Predicting Financial Distress of Indian Airline Companies

1. INTRODUCTION
Indian Aviation is facing its most uncertain phase in more than a decade. After reporting an estimated record loss of just over US $ 2 billion in the 12 months ended 31 st March 2012, Indias airlines are facing an equally challenging year ahead. Weak balance sheets, increasing costs, regulatory uncertainty, a sluggish Indian economy and a difficult global environment will continue to pile the pressure on airlines, especially the poor performing carriers. However, this may in turn create market opportunities to exploit for those that are better positioned. Over the near term the challenges facing the airline operators are related to high debt burden and liquidity constraints - most operators need significant equity infusion to effect a meaningful improvement in balance sheet. Improved financial profile would also allow these players to focus on steps to improve long term viability and brand building through differentiated customer service.Over the long term the operators need to focus on improving cost structure, through rationalization at all levels including mix of fleet and routes, aimed at cost efficiency. At the industry level, long term viability also requires return of pricing power through better alignment of capacity to the underlying demand growth.

However Indian aviation industry promises huge growth potential due to large and growing middle class population, favorable demographics, rapid economic growth, higher disposable incomes, rising aspirations of the middle class, and overall low penetration levels (less than 3%).Against this background this study will critically analyze the current scenario of the aviation industry and will make an attempt to predict the financial distress of Indian Airline Companies using the Altman Z Score model.

2. PROBLEM DEFINITION
Financial distress of infrastructure firms may jeopardize the sustainability of various services offered. The Aviation sector companies in India are facing a problem of financial crunch today, therefore it is necessary to analyze the bankruptcy situation and predict the financial distress of these aviation companies and suggest ways to overcome the problem so as to ensure smooth and sustainable operation of infrastructure companies.

Predicting Financial Distress of Indian Airline Companies

3. RESEARCH OBJECTIVE
1. Primary Objective: To study and understand the Altmans Z-Score model used to predict the financial heath and viability of the company To study and understand the Air-score model used to predict thefinancial health and viability specifically for the Airline Industry.

2. Secondary Objective: To analyze the present status of the Indian Aviation sector and predict the financial condition of the Indian airline companies using the Z-Score model and the Airscore model. The analysis will be conducted on 3 airline companies listed on BSE viz. Kingfisher Airlines Ltd., SpiceJet Ltd. and Jet Airways Ltd.

4. LITERATURE REVIEW
The earliest study using multivariate data analysis on failure prediction was conducted by Altman(1968) using a set of financial and economic ratios as possible determinants of corporate failures. Thestudy used sixty-six corporations from manufacturing industries comprising of bankrupt and nonbankruptfirms and 22 ratios from five categories, namely, liquidity, profitability, leverage, solvencyand activity. Five ratios were finally selected for their performance in the prediction of corporatebankruptcy and the derived model correctly classified 95 percent of the total sample (correctlyclassifying 94 percent as bankrupt firms and 97 percent as non-bankrupt firms) one-year prior to bankruptcy. The percentage of the accuracy declined with increasing number of years beforebankruptcy.Altmans original model is calculated as:

Z= 0.012 X1 + 0.014 X2 + 0.033 X3 + 0.006 X4 + 0.999 X5 Where, X1 Working Capital / Total Assets (a liquidity measure) X2 Retained Earnings / Total Assets (a measure for reinvested earnings) X3 EBIT / Total Assets (a profitability measure) 2

Predicting Financial Distress of Indian Airline Companies X4 Market Value of Equity / Book Value of Total Debt (a leverage measure) X5 Sales / Total Assets (a measure for sales generating ability of a firms assets) After publishing the model, a discussion on howthe Z-score model could be used for "non listed companies" started. Modification of the original modelconsisted in the total revaluation of the modeland the market value of owners equity in variableX4 was substituted with the book value of owners equity. In 1977 Altman published the final modelapplicable to companies nonlisted at the capitalmarket under the name ZETA and it is as follows: Z= 0.717 X1+ 0.847 X2 + 3.107 X3 + 0.420 X4 + 0.998 X5 Altman et al. (1994) reported the use of neural network in identification of distressed businessby the Italian central bank. Using over 1,000 sampled firms with 10 financial ratios as independentvariables, they found that the classification of neural networks was very close to that achieved byDiscriminant analysis. They concluded that the neural network is not a clearly dominant mathematicaltechnique compared to traditional statistical techniques.

Begley et al. (1995) incorporated the time bias factor into the classic business failureprediction model. Using Altman (1968) and Ohlsons (1980) models to a matched sample of failed andnonfailed firms from 1980s, they found that the predictive accuracy of Altmans model declinedwhen applied against the 1980s data. The findings explained the importance of incorporating the timefactor in the traditional failure prediction models.

