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Transcript of Airfrance Analysis
AIRFRANCE-KLM COMPANY ANNALYSIS
LEA
Lecturer: Prof. Dr. Ralf Hafner
Name: Kevin Gichimu (s0541454)
Page | 1
Contents 1.0 AIR FRANCE-KLM SA COMPANY PROFILE ..........................................................3
1.1 General information ...............................................................................................3
1.2 Structure .....................................................................................................................3
1.3 Management ................................................................................................................4
1.3.1 Organization of the Board of Directors as of May 20, 2014 ...............................4
1.3.2 Executive Management Committee .....................................................................4
1.3.3 Possible sources of conflict of interest between the management and
shareholders ..................................................................................................................5
1.4 Financial markets & interaction with investors. .......................................................5
1.5 Social obligations ........................................................................................................5
1.6 Shareholders Breakdown ...........................................................................................6
2.0 FINANCIAL ANALYSIS ...............................................................................................7
2.0.1 Air France-KLM Common-Size Balance Sheet ......................................................7
2.0.2 Air France –KLM Common-Size Income Statement .............................................8
2.1 Net Working Capital ......................................................................................................9
2.2 Average tax rate ..............................................................................................................9
2.3. Return on Equity (ROE) ...............................................................................................9
2.4 Return on Assets (ROA) .................................................................................................9
2.5 Return on Capital ......................................................................................................... 10
2.6 Market Value Added and Market Book Ratio ............................................................ 10
2.7 EFFICIENCY RATIOS ............................................................................................... 10
2.7.1 Asset Turnover Ratio ............................................................................................. 10
2.7.2 Receivables Turnover ............................................................................................ 11
2.7.3 Average collection Period ...................................................................................... 11
2.8 Profitability Ratios........................................................................................................ 11
2.8.1 Profit Margin ......................................................................................................... 11
2.8.2 Operating profit margin ........................................................................................ 12
2.9 LEVERAGE RATIOS .................................................................................................. 12
2.9.1 Long-Term Debt Ratio........................................................................................... 12
2.9.2 Long-Term Debt Equity Ratio .............................................................................. 12
2.9.3 Total Debt ratio ...................................................................................................... 12
2.9.4 Times Interest Earned ........................................................................................... 13
Page | 2
2.10 DU-Point System ......................................................................................................... 13
3.1 Risk profile .................................................................................................................... 14
3.1.1 Competition ............................................................................................................ 14
3.1.2 Jet fuel risks ........................................................................................................... 14
3.1.3 Foreign currency risk ............................................................................................ 14
3.1.4 Other Risks ............................................................................................................. 15
4.0 Stock Performance profile ............................................................................................ 15
5.0 COST OF CAPITAL .................................................................................................... 16
5.1 Optimal debt ratio .................................................................................................... 17
6.0 PROJECTS ................................................................................................................... 17
6.0.1 Current project ...................................................................................................... 17
6.0.2 Typical project ....................................................................................................... 17
7.0 Financing ....................................................................................................................... 18
7.1 Debt ........................................................................................................................... 18
7.2 Equity financing ........................................................................................................ 19
Page | 3
1.0 AIR FRANCE-KLM SA COMPANY PROFILE
1.1 General information
Air France-KLM SA, a limited liability company registered under French law on 5 May 2004 as a
result of a mutual agreement between Air France and Netherlands-based KLM. It`s the second-
largest airline in Europe after Deutsche Lufthansa and is headquartered in Paris France. Through
its operating units, Air France and KLM operate independently from hubs in Paris-Charles de
Gaulle and Amsterdam- Schiphol, and also have coordinated operations, both as sister companies
and as members of the Sky Team alliance.
The company`s principal activity is passenger transportation, contributing roughly 80% of the
Group’s revenues, among other activities that includes cargo, aeronautics maintenance and other
air-transport-related activities comprising of in-flight catering and charter services. The Airline
serves more than 230 destinations in 125 countries with a fleet of 552 aircrafts. In 2013, the
airline carried 77.3 million passengers and 1.3 million tons of cargo.
1.2 Structure
The company also holds vast minority ownership in a couple of other international airlines as
illustrated in table 1.
