Analysis
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Some key aviation industry figures
In 2007, Canadian Level I to III air carriers reported nearly 55 million enplaned passengers, an all-time high, up 6.0% from 2006, continuing the upward trend that began in 2004. The domestic sector grew 6.7% in 2007 to 33.1 million passengers, while the international sector (including Canada-United States) rose 4.8% to 21.8 million passengers. The scheduled passenger counts reached 50.4 million and the charter passenger counts, 4.6 million. Between 1990 and 2007, the number of passengers carried by the Canadian carriers rose 50.2%, from 36.6 million to nearly 55 million. Notable growth periods span the 1990s and the 2000s. The two exceptions came during the early recession of the 1990s and between 2001 and 2003 due to many contributing factors such as the terrorist attacks against the United States in September 2001, the outbreak of Severe Acute Respiratory Syndrome (SARS), as well as the beginning of war in Iraq in 2003. The Canadian air transportation industry recovered in 2004 and 2005, thanks to a strong economy and to its restructuring pattern.
Another important aspect in examining the industry's growth is the number of passenger-kilometres flown. Canadian Level I to III air carriers recorded 126.4 billion passenger-kilometres in their scheduled and charter operations in 2007, up 6.5% from the previous year. The domestic sector (+6.0%) advanced at about the same pace as the international sector (+6.7%). Between 1990 and 2007, the number of passenger-kilometres almost doubled. Over these years, the average passenger trip length increased 26.5%, from 1,820 kilometres in 1990 to 2,302 kilometres in 2007. The average passenger trip length in the domestic and international sectors were 1,316 kilometres and 3,794 kilometres respectively in 2007.
Financial analysis
In 2007, total operating revenues generated by the Canadian Level I to III air carriers amounted to $16.2 billion, up 6.1% from 2006, continuing the upward trend that began in 2004. In 1990, operating revenues were at $7.7 billion.
The total operating expenses from 1990 to 2007 have followed approximately the same growth curve as the operating revenues, although almost consistently they have been lower than the operating revenues (see Chart 1). From the $7.8 billion recorded in 1990, operating expenses increased to $15.1 billion in 2007, up 3.6% over the previous year.
From 1990 to 2007, the operating revenues and expenses, adjusted for inflation, showed increases of 47.4% and 36.1% respectively. As can be seen in Chart 1, in 1990, operating revenues were at about $9.9 billion, as were operating expenses. In 2007, they reached respectively $14.5 billion and $13.5 billion (2002 constant dollars).
However, there have been some exceptions to this pattern of steady upward growth. The strongest decreases occurred at the onset of the economic recession in Canada in the early 1990s and during the period from 2001 to 2003. From 1990 to 2007, the industry's current dollar operating revenues covered operating expenses in all but seven years (from 1990 to 1993 and from 2001 to 2003). During this period, the industry's net annual income showed losses on 12 occasions, and largely they were due to non-operating expenses. 1 Over the 15-year period from 1990 to 2004, the industry lost $6.9 billion. However, the Canadian Level I to III air carriers returned to profitability by 2005. In 2007, these carriers reported a net income of $909.9 million, an improvement in profitability from the $328.0 million recorded in 2006 and an all-time high.
A look at the operating revenue dollar
Another perspective on the industry can be gained by examining how the operating revenue dollar is spent. In 2007, for example, 93.0 cents of each operating revenue dollar were used to cover operating expenses. In 1990, however, the operating expenses were not all covered by the operating revenues; for each operating revenue dollar received, $1.01 was spent on operating expenses (see Table 1).
As shown in Chart 2, the two most costly expense areas of an airline business were aircraft operations 2 and general services and administration 3 . Of these two, aircraft operations absorbed the larger portion of each operating revenue dollar in 2007, at 47.7 cents. In 1990, 36.2 cents of each operating revenue dollar were spent on aircraft operations. The rise in the expenses related to aircraft operations can be largely explained by increases in fuel costs and wages and salaries (see Table 2). Between 1990 and 2007, expenses related to general services and administration declined substantially from 48.0 cents of each operating revenue dollar to 29.9 cents. In 1990, if the expenses allocated to this category absorbed almost half of each operating revenue dollar, this was partly due to the increased need for airlines to administer the areas that were regulated by the government prior to 1988. 4 Over the years, the relative share of depreciation and maintenance (flight equipment and ground property and equipment) expenses remained quite stable. This is partially due to the fleet renewal programs—the airlines' modernized fleet required less maintenance.
