Air New Zealand Ltd.

Level 3 Accounting
Internal Assessment 2004
Achievement Standard 90504
Who the report is prepared for:
This report is being prepared for a potential shareholder and would include
my advice as to whether or not they should purchase shares in Air New
Zealand Ltd.

Purpose of report:
The purpose of this report is to fully analyze and interpret the company’s
annual financial statements and other relevant information to derive the
advice for the potential shareholder. Analysis and Interpretation aims to
assess the profitability, liquidity and financial stability and market
analysis of Air New Zealand.

Company information:
Air New Zealand is a company that focuses on the operation of Domestic and
International passenger transport and cargo. Express Class launched on 1
November 2002 and with this success Air New Zealand is turning it’s
attention to the short haul international (Tasman and South Pacific) and
long haul international products and services.

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The overall profitability of Air New Zealand shows positive trends during
2002 and 2003.

The interest expense percentage, which measures the interest expense per
sales dollar decreased from 2.57% in 2002 to 1.05% in 2003.

This fall in interest expense percentage contributed to the increasing Net
Profit percentage as net profit increases when expenses decrease.

The declining interest expense percentage has been caused by a decrease in
both current and non-current liabilities(no use ) as the business paid back
some of its borrowings and finance lease liabilities which means less
interest expense was required to be paid on those borrowings.

In this situation, the decrease in interest expense is a good trend.

Although the total revenue of Air New Zealand decreased to $807,605 in 2003
the effect was eliminated by a more significant decrease in interest
expense as the company paid back some of its debts causing the interest
expense percentage to decrease by 1.52%.

The net profit percentage which measures the net profit per sales dollar
increased from -7.23% in 2002 to 4.58% in 2003. The net profit has
increased in 2003 as borrowing substantially decreased causing the interest
expense percentage to decrease.

Although the net profit percentage became positive in 2003 it was still not
a great percentage of total revenue because even the year of 2002 begin
well as traffic recovered from the September 2001 terrorist attacks, the
operating of Domestic Express Class in November 2002 was quite successful
and improved profitability of the business and the lower fares also
resulted increase in traffic the business was not that well off. There was
a decline in air travel and hence revenue due to the war in Iraq and
outbreak of SARS which resulted in many passengers delayed or canceled
travel plans.

However, the increase in Net Profit Percentage is a good trend.

The increasing net profit percentage is caused by the decline in operating
expenditure (down by $848,291) which is a greater decrease than the decline
in operating revenue (down by $807,605) due to better expense control and
mostly the strengthening of the New Zealand Dollar against the United
States Dollar as the expenses are predominantly United States Dollar
denominated and the strong New Zealand Dollar provided exchange benefit.

Nevertheless, the revenue fell from 2002 to 2003 because there was less
demand for the airline service in the second half of the financial year due
to SARS outbreak and war in Iraq thus the net profit was not as high as it
could have been.

The Rate of Return on equity percentage which measures the Net Profit per
dollar invested by shareholders has risen from -45.72% in 2002 to 17.33% in
2003. This measure increased by 63.05% as a result of a 151.79% increase in
Net Profit.

The Rate of Return on equity percentage has increased as a result of the
significant increase in net profit while the numbers of shares remained the
same as Air New Zealand decided not to issue more shares to the public.

The increase in the Rate of Return on equity percentage is a satisfactory
trend as this means the return to shareholders for their investment was
more in 2003 than 2002.The reason for this positive trend is due to an
increase in net profit and the funds used to buy the large and expensive
aircraft required for the long distances of international business and
other property and equipments was mostly funded by borrowing rather than
share issue.

The Rate of Return on equity percentage increased in 2003 because net
surplus after tax increased by $485,706 while the number of shares remained
the same.

The return on Total Assets which measures how effectively a company uses
its assets has increased from -0.54% in 2002 to 6.15% in 2003.

The return on Total Assets increased by 6.69% as a result of the 151.79%
increase in Net Profit which resulted from the decrease in operating
expenditure. An increase in net profit before interest and tax (up by
$265,942) and a decrease in average total assets the company holds (down by
$2207,211) as it disposed some property, plant and equipment and the sale
of some investment also contributed to this.

The return on Total Assets has a good trend as it indicate the improved
earning capacity of Air New Zealand (In other words, more efficient use of
Company assets).

