ACCT1511 TOPIC 9 HOMEWORK

Semester 2, 2012 Final Exam Question 3

(a) You are considering the investment in one of the above airline companies. Choose one (1) of the airline companies listed. What would be your price target
and recommendation? Show your calculations and round to nearest cent. (3 marks)
Company chosen (no marks but for reference purposes in calculating price target): Price target (3 marks): 1 mark for 1st company PE/PEG, 1 mark for 2nd
company PE/PEG, 1 mark for price target calculation.
Cathay Pacific Qantas Virgin Singapore Airlines China Southern Airlines
Cathay Pacific PE = Qantas PE = 1.16/0.026 = Cathay Pacific PE = 35.33 SIA PE = 10.95/0.31 = 35.32 China Southern Air PE =
12.72/0.45 = 28.27 44.62 Virgin Australia PE = Growth=0.66/0.31 4.14/0.39 = 10.62
SIA PE = 10.95/0.31 = 35.32 Virgin = 0.43/0.025 = 17.2 0.43/0.025 = 17.20 Price target=35.32 x 0.66 = Cathay Pacific Air PE =
Price target = 12.72 x Price target = 1.16 x Price Target = 0.43 x SGD23.31 12.72/0.36 = 35.33
35.32/28.27 = HKD15.89 17.2/44.61 = AUD0.45 35.33/17.20 = AUD0.88 Price Target = 4.14 x
35.33/10.62 = CNY 13.77
Cathay Pacific PE = Qantas Airways PE= Virgin Australia PE (use EPS China Southern Airlines
12.72/0.45 = 28.27 1.16/0.026 = 44.62 this FY) = 0.43/0.025 = 17.2 Forecast PE: 4.14/0.42=9.86
Growth = 0.92/0.45=104% Cathay Pacific PE = Qantas Airways PE= Cathay Pacific Forecast PE:
Price target = 28.27 x 0.92= 12.72/0.36 = 35.33 1.16/0.026 = 44.62 12.72/0.92=13.83
HKD26.01 Price Target Q= 1.16 X Price Target= 0.43 x Price target:
35.33/44.6= AUD0.91 44.62/17.2= AUD 1.116 4.14*13.83/9.86=5.81
PEG=28.27/104%=0.27 China Southern Airlines
Price target=12.72 / PE:4.14/0.42=9.86
0.27=HKD47.11 Cathay Pacific PE:
12.72/0.45=28.27
Price target:
4.14*28.27/9.86=11.87
Recommendation (no marks but must be consistent with price target to obtain marks for price target):
Buy Sell Buy Buy Buy
Note: Cannot use negative historical EPS – not meaningful to calculate PE with negative EPS. Why use next FY EPS instead of EPS for this FY? If you argue
that a company’s EPS is not reflective of its long run performance due to short term poor performance, with next FY’s EPS reflecting a more normalised
performance.

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(b) In your calculation of the price target, you had selected another company as the base for peer comparison. State the name of the peer company and give
ONE (1) reason why your choice of peer comparison is appropriate. (1 mark for reason, no mark for name of peer company)
Cathay Pacific Qantas Virgin Singapore Airlines China Southern Airlines
Singapore Airlines. an Asian Virgin is Australian based Qantas is Australian based Cathay Pacific: an Asian Cathay Pacific is suitable
based carrier most closely and compete on similar and compete on similar based carrier most closely because both is and China
aligned with Cathay Pacific domestic routes. domestic routes. aligned with Singapore Southern Air serve
in terms of air routes and Airlines in terms of air routes principally the booming
business segments. and business segments. Chinese market.
Singapore Airlines as it
serves international routes.

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(c) Give FOUR (4) reasons in support of the above stock recommendation. (1 marks for each reason):
Cathay Pacific
Has best 5 year stock price
performance.
Good ROE of 3.25% (not the Sales growth is at 5.75%
best –China Southern) but
better than main competitor
Singapore Airlines.
Well placed to exploit
growth in China.
Qantas
Qantas appears to be in
decline with dropping share
price over 5 years.
compared to Virgin of
18.37%.
Its profit margin is negative Asset turnover is highest,
at -4.55%, is worse than
Virgin at -1.11%, and
indicates company is in
decline.
EPS of Qantas is improving
from historical -0.10 to
expected future 0.124
indicating that its
performance is expected to
recover.
Virgin Singapore Airlines
Virgin has the highest sales Singapore Airlines has an
growth of 18.37% expectation of increasing
EPS over 3 years from
historical, to this year, to
next year.
Historically, Virgin had Current ratio of > 1, and
negative EPS, but expected lowest D/E which is close to
EPS have gone up and zero, indicates hardly no
predicted to be almost double debt, indicating a very
next FY conservative financial
management => low
bankruptcy risk.
Low debt/equity ratio
Virgin is utilising its
resources more efficiently
than competitors at 0.9,
compared to the second
highest (0.78)
Both Qantas and Virgin had Stable, increasing EPS.
experienced declines in their Whilst not the highest EPS,
stock prices, but the price of Sing Air’s EPS has increased
Virgin tended to increase by ~68% each financial year,
from mid-2011 till now, but meaning shareholders can
Qantas continues to decline. expect increasing earnings.
Reputation and legacy of a
an airline for great service,
for example Singapore
Airline.
China Southern Airlines
Has the highest ROE
13.71%.
Has very high sales growth
17.76%– suggesting it is
highly likely that higher
revenue will be generated in
the future.
Its low current ratio (0.42)
indicates its ability to operate
using other people’s money,
which shows it has good
management.
Higher profit margin
(5.37%), indicating that
China Southern Airline is
able to maximise profit and
minimise expense.
Lowest P/E relative to other
companies, indicates that it is
least overvalued.