Mossman et al. (1998) conducted a study to compare four types of bankruptcy predictionmodels that are based on financial statement ratios, cash flows, stock returns, and returns standarddeviations. They tested four bankruptcy models: Altmans (1968) Z-score model based on financialratios; Aziz et al.s (1988) model comprised of cash flows; Clark and Weinsteins (1983) market returnmodel, and Aharony et al.s (1980) market return variation model. They found that in the year prior tobankruptcy, the ratio model is the most effective in explaining the likelihood of bankruptcy. In thethree years preceding bankruptcy, the cash flow model most consistently discriminates betweenbankrupt and on-bankrupt firms. The findings suggest different uses for the models, as stakeholdersmight be particularly interested in cash

Predicting Financial Distress of Indian Airline Companies flow variables as an early warning indicators of failure.Alternatively, a large negative shift in accounting ratio variables could be a useful indicator ofimminent financial collapse.

Possibilities of the Altman zeta model application to Czech firms an article from the journal Ekonomika A Management published in March 2011 tried analyzing the Altmans Zeta model by applying it to Czech firms. The study included 37 Czech companies of which 13 were bankrupt and the results corroborated that the model was highly reliable in predicting the financial distress or more precisely the bankruptcy of a given company. However it also confirmed that the Altman Model canpredict bankruptcies in the distant future onlywith low reliability. Business bankruptcy prediction models: A significant study of the Altmans Z-score model an article from the Asian Journal of Management Research, Volume 3 Issue 1 (2012), tried summarizing the studies done in the field of bankruptcy prediction. It provided an in depth understanding of the development of Altmans Z-Score model and provided a comparison of various bankruptcy models which are commonly used. It concluded that most of the bankruptcy studies used multiple discriminant analysis (MDA) statistical techniques to develop models and included large and small firms, as well as private & publicly held firms and that discriminant analysis was better than the neural networks. This was mainly as it was possible to learn what the most importantvariables were for explanation purposes, which was not possible with neural networks that had illogical behavioral pattern.

Richard D. Gritta et al. in his paper A Review of the History of Air Carrier Bankruptcy Forecasting and the Application of Various Models to the US Airline Industry:1980-2005, conducted a study to outline and briefly discuss many of the different models, both generic and industry specific, that have beenused to assess the financial health of air transportation.

History of Insolvency and Bankruptcyfrom an International Perspective a book by Karl Gratzer and Dieter Stiefel brings together new international research on bankruptcy and insolvency.All contributions try to answer questions about these problems from differentperspectives, subjectspecific traditions and levels of investigation. Through the various cases discussed the book provides in depth insights into some of the general problems that research oninsolvency is wrestling with today 4

Predicting Financial Distress of Indian Airline Companies

5. RESEARCH METHODOLOGY Research Design

Desk Research Design is used to analyze the financial health of various companies. Desk Research design involves using established information (data) by different agencies and also using the information available from the internal sources of the company. The information published in trade journals, commercial press and data internally generated by the company are used for the desk research. Thus it is actually finding out the required information from published journals, annual reports etc. and using it for the study of the research problem. The financial statements of the 3 listed Indian airline companies viz. Kingfisher Airlines Ltd., SpiceJet Ltd. and Jet Airways Ltd. are analyzed to predict their solvency using the Altman Z Score model and Air-Score model.

Data Collection
1. Nature of Data: Data collection for this research is completely based on the secondary sources of data 2. Sources of Data: The secondary data is mainly collected from the research papers, companys annual reports, websites and Dion database

Tools Used To predict the financial distress two models have been used namely the Z-Score model, developed by Edward Altman and the Air- Score model, developed specifically for the airline industry

Scope and Limitations

1. The scope of the study is limited to predicting the financial health or distress of only the public sector companies in the Indian Aviation industry namely Jet Airways Ltd, SpiceJet Ltd and Kingfisher Airline Ltd 2. Due to the time constraints the financial health prediction is limited only to 3 years financial performance of the companies

3. There is heavy reliance on the financial information that is provided by the companys
annual reports and data that is obtained from the Dion database 5

Predicting Financial Distress of Indian Airline Companies

6. CURRENT SCENARIO OF THE INDIAN AVIATION SECTOR

The Indian Aviation Industry has been going through a turbulent phase over the past several years facing multiple headwinds high oil prices and limited pricing power contributed by industry wide over capacity and periods of subdued demand growth.While in the beginning of 2008-09, the sector was impacted by sharp rise in crude oil prices, it was the decline in passenger traffic growth which led to severe underperformance during H2 2008-09 to H1 200910. The operating environment improved for a brief period in 2010-11 on back of recovery in passenger traffic, industry-wide capacity discipline and relatively stable fuel prices. However, elevated fuel prices over the last three quarters coupled with intense competition and unfavorable foreign exchange environment has again deteriorated the financial performance of airlines.

