Submitted By: Mansi. Mehak. Nakul. Pragya 50082. 50088. 50090.

50110 BBS II-C

Index
Acknowledgments Leverage Types of Leverage Indian Aviation Industry

Capital Structure
Working Capital Kingfisher Airlines- Overview The King of good times gone bad Leverage Analysis of Kingfisher Airlines Analysis of Ratios Kingfishers Future & Options Conclusion Bibliography

Acknowledgements

We would like to thank Mr. Neeraj Kumar Sharma our Financial Management professor for his constant support and guidance throughout this project & for giving us an opportunity in practical application of our classroom knowledge through this project.

Leverage
The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.

OPERATING LEVERAGE It is a measure of how sensitive net operating income is to percentage changes in sales. Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in sales can produce a much larger percentage increase in net operating income.
DEGREE OF OPERATING LEVERAGE The degree of operating leverage (DOL) is a measure, at a given level of sales of how a percentage change in sales volume will effect profits. The higher the degree of operating leverage, the greater the potential danger from forecasting risk. That is, if a relatively small error is made in forecasting sales, it can be magnified into large errors in cash flow projections. The opposite is true for businesses that are less leveraged. A business that sells millions of products a year, with each contributing slightly to paying for fixed costs, is not as dependent on each individual sale.

Leverage
FINANCIAL LEVERAGE- Financial leverage can be defined as the degree to which a company uses fixed-income securities, such as debt and preferred equity. With a high degree of financial leverage come high interest payments. As interest payments increase as a result of increased financial leverage, EPS is driven lower. As mentioned previously, financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company's capital structure. As a company increases debt and preferred equities, interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company.

DEGREE OF FINANCIAL LEVERAGE- This measures the percentage change in earnings per share over the percentage change in EBIT. This is known as "degree of financial leverage" (DFL). It is the measure of the sensitivity of EPS to changes in EBIT as a result of changes in debt.

Indian Aviation Industry

The above quote summarizes the performance of the airlines industry in India. For majority of the years since the inception the firms have been making net losses, with their operating costs (specially the aviation fuel cost) increasing at a rate far more than the rate of increase of the operating revenues. The demand for the industry is highly elastic and it is affected a lot by the adverse global events, like the economic crisis of 2008, the global meltdown post the crisis, the earthquake and tsunami of Japan. This is not to say that the future of the Indian Aviation industry does not hold some promise.

Capital Structure
Todays competitive environment in the airline industry has never been tougher or more unforgiving. More and more players are one strategic misstep away from competitive extinction. Approaches that worked in the past simply dont cut it in todays hypercompetitive marketplace.

In their efforts to manage growth, airlines should dominate home markets and create an adaptive cultureone that can leverage the opportunities of a rapidly changing marketplace. In an industry of paper-thin margins, airlines need to significantly improve their customer experience, and do so throughout the travel value chain. And carriers might need to rethink their existing operating models to manage operational excellence by wringing out value from merger and acquisition activity, through sales and marketing and by new market entry and alliances.

Working Capital
Receiv ables Inven Worki Paya Net tory ng ble Work Cycle ing Cycle Deb ROE t/ Equ ity

44

105

149

97

52

0.0 112

Working Capital
Rising working capital along with huge debts can create a precariously weak financial position threatening the survival of companies. The Aviation industry has been in the eye of the storm battling with cash crunch. Airline companies such as Air India, Jet Airways and Kingfisher Airlines had borrowed heavily to expand air-fleet. However, the recent surge in crude price along with the weakening rupee left the over-leveraged companies high and dry. This coupled with exorbitant state fuel taxes, high maintenance charges and irrational ticket pricing have stretched working capital cycles creating a huge strain on the cash position of the companies. In fact Kingfisher Airlines was left with no cash to run its day-to-day operations and approached the government for a bail-out. In the case of Jet Airways, the auditors have raised a red flag on its going concern status, and asked it to raise funds to maintain its operations. This shows that increasing working capital cycle can spell havoc in a debt laden company putting its existence under cloud.

KFA-Overview
Owned by Vijay Mallya of United Beverages Group, Kingfisher Airlines started its operations on May 9, 2005, with a fleet of 4 brand new Airbus - A320, a flight from Mumbai to Delhi to start with. The airline currently operates on domestic as well as international routes, covering a number of major cities, both in and outside India. In a short span of time, Kingfisher Airlines has carved a niche for itself in the civil aviation industry.

