Earnings Qantas Airways Limited

Question: Discuss about the Earnings Qantas Airways Limited. Answer: Introduction: Qantas Airways Limiteds financial performance has improved in the financial year 2016 as compared to the previous year, which is depicted in the increase in the return on invested capital. The company has reported a return on invested capital of 22.70% for the financial year 2016, which is greater than that reported for the year 2015 (Qantas, 2016). In the year 2015, the company reported a return on invested capital of 16.20%. The return on invested capital has been computed by dividing the earnings before interest and tax (EBIT) by average invested capital. Thus, the increase in the return on invested capital could be attributed to the increase in EBIT or reduction in the average invested capital (Bernstein, 2004). In the current case of Qantas, both the factors such as increase in EBIT and reduction in average capital employed have contributed to the increase in the return on invested capital. The EBIT was observed to be $1,476 million for the year 2015, which increased to $2,009 million in the year 2016. Further, the average invested capital was observed to be $9,091 million for the year 2015, which reduced to $8,857 million in the year 2016 (Qantas, 2016). The combined impact of increase in the EBIT and the reduction in the average invested capital caused substantial increase in the return on invested capital in the year 2016. The increase in the EBIT indicates improvements in the operational performance of the company in the year 2016. The primary reason for improvement in the operational performance has been observed to be increase in the revenues. The revenues of the company increased from $15,816 million in the year 2015 to $16,200 million in the year 2016 (Qantas, 2016). In addition to this, there have been observed a reduction in the operating cost as well. The major reduction was found to be in fuel cost, which reduced from $3,937 million in the year 2015 to $3,250 million in the year 2016 (Qantas, 2016). Further, the reduction in the average invested capital also caused improvement in the operational performance of the company. In the regard, the major improvement was observed in the managing receivables. The accumulation in receivables went down from $1093 million in the year 2015 to $929 million in the year 2016. Further, slight increases in the liabilities such as payables and advance revenues helped in optimizing the invested capital, which ultimately caused enhancement in the return on invested capital (Bernstein, 2004). Cost of Debt for Qantas Amount ($M) Amount ($M) Interest bearing debt 2015 Current 771.00 Non-Current 4,791.00 Total 5,562.00 Interest bearing debt 2016 Current 441.00 Non-Current 4,421.00 Total 4,862.00 Average level of debt for 2016 5,212.00 Total Interest paid out in 2016 284.00 Cost of Debt (Interest paid/Average level of debt 2016) 5.45% The market value of shares is taken as the weight of equity in the computation of WACC. Therefore, the average equity level has been calculated based on the market value of shares as shown below: Market Value of share capital of Qantas Share Capital Market Value on 01.07.2015 No of Shares (million) 2,205 Share Price on 01.07.2015 3.26 Market Value (A) ($M) 7,187.40 Share Capital Market Value on 31.06.2016 No of Shares 2,083 Share Price on 31.06.2016 2.82 Market Value (B) ($M) 5,874.05 Average Equity Levels for 2016 2016 ($M) 2015 ($M) Market Value of Shares 5,874.05 7,187.40 Treasury Shares (50.00) (7.00) Reserves (220.00) (66.00) Retained Earnings (100.00) (1,115.00) Total Equity 5,504.05 5,999.40 Average Equity for 2016 5,751.73 Cost of Equity for Qantas: Using CAPM Model Description Rate Remarks A. Risk free rate 1.77% Based on 5 years bond yield (Bloomberg, 2016) B. Market return 7.18% Based on average annual returns on ASX 200 (refer appendix-B) C. Beta of Qantas 0.86 Computed variance and covariance of returns (refer appendix-A) CAPM 6.40% Weighted average cost of capital Weight Cost Weighted Average Debt 0.48 5.45% 0.026 Equity 0.52 6.40% 0.034 WACC 5.95% The return on invested capital is the return earned by the company on the amount of capital or resources used in earning that return. The weighted average cost of capital (WACC) is the return that the investor may desire from the company to earn. Thus, the weighted average cost of capital designates the investors expectations from the company (Brigham and Daves, 2014). In case of Qantas, the company earned after tax return on invested capital of 15.90%, while the weighted average cost of capital is worked out to be 5.95%. This indicates that the company is earning more than the investors expectations. Therefore, the return on invested capital of 15.90% is very much acceptable from the investors perspective. The company is following policy of paying dividend and buying the shares back from the shareholders. This policy of the company seems to be inappropriate in the given circumstances because the company is earning more than the investors expectations. In such circumstances, the company should retain the profits and reinvest the same in the operations rather than distributing as dividend to the shareholders. On the same grounds the company is advised to stop buy back of the shares also. References Qantas. 2016. Preliminary Final Report for the Financial Year Ended 30 June 2016. [Online]. Available at: https://investor.qantas.com/FormBuilder/_Resource/_module/doLLG5ufYkCyEPjF1tpgyw/file/full-year-results/preliminaryFinalReport16.pdf [Accessed on: 20 September 2016]. Bernstein. 2004. Analysis of financial statement. Tata McGraw-Hill Education Brigham, E.F. and Daves, P.R. 2014. Intermediate financial management. Cengage Learning. Bloomberg. 2016. Australian bond rates. [Online]. Available at: https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia [Accessed on: 20 September 2016].