To address the concerns surrounding the operating viability of Indian carriers, the Government on its part has recently initiated a series of measures including (a) proposal to allow foreign carriers to make strategic investments (up to 49% stake) in Indian Carriers (b) proposal to allow airlines to directly import ATF (c) lifting the freeze on international expansions of private airlines and (d) financial assistance to the national carrier.Despite reforms, the domestic aviation sector continues to operate under high cost environment due to high taxes on Aviation Turbine Fuel (ATF), high airport charges, significant congestion at major airports, dearth of experienced commercial pilots, inflexible labor laws and overall higher cost of capital. While most of these factors are not under direct control of airline operators, the problems have compounded due to industry-wide capacity additions, much in excess of actual demand.Besides, aggressive fleet expansion (Low Cost Carrier (LCC) airlines on long termoperating leases; Flight Service Carriers (FSC) have purchased aircrafts by debt financing backed by bank guarantees) to leverage the anticipated robust growth and to support and expand international operations impacted significantly on the capital structure and weakened the creditprofile of most domestic airlines.The higher theamount of debt that the firm uses, the higher is the financial risk and higher are the chances of bankruptcy under the conditions of low operating profits.

While the domestic airlines have not been able to attract foreign investors (up to 49% FDI is allowed, though foreign airlines are currently not allowed any stake), foreign airlines may be interested in taking strategic stakes due to their deeper business understanding, longer 6

Predicting Financial Distress of Indian Airline Companies investment horizons and overall longer term commitment towards the global aviation industry. Healthy passenger traffic growth on account of favorable demographics, rising disposable incomes and low air travel penetration could attract long-term strategic investments in the sector. However there are two key challenges: i) aviation economics is currently not favorable in India resulting in weak financial performance of airlines and ii) Internationally, too airlines are going through period of stress which could possibly dissuade their investment plans in newer markets.From the working capital standpoint too, airlines will need to deploy significant amount of resources in sourcing fuel which may not be easy given the stretched balance sheets and tight liquidity profile of most airlines.

7. OVERVIEW OF THE LISTED INDIAN AIRLINE COMPANIES Kingfisher Airlines Ltd

1. Company History: Kingfisher Airlines is one of the leading private players in the Indian aviation industry. Incorporated in 1995 as Deccan Aviation, the company is engaged in the business of providing passenger services and helicopter charter services.The name was changed to Kingfisher Airlines in the year 2008. The airline is part of UB Group owned by Dr Vijay Mallya.Kingfisher Airlines owns 76 aircraft comprising A330, A 321 (single and double cabin), A 320 (single and double cabin), A 319, ATR 72-500 and ATR 42-500.In India, the airline has a network in 72 cities operating more than 400 flights a day and commands a market share of 25%. Internationally, it operates flights to Dubai, Colombo and London.

2. Awards: Kingfisher Airlines was awarded NDTV Profit Business Leadership Award for Aviation. Kingfisher Airlines was acknowledged as 'India's only 5 Star airline' and '6th airline in the world' was certified by Skytrax. Kingfisher was rated as Asia Pacific's 'Top Airline Brand' in a survey conducted by TNS on 'Asia Pacific's Top 1,000 Brands' for 2008.

3. Financials: Kingfishers profitability situation is the most concerning. While the carrier reported an EBTIDAR profit of INR1.25 billion (USD25 million) in the quarter (EBITDAR margin declined 7

Predicting Financial Distress of Indian Airline Companies from 17.5% to 8.1%), it was loss-making at the EBITDA level (INR1.47 billion/USD30 million) with its EBITDA margin declining from 2.5% to -9.5% in the quarter. The carrier also reported a loss before exceptional items and tax of INR5.78 billion (USD117 million) and a net loss of INR4.44 billion (USD90.2 million) for a net loss margin of 33%.

Jet Airways Ltd

1. Company History: Jet Airways (India) was incorporated in 1992, as an airline company. In India it has over 357 fights daily to 42 destinations. It operates flight to 20 international destinations.The Companys subsidiaries include Jet Lite (India), Jet Airways LLC, Trans Continental e Services, Jet Enterprises, Jet Airways of India Inc., India Jetairways Pty and Jet Airways Europe Services N.V. It provides services such as airport lounges, bus services, coach services, complimentary chauffeur drive services.

2. Awards: Jet Airways won airline with best first-class service in the world award at Business Travelers 20th annual best in business travel awards gala in the USA. Jet Airways was awarded Best Cargo Airline of Central Asia at the prestigious Cargo Airline of the Year Awards. Jet Airways was voted as the Best Airline in Central/South Asia and India in an annual Global Traveler magazine survey.