KFA-Overview
Kingfisher Airlines proved to be a stiff competition for other domestic airlines of India, with its brand new aircraft, stylish red interiors, stylishly dressed cabin crew and ground staff. The airline introduced in-flight entertainment (IFE) systems, for the first time to Indian consumers. The IFE systems were provided on every seat, even on the domestic flights. The airline offers attractive services to its on board passengers. Years following its inception proved to be beneficial for the airline, in terms of its booming business, with a good track record of customer satisfaction. However, it faced a worsening economic scenario in 2008.

KFA-Overview
In 2008, due to the prevalent economic downturn, the civil aviation industry faced the worst period in its history. It was the time, when air passenger traffic started dripping, and the aircraft fuel prices went sky rocketing. As a result, Kingfisher Chairman Vijay Mallya and his Jet Airways counterpart Naresh Goyal announced an alliance, after a meeting. According to the alliance, both the airline companies decided to implement code-sharing on both domestic and international flights. It was a step to reduce the expenses.

The King of good times gone bad

Kingfishers downfall from a luxury airline to one that doesnt have money for day to day operations can be attributed to three mistakes committed by its management-

MERGER AND ACQUISITION OF AIR DECCAN It was when the good times seemed to last forever that Mallya made his first strategic mistake. Deccan Aviation's Capt G.R. Gopinath, who was desperately looking for a buyer for his airline, Air Deccan, had all but tied up with the Anil Ambani for a sell-out. Some last-minute delays eventually led to the collapse of the deal. That's when Mallya, who kept denying that he couldn't even think of buying an airline whose business model was different than his own, suddenly put in his bid, apparently offering more money than the previous one to clinch the deal.

The King of good times gone bad

UN-PROFESSIONAL MANAGEMENT It wasn't, actually. Mallya was not just into one business but several and each as different as the other. Normally, for such diverse businesses, one would appoint a CEO each to run it with a hands-on approach who would, in turn, report to the group chairman. While the liquor and the beer businesses had an experienced set of officials running the show, the others needed the undivided attention of Mallya himself. More so for the airline venture. This was where his second mistake came in. The airline had everything going for itself: great brand visibility, loyal customers and a wide network. But as a former business partner of Mallya pointed out recently, he was more like an absentee landlord.

The King of good times gone bad

RUSHED EXPANSION AMBITIONS GONE WRONG Industry analysts say the third mistake was that the airline should have first consolidated its domestic operations and then introduced international routes because on the foreign routes, the competition only gets bigger and with those who have deeper pockets

The King of good times gone bad

RECENT DEVELOPMENTS : NOVEMBER 2011 Even the 40 flight cancellations over last few days have come on the back of nearly 100 pilots having exited the airline over the last few months and its fast-mounting dues with airport companies and oil companies.

Both the airlines have attributed the loss to depreciation of the rupee, higher fuel prices, and some 'irrational' -read low- prices from Air India. The airline which started operations in 2005 hasn't reported a profit ever. What is also worrisome is that a bulk of the airline's Rs 6,000 crore debts are on account of operating losses and only some of it is due to the merger with the loss-making Air Deccan that Kingfisher took over in 2007.
Kingfisher had cut its debt through a restructuring by issuing shares to 14 banks, including State Bank of India and ICICI Bank. According to the plan, a consortium of 13 banks converted a Rs 750 crore loan into 23.37 per cent equity in the airline, valuing its shares at a nearly 62 per cent premium over the prevailing market price.

The King of good times gone bad

Ajit Singh, Aviation Minister says license cant be cancelled as long as KFA has minimum 5 planes operational and certain amount of equity.(Currently KFA has on 16 operational out of the previously 64 owned planes) Total debt of about Rs 7,057 crore and accumulated losses of about Rs 6,000 crore. KFA has decided to suspend all international flights from March 25 and further curtail domestic operations. Cash-strapped Kingfisher Airlines has to pay Rs 40 crore ($8 million) dues in indirect taxes by March 31, Central Board of Excise and Customs (CBEC) Chairman S K Goel.

Leverage Analysis of KFA

1) DFL= % change in EPS/ % change in EBIT From the statements, EBIT= PBDIT Interest

Leverage Analysis of KFA

As can be seen from the data above, DFL became unfavourable or negative in two years, FY ending 2009 and 9 months ending Dec 11. This implies that the return earned on assets employed by the firm paled in comparison to the cost of the same funds. The sharp decline in Q3 of FY 2012 can be attributed to the skyrocketing debt of close to Rs. 500 crore of the company, its approaching the govt. for a bailout, not having enough money for daily operating expenditure and more. In 2009, it can be attributed to the decision of the company to invest close to Rs. 550 crore in Kingfisher Red, a venture that ended up resulting in losses worth Rs. 550 crore.