Airline % Of Ownership
Kenya Airline 26
Air Côte D’ivoire 20
Air Corsica 12
Alitalia 7,08
Air Tahiti 7
Air Mauritius 3
Royal Air Maroc 3
Air Calédonie 2 Table 1
Air France KLM
(Listed company)
KLM
(Operating Company)
Air France
(Operating Company)
Page | 4
1.3 Management
Shareholders are involved in electing eleven of the fourteen Board of Directors. As a requirement
two of them have to be representatives of the employee shareholders, while the remaining three slots are allocated to French State that’s represented though ministerial orders appointments.
The Board of Directors determines the direction of the Group's activities and ensures that they are
implemented in accordance to the plan. Furthermore, it’s mandated to work with the General
Management to ensure smooth company operations in line with the opinions and recommendations of its specialized committees.
Alexandre de Juniac serves as the Chairman of the Board of Directors and the group Chief
Executive Officer. This establishes a link between the Board and Management therefore ensuring that the Management acts to the best interest of the shareholders.
The company has a Supervisory Board in place that comprises of independently appointed
directors mandated with the duties of monitoring the management. Table 2 and 3 shows the composition of Air France-KLM SA Board of Directors and Executive management respectively.
1.3.1 Organization of the Board of Directors as of May 20, 2014
Name Position Alexandre de Juniac. Chairman and C.E.O
Peter F. Hartman Vice Chairman Of the Board of Directors
Régine Brehier Representative of the French State
Jean-Dominique Comolli Representative of the French State
Solenne Lepage Representative of the French State
Christian Magne Representative of the ground staff and cabin crews
Louis Jobard Representative of flight deck crew
Jean-François Dehecq Member Of the Board of Director
Jaap de Hoop Scheffer Member Of the Board of Director
Cornelis J.A van Lede Member Of the Board of Director
Isabelle Bouillot Member Of the Board of Director
Maryse Aulagnon Member Of the Board of Director
Isabelle Parize Member Of the Board of Director
Leo M. van Wijk Member Of the Board of Director Table 2
1.3.2 Executive Management Committee
Name Position
Frederic Gagey C.E.O Air France
Camiel Eurlings C.E.O KLM
Alain Bassil C.O.O Air France
Pieter Elbers C.O.O KLM
Patrick Alexandre EVP Commercial-Passenger Business
Pieter Bootsma EVP Commercial Marketing-Passenger Business:
Bram Gräber EVP Strategy-Passenger Business
Wim Kooijman EVP Human Resources
Jean-Christophe Lalanne EVP Information Technology
Franck Terner EVP Engineering and Maintenance
Erik Varwijk EVP Cargo
Jacques Le Pape EVP Corporate Secretary
Pierre-François Riolacci Chief Financial Officer
Table 3
Page | 5
1.3.3 Possible sources of conflict of interest between the management and
shareholders
a) Since they use the principle of one share one vote, shareholders who hold more shares by
de facto have more voting power in enforcing crucial company’s decisions including
elections of members to the .Board of Directors. This may lead to decisions that favour
them rather than the company.
b) The combined role of chairman and C.E.O in my view gives him so much responsibilities
and may be a burden especially in decision making processes.
1.4 Financial markets & interaction with investors.
Air France-KLM is listed for trading in Paris (Euronext) and Amsterdam (Euronext). As all listed
companies are obliged to do, present and potential investors can easily find the company
published quarterly and annual financial reports as well as current stock information on their
investor relations website (www.airfranceklm-finance.com). In addition, Shareholders are also
invited to subscribe to the group’s financial send outs and news via email and mobile messages.
Furthermore, interested investors can inform themselves about the company’s business in press and market analytical researches.
The Shareholders’ Club also gives holders of at least 50 shares an exclusive link with the
company and access to all the company’s general and financial information, notably through the ACTION ‘air shareholders’ newsletter.
There also exists an Individual Shareholders’ Committee (ISC) which represents individual
shareholders to the Group’s management bodies. The Committee main aim is to communicate the
needs of individual shareholders, particularly in terms of financial communication, and pass on their questions, suggestions and requests.
1.5 Social obligations
The group has subdivided its corporate social responsibilities in the following categories
a) Environment
The company aims at reducing environmental footprint by improving its operations though
innovation of the supply chain and by mobilizing the entire staff and industry.