3. Financials: Jet Airways posted its fourth straight quarterly loss in 3QFY2012. While the carrier, which is reportedly seeking to raise INR 10 billion (USD203 million) in working capital loans, was profitable at an EBITDAR level with an INR 2099 million (USD40 million) profit in the quarter, its loss after tax stood at INR 1012 million (USD19 million) compared with a profit of INR 1182 million (USD26 million) in 3QFY2011. Jet Airways, most likely, will post a full year loss in FY2011/12 and the coming financial year looks equally challenging. However, the airline is likely to benefit from the weakness at both Kingfisher and Air India, with the carrier having success at attracting corporate customers and improving yields and loads factors, which are now in the 85-90% range in the domestic market. 8

Predicting Financial Distress of Indian Airline Companies

SpiceJet Ltd
1. Company History: Royal Airways-promoted SpiceJet is an airline company, which was earlier known as Modiluft. It was among the first private companies that stepped into the Indian aviation sector.Further, in May 2005 Royal Airways changed its name to SpiceJet.SpiceJet was launched with an objective to deliver the lowest air fares with the highest consumer value, to price sensitive consumers.Currently, the company enjoys a market share of over 8%.SpiceJet follows Low Cost Carrier (LCC) business model on the lines of the most successful LCCs globally and provides the lowest cost per unit amongst Indian LCCs.It owns 11 Boeing 737 800 aircraft. SpiceJet currently operates 83 flights daily to 14 destinations connecting metros and nonmetros. The aircraft utilization of SpiceJet is amongst the highest in India.

2. Awards: SpiceJet was awarded '2008 Emerging Company of the Year Award for Indian Commercial Aviation' by Frost & Sullivan. SpiceJet was ranked amongst the top 10 budget airlines in Asia by Smart Travel Asia magazine based on a surveyed commissioned 'Best in Travel Poll' on the low-cost carriers. SpiceJet won 'CIO 100 award' from CIO magazine for its technological innovations in aviation industry.

3. Financials: SpiceJet reported a loss before and after tax of INR392.5 million (USD8 million) in the quarter, compared to profits of USD24 million and USD19.3 million, respectively, in 3QFY2011. Despite the losses in the first three quarters of the current fiscal year, SpiceJet has reported growth at both the top and bottom lines in the past two financial years.

Predicting Financial Distress of Indian Airline Companies

Graphical Representation
The following graphs shows the sales and PAT figures for all the 3 airlines for the year ending March 2012 and their latest quarterly results

Graph 1: Annual Results as on Mar 12

Graph 2: Latest Quarterly Results 6. OVERVIEW OF THE LISTED INDIAN AIRLINE COMPANIES

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Predicting Financial Distress of Indian Airline Companies

8. ALTMANS Z SCORE MODEL

In 1968, Edward Altman published what has become the best known predictor of bankruptcy. This predictor is a statistical model that combines five financial ratios to produce a product called a Z score. The model has proven to be a dependable instrument in forecasting failure in a diverse mix of business entities. Dr. Altmans original model is calculated as:

Z= 0.012X1+0.014X2+0.033X3+0.006X4+0.999X5 Where Z Represents the overall Score X1 Working Capital / Total Assets Working capital/total assets (X) is a measure of liquid assets in relation to the firms size. The difference between current assets and current liabilities represents working capital. The current assets of a firm include cash on hand, accounts receivable, and inventories; the latter two assets are considered current, if cash conversion is expected within an operating cycle of a business. Current liabilities consist of the firms financial obligations-short-term debt and accounts payablewhich will be met during the operating cycle. A positive working capital indicates a firms ability to pay its bills. A business entity with a negative working capital will experience difficulty meeting its obligations. Altmans research finds this ratio to be more helpful than other liquidity ratios, such as the current ratio or the quick ratio. (Altman, 2000; Chuvakhin& Germania, 2003)

X2 Retained Earnings / Total Assets Retained earnings/total assets (X2) represent a measure of cumulative profitability reflecting the firms age as well as its earning power. A history of profitable operations and reduced debt is signified by firms that retain earnings or reinvest operational profits. Low retainedearnings may indicate a poor business year or reduced longevity for the firm. According to Dun and Bradstreet, 50% of businesses fail within the first five years of operation (Altman, 2000, 2002).

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Predicting Financial Distress of Indian Airline Companies X3 EBIT / Total Assets (a profitability measure) A measure of an organizations operating efficiency separated from any leverage effects is a true depiction of asset production. Represented as earnings before interest and taxes/total assets (X3), this ratio estimates that cash supply available for allocation to creditors, the government, and shareholders. Altman (2000) classifies the ratio as a superior measure of profitability that is better than cash flow.

X4 Market Value of Equity / Book Value of Total Debt (a leverage measure) Altman (2000, 2002) defines the market value of equity, or market capitalization, as a summation of both preferred and common stock or market value of equity/book value of total debt (X4). The stock market, the primary estimator of a firms worth, sugge sts that price changes may foreshadow pending problems if a firms liabilities exceed its assets. Altman believes this ratio is a more effective financial distress predictor than net worth/total debt (Book values).