Leverage Analysis of KFA

2) DOL= % change in EBIT/%change in Sales

Leverage Analysis of KFA

This indicates that in the former years, DOL is negative which means that the elasticity of EBIT viz a viz the change in sales is less which means that even though the sales have increased over the years as can be seen from the financial statements, the same could not bring about a change in EBIT because of miscellaneous expenditures such as high fuel costs, recession and failed acquisition of Air Deccan. In the last one year though, it has become positive as a result of major debt restructuring undertaken by the company including converting debt into equity etc.

Analysis of Value of KFA

COST OF CAPITAL The cost of capital is a term used in the field of financial investment to refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio of all the company's existing securities". For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital. The cost of capital is the rate of return that capital could be expected to earn in an alternative investment of equivalent risk. COST OF DEBT The cost of debt is computed by taking the rate on a risk free bond whose duration matches the term structure of the corporate debt, then adding a default premium. This default premium will rise as the amount of debt increases . Since in most cases debt expense is a deductible expense, the cost of debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are after-tax as well). Thus, for profitable firms, debt is discounted by the tax rate. The formula can be written as (Rf + credit risk rate)(1-T), where T is the corporate tax rate and Rf is the risk free rate. The yield to maturity can be used as an approximation of the cost of debt.

Analysis of Value of KFA

COST OF EQUITY Cost of equity = Risk free rate of return + Premium expected for risk Cost of equity = Risk free rate of return + Beta x (market rate of return- risk free rate of return) where Beta= sensitivity to movements in the relevant market Where:Es=The expected return for a security Rf=The expected risk-free return in that market (government bond yield) s=The sensitivity to market risk for the security RM=The historical return of the stock market/ equity market (RM-Rf) The risk premium of market assets over risk free assets. The risk free rate is taken from the lowest yielding bonds in the particular market, such as government bonds.

Analysis of Value of KFA

Analysis of Value of KFA

It can be seen that the value of the firm was falling from 2006 to 2009 and then saw an increase from 2009 to 2011. The sudden increase in the sharply declining value of the firm can be owed to the cut in debt by Kingfisher. Shares of Kingfisher Airlines rose more than 4 per cent on when it was reported that the cash-strapped carrier would consider proposals, including selling property and converting Rs.675 crore worth of debt into equity, to cut its $1.3 billion debt by more than half and then approach banks for loans only for the purposes of working capital. The debt was secured in part by a combination of guarantees by the airline's parent, the UB group, as well as Kingfisher shares, Mallya's personal guarantees, Mumbai real estate assets and the Kingfisher brand itself. Kingfisher's bank consortium consists mainly of state lenders led by State Bank of India. This step was taken because Kingfisher's survival depended on the equity infusion. The company had a mountain of debt and had a huge liability towards employees, oil companies and leasing companies. It was also reported that the debt number was understated, as current liabilities, a large part of which comprise overdue payments, are very high. One could say that almost half of current liabilities of the airline are overdue payments and, hence, equivalent to debt.

Analysis of Ratios
INVESTMENT VALUATION RATIOS Operating Profit per share has shown a positive favorable value only from the financial year ending March 2010. The reasons for this can be attributed to a visible improvement in Kingfishers operational performance over the past 4 to 5 quarters. The carrier reported a 2% year-on-year improvement in the three months ended 31-Dec-2010 (3Q2009-10). Net Operating Profit per share peaked for the year 08-09 at 198.1 crores and has steadily declined to 125.22 m for the year 10-11 due to a significant rise in operating cost (30%) that outpaced the 8% increase in revenues. It is a very competitive environment, it is a high-tax environment and its a hostile environment as far as investment is concerned. The fact of the matter is that the entire industry is in serious trouble, Dr. Mallya said. Kingfisher shares have reportedly lost around 67% of their value in 2011 and reached a record low on 11Nov-2011, reducing the carriers market value to around USD 213 million.

Analysis of Ratios
PROFITABILITY RATIOS EBIT profit stood at INR 550 million (USD11 million) for the financial year 10- 11. However, by this point of time, profits had begun to steadily decline and EBIT loss for 2QFY2011 stood at INR2.71 billion (USD54.2 million). Gross Profit Margin is highest for the year 2010-2011 at 11.88% in the past 5 years. However, this margin of Gross Profit is insufficient to cover costs and net profit margin is as low as 16%. It may also be observed that the net profit margin has been a negative value for a stretch of the past 5 financial years (07- 11). Net profit margin is 15.99% for 2010/11 inspite of an increase in net sales. Return on Capital Employed has been negative for the years 2007-09 and is highest at 21.72% for 2010/11. Return on Net Worth has been positive 2009 onwards. Return on assets has been negative throughout the 5 year period. In Sep 2011, the Chairman & Managing Director of Kingfisher Airlines made following disclosure to BSE: The Company has incurred substantial losses and its net worth has been eroded.