The company is investing in the use of biofuel-operated aircrafts as an alternative to fossil fuel.it
in fact operated the world’s first two commercial passenger flights using biofuels without any
changes to the aircrafts engines which is the first step to ensuring environmental sustainability.
Furthermore, the group supports environmental protection programs led by NGOs and also
supports efforts towards achieving a global climate agreement.
b) Customer experience
The company strive to integrating sustainability within the entire value chain in order to offer
customers sustainable and innovative products and services.
c) Responsible human resources
The company aims at maintaining a responsible social policy and encourage personal
development to ensure the motivation and professionalism of its employees. It seeks to uphold
gender equality and put in place measures that favour employment of disabled.
d) Local development
Aims at creating economic and social value at their hubs and destinations. In the recent past the
company has run
Page | 6
1.6 Shareholders Breakdown
Number of issued shares at March 31, 2014
Number of shares issued 300,219,278
Number of theoretical voting rights 300,219,278
Number of exercisable voting rights 296,039,474
58,1%
17,6%
15,9%
7,0%1,4%
Institutional Individuals French state Employees Treasury stock
Breakdown of shareholding as of march 31, 2014
Page | 7
2.0 FINANCIAL ANALYSIS
2.0.1 Air France-KLM Common-Size Balance Sheet
In € million 2013 2012
Goodwill 237 0,93% 252 0,94%
Intangible Assets 896 3,52% 842 3,15%
Flight Equipment 9391 36,94% 10048 37,60%
Other Property, Plant And Equipment 1819 7,15% 1932 7,23%
Investments in Equity Associates 177 0,70% 381 1,43%
Pension Assets 2454 9,65% 2477 9,27%
Other Financial Assets 1963 7,72% 1665 6,23%
Deferred Tax Assets 436 1,71% 1392 5,21%
Other Non-Current Assets 113 0,44% 152 0,57%
TOTAL NON-CURRENT ASSETS 17486 68,78% 19141 71,64%
Assets Held For Sale 91 0,36% 7 0,03%
Other Short-Term Financial Assets 1031 4,06% 933 3,49%
Inventories 511 2,01% 521 1,95%
Trade Accounts Receivables 1775 6,98% 1859 6,96%
Income Tax Receivables 23 0,09% 11 0,04%
Other Current Assets 822 3,23% 828 3,10%
Cash And Cash Equivalents 3684 14,49% 3420 12,80%
TOTAL CURRENT ASSETS 7937 31,22% 7579 28,36%
TOTAL ASSETS 25423 100% 26720 100%
LIABILITIES AND EQUITY
Issued Capital 300 1,18% 300 1,12%
Additional Paid-In Capital 2971 11,69% 2971 11,12%
Treasury Shares (85) -0,33% (85) -0,32%
Reserves And Retained Earnings (944) -3,71% 403 1,51%
Equity (Air France -KLM) 2242 8,82% 3589 13,43%
Non-Controlling Interests 48 0,19% 48 0,18%
TOTAL EQUITY 2290 9,01% 3637 13,61%
Provisions And Retirement Benefits 3102 12,20% 3158 11,82%
Long-Term Debt 8596 33,81% 9565 35,80%
Deferred Tax Liabilities 178 0,70% 149 0,56%
Other Non-Current Liabilities 397 1,56% 384 1,44%
TOTAL NON-CURRENT LIABILITIES 12273 48,28% 13256 49,61%
Liabilities Relating To Assets Held For Sale 58 0,23% - 0,00%
Provisions 670 2,64% 555 2,08%
Current Portion Of Long-Term Debt 2137 8,41% 1434 5,37%
Trade Accounts Payables 2369 9,32% 2219 8,30%
Deferred Revenue On Ticket Sales 2371 9,33% 2115 7,92%
Frequent Flyer Programs 755 2,97% 770 2,88%
Current Tax Liabilities 2 0,01% 3 0,01%
Other Current Liabilities 2332 9,17% 2474 9,26%
Bank Overdrafts 166 0,65% 257 0,96%
TOTAL CURRENT LIABILITIES 10860 42,72% 9827 36,78%
TOTAL LIABILITIES 23133 90,99% 23083 86,39%