X5 Sales / Total Assets (a measure for sales generating ability of a firms assets) The next ratio, sales/total assets (X5) signifies a standard turnover measure that unfortunatelyvaries from one industry to another. Yet, the ratio is an indicator of a firms efficient use of assets to create sales (Chuvakhin&Gertmenian, 2003). Altman (2000) has defined this as one measure of managements capacity in dealing with competitive conditions (p.22). Finally, Eidleman (1995) explains the applicability of the previously discussed ratios. Specifically, Eidleman states Each of these ratios is multiplied by a predetermined weight factor, and the results are added together. If the score is above 2.99, the firm is healthy. If it is below 1.81, the firm is viewed as failing. Values ranging from 1.81 to 2.99 represent the socalled grey area, when there is no clear prediction.

Altmans pioneer study was based on a sample of 66 publicly traded, manufacturing firms. Thirty-three of the firms had filed for bankruptcy and all had assets over$1million.His model correctly predicted financial failure for 95% of the firms, one year prior to their demise. Accuracy decreased to 72% two years out and to 52% three years prior to insolvency (Altman, 1968). Type I errors, those that predict a bankruptcy that does not occur, were shown for 6% of

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Predicting Financial Distress of Indian Airline Companies the firms analyzed. Type II errors also were shown for 6% of the firms analyzed. Type II errors predict a solvent firm that files bankruptcy (Altman, 1993).

In 1983, Altman developed a revised Z-score model for privately held firms. The revised Z-scores substituted the book value of equity for the market value in X4. The new Z-score model known as Zeta Model is as follows

Z= 0.717 X1+0.847 X2+ 3.107 X3+0.420 X4+ 0.998 X5

Cut off scores were also adjusted so that scores of <1.23 indicate bankrupt firms and scores of >2.90 are indicators of non bankrupt firms. Firms with scores between 1.23 and 2.90 are determined to exist in the grey area or zone of ignorance (Altman, 1993). Altmans new sample produces similar results as the original Z-score model, indicating 90.9% accuracy in bankruptcy forecasting at least one year prior to actual failure. Firms with scores over 2.90 have a 97% chance of continuing operations with financial health (Altman, 1993).

Altman does not view his original model or his revised Zeta model as perfect, citing four issues: (a) subjectiveness in the weightings, (b) an element of ambiguity within the model, (c) the univariate approach, and (d) some misleading ratios. He further feels that the fifth ratio (sales/total assets) does not represent a difference between failed and nonfailed firms and does not reflect any variations from industry to industry. In addition, the model is unable to accurately forecast financial difficulties for non-manufacturing firms and non-publicly operated forms. As the market value of equity is based on stock prices, thefourth ratio is difficult to establish in non-public firms. In 1993, Altmans continued research produced a further revised model, one that eliminates variables X5, sales/total assets. Eliminating sales/totals assets minimizes the potential industry effect which is more likely to take place when such an industry sensitive variable as asset turnover is included. The revised Z-score model uses X4=Net Worth (Book value)/total liabilities to maintain its applicability to privately owned firms. The first three variables are unchanged; however, the weight factor is again recalculated. Hence the revised Zscore model is represented as

Z=6.56 X1 + 3.26 X2 + 6.72 X3 + 1.05 X4 13

Predicting Financial Distress of Indian Airline Companies

Where cut off scores reflect Bankrupt firms< 1.10 Non bankrupt firms>2.60 Grey area= 1.10-2.60 Results of Altmans newest revised Z-score model exhibit a 90.9% success rate in predicting bankruptcy one year prior to firms demise and a 97% accuracy rate for identifying non bankrupt firms with continuing economic solvency. Table below illustratesAltmans

bankruptcy models

Coefficient Variables X1 X2 X3 X4 X5

Original Model (1968) 1.21 1.41 3.30 0.6 0.999

Revised Model (1983) 0.717 0.847 3.107 0.42 0.998

Revised Four Model (1993) 6.56 3.26 6.62 1.05 NA

Firms Bankrupt Firms Non Bankrupt Firms Grey Area Accuracy Type I Accuracy Type II Accuracy

Cutoff Scores < 1.81 > 2.67 1.81 - 2.67 < 1.23 > 2.90 1.23 - 2.90 < 1.10 > 2.60 1.10 - 2.60

94% 97%

90.9% 97%

90.9% 97%

Altman cautions that his model has limitations in its applicability to different business entities with the same prediction accuracy. First, 20 years of studies encompass a diverse assortmentof manufacturing firms that vary in size. Second, his model does not always have the same accuracy across these businesses. Even though Altmans bankruptcy prediction model is the most popular analytical tool utilized by investors, auditors, and stakeholders, Altman advises not to use his formula to the exclusion of other analytical techniques.