Financial performance indicators
Financial ratios are a good way to gauge the economic health of an industry, and in this case, the airline industry. The income statement shows the current financial health while the balance sheet indicates long-term financial achievement. Ratios are also used to compare the performance of individual carriers, to locate the efficiency of a particular carrier within the industry, and to measure the results of one industry against another or of the Canadian aviation industry to another country.
The three major types of financial ratios which have been considered include: liquidity, solvency and profitability. For each category, the ratios considered in this analysis were calculated as follows:
Liquidity ratios
The current ratio is current assets divided by current liabilities.
The debt structure ratio is current liabilities divided by total liabilities.
Solvency ratios
The debt-to-asset (debt) ratio is total liabilities divided by total assets.
The debt-to-equity (leverage) ratio is total liabilities divided by total shareholders' equity.
Profitability ratios
The operating ratio is operating expenses divided by operating revenue.
The profit margin is net income divided by operating revenue.
The return on assets is net income divided by total assets.
The return on investment is the sum of net income and interest expenses divided by total assets.
In 2007, the operating ratio (it displays the carrier's ability to meet its short-term obligations and represents the proportion of operating revenue absorbed by operating expenses) stood at 0.93, down from 0.95 in 2006. Overall, this means that the Canadian Level I to III air carriers made 7.0 cents of profit for every dollar spent in 2007 and 5.0 cents in 2006. Operating ratios greater than one indicate that the industry experienced an operating loss, as was the case in the recessionary year of 1990 (see Chart 3). The rising cost of fuel and employment coupled with lower load factors helped to explain the decrease in operating income.
As can be seen in Charts 4 and 5, the liquidity of the industry, as measured by the current ratio (it measures the carrier's ability to meet financial obligations as they come due, without disrupting normal operations) and the debt structure ratio (it measures the proportion of total debt due and payable within the current year), showed some fluctuations over the years. The current assets-to-current liabilities ratio moved down in 2007, reaching 0.79, compared to 0.86 in 2006. The lower ratios recorded since 2000 mean that Canadian Level I to III air carriers have a reduced ability to pay short-term debts compared to earlier periods. Current ratios greater than one indicate that the industry is considered to be liquid, as was the case in 1990. The debt structure ratio declined from 49.9% in 2006 to 40.6% in 2007, roughly the same level as in 2005 (40.9%). Overall, the aviation industry in Canada is still generating a positive net worth (total assets minus total liabilities). The net worth of the industry increased 27.0% to $4.0 billion in 2007, as assets rose and liabilities decreased.
The extent to which borrowed funds are used is reflected in the debt-to-asset ratio (it is a measure of the extent of leverage being used by an airline) and in the debt-to-equity ratio (it is a measure of the degree to which the creditors have financed the airlines compared to the shareholders). The debt-to-asset ratio of 0.77 in 2007, for example, showed that every dollar of assets was financed with 77.0 cents of debt. Such a highly leveraged industry is more efficient during growth years when profits can both pay off interest charges and more. This ratio climbed to 0.84 in 2005 and to an even higher 0.93 in 2000, concurrent with the beginning of problems by the aviation industry in Canada in acquiring finances 5 (see Chart 6). Highly leveraged airlines run the risk of large losses during a recession or an economic slowdown, but also have a chance of gaining high profits when the industry is growing. Owners may prefer high leverage either to magnify earnings or because raising new equity means giving up some degree of control. Fleet renewal programs and mergers and acquisitions within the industry may partly explain the increase in the use of debt during the early 2000s. As shown in Chart 7, the solvency, as measured by the debt-to-equity (leverage) ratio, showed an improvement from 4.44 in 2006 to 3.41 in 2007. This means that in 2007, for example, for every $3.41 in debt, the airlines had $1.00 in equity (shareholders' money). In 2000, this ratio was 13.46.