TOTAL LIABILITIES AND EQUITY 25423 100% 26720 100%
Page | 8
2.0.2 Air France –KLM Common-Size Income Statement
EUR millions 2013 % 2012 %
REVENUE 25520 100% 25420 100%
Cost of Goods Sold 2348 92,01% 2393 94,14%
Amortization Expense 80 0,31% 70 0,28%
Depreciation 149 5,84% 151 5,94%
Amortization of Intangibles 80 0,31% 67 0,26%
GROSS INCOME 470 1,84% (86) -0,34%
Other Operating Expense 340 1,33% 339 1,33%
Unusual Expense 241 0,94% 320 1,26%
EBIT( after Unusual Expense) (241) -0,94% (320) -1,26%
Non-Operating Income/Expense (87) -0,34% 119 0,47%
Non-Operating Interest Income 26 0,10% 28 0,11%
Interest Expense 356 1,39% 342 1,35%
Gross Interest Expense 365 1,43% 356 1,40%
Interest Capitalized 9 0,04% 14 0,06%
PRETAX INCOME (528) -2,07% (940) -3,70%
Income Tax 957 3,75% 17 0,07%
Equity in Affiliates (211) -0,83% (66) -0,26%
Consolidated Net Income 1700 6,66% (1020) -4,01%
Minority Interest Expense 9 0,04% 5 0,02%
NET INCOME (1710) -6,70% (1030) -4,05%
Extra ordinaries & Discontinued Operations (122) -0,48% (197) -0,77%
Discontinued Operations (122) -0,48% (197) -0,77%
NET INCOME AFTER EXTRA ORDINARIES (1830) -7,17% (1230) -4,84%
Preferred Dividends 0 0,00% 0 0,00%
NET INCOME AVAILABLE TO COMMON (1710) -6,70% (1030) -4,05%
EPS (Basic) (6,17)
(4,14) Basic Shares Outstanding 296,04
295,87
EPS (Diluted) (6,17)
(4,14) Diluted Shares Outstanding 296,04
295,87
Note
Calculations of EBIT for the last two financial years are as shown in the Common-size income
statement above
Page | 9
2.1 Net Working Capital
The working capital acts as an indicator of whether a company has enough short term assets to cover its short term debt
Formula 2013 2012
Current Assets - Current Liabilities
= - 2961 million
= - 2248 million
The negative numbers may be an indicator of serious financial problems the company is facing,
but on the hand it may also indicate managerial efficiency as most airline companies operate on upfront payments basis the significantly reduces short term liabilities.
2.2 Average tax rate
The average tax rate is average percentage a company has to pay from its taxable income
Formula 2013 2012
Total Taxes Owed
Total Income
=−957
2290= −𝟎. 𝟖𝟎
=−1225
3637= −𝟎. 𝟑𝟒
In case of losses, as in AIR-France KLM, the principle of tax carry forward permitted by the French
tax law was utilized. The taxes can be carried forward for an indefinite period, however, the amount
of the fiscal loss recoverable each year is set at 50% of the profit for the period beyond the first
million.
2.3. Return on Equity (ROE)
This is a measure of the returns on the money invested by the shareholders.
Formula 2013 2012
Net Income
Equity (Year Beginning)
=−1710
2290= −𝟎. 𝟕𝟓
=−1030
3637= −𝟎. 𝟐𝟖
The negative ROEs shown above as a reflection of the losses that the company incurred in the
respective years translating to no dividends payments.
2.4 Return on Assets (ROA)
ROA is a measure of how efficient company is in generating profits from its assets.
Formula 2013 2012
After Tax Operaring income
Average Total Assets
=−1710
7939= −𝟎, 𝟐𝟏
=−1030
7579= −𝟎, 𝟏𝟒
Page | 10
2.5 Return on Capital
Formula 2013 2012
After Tax operating Income
Average Total Capitalisation
−1460.8
2290= −𝟎. 𝟔𝟑
−790.6
3637= 𝟎. 𝟐𝟏
2.6 Market Value Added and Market Book Ratio
The Market Value Added is the difference between the current market value of a firm and the
capital contributed by investors.