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Predicting Financial Distress of Indian Airline Companies

9. AIR-SCORE MODEL
Bankruptcy and distress prediction for airlines was pioneered by two financial based DMAstudies in the early eighties (Gritta, 1982; Altman and Gritta, 1984). In these two studiesgeneric bankruptcy models, not specifically developed for the airline industry, were appliedon airline data to assess the risk of bankruptcy. Later a dedicated MDA model for the airlineindustry appeared, named AIRSCORE (Chow, Gritta and Leung, 1991).

It can be argued that a model derived from a sample of the same industrywould be even more accurate that a generalized model such as the Altman ZScore or ZETAcredit scores. With that in mind, an industry specificmodel, Air-Score, was specified using a sample restricted to the airlineindustry (Chow, Gritta and Leung 1991). It included a significant sample ofthe large and smaller carriers (the latter referred to as regional airlines). Usingan MDA approached similar to that utilized by Altman, the model derivedwas:

Air-Score = -0.34140X1 + 0.00003X2 + 0.36134X3

The three ratios that were predictive of insolvency or stress were: X1 = interest/total liabilities (the imputed interest rate on debt) X2 =operating revenues per air mile X3 = shareholders equity/ total liabilities

Because the distribution of the scores made the application of a single cut-off pointdifficult and inappropriate, several gray zones were defined and the model yieldedresults similar to the Altman Z Score and to ZETA credit scores. It was able to achieveaccuracy rates of between 76% and 83%, depending on the zone used. While the modelwas somewhat accurate, it did seem to be a bit biased toward the larger carriers in thesample. The interested reader is referred to the article for different cutoffs and the results.

Where Air-Score reflect Healthy firms>0.03 Firms in trouble < -0.095 Grey area= 0.03 to -0.095 15

Predicting Financial Distress of Indian Airline Companies

10. DATA ANALYSIS AND INTERPRETATION Kingfisher Airlines Ltd. Table 1: Computation of Z Scores for Kingfisher Airline Ltd.

Variable Working Capital to Total Assets (X1) Retained Earnings to Total Assets (X2) EBIT to Total Assets (X3) MV of Equity to BV of Debt (X4) Sales to Total Assets Z Score

2012 0.510 (-) 2.604 (-) 0.736 0.317 1.864 1.809

2011 0.423 (-) 1.303 0.217 0.228 1.518 1.512

2010 0.334 (-) 1.074 0.044 0.239 1.259 1.250

Source: https:\\insight.dionglobal.in

Graph 1: Graphical Representation of Z Scores for Kingfisher Airline Ltd.

Interpretation: The company has been continuously failing in terms of improving its profitability and is continuously running into losses, a poor Retained earnings to Total Assets ratio puts a question mark on the firms longevity. The cash supply available for creditors, government and other shareholders have also suffered for the year 2012. The Z-score,although improving, has been continuously in the gray zone(Between 2.67 to 1.81) for all the three years. To improve its financial position the company will have operate more efficiently and make optimum utilization of resources, otherwise it would be difficult for them to sustain in the long run.

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Predicting Financial Distress of Indian Airline Companies

Table 2: Computation of Air-Scores for Kingfisher Airline Ltd.

Variable Interest to Total Assets (X1) Operating Revenues per air mile (X2) Shareholders equity to Total Liabilities (X3) Air-Score

2012 0.43301 4.29 -1.72425 -0.77074

2011 0.569992 4.76 -0.74942 -0.46525

2010 0.558028 4 -1.00496 -0.55352

Source: https:\\insight.dionglobal.in, Annual Report

Graph 2: Graphical Representation of Air-Scores for Kingfisher Airline Ltd.

Interpretation: It can be interpreted that Kingfisher Airlines has not been doing well in the past three years and have negative retained earnings leading to negative shareholders equity to liabilities ratio indicating their performance was not good enough. As per the Air-Score model, the firm is in trouble (< -0.095) and must take steps necessary to improve their finances or they face a very high risk of going bankrupt in the near future.

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Predicting Financial Distress of Indian Airline Companies

Jet Airways Ltd. Table 2: Computation of Z Scores for Jet Airways Ltd.

Variable Working Capital to Total Assets (X1) Retained Earnings to Total Assets (X2) EBIT to Total Assets (X3) MV of Equity to BV of Debt (X4) Sales to Total Assets Z Score

2010 (-) 0.351 (-) 0.189 0.123 0.486 1.474 1.473

2011 0.028 (-) 0.050 0.123 0.357 0.893 0.898

2012 0.004 (-) 0.050 0.088 0.347 0.709 0.713

Graph 2: Graphical Representation of Z Scores for Jet Airways Ltd.

Interpretation: The company has been running into losses, a poor Retained earnings to Total Assets is an indication of the same. Also for the year 2012 the company has registered a negative working capital to total assets ratio showing the companies poor liquidity condition. The cash supply available for creditors, government and other shareholders have also suffered for the year 2012. The Z-score,although improving, points to the distress situation (< 1.81) that the company is in. The company will have to work towards improving its overall profitability and liquidity in order to survive this stressed industry.

