Absolute ebitdar

What Is Absolute EBITDAR?

Absolute EBITDAR, standing for Earnings Before Interest, Taxes, Depreciation, Amortization, and Rent (or Restructuring Costs), is a financial metric used in financial analysis to assess a company's operational profitability before the impact of non-operating expenses, non-cash charges, and lease obligations. It falls under the broader category of adjusted financial metrics and is often considered a non-GAAP (Generally Accepted Accounting Principles) measure because it deviates from standard accounting frameworks by adding back rent expenses. This adjustment aims to normalize the financial performance of companies, especially those with significant lease expenses, allowing for more direct comparisons regardless of their financing structures (i.e., whether they lease or own assets).

History and Origin

The concept of EBITDAR, and by extension Absolute EBITDAR, gained prominence in industries characterized by substantial leasing activity, such as airlines, retail, and transportation. Before the adoption of new lease accounting standards, many companies utilized operating leases, which were traditionally treated as off-balance sheet financing. This meant that lease obligations did not appear as liabilities on the balance sheet and rent payments were simply recorded as operating expenses on the income statement.

However, this practice obscured a significant portion of a company's financial obligations and made it difficult for investors and analysts to compare the true operational performance of companies that leased many assets versus those that owned them outright. To address this lack of transparency, analysts began using EBITDAR to create a more level playing field. The Financial Accounting Standards Board (FASB) in the United States introduced ASC 842 (Leases) and the International Accounting Standards Board (IASB) introduced IFRS 16 (Leases), both effective around 2019, which fundamentally changed lease accounting by requiring most leases to be recognized on the balance sheet as "right-of-use" assets and corresponding lease liabilities⁷, ⁸, ⁹. This significant shift, described by EY as one of the most impactful changes to lease accounting in over 30 years, has affected balance sheets across various sectors, particularly air travel and retail, by increasing reported assets and liabilities⁶. Despite these accounting changes, Absolute EBITDAR continues to be used as a supplementary measure by some analysts, particularly for historical comparisons or specific industry analyses, though its relevance in its original context of off-balance sheet operating leases has diminished.

Key Takeaways

• Absolute EBITDAR is a non-GAAP financial metric that adds back rent expenses to EBITDA.
• It is particularly useful for comparing companies in capital-intensive industries with varying lease versus buy strategies.
• The metric aims to standardize profitability analysis by neutralizing the impact of different financing approaches for assets.
• It is widely used in sectors like airlines, retail, and transportation for credit analysis and valuation purposes.
• While offering comparative benefits, Absolute EBITDAR lacks standardization and can be subject to different interpretations.

Formula and Calculation

The formula for Absolute EBITDAR starts with a company's net income and adjusts it for interest, taxes, depreciation, amortization, and rent expense.

The general formula is:

Alternatively, if a company's Earnings before interest, taxes, depreciation, and amortization (EBITDA) is readily available, the calculation can be simplified:

Where:

• Net Income: The company's profit after all expenses, including taxes and interest, have been deducted from revenue.
• Interest Expense: The cost of borrowing money.
• Taxes: Income tax expense.
• Depreciation: A non-cash expense that allocates the cost of a tangible asset over its useful life.
• Amortization: A non-cash expense that allocates the cost of an intangible asset over its useful life.
• Rent Expense: The cost of leasing assets, which may include operating lease payments or the implicit rent portion of capitalized leases, depending on the accounting standard and calculation methodology.

Interpreting the Absolute EBITDAR

Interpreting Absolute EBITDAR primarily revolves around its ability to provide a clearer picture of a company's core operating performance, especially when comparing entities with different asset financing strategies. By adding back rent expenses, Absolute EBITDAR attempts to treat all assets as if they were owned, regardless of whether they are financed through debt or leases. This normalization allows analysts to focus on the operational efficiency and underlying earning power of the business.

For instance, two airlines might have similar flight operations and passenger volumes, but one might primarily own its aircraft (leading to higher depreciation and interest expenses) while the other predominantly leases its fleet (resulting in higher rent expenses). Without adjusting for these financing differences, a direct comparison of their reported operating income or even EBITDA could be misleading. Absolute EBITDAR aims to mitigate this by providing a metric that removes the impact of both ownership-related financing costs and lease-related operating costs, offering a more "apples-to-apples" comparison of their operational capabilities. It helps in evaluating the intrinsic performance of a business before considering its capital structure decisions.

Hypothetical Example

Consider two hypothetical retail companies, Retailer A and Retailer B, both selling similar products and generating the same revenue.

Retailer A: Owns most of its store locations.
Retailer B: Leases most of its store locations.

Let's look at their simplified financial data (in millions USD):

Calculation for Absolute EBITDAR:

For Retailer A:
Absolute EBITDAR = Net Income + Interest Expense + Taxes + Depreciation + Amortization + Rent Expense
Absolute EBITDAR = $100 + $20 + $30 + $40 + $5 + $10 = $205 million

For Retailer B:
Absolute EBITDAR = Net Income + Interest Expense + Taxes + Depreciation + Amortization + Rent Expense
Absolute EBITDAR = $80 + $5 + $20 + $10 + $2 + $45 = $162 million

In this hypothetical example, Retailer A's Absolute EBITDAR of $205 million is higher than Retailer B's $162 million. This suggests that, before considering their differing approaches to real estate financing, Retailer A demonstrates stronger core operational earnings. While Retailer B has lower interest and depreciation due to leasing, its higher rent expense is factored back in, providing a normalized view of profitability that helps in a direct comparison of the companies' underlying business performance.

Practical Applications

Absolute EBITDAR finds practical application primarily in specialized financial analysis, particularly for industries with significant asset leasing.