Market capitalisation = (Shares Outstanding * share price) – Equity Book Value
= (300,219,278 * € 9, 60) – 2,290,000,000
= 592,105,068.8
Market Book Ratio = Market price per stock / Book value per stock
= 9.6/7.62
= 1.26
The book-to-market ratio attempts to identify undervalued or overvalued securities by taking the book
value and dividing it by market value. Since the ratio is above 1 the stock is undervalued
2.7 EFFICIENCY RATIOS
The ratios reflect how efficient a company is in using its assets.
2.7.1 Asset Turnover Ratio
Formula Air France-Klm Average Airline
industry
Revenue
Average Total Assets
=𝟐𝟓𝟓𝟑𝟎
(24423+26720)/2 = 1
0,89
For Air France KLM, each Euro of assets produced €1 of Revenue which slightly higher as compared
to the average Airline industry ratio of 0, 89 € meaning that the company had better mechanisms of
generating revenues from its assets.
Page | 11
2.7.2 Receivables Turnover
The ratio measures the firms’ sales in proportion of its receivables.
Formula Air France-Klm Average Airline
industry
Revenue
Average Receivables
=𝟐𝟓𝟓𝟑𝟎
(2072+2200)/2 = 11.95
48,81
2.7.3 Average collection Period
This measures the speed with which customers pay their bills. It expresses accounts receivable in
terms of daily revenue
Formula Air France-Klm Average Airline
industry
Average Receivables
Sales/365
=(2072+2200)/2
25530/365 = 30.53
22,47
As compared to the Airline industry collection period of about 23 days, Air France KLM customers
pay their bills at a lower rate of about 31 days which means the company credit policies are a little bit
lenient in collection of bills from clients or the bill collection mechanism is marginally inefficient.
Generally, the industry has the highest average collection period ratio within the transport industry due to the fact that most the clients pay for flights in advance
2.8 Profitability Ratios
The ratios are financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time.
2.8.1 Profit Margin
Formula Air France-Klm
Net Income
Sales
=−1827
25530 = - 0.07 or (-7%)
The company has a net loss of € 0.07 for each euro of revenue.
Page | 12
2.8.2 Operating profit margin
Formula Air France-Klm
Net Income + after tax interest
Sales
=−1827+−186
25530 = - 0.08 (-8%)
2.9 LEVERAGE RATIOS The ratios measure the financial leverage of a company which is the degree to which a company uses
fixed-income securities such as debt and preferred equity. The more debt a company uses, the higher
its financial leverage. A higher financial leverage means high interest payments, which negatively affect the company’s bottom –line earnings per share.
2.9.1 Long-Term Debt Ratio
Formula 2013 2012
Long Term Debt
Long Term Debt + Equity
=4913
4913 + 2290= 𝟎, 𝟔𝟖
=5839
5839 + 3637= 𝟎, 𝟔𝟐
In 2013 68 cents of every euro of long-term capital is in form of a long-term debt this translates to a
company heavily financed
2.9.2 Long-Term Debt Equity Ratio
Formula 2013 2012
Long Term Debt
Equity
=4913
2290= 𝟐, 𝟏𝟓
=5839
3637= 𝟏, 𝟔𝟏
2.9.3 Total Debt ratio
Formula 2013 2012
Total liabilities
Total assets
=23780
25423= 𝟎, 𝟗𝟒(𝟗𝟒%)
=23719
26720= 𝟎, 𝟖𝟗 (89%)
The company was heavily indebted in the years 2012 and 2013, on average 92% was financed with
debt, both long-term and short-term, compared to 8% Equity finance.
Page | 13
2.9.4 Times Interest Earned
Acts as a measure of the extent to which a company interest obligations are covered by earnings.
