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Air New Zealand nets accounting red herring over aircraft leasing payments

By Alan J Robb

Friday 8th September 2000

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Air New Zealand's annual reports have been criticised for understating the value of assets by millions of dollars (The National Business Review, April 23, 1999) while complying to the letter with accounting standards.

The latest release from the company also opens it to criticism in its use of a variant of ebitda, which was criticised last week in relation to Advantage and Sky Network Television as not being a measure of profitability or cashflow; in fact having no redeeming features (NBR, September 1).

Air New Zealand's creation, ebitdra, is even more meaningless. It appears to have passed unnoticed by all financial reporters, who have simply reprinted the fact it increased 14.3% to $664 million without asking the fundamental question: "Does ebitdra mean anything?"

Ebitdra is defined in the chairman's overview of results as being "earnings before interest, depreciation, rentals and amortisation." Recent financial statements have not shown any rentals as such but the company does have substantial lease obligations for aircraft and properties.

In its previous balance sheet it reported liabilities of $199.2 million for capitalised finance leases and commitments of $582.9 million for operating leases. The amounts payable within one year of balance date were a little over $256 million.

This is almost exactly the amount incorporated in the computation of ebitdra, given that interest expense was $72 million and depreciation and amortisation was $185.8 million.

In other words, Air New Zealand spent $256 million or over $5 million dollars a week leasing aircraft. It was an essential outgoing to earn the revenue. It was both an expense and a cashflow. Had it not been paid, there would have been no revenue, no earnings.

How then can there be any point in computing a figure for earnings before rentals (or interest, taxes, depreciation or amortisations)? Like ebitda it does not measure profitability or cashflow. Air New Zealand does its shareholders no service by including it in the chairman's overview.

Air New Zealand, and those public relations experts who are tempted to report such meaningless numbers, would benefit by reading a recent report from Moody's Investors Services entitled Putting ebitda in perspective: 10 critical failings of ebitda as the principal determinant of cash flow.

Pamela Stumpp, a senior vice-president with Moody's, warns ebitda:

  • ignores changes in working capital and overstates cashflow in periods of working capital growth;
  • can be a misleading measure of liquidity;
  • does not consider the amount of required investment, especially for companies with short-lived assets;
  • says nothing about the quality of earnings;
  • is an inadequate standalone measure for comparing acquisitions;
  • ignores distinctions in the quality of cashflow resulting from differing accounting policies;
  • is not a common denominator for cross-border accounting conventions;
  • offers limited protection when used in indenture covenants;
  • can drift from the realm of reality; and
  • is not well suited for analysis of many industries because it ignores their unique attributes.
There is no place for ebitda in accounting standards and little prospect of there ever being so. The Stock Exchange and the Securities Commission collectively owe investors a duty of care to stamp out the use of this meaningless ratio in media releases. If not we may well see labour-intensive companies reporting earnings before wages and salaries, transport companies reporting earnings before petrol and diesel, newspaper publishers reporting earnings before paper costs.

Perhaps ebitda and its relations should be known collectively as ebitdaft - earnings before items that are damnably awkward and factually true.

Alan Robb is a senior lecturer in accountancy at the University of Canterbury. He holds no shares in Air New Zealand

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