The creditors and investors are care more about the financial leverage ratios because it reveals the extent of company management which is willing to fund its operations with debt, rather than equity. A high debt/equity ratio generally means that Cathay Pacific has been aggressive in financing its growth with debt. This can result in volatile earnings of the additional interest expense. If a lot of debt is used to finance increased operations (high debt to equity), Cathay Pacific could potentially generate more earnings than it would have without this outside financing.
If there were increasing earnings by a greater amount than the debt cost (interest), then the shareholders’ benefit as more earnings are being spread among the same amount of shareholders. However, the cost of the debt financing may outweigh the return that the company generates the debt through investment and business activities. It becomes too much for the company to handle. But, it is a special case for CX to handle. Creditors would not be satisfied to see the leverage ratios. The ratios show that Cathay pacific has insufficient cushion against the operating losses.
When the airline industry less relies upon debt financing, the facts that debt and debt-to-equity ratios are quite high and have the increasing trend which are obviously favorable at the creditor’s point of view. For owners, on the other hand, such high leverage ratios may be preferable because they do not likely to the leverage in order to maximize their return on their investments. There were increasing interest charges for the recent 10 years seems to be attributed to the large debt as well. The higher the ratio, the greater risk will be associated with the Cathay Pacific’s operation.
In addition, high debt to assets ratio may indicate low borrowing capacity of a firm, which in turn will lower the Cathay Pacific’s financial flexibility. Like all financial ratios, Cathay Pacific’s debt ratio should be compared with their industry average. The normal level of debt to equity has changed over time, and depends on both economic factors (2008) and society’s general feeling towards credit. Generally, Cathay Pacific has a debt to equity ratio over 80% to 100% that it should be looked at carefully to make sure no liquidity problems.
Overall, CX has the fluctuation in the profitability that the operating margin, net profit margin, ROA, ROE and earnings per share were unstable from 2002 to 2011. The best profitability performance was recorded in 2010 but the performance is under the industry average, expect the net profit margin. It is because the passenger and cargo businesses both performed well and CX benefited from the strong profits earned by Air China which contributed HK$2,482 million to the 2010 result.
However, the lower ROA and ROE show that CX could have many debts and invested much money into the assets. The higher net profit margin also uncovers that CX had a desirable net income in 2010. From the table 3, the data shows that the profitability of CX have some problems in 2008. The negative profitability ratios were recorded in 2008. A big drop in the net profit margin indicates that the management did not effectively generate profits.
CX had the increasing number of passengers which was 25 million in the early of 2008, however, the global financial tsunami, extremely high fuel prices and a plunge in both passenger and cargo demand had adversely impacted in the financial results. In 2011, the profitability ratios of CX were decreased because the cargo business was adversely affected by a substantial reduction in demand for shipments from the two key export markets, Hong Kong and Mainland China. According the 2011 annual report, CX has invested total 5.
7 billion to build the Cargo Terminal. Moreover, the fuel expenses had a significant effect on the operating of CX. The operation expenses were increased that the net income became smaller in 2011. In 2003, there were significant drop in the profitability ratios. The SARS disease was the main reason which leading the sharply decrease in sales performance. The greatest difference between the operating margin and the net profit margin in 2003 shows that the largest amount of tax and interest expenses further declined the profitability of CX.
CX will have an unstable trend of profitability in the future due to many factors, especially the high fuel prices and the global economic uncertainties. However, CX has the ability to overcome the future challenges that CX has the good performance in the net profit margin and higher earnings per share. It is attractive for the investors to invest money into CX. Market-based Ratios In analyzing the financial performance of Cathay Pacific, conducting the financial market’s assessment is one of the important tools to evaluate the firm’s financial condition. The major discussion is written in following.
Courtney from Study Moose
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