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Predicting Financial Distress of Indian Airline Companies

Table 2: Computation of Air-Scores for Jet Airways Ltd.

Variable Interest to Total Assets (X1) Operating Revenues per air mile (X2) Shareholders equity to Total Liabilities (X3) Air-Score

2012 0.19473 4.48811 -0.0522 -0.0852

2011 0.130803 4.216255 0.058441 -0.02341

2010 0.12392972 6.95 0.05616752 -0.0218055

Source: https:\\insight.dionglobal.in, Annual Report

Graph 2: Graphical Representation of Air-Scores for Jet Airways Ltd.

Interpretation: It can be seen that the solvency of Jet Airways has been deteriorating over the past 3 years indicating their performance was not good enough.Howeveras per the Air-Score model they are neither in a healthy state nor in trouble (between 0.03 to -0.095) but they will have to improve upon their profitability to prevent insolvency.

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Predicting Financial Distress of Indian Airline Companies

SpiceJet Ltd. Table 1: Computation of Z Scores for SpiceJet Ltd.

Variable Working Capital to Total Assets (X1) Retained Earnings to Total Assets (X2) EBIT to Total Assets (X3) MV of Equity to BV of Debt (X4) Sales to Total Assets Z Score

2010 (-) 0.201 (-) 1.874 (-) 0.782 3.062 5.568 5.526

2011 (-) 0.716 (-) 1.773 1.386 5.308 7.077 7.114

2012 (-) 3.077 (-) 8.556 4.770 22.464 22.691 22.804

Graph 1: Graphical Representation of Z Scores for SpiceJet Ltd.

Interpretation: The company was in a very strong position in 2010 with a Z-Score of 22.8 way above 2.67 above which the company is considered to be having enough solvency to survive.The profitability and liquidity of the company is under pressure for the last two years and therefore their Z-Score have come drastically down to 5.52 in 2012. However as per the Z-Score model the company falls in the category of Non-Bankrupt firms (> 2.67) and therefore has good solvency state in the category.

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Predicting Financial Distress of Indian Airline Companies

Table 2: Computation of Air-Scores for Jet Airways Ltd.

Variable Interest to Total Assets (X1) Operating Revenues per air mile (X2) Shareholders equity to Total Liabilities (X3) Air-Score

2012 0.19473 4.48811 -0.0522 -0.0852

2011 0.130803 4.216255 0.058441 -0.02341

2010 0.12392972 6.95 0.05616752 -0.0218055

Source: https:\\insight.dionglobal.in, Annual Report

Graph 2: Graphical Representation of Air-Scores for Jet Airways Ltd.

Interpretation: It can be seen that the solvency of SpiceJet has been improving over the past 3 years indicating that the company is trying hard to improve its overall operations and thereby improve its profitability and liquidity. Their performance,although improving, as per the Air-Score model they are in trouble (< -0.095) but only by a slight margin. So the company can keep on improving and optimizing in terms of their asset utilization so as to come out of this trouble state and move towards the healthy state slowly and steadily.

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Predicting Financial Distress of Indian Airline Companies

11. COMPARATIVE ANALYSIS

Particulars Net Sales Net Profit Net Working Capital Return on Assets Interest as a % of EBIT Net Worth Reserves Z-Score AIRSCORE Kingfisher Airlines 5493.41 -2328.01 1504.54 -25.63 -58.82 -5082.4 -6213.15 1.809 -0.77074 Jet Airways 15224.68 -1179.51 -3621.85 -7.05 158.492 -539.45 -625.78 1.473 -0.0852 SpiceJet 3943.26 -605.77 -142.07 -30.74 -9.44% -147.23 -588.68 5.526 -0.10024

Graph 7:Jet Airways, SpiceJet and Kingfisher net profit (loss) margin: 1QFY2010 to 3QFY2012

The losses in the quarter reflect not only issues at the individual carriers but some fundamental and structural challenges in the Indian aviation sector. As previously noted, growth in the robust domestic market has failed to translate into profits for India's airline industry. All the major carriers are loss-making as a result of the impact of high jet fuel costs, compounded by heavy taxation, inefficient infrastructure and an inability to raise fares in a highly competitive market. In addition, rising debt levels and a depreciating rupee are placing further pressure on margins. As a result, the nations airlines are seeing a sharp increase in their cost base at a time when yield and unit revenue growth is pressured. 22

Predicting Financial Distress of Indian Airline Companies Viability: There is a huge concern over Kingfishers ability to remain a Going Concern for which the company would require to inject more funds, as the net worth of the company has been eroded substantially. For Jet Airways the carrier needs to raise funds in order to meet its obligations, fund the operations of loss-making JetLite and ensure the carrier continues as a 'going concern'. Also for SpiceJet too the networth has eroded however the airline noted an increase in its net worth in the last quarter after its promoters infused funds into the carrier.

