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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 1 st company PE/PEG, 1 mark for 2 nd company PE/PEG, 1 mark for price target calculation.

Cathay Pacific



Singapore Airlines

China Southern Airlines

Cathay Pacific PE = 12.72/0.45 = 28.27

Qantas PE = 1.16/0.026 =

Cathay Pacific PE = 35.33 Virgin Australia PE = 0.43/0.025 = 17.20 Price Target = 0.43 x 35.33/17.20 = AUD0.88

SIA PE = 10.95/0.31 =

China Southern Air PE = 4.14/0.39 = 10.62 Cathay Pacific Air PE = 12.72/0.36 = 35.33 Price Target = 4.14 x 35.33/10.62 = CNY 13.77



SIA PE = 10.95/0.31 =

Virgin = 0.43/0.025 = 17.2



Price target = 1.16 x

Price target=35.32 x 0.66

Price target = 12.72 x 35.32/28.27 = HKD15.89

17.2/44.61 = AUD0.45

= SGD23.31

Cathay Pacific PE = 12.72/0.45 = 28.27 Growth = 0.92/0.45=104% Price target = 28.27 x 0.92= HKD26.01

Qantas Airways PE= 1.16/0.026 = 44.62 Cathay Pacific PE = 12.72/0.36 = 35.33 Price Target Q= 1.16 X 35.33/44.6= AUD0.91

Virgin Australia PE (use EPS this FY) = 0.43/0.025 = 17.2 Qantas Airways PE= 1.16/0.026 = 44.62 Price Target= 0.43 x 44.62/17.2= AUD 1.116


China Southern Airlines Forecast PE:


Cathay Pacific Forecast PE: 12.72/0.92=13.83 Price target:





China Southern Airlines

Price target=12.72 /



Cathay Pacific PE:


Price target:


Recommendation (no marks but must be consistent with price target to obtain marks for price target):







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.

(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



Singapore Airlines

China Southern Airlines

Singapore Airlines. an Asian based carrier most closely aligned with Cathay Pacific in terms of air routes and business segments.

Virgin is Australian based and compete on similar domestic routes.

Qantas is Australian based and compete on similar domestic routes.

Cathay Pacific: an Asian based carrier most closely aligned with Singapore Airlines in terms of air routes and business segments.

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


Singapore Airlines as it serves international routes.



(c) Give FOUR (4) reasons in support of the above stock recommendation. (1 marks for each reason):

Cathay Pacific



Singapore Airlines

China Southern Airlines

Has best 5 year stock price performance.

Qantas appears to be in decline with dropping share price over 5 years.

Virgin has the highest sales growth of 18.37%

Singapore Airlines has an expectation of increasing EPS over 3 years from historical, to this year, to next year.

Has the highest ROE


Good ROE of 3.25% (not the best –China Southern) but better than main competitor Singapore Airlines.

Sales growth is at 5.75% compared to Virgin of

Historically, Virgin had negative EPS, but expected EPS have gone up and predicted to be almost double next FY

Current ratio of > 1, and lowest D/E which is close to zero, indicates hardly no debt, indicating a very conservative financial management => low bankruptcy risk.

Has very high sales growth 17.76%– suggesting it is highly likely that higher revenue will be generated in the future.


Well placed to exploit growth in China.

Its profit margin is negative at -4.55%, is worse than Virgin at - 1.11%, and indicates company is in decline.

Asset turnover is highest, Virgin is utilising its resources more efficiently than competitors at 0.9, compared to the second highest (0.78)

Low debt/equity ratio

Its low current ratio (0.42) indicates its ability to operate using other people’s money, which shows it has good management.

Reputation and legacy of a an airline for great service, for example Singapore Airline.

EPS of Qantas is improving from historical -0.10 to expected future 0.124 indicating that its performance is expected to recover.

Both Qantas and Virgin had experienced declines in their stock prices, but the price of Virgin tended to increase from mid-2011 till now, but Qantas continues to decline.

Stable, increasing EPS. Whilst not the highest EPS, Sing Air’s EPS has increased by ~68% each financial year, meaning shareholders can expect increasing earnings.

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: 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.