Formula 2013 2012
EBIT
Interest Payments
=149
356= 𝟎, 𝟒𝟐
=−414
342= −𝟏, 𝟐𝟏
Cash Coverage Ratio
Formula 2013 2012
EBIT + Depreciation
Interest Payments
=23780
25423= 𝟎, 𝟗𝟒
=23719
26720= 𝟎, 𝟖𝟗
2.10 DU-Point System
ROA =Sales
Assets∗
Net income + interest
sales
ROA =2552
25423∗
−1710+356
2552= -0.1
ROE =Assets
Equity∗
Sales
Assets ∗
Net income + interest
sales∗
Net Income
Net income + Interest
ROE =25423
2290∗
2552
25423 ∗
−1710 + 356
2552∗
−1710
−1710 + 356= −𝟎. 𝟕𝟒
Page | 14
3.1 Risk profile The risks exposed to Air France-Klm are the same risks associated to air transport and running a business. Some of the risks are analysed below
3.1.1 Competition
The average annual growth ofworldairtravelhasbeen roughly5% over the last 30 years which is
almosttwicetheannualgrowthof the global economy. The 1997 liberalization of the European
markets has been a fundamental factor to the cutthroat completion that besieges the airline industry not
only from within the airline industry but also from the general transport industry. Emergence of new completely priced airlines e.g. Easy jet and railway companies has that are Passenger growth as
shown in the table has not been strong New entrants of firm’s thus increasing horizontal competition
and also vertical completion to the industry the going
3.1.2 Jet fuel risks The Airline industry is heavily reliant on fuel prices. Any unforeseen changes in prices as in 2008 and 2011(as shown in table) drastically dent their short-term profitability and deter general operation. Most
airline companies mitigate this risk by use of use of fuel hedge strategies. These are contractual tools
that use swaps and options to reduce the exposure to volatile price fluctuations.
Therefore, companies gain planning
confidence especially for budgeting
purposes as well as give them ample time to adapt to the changing market conditions.
Air France –KLM fuel hedge framework sets the time span of the hedges to 2 years
(a rolling 24 months) with a target hedge
ratio of 60%.
As at December 30th 2013 the company
fuel exposure based on futures prices at December 27th 2013 ($109, 30 a barrel for
2014 and $102, 95 a barrel for 2015) was
as follows
In US$ million 2014 2015
Gross expenditure before hedging 9427 8906
Hedge percentage 60% 23%
Gain on hedging 223 26
Net expenditure 9204 8880
Based on the forward curve at December 27, 2013, an increase of $10 per barrel over 2014 would give
an average price of $119.30 per barrel and would lead to a $370 million increase in the fuel bill after hedging, i.e. a total fuel bill of $9.57 billion in 2014 for the Air France-KLM Group. Symmetrically, a
fall of $10 per barrel over 2014 would give an average price of $99.30 per barrel and would lead to a
$640 million reduction in the fuel bill after hedging, i.e. a total expense of $8.56 billion.
3.1.3 Foreign currency risk Currency volatility is a major issue for the airlines and particularly for the European carriers whose
costs are, for the most part, linked to the US dollar while their revenues are sensitive to all currencies.
Any depreciation in the euro relative to all currencies makes them more competitive at commercial
level. On the other hand, a fall in the euro relative to the dollar alone has a negative impact on costs.
Any appreciation in the euro relative to all currencies or only the dollar has the inverse effects. The
hedging strategies put in place by the airline with the aim of reducing the effects of currency volatility
73,3
99
61,5
79,4
111,
1
111,
8
0
20
40
60
80
100
120
2007 2008 2008 2010 2011 2012
Pri
ce($
)
Years
Oil Price/Barrel
Page | 15
3.1.4 Other Risks
Other risks that face the company includes;
GovernmentRegulations
Weather
Terrorism
Geopolitical instability
4.0 Stock Performance profile The stock gained 8.4 percent in 2013, trailing smaller competitor International Consolidated Airlines
Group SA (IAG), whose stock price more than doubled. It was the worst performer on Paris' broad
SBF 120 index. Generally, SBF120 fell by 52 %-- almost twice as much as German rival Lufthansa
(LHAG.DE) and underperforming International Airlines Group (ICAG.L). The drop shrunk the airline's market capitalisation to around 2 billion euros as it posted a 1.3 billion euro operating loss
quite comfortably the weakest financial performance of any European airline. High expenses on staff
costs of about a third of its revenue as compares with about a quarter for Lufthansa and IAG and a large debt pile of about 8 billion euros as compared to 1.4 billion of Lufthansa and tough competition
that have battered its shares.
Implementation of meaningful more aggressive instead of focusing on a multi-year strategies is
certainly needed on the cost side given an unreliable revenue environment. The management is trying
to adopt some measures to improve its competiveness with a plan to offer medium-haul flights from
regional bases in France in an effort to reduce operating costs by 15 percent.