Revenues: Kingfisher Airlines reported a 5% decline in revenue in the quarter to USD314 million, reflecting the carrier curtailing operations during the Dec-2011 quarter. Revenue moved in the other direction for Jet Airways and SpiceJet, with revenue growth of 14% to INR39,869 million (USD794 million) for Jet Airways and 42% to INR11,758 million (USD240 million) for SpiceJet.

Operating Costs: SpiceJet reported the largest year-on-year increase in total operating costs, by 67% to INR11,949 million (USD244 million). Jet Airways also reported double-digit operating costs increases, of 34% to INR44,527 million (USD887 million).While Kingfisher Airlines reported a lower increase in operating costs, of 7% to INR16,940 million (USD344 million), its unit costs remained high at INR4.42/USD8.97 (+12%), and its staff and fuel costs remained higher than its peers as a proportion of revenue.Kingfisher's employee expenses as a percentage of sales increased from around 12% in Sep-2011 quarter to more than 13% in Dec-2012 quarter. On the other hand, Jet Airways and SpiceJet saw the ratio of employee expenses to sales reduce, from 13% to 11.4% for Jet Airways and from 11.4% to 9.7% for SpiceJet.

CAPA India estimated losses by Indian carriers, three months ended 30-Sep-2012 Jet Airways: (USD45-60 million loss) Kingfisher: (USD110-130 million loss) SpiceJet: (USD25-28 million loss) Thus Kingfishers ill-timed expansion and limited funding options have brought its operations to a stand-still. Jet Airways and SpiceJet are also loss-making but are fundamentally more robust. 23

Predicting Financial Distress of Indian Airline Companies

12. FINDINGS

Criteria Airline In Distress Airline in Gray Zone Airline is Healthy

Z-Score Less than 1.81 1.81 to 2.67 Greater than 2.67

Air-Score Less than -0.095 0.03 to -0.095 Greater than 0.03

Kingfisher Airlines Ltd.

According to the Z-Score model Kingfisher Airlines Ltd is predicted to have financial distress. According to the Air-score model Kingfisher is in trouble with respect to solvency. Bankruptcy Prediction Model Z-Score Model Air-Score Model Score 1.809 -0.77074 Conclusion Airline in Distress Airline in Distress

Jet Airways Ltd.

According to the Z-Score model Jet Airways Ltd is predicted to have financial distress. According to the Air-score model Jet Airways is neither healthy nor in trouble with respect to solvency. Bankruptcy Prediction Model Z-Score Model Air-Score Model Score 1.473 -0.0852 Conclusion Airline in Distress Airline in Gray Zone

SpiceJet Ltd.
According to the Z-Score model SpiceJet Ltd is predicted to have financial distress. According to the Air-score model SpiceJet is neither healthy nor in trouble with respect to solvency. Bankruptcy Prediction Model Z-Score Model Air-Score Model Score 5.526 -0.10024 Conclusion Airline in Distress Airline in Gray Zone

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Predicting Financial Distress of Indian Airline Companies

13. RECOMMENDATIONS
The company can deal the financial distress by disposing of real properties and may opt to sell the property to pay the creditors so that working capital of the companies will improve. The operating costs and other costs can be financed by such activity. The companies can reframe the terms and condition with creditors to extend the credit period and the new interest rate to save the company from bankruptcy. The merger or strategic alliance can put the distressed company back in good financial position. The company can use its authorized capital by offering the stake to foreign companies, instead of adding leverages into capital structure.

14. CONCLUSION
Altmans Z-score model is one of the most effective Multiple Discriminant Analysis, which has been researched throughout the last 40 yearsand has been usedin various industries to predict bankruptcy. Researchers have used Altmans Z score model in the service industry, manufacturing industry, publically listed companies, and banks alike to predict if the business will have a downfall. All the 3 revision of Altman equation has being used by different authors in their studies, with constructive predictability. It can be safely said that Altmans Z score Model can be applied to modern economy to predict distress and bankruptcy one, two & three years in advance. Also an industry specific model, Air-Score model, bolstered the prediction made by Z-Score model.

Finally we can infer that there are number of prediction models available for bankruptcy prediction. It is possible forthe companies to reduce the rate of bankruptcy through the use of such models by identifying and controllingthe variables that induce the financial failure. EBIT is an important factor responsible for the solvencyposition of the company along with it the retained profits and the utilization of capital overthe assets also have a key role to play. The rise in the creditors and liabilities create pressure on thefinancial position as the interest payment pulls down the overall profit margins. Hence more the earnings,better is the solvency position of the companies.By applying these models various stakeholders can use these models to find out how the company is performing so as to avoid further losses and also it could assist companies in knowing in which direction they are headed if they are not performing well.

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