Analysis of Ratios
LIQUIDITY AND SOLVENCY RATIOS Current Ratio is 1.22 for the year ended march 2011 and less than 1 for the previous 4 years. The chief cause for the low current ratio is high debt levels that can be attributed to Kingfishers expensive acquisitions. Losses mean that Kingfisher needs USD400 million in the next three months alone to maintain operations, with the carrier seeking more bank loans to support its operations. Quick Ratio which should ideally be 1 has also been low for the past 5 years. Kingfisher has a debt of almost Rs.8000 crores of banks, aircraft leasing companies, oil companies and airports.

Analysis of Ratios
DEBT COVERAGE RATIOS The interest coverage ratio is a measure of a companys ability to pay interest on its debt and is thus an indicator of its safety margin when deciding if the business is a good credit risk. The ratio shows how many times a company can cover its interest charges on a pre-tax basis. A ratio of 1.5 or less should trigger serious concern about a companys overall financial health. When the ratio is less than 1, it means the company is not earning enough revenues to pay its interest charges. It may then have to honor its debt obligations by borrowing further funds. In the case of Kingfisher, the interest coverage ratio for the past 5 years has been less than 1 which is very low. Financial charges coverage ratio, due to the heavy fixed financial charge and low reserves, is also very low. Hence, it is no wonder that Kingfisher Airlines faces a crisis like it does today.

Analysis of Ratios
MANAGEMENT EFFICIENCY RATIOS Inventories turnover ratio has been declining over the past 3 years and indicate that that it takes an average of 4185 days in 2010/11 which is a decrease from 4660 days on the year before. Stock held can be sold off quicker and reduces on storage costs, and also frees up funds quickly. Since stock remains relatively around the same price and cost of sales has increased this accounts for the improvement in the ratio. The higher the fixed assets turnover ratio, the better the utilization of fixed assets and vice versa. Asset turnover ratio has remained fairly constant over the past three years though asset utilization efficiency is only average.

Analysis of Ratios
EARNINGS PER SHARE An ideal company should have a steady rising EPS growth. However, Kingfisher is far from this ideal situation with a negative EPS consistently over the past 5 financial years.

Analysis of Ratios
WORKING CAPITAL MANAGEMENT OF KINGFISHER AIRLINES The ideal scenario is when the company's working capital is serviced internally without relying on costly loans. Even in less ideal situations, the net working capital can be significantly reduced by efficient inventory and receivables management.

Analysis of Ratios
The above data shows a positive description of net working capital. As it indicates the amount of current liabilities that can be paid off using all current assets excluding cash and bank balances.

KFAs Future & Options

Kingfisher's Future & Options
Route rationalization: Cutting back unprofitable sectors and services to several cities Debt recast: Asking banks to reduce rates or take a cut on loans or find a 'local investor' Raising capital: It has plans to raise $200 million through GDR FDI: If the FDI limit is raised and foreign airlines are allowed to buy a stake, Mallya could recapitalise Kingfisher

Conclusion
Having analyzed operating leverage, we saw that the return earned on assets employed by the firm paled in comparison to the cost of the same funds. Also, even though the sales have increased over the years as can be seen from the financial statements, the same could not bring about a change in revenue because of miscellaneous expenditures such as high fuel costs, recession and failed acquisition of Air Deccan. In the last one year though, the operating leverage rose as a result of major debt restructuring undertaken by the company including converting debt into equity etc.

Further analyzing the working capital, we saw that Kingfisher due to cut in debt and current liabilities, facilitated due to the loan from SBI and coupled with previous debt reduction plans, was recovering from the cash crunch in the past 5 years. And hence, working capital was significantly rising except in 2008-09 because of few noted factors, including the initiation cost of international operations and the impact of exchange fluctuation in dollar denominated costs coupled with the hike in fuel prices.

Conclusion
However, at the same time, because of all the aforementioned mistakes of the company, its ratios including negative cash flows, negative profit margin and negative return on capital employed amongst others shouldve spelt CRISIS for the company ages ago. A practice called value based management is followed by world-class fortune 500 companies which specifically treats cash as the king and life-blood of an organization that it really is . Hence, the key management indicators for VBM should be operating profit and return on capital employed (ROCE) and this is something that we believe KFA should have followed.

Bibliography
www.businesstoday.in www.wikipedia.co.in www.google.com www.timesofindia.in www.theeconomictimes.in www.Businessworld.com www.flykingfisher.in