The highest stock price was in March 31 2014 (€11.95) and also picked up on June 1 2014 when
Alitalia some positive developments from Etihad airlines for the purchase of to buy 49% which Air France Klm has a 7% stake closing at €10.72
Page | 16
Its competitors are In the similar scenarios as shown in the graph below that compares Air
France –KLm to Lufthansa.
Air France –Klm Vs Lufthansa
5.0 COST OF CAPITAL
Beta = 1.56
Risk free rate (France) = 5.0 %
Mature Market Expected Risk Premium (Damodaran as of 1 Jan. 2014) = 5%
𝑘𝐸 = 𝑅𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 + 𝑏𝑒𝑡𝑎 ∗ 𝑚𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚
𝐾𝑒 = 5.0 + 1.56 ∗ 5 = 𝟏𝟐. 𝟖
𝐾𝑑 = (5.0 + 0,5) ∗ (1 − 0) = 𝟓. 𝟓
𝑊ACC = Ke ∗E
D + E + Kd
D
D + E
WACC = 12.8 ∗2290
12273 + 2290 + 5.5 ∗
12273
12273 + 2290
= 6.65
Page | 17
5.1 Optimal debt ratio
Cost of capital approach is used to determine the company optimal debt. The cost of capital is the cost of funds used for financing a business. Cost of capital depends on the mode of financing used – it
refers to the cost of equity if the business is financed exclusively through equity or to the cost of debt
if it is financed solely through debt. Another component of financing can be preferred stock. It will
also depend on the cost of each component.
Many companies use a combination of debt and equity to finance their businesses, and for such
companies, their overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WACC).
If the cash flows to the firm are held constant and the cost of capital is minimized then the value of the firm will be maximized. Therefore the value of a firm is represented as the present value of cash flows
to the firm, discounted back at the cost of capital.
The company is having a debt ratio at about 90%. According to the Cost of capital approach it would
be better to have a debt ratio at about 40%.
6.0 PROJECTS
6.0.1 Current project
The airline planning to is offer low-cost operative flights, a market where the airline has lagged behind
its competitors. The company will offer such services though Transavia airline, a subsequent sister
airline, and this will allow the airline increase its footprint in fastest growing European market.
Air France-KLM is also running a comprehensive transformation project, "Transform 2015" with the
aim of regaining competitiveness and repositioning its products and services at the highest international level. To refocus the airline on the customer and to regain economic independence,
Transform 2015 is based on an industrial plan reflecting this ambition in all areas of activity, on
actions to transform organization and management methods and to reconsider social agreements, while ensuring two fundamentals: flight safety and work safety. To ensure the sustainability of the airline
and ensure continued investment for customers, a return to breakeven is essential for Air France in
2014. The measures implemented to achieve this aim both to reduce costs, increase efficiency and to
enter a new phase of improved revenue, to better meet customer expectation.
The company is also investing 700 million euros in new cabins to stay competitive.
6.0.2 Typical project
Since the company is immensely emerged in debt, a transformation comprehensive project should be
launched with the aim of identifying propels to managing the debt. Serious transformational ideologies
should be implemented so as the airline can regain its way back to profitability.
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7.0 Financing
7.1 Debt The company capital structure is comprised of approximately 90% debt of about 10 billion euros.
Most of its debt is inform of bonds offered as shown in the table below.
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Debt type and maturity profile
At December 31, 2012, 32% of the current and non-current financial debt is made of bonds:
Bonds Amount in €
Perpetual subordinated bond 251
Perpetual subordinated bond 357
2020 convertible bond 420
2015 convertible bond 661
2014 bond 750
2016 bond 700
2018 bond 500
Advantages and disadvantages of using debt financing
Debt financing has definitely had positive and negative features. Companies face trade-off for opting
debt over equity as the cost of debt becomes a financial liabilities and potential bankruptcy risk. As for
the positive features, using debt sets some pressure on management for securing positive cash flows,
which could be a good practice for firms mainly financed by equity and/or not having a major
shareholder to put pressure on the management. There is a higher importance in picking stable and
profitable projects to cover for the future interest payments and to keep their job. In general, using debt
helps to keep profits within a company and increases returns on equity for current company owners
helps secure tax savings
7.2 Equity financing
Equity comprises of 10% of the company capital structure. This is mainly from offering
shares on the stock exchange. Composition of its shares is as discussed previously on the
financial structure.