RYANAIR - KING OF THE SKIES?
9th March 2021
The first time I read through RyanAir's annual report, I found something that nearly made me fall off my chair. The depreciation policy on the fleet of aircraft has an enormous impact on the reported results. An airline requires enormous capital investment on a continuous basis, as all of those jets it requires must be bought or leased. An asset, such as a jet, must be depreciated over its expected useful life, according to the accounting standards.
What is the expected useful life of a jet? It seems to me that this is a bit of a grey area, and therefore there is plenty of scope for the Chief Financial Officer (CFO) of an airline to play around with the numbers here.
Lets take a hypothetical example to explain the impact. We'll call our fictitious airline 'Shakey Airlines'. Lets say the depreciation policy is 25 years. The shares are straggling along on the market, as the airline has only ever reported modest profits, and whenever it looks like next year will be a better year - it isn't, as something always seems to go wrong. The balance sheet is quite stretched with a high level of debt, from years of huge capital investment and poor returns on same.
Then suddenly, lo and behold, the airline announces record earnings, much higher than analysts had expected and the shares take a massive leap upwards. The Chairman in his piece in the annual report states that he is delighted to announce these record results, in his final year before retirement. He then goes into corporate-speak overdrive, talking about the "company's vision", "customer focus" and "commitment to excellence" etc.
Three months later, when the shares have gone up about 30% since the day of the results, the airline has a massive, and heavily dilutive rights issue. It is heavily subscribed by enthusiastic investors, due to the recent impressive results.
Four months later, the Chairman announces his retirement, a little earlier than expected, due to the controversy arising from his personal relationship with a member of the cabin crew. He has not broken any law and the airline has no policy prohibiting these relationships between any staff members. However, much outrage is expressed on twitter - so he has to go.
Twelve months later, the shares go into a steep decline, as the annual results dash hopes that analysts had of a golden period of earnings growth for the airline. Analysts cut their earnings forecasts and trot out the usual barrage of figures for EBITDA, ROCE, EPS, NAV etc.
Nobody seems to have noticed that in last year's annual report, in note 25 to the accounts, on page 67, about halfway down the page, in small print, there is a note about the change in accounting policy for depreciation. There is some mumbo jumbo containing technical engineering references, and the gist of it is that the depreciation policy for the fleet of aircraft is being changed from a write down over 25 years, to a write down over 30 years.
This has a massive impact on the reported profits for that year, as the depreciation charge is now significantly less in the profit and loss account, compared to last year, with a corresponding increase in reported profits as a result.
A few years later, there is a huge charge for 're-structuring costs' on some pretext such as; changes to 'Open Skies' rules between the EU & US, or on a reorganisation of the airlines operations etc. Included in this is a write down charge for much of the airline fleet, as it became increasingly obvious that the annual depreciation charges were inadequate.
Analysts never really pay much attention to 'exceptional' items such as the above. The assumption is that these are once off costs, and therefore non-recurring, so that they do not impact on the underlying earnings. Therefore, these 'exceptional items' are a great way for a company with overly optimistic accounting policies to make the necessary write offs that will become necessary to assets, due to annual depreciation charges being too low. Throw in a lot of other stuff to obscure the trail, or better still, say that there are 'restructuring costs' due to a major shake up in the operations of the company.
Do all airlines have the same depreciation policy for their fleet of aircraft, so that we are comparing like with like, when we are examining their respective results?
Last time I checked, I found that they most certainly do not.
My guess is that the weaker airlines have a very lax depreciation policy, thereby flattering their results, and the stronger airlines have a more conservative policy as they do not need this artificial boost to their reported earnings.
Or perhaps, some of the better performing airlines are flattering their results with a lax depreciation policy?
Lets have a look at the accounts of some of the major airlines, along with RyanAir, and see how the depreciation policies compare. I suspect it will tell us all we really need to know about the underlying financial health and the likely future prospects of each airline.
READ THE REMAINDER OF THIS ARTICLE IN THE MEMBER'S AREA