• Credit Analysis: Credit rating agencies and lenders often use Absolute EBITDAR, or ratios derived from it (like Debt/EBITDAR), to assess the creditworthiness of companies in sectors like airlines, shipping, and retail. These industries frequently lease high-value assets (aircraft, ships, store properties). By adding back rent, analysts can better compare companies with different financing models and understand their capacity to cover fixed charges. S&P Global Ratings, for instance, has noted that airlines, alongside shipping and trucking, represent some of the highest industry risks among industrial companies, making such adjusted metrics valuable for their credit rating analysis⁵. The International Air Transport Association (IATA) also uses adjusted net debt/EBITDAR as a key financial ratio to gauge the airline industry's financial health⁴.
• Valuation and Benchmarking: Investment analysts may use Absolute EBITDAR when performing valuation of companies within these capital-intensive industries. By normalizing for lease obligations, it allows for a more consistent comparison of operating performance across competitors, regardless of their lease accounting practices. This can lead to a more accurate calculation of enterprise value multiples when comparing firms that lease versus those that own.
• Mergers and Acquisitions (M&A): During M&A due diligence, buyers might use Absolute EBITDAR to evaluate the true operating earnings of target companies, especially if the targets have complex leasing arrangements. This helps in understanding the underlying business profitability free from specific lease financing choices.

Limitations and Criticisms

Despite its utility in specific contexts, Absolute EBITDAR is subject to several limitations and criticisms:

• Non-GAAP Nature: Absolute EBITDAR is a non-GAAP financial measure, meaning it is not defined or standardized under generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS). This lack of standardization allows companies flexibility in its calculation, which can lead to inconsistencies and make comparisons difficult even within the same industry. The U.S. Securities and Exchange Commission (SEC) provides guidance on the use of non-GAAP measures, emphasizing that they should not be more prominent than GAAP measures and that adjustments should be clearly reconciled and explained to avoid misleading investors¹, ², ³.
• Does Not Reflect Cash Flow: By adding back rent expense, Absolute EBITDAR does not reflect the actual cash outflow associated with lease payments. Rent, whether from operating or finance leases, represents a real and often significant cash commitment for a business. Therefore, relying solely on Absolute EBITDAR can provide a misleading picture of a company's true cash flow generation.
• Potential for Manipulation: Due to its non-GAAP status, there is a risk that companies might manipulate the definition or calculation of Absolute EBITDAR to present a more favorable financial picture. Analysts must carefully scrutinize the specific adjustments made by management to understand the underlying economics.
• Diminished Relevance Post-Lease Capitalization: With the implementation of new lease accounting standards (ASC 842 and IFRS 16), which require most operating leases to be recognized on the balance sheet as assets and liabilities, the original rationale for using EBITDAR to normalize off-balance sheet leases has largely diminished. While rent expense is still present, the comprehensive recognition of lease obligations as lease liabilities means much of the "off-balance sheet" nature is gone, making the need for extensive adjustments less critical than before. However, the metric may still be used to compare periods before and after the adoption of the new standards.

Absolute EBITDAR vs. EBITDA

The primary distinction between Absolute EBITDAR and Earnings before interest, taxes, depreciation, and amortization (EBITDA) lies in the treatment of rent expense. EBITDA is a measure of a company's operational profitability before accounting for interest, taxes, depreciation, and amortization. It aims to strip away the effects of financing and accounting decisions to show core operating performance.

Absolute EBITDAR takes EBITDA a step further by adding back rent expenses. This adjustment is particularly relevant for industries where leasing is a significant mode of asset acquisition, such as airlines, retail chains, and transportation companies. The rationale for adding back rent is to neutralize the impact of varying financing structures. For example, a company that leases a significant portion of its assets will have higher lease expenses compared to a competitor that owns its assets, which would instead incur higher interest and depreciation charges. By including rent back into the calculation, Absolute EBITDAR attempts to create a metric that allows for a more "apples-to-apples" comparison of operating performance, regardless of whether assets are owned or leased. Essentially, while EBITDA focuses on operational profitability before all non-operating and non-cash items, Absolute EBITDAR specifically aims to normalize for the financial impact of leases, treating them more like capitalized assets.

FAQs

What industries commonly use Absolute EBITDAR?

Absolute EBITDAR is most commonly used in capital-intensive industries that have historically relied heavily on leasing assets, such as airlines, freight and logistics, and large retail chains with numerous store leases. Analysts use it to compare companies that may have different strategies for acquiring assets (owning versus leasing).

Is Absolute EBITDAR a GAAP measure?

No, Absolute EBITDAR is a non-GAAP financial measure. It is not defined or standardized by generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS). This means its calculation can vary between companies, making direct comparisons challenging without understanding the specific adjustments made.

Why is rent expense added back in Absolute EBITDAR?

Rent expense is added back to normalize the financial performance of companies, particularly in industries where companies may either own or lease their primary assets. By adding back rent, analysts aim to compare companies' operational efficiency and profitability as if all major assets were owned, thereby removing the impact of different financing structures and providing a more consistent basis for comparison.

How does Absolute EBITDAR differ from EBITDA?

The key difference is the "R" for Rent (or Restructuring Costs). EBITDA measures earnings before interest, taxes, depreciation, and amortization. Absolute EBITDAR adds rent expense back to EBITDA, making it useful for comparing companies with significant lease obligations to those that primarily own their assets.

Can Absolute EBITDAR be used for all companies?

While it can be calculated for any company, Absolute EBITDAR is most meaningful for businesses in industries with substantial lease expenses, where the difference between owning and leasing assets significantly impacts traditional profitability metrics. For companies with minimal leasing activity, the additional adjustment for rent may not provide significant new insights compared to EBITDA.