The aviation industry's earning power is reflected in the profitability ratios of profit margin, return on investment and return on assets. In 2007, the profit margin (it indicates the profit margin earned by revenue dollar—this ratio is expressed as a percentage) was higher than in 2006, rising from 2.1% to 5.6%. This shows that every dollar of service sold earned 5.6 cents of profit for the Canadian Level I to III air carriers (see Chart 8). The results for 1990 (-2.1%), 1995 (-1.3%) and 2000 (-0.6%) reflected the increases in operating expenses (aircraft operations—fuel cost and wages and salaries—and general services and administration) and non-operating expenses (capital losses, interest expenses and net miscellaneous non-operating expenses), which offset the gains in operating revenues.
Return on assets was perhaps the best long-term measure of the operating efficiency of an airline or enterprise. It is used to evaluate the proceeds gained on all the assets entrusted to management. If interest is removed from this computation, it is possible for an investor to compare the return on investment in the airline industry to, for example, the interest rates of a bank deposit 6 or some other investment to determine the best return. As interest expense is income tax deductible to the airline, financing with debt is efficient to the carrier, providing it costs less than financing with equity. As displayed in Charts 9 and 10, both return on assets and return on investment showed thriving profitability within the aviation industry in 2007. The rate of return on assets went from 1.9% in 2006 to 5.2% in 2007, while the rate of return on investment went from 3.9% in 2006 to 7.6% in 2007. Over the years, there has been a close correlation between the profit margin and the return on investment and the return on assets.
Productivity measures
A major component of airline costs is employment. In 2007, 16.7% of the operating expenses of the Canadian Level I to III air carriers were payments to their employees in wages and salaries. This represented an increase of 0.8 percentage points from 2006. In 1990, this percentage was substantially higher, when 27.2% of the budget went to wages and salaries. The 2007 percentage can be partly explained by the reduction in personnel (the number of employees working for air carriers went from 52,088 in 1990 to 40,649 in 2007—it was 58,911 in 2000) and by rising fuel costs which reduced the proportion of labour costs to total costs (see Table 2).
As shown in Table 3, in 2007, the operating revenue per employee reached $399,084, up 1.4% compared to 2006. This gain followed the 6.3% increase registered between 2005 and 2006. From 1990 to 2007, this employee productivity measure increased 2.7 times. Another yardstick used to measure productivity within the aviation industry is to calculate tonne-kilometres flown per employee. According to this measure, labour productivity in 2007 declined 2.9% compared to 2006, while in 2006 it bettered the previous year level (+6.2%). From 1990 to 2007, the tonne-kilometres flown per employee increased 2.2 times. Over the same period, average wages and salaries increased by a factor of 1.5, from $40,753 per year in 1990 to $61,885 in 2007. However, when adjusted for inflation, the average wages and salaries in 2007 were slightly higher than the 1990 level (see Table 2).
Fuel costs are also an important part of the budget for Canadian air carriers. However, while they figured very highly in the mid-2000s, they were less prominent in the 1990s and in 2000. In 1990, for example, they accounted for 17.9% of all operating expenses and in 2000, for 16.8%. In 2005 and 2006, however, fuel took up a quarter of all operating expenses (25.7%), increasing slightly to 26.3% in 2007. From 1990 to 2007, the price of fuel posted a twofold increment, going from 30.1 cents a litre to 67.4 cents a litre. Between 2005 and 2007, on a year-over-year basis, fuel costs advanced at a much faster pace (+25.3%, +9.3% and +4.5%, respectively) than the rate of inflation (+2.2%, +2.0% and +2.2%, respectively).
Increases in tonne-kilometres flown per litre of fuel consumed occurred in both 2006 (+8.6%) and 2007 (+0.1%). These results indicated that the Canadian Level I to III air carriers were able to protect themselves partially from the effects of fuel price increases through technological improvements and productivity increases. Overall, from 1990 to 2007, productivity in the industry for one litre of fuel increased on average from 1.81 tonne-kilometres to 2.49 tonne-kilometres (see Table 3).
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