Reports & Clippings, 2006 - 2010

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