Strategy analysis

TOPICS FOR THE SESSION

 Strategy analysis

 Industry analysis

 Business analysis

o Standardize financial statements to be used in the FSA

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Industry analysis

Goal:
• Identify determinants of industry
profitability;
• Identify main players and market
shares;
• Collect information useful to create
future firm performance’s expectations;

Possible frameworks :
• Porter five forces (highly cited in the
strategy literature)

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Applying industry analysis: The European airline industry

Quick “history” of the industry:

• 80’s: highly regulated industry; partly owned by governments (“flag carriers”);

agreements between governments to limit competition (which airlines operate which
routes at what price)

• 90’s: EU liberalized industry, greater competition; steady growth in passenger traffic;

Source: Palepu, Healy and Peek. 6th edition

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Applying industry analysis: The European airline industry

• During the first two decades of the 2000s, industry profitability has been low.
– Industry growth (4.5% to 5.5%) much affected by Sep 11, credit crisis, COVID;

• Competitive forces: Moderate industry growth; fragmented industry; few

opportunities to differentiate and low switching costs; high excess capacity.
– Fragmented industry: inefficient airlines being taken over by government, M&A not attractive due to
regulatory hurdles (renegotiation of labor and lease contracts were complicated)
– Differentiation: services are identical; exceptions: frequent flyer programs
– Excess capacity: 5 larger airlines accounted for 81% of the passengers' seats filled

• Threat of new entrants: Budget airlines, no frills services prices;

– New entrants: easy access to capital, second-hand aircrafts became cheap during industry downturns
– Different prices for each service provided

• Threat of substitute products: High-speed rail networks.

• Bargaining power of suppliers and buyers:

– Suppliers: aircraft (Boeing or Airbus), fuel & ground handling (airports can only have two competimg
agents), labor (high power union forces, strikes)
– Buyers: high price transparency due to web booking systems.

Source: Palepu, Healy and Peek. 6th edition

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes
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Strategy analysis

Applying industry analysis: The European airline industry

• Some numbers

Source: Marketline: Sectors: Airlines: Airlines Global Industry Data

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes
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Strategy analysis

Applying industry analysis: The European airline industry

• Some numbers

Source: Largest airlines in the world - Wikipedia

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes
 Strategy analysis

Business analysis

Goal:
• Identify firm value drivers/key success factors: “how is the firm creating value”?
• Identify key risk factors and risk mitigation strategies: “what factors might block
the company of creating value?”
• Collect information useful to create expectations about firm’s past performance
and financial position;

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Applying business analysis: Apple

Overall
• Designs, manufactures and markets mobile communication and
media devices, personal computers and portable digital music
players and sells a variety of related software, services, accessories,
networking solutions and third-party digital content and applications.

• Revenue breakdown 2017 2016 2015 2014

iPhone 61% 63% 66% 56%
iPad 8% 10% 10% 17%
Mac 11% 11% 11% 13%
Services 7% 11% 9% 10%
Other 6% 5% 4% 4%

Source: Palepu, Healy and Peek. 6th edition

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes
 Strategy analysis

Applying business analysis: Apple

1. Key success factors

• Unique ability to design and develop its own operating systems, hardware,
application software and services;

• Provide customers with new product and solutions with superior ease of use,
seamless integration and innovative design;

• Use of own retail stores and online sales to ensure a high-quality buying
experience (25% of sales)

• Use of third-party distributors, particularly cellular network carriers who

heavily subsidize product sales.

• etc.

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Applying business analysis: Apple

2. Key risks
• Highly competitive market (Samsung, LG etc.)
• Need frequent successful new product introductions and transitions to grow
and maintain sales
• Apple has historically benefited from relatively high margins on iPhone, but
is coming under increasing pressure in this market
• Cellular carriers may cut or discontinue subsidies

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Applying business analysis: Apple

3. Plans to address risks

• Frequent and timely introduction of innovative new products, services and
technologies to the marketplace.
• Investing heavily in R&D.
• Continue to develop entire solutions for its products which include hardware,
OS, software applications and related services.
• Continue to invest in programs to enhance reseller sales, including staffing
selected resellers’ stores with Company employees and contractors, and
improving product placement displays.