(d) In financial statement analysis, it is important to consider special situations or context that may affect your analysis. Give TWO (2) reasons from the
information provided or from your general knowledge that may affect your decision. (2 marks)
Low cost carriers such as AirAsia are changing the air travel business paradigm, taking business away from full service carriers.
Alliances of competitors (e.g. Qantas and Emirates, Qantas and China Eastern) may toughen the competitive environment.

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Full service carriers starting new discount carrier offshoots may toughen the competitive environment (e.g. Scoot for Singapore Airlines).
Full service airlines relying on business travel will face competition from alternative means of conducting business such as teleconferencing.
The global financial crisis may affect overall demand for air travel.
Oil price cost may increase cost of air travel reducing airline profitability, and also higher cost may reduce demand for air travel.
Relevant for Qantas only: aircraft has been involved with a number of incidents and may lead to air safety concerns and customer avoidance.
Relevant for Qantas only: Qantas has been involved in disputes with employees resulting in strikes/lockouts which may result in customer avoidance, which
may also indicate poor management.
Whether the airline is mostly government-owned (e.g. China Southern Air, Singapore Airlines) will affect the risk of investing in such companies.
Relevant for Qantas & Virgin only: Australia’s high currency may affect their business given their exposure to flights to and from Australia relative to the
other non-Australian based airlines.

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Question 5 (4 marks)

(a) If you had fully invested your entire portfolio in CBA, would you now consider buying another Australian bank or banks in one of the other countries in
the table? Choice of bank: (no marks, e.g. NAB or Korean Banks) Any bank = no marks

Give two reasons using the valuation metrics in the table (1 mark each).
China Banks WBC UK Banks Indonesian Banks
EPS growth is higher than CBA in 2014. EPS growth is on Highest EPS growth in PE ratio is significantly lower
par with CBA, but 2013 and 2014. compared to CBA, showing that the
will overtake it in share price is not overvalued.
FY14
ROE is higher than CBA in all three financial PE lower Based on PE ratio, stock ROE is higher than CBA.(also the
years. (undervalued) price of CBA is highest among all banks)
compared to CBA overvalued compared with
over all 3 years. UK Banks.
Higher dividend yield compared to CBA, and WBC has higher Has highest and one of the most
other Australian banks. dividend yields consistent EPS growth rates of 12%
than CBA over over the 3 years.
three years.
Has higher and more consistent EPS growth PEG of 12.2/22.5 in FY12 compared
than CBA, of 6% or better over the 3 years to CBA PEG of 15.8/2.9 shows its
more undervalued.
ROE of around 20% over the 3 years is the ROE of above 22% over the 3 years
best (except for Indonesian banks). is among the best in the world.
PE lower (undervalued) compared to CBA
over all 3 years.
(b) Needs to be linked to choice in (a)
Hidden bad debts/ shadow banking system in the The investment in UK may Natural disasters such as Indonesian
banking system may pose future risks to the not be profitable due to Tsunami may affect economic
financial system. recession in UK. growth and future Indonesian bank
performance.
The property bubble could be a risk as banks have Unstable political system and
lent heavily in property. exchange rate might increase the risk
of investment
Large and growing economy in China may lead to

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 greater future performance.
The relatively stable fixed exchange rate reduces
the risk to foreign investors.
High inflation in China might decrease the value of
profit generated from investment
The Chinese government may impose policy
directed lending restrictions on how banks can
operate there which may have a negative impact on
the operation of banks.
The resilience of the Chinese economy from the
GFC makes it a stable choice
Chinese economy is projected to slow down and
will negatively affect China bank performance
ALL: The GFC may have a negative impact on the bank/ banking system’s performance. /
After the GFC many Australians are more cautious about borrowing which means lower future performance for banks.
ALL: Need to consider risk of central bank raising policy/cash rate on their country’s banks performance.
ALL: The likelihood of the bank(s) being bailed out by their government affects the investment risks
ALL: Should consider diversifying out of investment in banks, into other areas such as property or high growth young companies.
For Asia-Pacific Banks Lack of well-defined and transparent financial and legal framework is the risk of investments in the country’s banks.
For Asia-Pacific Banks: The Asia-Pacific region is seeing strong economic growth relative to US and Europe and investment in these banks may result in
future profits.
For Asia-Pacific Banks: The decline in ROE in many Asia-Pacific countries indicate declining economic activity.
Australian Banks: Diversifying into another Australian bank may be risky as a recession in Australia would affect all Australian banks.
Australian Banks: The Australian economy remained stable during and after the GFC compared to ROW, so Australian banks remain a good investment
compared to banks from other countries.
Australian Banks: Australian banks in general are highly exposed to the domestic home loan property market and constitute an underlying vulnerability.
Australian Banks: With forecasted slowdown of China, which Australia very heavily relies on, the Australian economy may see a decrease in growth and
firm performance.
Australian Banks: With strong growth in China, Australia continues to attract much investment from China underpinning growth in the Australian economy.
Australian Banks: Australian banks are well regulated by ASIC/APRA which makes the Australian banks and financial system more stable.
Australian Banks: Australian banks are as a whole overpriced relative to other banks globally and their share price could fall in the future.
Australian Banks: The falling AUD means that there is higher exchange rate risk for foreign investors in Australian banks