The selling of redundant assets is quite wise as the sale of redundant
assets helped to improve Profitability.

The overall liquidity of the business has improved over the two years.

The current ratio which measures the ability of the business to meet
current debts as they fall due in the next accounting period has increased
from 1.15:1 in 2002 to 1.21:1 in 2003.

There has been a decrease in the amount of current assets as well as a
decrease in the current liabilities. The current ratio has increased
despite the decrease in current assets because the decrease in current
assets (down by $65,230 which is a 4.54% decrease from 2002 to 2003) was
less than the decrease in current liabilities (down by $111,018 which is
8.90% decrease from 2002 to 2003). The current assets decrease was due to
asset sales and the current liabilities decrease was due the fact that the
business paid off some of its short term borrowings.

This trend is certainly good but should look for further improvement in the
ratio as the airline industry is quite unsteady and the ratio need to be
higher to indicate the company do have strong ability to pay current debts
when they fall due even it faces unexpected events.

However, the more urgent need to pay back these current liabilities may
have affected the decisions of the directors of not giving out a dividend.

Cash Management
The overall control over cash seemed to have improved as it reported a net
increase in cash holding of $171,063.

There was a strong improvement in Operating Cash Flow as it increased from
$56,247 in 2002 to $523,091 in 2003.Cash receipts actually decreased by
$758789 which is a 16.67% change but the net cash flows from operating
activities still increased due to the greater decrease in cash payments of
$1,225,633 which is a significant 27.26% decrease and this proves to be a
very satisfactory trend. This increase is due toimprovedtrading
conditions, a decrease in net interest paid and an improvement in the
management of working capital.

The net cash flow from operating activities contributed to the improving
current ratio as the cash from operations was sufficient to repay some
payments to suppliers and employees.

The cash outflow resulted from investing activities was due to the high
capital expenditure of $242,882 and some cash was received from selling
fixed assets and other miscellaneous items (probably form the discontinued
activities) and thus offset some part of outflow.

The net cash outflow from financing activities increased from -$64,963 in
2002 to -$135,031 in 2003. This net cash outflow was due to debt repayment
made during the year and the coupon payment on Convertible Preference Share
held by Crown. The repayment of debts helped to improve the both the
liquidity and financial stability of the company. Receipts from the issue
of Convertible Notes to Qantas on 31 December 2002 offset some outflow.

Conclusion on cash management
Financial Stability
The interest cover which measures the times the net operating surplus
covers the interest improved significantly from a very unsatisfactory -0.29
times in 2002 to 6.15times in 2003 which the interest expenses is a lot
more manageable.

The interest cover increased in 2003 as net surplus before interest and tax
increased from a deficit of -$32,528 to a surplus of $233,414. The amount
of interest expense that has fallen significantly due todecreased
borrowings as shown by the decreased gearing ratio has also contributed
further to the improved interest cover.

The trend shown is quite satisfactory and indicates the business has the
ability to meet its interest payments from operating income in 2003.

The equity ratio that indicates how the business is financed increased from
0.23:1 to 0.28:1 due to the slight increase in equity and decrease of total
assets. This is good trend but the ratio itself is very unsatisfactory as
it is less than 0.5:1(In 2003, the shareholders only contributed 28 cents
for every dollar of assets the company has.) which shows outsider have
greater claim to the business assets than owners which can be also be
proved by the high gearing ratio. This made the company quite risky as it
means the company may be forced to close down (although not very likely)
by creditors if it fails repay its debts.

The gearing ratio that measure the proportion of the company’s total
capital that is borrowed decreased from 3.42:1 in 2002 to 2.59:1 in 2003.

The gearing ratio improved because total liabilities decreased by $363973
and total equity increased by $149936.Another contributiontothis
improvement was an increase in New Zealand dollar value against the United
States Dollar as aircraft leases and financing liabilities are denominated
in United States Dollars and the strengthening New Zealand Dollar has
decreased the value of these liabilities on translation.

This ratio has a good trend as it indicate a lower risk as borrowing
decreased but even the improved gearing ratioin2003isquite
unsatisfactory as its borrowing is still extremely high. The more the
company borrows the more interest it would have to pay and they have to pay
the interest whether the investment is a success or not. As borrowing is a
risk and the Air New Zealand borrowed so much, the business is quite risky.

