ACCT1511 TOPIC 5 Part 1 SEMINAR SOLUTION

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
0.43/0.025 = 17.20
Price target=35.32 x 0.66 =
SIA PE = 10.95/0.31 = 35.32 Virgin = 0.43/0.025 = 17.2
Cathay Pacific Air PE =
Price Target = 0.43 x
SGD23.31
Price target = 12.72 x
Price target = 1.16 x
12.72/0.36 = 35.33
35.33/17.20 = AUD0.88
35.32/28.27 = HKD15.89
17.2/44.61 = AUD0.45
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 companys EPS is not reflective of its long run performance due to short term poor performance, with next FYs EPS reflecting a more normalised
performance.

(b) In your calculation of the price target, you had selected another company as the base for peer comparison. State the name
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
Singapore Airlines. an Asian Virgin is Australian based
Qantas is Australian based
Cathay Pacific: an Asian
based carrier most closely
and compete on similar
and compete on similar
based carrier most closely
aligned with Cathay Pacific
domestic routes.
domestic routes.
aligned with Singapore
in terms of air routes and
Airlines in terms of air routes
business segments.
and business segments.
Singapore Airlines as it
serves international routes.

of the peer company and give

China Southern Airlines
Cathay Pacific is suitable
because both is and China
Southern Air serve
principally the booming
Chinese market.

(c) Give FOUR (4) reasons in support of the above stock recommendation. (1 marks for each reason):
Cathay Pacific
Qantas
Virgin
Singapore Airlines
Has best 5 year stock price
Qantas appears to be in
Virgin has the highest sales
Singapore Airlines has an
performance.
decline with dropping share
growth of 18.37%
expectation of increasing
price over 5 years.
EPS over 3 years from
historical, to this year, to
next year.
Good ROE of 3.25% (not the Sales growth is at 5.75%
Historically, Virgin had
Current ratio of > 1, and
best China Southern) but
compared to Virgin of
negative EPS, but expected
lowest D/E which is close to
better than main competitor
18.37%.
EPS have gone up and
zero, indicates hardly no
Singapore Airlines.
predicted to be almost double debt, indicating a very
next FY
conservative financial
management => low
bankruptcy risk.
Well placed to exploit
Its profit margin is negative
Asset turnover is highest,
Low debt/equity ratio
growth in China.
at -4.55%, is worse than
Virgin is utilising its
Virgin at -1.11%, and
resources more efficiently
indicates company is in
than competitors at 0.9,
decline.
compared to the second
highest (0.78)
EPS of Qantas is improving
Both Qantas and Virgin had
Stable, increasing EPS.
from historical -0.10 to
experienced declines in their Whilst not the highest EPS,
expected future 0.124
stock prices, but the price of
Sing Airs EPS has increased
indicating that its
Virgin tended to increase
by ~68% each financial year,
performance is expected to
from mid-2011 till now, but
meaning shareholders can
recover.
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 peoples 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.
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: Australias high currency may affect their business given their exposure to flights to and from Australia relative to the
other non-Australian based airlines.

Q2: Starbucks
(1) Give one reason why McDonalds as peer comparison for Starbucks is appropriate. (1
mark). Note: These answers are provided from when this question was used as a team
exercise in 2015s1.
Both of the companies, McDonalds and Starbucks are chain restaurants that sell coffee and
cakes. McDonalds already has plans to emulate Starbucks style coffee bars to nearly 14,000
of its American restaurants and has emerged as one of its biggest competitor. Therefore, they
both sell similar products and in a similar industry.
Both McDonalds and Starbucks are on a global scale with international stores within the fast
food industry. This can be supported by McDonalds having 36,000 outlets in 119 countries
serving around 68 million customers daily (as at 2012) and Starbucks has 20,519 stores (at
30 March, 2014).

Theyre both similar sized Transnational Corporations with a vast number of franchises
throughout the world. Both companies are well known and in the hospitality: food and
beverage industry, thus making them similar in their provision of food, drinks and customer
service. Ultimately, in terms of their business models, size and global recognisability they
are appropriate for comparison
(2) Give one reason McDonalds is NOT an appropriate peer comparison. (1 mark). Note:
These answers are provided from when this question was used as a team exercise in
2015s1.
McDonalds may not be appropriate as its main focus is selling fast food whereas Starbucks
main focus is on selling coffee and caf style food.
Starbucks sells coffee beans, tea, drinkware and coffee machines online while McDonalds
does not. McDonalds has only recently introduced online ordering and delivery of food and
drink and in a very limited capacity through a small number of stores.
Starbuck focuses on selling drinks and some dessert and McDonalds is a fast food chain with
a strong focus on selling burgers and chips to consumers. Thus, it has a broader range of
products, so their service ranges do not match well.
Both companies are in different sectors of the food industry and thus, make and sell different
products. McDonalds is a fast food chain that specialises in burgers, fries and desserts with
some stores having a McCafe coffee section, whereas Starbucks is a coffeehouse chain
whose revenue primarily comes from hot and cold drinks, but they also sell sandwiches and
cakes. Ultimately, a comparison of Starbucks and McDonalds may be inappropriate since
better comparisons could be made with other coffeehouse chains, such as Tim Hortons.

(3) Explain why Gloria Jeans, part of the Retail Food Group, is not a suitable peer
comparison for Starbucks. (1 mark) These answers are provided from when this question was
used as a team exercise in 2015s1.
Gloria Jeans operates on a smaller scale than does Starbucks. Gloria Jeans has only 1,000
stores worldwide compared to Starbucks which has 20,519 stores (as at 30 March 2014) and
is the subsidiary of larger conglomerate, Retail Food Group. The difference in size with both
companies make Starbucks registered in worldwide stock exchange while Gloria Jeans is a
private company. Thus, we cannot find and predict the current market price target making
Gloria Jeans an inappropriate comparison
Starbucks is a public company which was listed on the stock market in June 1992 whereas
Gloria Jeans is a privately held company. This difference allows the company to reach a
completely different market place. The number of locations for Starbucks is larger than
Gloria Jeans, which means that the area served is more in Starbucks. So geographically they
are situated in a very different market and there is a strong difference in regards.
(4) 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):
Starbucks US and Canadian stores have been expanding into alcoholic beverages including
wine, craft beer and cider (from 2010 in the US Starbucks Evening stores and 2016 for its
Toronto locations). The introduction of alcoholic beverages in the Canadian market is well
matched to demand Canadians are estimated to drink more of both coffee and wine than
Americans.
http://fortune.com/2016/04/04/starbucks-canada-alcohol/
Starbucks main raw material is coffee beans as such coffee bean shortages can negatively
affect the company as it increases its cost of goods sold and decreases net profits. In early
2016 a global coffee bean shortage has been predicted which could increase Starbucks cost
of goods sold and could require additional expenditure in establishing new suppliers for their
coffee beans.
http://www.abc.net.au/news/2016-01-22/global-coffee-shortage-could-cause-melbourne-cafeclosures/7107110
Competitors of Starbucks, including Dunkin Donuts and McDonalds, are taking steps to
appeal to the growing market of coffee connoisseurs. Recent media articles have compared
Starbucks and McDonalds coffees and found that in the US market McDonalds coffees are
cheaper, there is less time spent in the ordering process, the process for ordering a coffee is
clearer, there is a wider menu of food with an in-house kitchen.
http://www.businessinsider.com.au/i-started-going-to-mcdonalds-instead-of-starbucks-formy-coffee-here-are-4-reasons-why-2015-10