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Applying business analysis: Apple

4. Overall Evaluation of Apple’s Business Strategy

• Currently characterized by slowing sales growth and high margins;

• Key competitive advantage is in‘seamless’integration of hardware,

operating system, application software and services;

• But competition is catching up and new product cycles appear to be offering

fewer significant improvements;

• Cellular carriers generate the bulk of sales through contract subsidies that
may be cut or discontinued;

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

TOPICS FOR THE SESSION

 Strategy analysis

 Industry analysis

 Business analysis

o Standardize financial statements to be used in the FSA

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

5. Prepare standardized FS
Purpose:
• Prepare FS to be used in the analysis: classify items into categories to facilitate
calculation of comparable performance metrics
o Firms can vary in the nomenclature and formats used to report financial results

How to implement:
• Separate business activities
o operating and investing activities (affect firm’s value creation) vs
o financing activities (affect the allocation of value among firm’s capital providers)

• Separate assets and/or liabilities from continued versus discontinued operations;

recurring versus transitory income
o Recurring income is expected to continue in the future
o Transitory income: eg: restructuring activities; one-off impairments
FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes
 Strategy analysis

Applying to Wal Mart

“As of reported balance sheet”

Wal Mart GAAP Balance Sheet (in million USD)
Y2 Y1
Assets 2017
Y2 2016
Y1 Liabilities 2017 2016
Cash and cash equivalents 6,867 8,705 Commercial paper 1,099 2,708
Receivables 5,835 5,624 Accounts payable 41,433 38,487
Inventories 43,046 44,469 Accrued liabilities 20,654 19,607
Pre-paid expenses and other 1,941 1,441 Accrued income taxes 921 521
57,689 60,239 Current portion - LT debt 2,256 2,745
Current portion - capital leases 565 551
66,928 64,619

LT debt 36,015 38,214

Net property, plant and equipment 107,710 110,171 LT capital lease obligations 6,003 5,816
Net property under capital leases 6,468 6,345 Deferred income taxes and other 9,344 7,321
Goodwill 17,037 16,695 Minority interests 2,737 3,065
Other assets 9,921 6,131 Shareholders equity 77,798 80,546
198,825 199,581 198,825 199,581

What is the amount of net operating assets?

What is the amount of invested capital (own equity and debt)?

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Strategy analysis

Standardized balance sheet

Wal Mart Balance Sheet Operating/Financing perspective
Operating activities 2017
Y2 2016
Y1 Financing activities Y2
2017 Y1
2016
Commercial paper 1,099 2,708
Receivables 5,835 5,624 Current portion - LT debt 2,256 2,745
Inventories 43,046 44,469 Current portion - capital leases 565 551
Pre-paid expenses and other 1,941 1,441 Current financial liabilities 3,920 6,004
Current operating assets 50,822 51,534
LT debt 36,015 38,214
Net property, plant and equipment 107,710 110,171 LT capital lease obligations 6,003 5,816
Net property under capital leases 6,468 6,345 Minority interests 2,737 3,065
Goodwill 17,037 16,695 Long term financial liabilities 44,755 47,095
Other assets 9,921 6,131
Long-term operating assets 141,136 139,342 Financial obligations 48,675 53,099
Financial assets (cash and cash e 6,867 8,705
Operating assets 191,958 190,876 Net financial obligations 41,808 44,394

Accounts payable 41,433 38,487 Common equity 77,798 80,546

Accrued liabilities 20,654 19,607 Invested capital 119,606 124,940
Accrued income taxes 921 521
Current operating liabilities 63,008 58,615

Deferred income taxes and other 9,344 7,321

Operating liabilities 72,352 65,936

Net operating assets 119,606 124,940

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes
 Strategy analysis

Implementation tools
• Standardized categories of FS items to prepare common format FS

o Firms usually use different nomenclature and format to present FS

o The book presents one suggestion on these categories

o Databases such as Marketline might use different categories (see their list and
definitions of categories)

• Excel tool to help in preparing standardized FS (see on Moodle 50.Extra materials;

also available on PHP online resources)

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Categories

Sources: PHP pages 78-87

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Categories

Sources: PHP pages 79 -94

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Categories

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes

 Next class

Preparation, deliveries and deadlines:

 Prepare standardized FS (balance sheet and income statement) for your firm – these
have to be included in the group project

FINANCIAL ANALYSIS & FORECASTING | Joana Cardoso Fontes