However ,the directors are quite aware of this fact and intends to do
something to improve it in the future.

Market Analysis
The earnings per share ratio which shows the amount of earnings for each
ordinary share is the most important ratio used by investors. It has
increased from -10.95 cents in 2002 to a more promising 5.67 cents in
2003.However the business does not seem to be a worthwhile investment when
compared to the Qantas’ earnings per share. Qantas reported an earnings per
share of 20.0 Australian cents which can be converted to 21New Zealand
PM, Thursday 02 September 2004).This is a lot (15.33cents more) higher than
the earnings per share of Air New Zealand.

The level of earnings per share has increased for Air New Zealand because
the company did not issue any shares and funded their capitals with
borrowing from outside sources. The net surplus after tax have also
increased from a deficit of -$319,980,00 in 2002 to $165,726,000 in 2003.

Air New Zealand did not declare any dividend and shareholders should
probably look for returns in other forms such as capital gain instead. But
in 2003, the shareholders actually lost 10 cents of share value.

The directors have decided not to declare a dividend for the 2003 year even
it meets the requirements of a solvency test due to the high and
unsatisfactory gearing ratio and the business continues to have strong
capital demands.

Due to the fact that Air New Zealand did not pay a dividend, both dividends
per share and dividend yield could not be calculated and analyzed.

I recommend the potential shareholder not to purchase shares in Air New
Zealand. The reasons for this recommendation are:
1. The equity ratio and gearing ratio are both very unsatisfactory. They
suggest that creditors have greater control over the company which puts the
company at risk. The company may find it much more difficult to raise
further debt finance in the future.

2. Air New Zealand continues to have strong capital demands due to the fact
that it is flying both the shortest and longest route in the world. This
probably requires further borrowing from creditors and may deteriorate the
gearing and equity ratio which is already very unsatisfactory.

3. The earnings per share is unsatisfactory when compared with Qantas.

(15.33 cents less)
4. No dividends were issued in both 2002 and 2003 due to high gearing
ratio. There were also no capital gain (shares value decreased by 10
cents)to compensate this.

5. The risk is too high compared to other investments such as a term
deposit. The CEO, Ralph Norris believes that “There are numerous recent
examples of airlines that have been profitable one year and bankrupt
shortly afterwards.” Air New Zealand may well be one of them!
6. Revenue is likely to decrease due the fact that the Trans-Tasman market
may became even more competitive with new airlines to entering.

7. The proposed alliance with Qantas would certainly make Air New Zealand a
more worthwhile investment but the whole alliance needs approval on both
sides of the Tasman. However, many organizations and regulators including
Commerce Commission and The Australian Competition and Consumer Commission
(ACCC) opposed this alliance. Expenses associated with pursuing Australian
and New Zealand regulator have already been paid in 2004. Increased
expenses lead to reduced profit. Shareholder should really wait until the
alliance is approved before investing in the company.

8. There were actually some improvements in the financial position and
performance of Air New Zealand in the year 2004. However, Air New Zealand’s
Cargo business was impacted by the strong New Zealand currency which leads
to a revenue 10% lower. Operating cash flow of $466.9 million was 10.7
percent lower, as a result of a $62.9 million increase in income tax
payments over the previous period. The investing and financing activities
continued to face cash outflow which indicate the company has not fully
recovered from the outbreak of SARS and war in Iraq. Air New Zealand’s
gearing has improved but is still very unsatisfactory.

Therefore I advise the potential shareholder to purchase shares in other
companies or another form of investment. The shareholder could perhaps
consider a term deposit especially if him/her has a large amount of funds
available for investment as a term deposit is much less risky. On September
2, 2004, The National bank advertised a term deposit arrangement with a 7%
per annum for 2 years return if you invest $10,000 or more which is quite a
high return and this option could be considered bythepotential

?Only two years of information was available which makes the conclusions
less reliable.

?No industry averages were available for comparison.

?Only the most important and useful analysis measures were considered.

?The earnings per share ratio is misleading due the fact that the
shareholders did not actually receive any return.

? Dividends per share and dividend yield were not analyzed as no dividends
were declared. Thus the market analysis is not fully completed.

?The 2003 annual report was used for the analyses and interpretations which
means the information is out of date.

Basically your ass is all rite ! do the conclusion on cash management by
yourself I believe you can get the full mark !