Flight Centre Limited - Competitive Positioning, Financial Analysis, and Security Valuation - Example

Student Research: The report is published for education purpose only, by students enrolled in the subject Security Valuation. 16th May 2015 Ticker: FLT Recommendation: HOLD Price: $39.30 Target price: $45.30 Year to Jun NPATs EPSchg(%) EPS The PER DPS The Yields (%) Franking (%) 2016 F 296.1 10.4 294.5 15.9 177.0 3.8% 100.0% 2015 F 268.7 1.9 266.8 17.6 160.0 3.4% 100.0% 2014 A 263.6 9.9 261.8 18.4 152.0 3.2% 100.0% Source: Morning-star 2011 Investment summary Initializing coverage of Flight's Centre Limited (FLT) with a hold recommendation and the target prices of $45.30 using discounted flow cash analysis (DCF), presenting a 14% increase from current price at $39.30 on 18th May 2015. On our analysis on revenue estimation is based on top down approach considering FLT's global operational risks, growth and margin based on different distinct regions. We have confidence that FLT's will offer long term gradual increase in price based on new market ventures targeted. Business Description Flight Centre Travel Limited previously referred to as Flight Centre Limited (FLT) is a business-oriented company engaged in travel agency across the world. It was founded in 1981; its headquarters is based in Queen Street Brisbane, Australia. Business people and leisure travellers in Australia, United States, New Zealand, United Kingdom, Middle East, Asia, Europe and Africa enjoy complete travel services from the company. Flight Centre Travel Limited entails a number of more than thirty brands based on three categories namely; corporate, Leisure and wholesale. Leisure brand is regarded as flagship brand in Flight Centre (Flight Centre 2014). The company has extensive services to its customers in flight, hotel, rail, tours, cruises, car hire, travel insurance and holiday packages. Through tour travels, it enables its customers to experience the world’s natural attractions build on social and environmental causes. The company employs approximates fifteen thousand competent employees offering various services to clients globally. The company’s strategy is to have greater market share and to emerge as the most preferred leader in retail and corporate travel market. The company is considering developing complementary on-line and off-line product and service offering to enhance its local and international consumers (Hernon & Whitman 2000, p. 04). Industry Overview Flight Centre Tour Group is a corporate, leisure and wholesale travel tour business with operations almost all over the world. The company’s global corporate network spans 75 countries with locally based agencies entrusted to licence them. Moreover, the company also undertakes operations in areas such as bike retailing and exchange of foreign currencies. Corporate Travel caters to the corporate market, with operations across Australia and New Zealand, North America, Asia and Europe. It offers a one-stop shop that includes airfares, accommodation, transportation, insurance and visas. It also provides products and systems to assist companies manage travel costs, such as expense management, on-line booking and tracking tools. FLT has established a five-year plan strategy spanning until 2017. In the retail sector, the company plans to develop retail effectiveness and shopping operations into a stimulating and inspirational experience to its customers by argumentation and branding its products (Rajola 2013, p.14). On-line sales are expected to increase since the company plans to undergo aggressive promotions and offering.FLT plans to accelerate corporate travel growth in the next three years (Belobaba & Barnhart 2009, p. 03). These will in turn increase the revenue earned over the years, meaning Flight Company will not experience financial distress once the plans are fully implemented. In collaboration with other associate companies, the company plans to extend supply chain so as to increase sales of its products. Flight Centre is a robust company that shows strong financial health due to better customer satisfaction. In a bid to increase sales and win the minds of the customers, the company has initiated a programmed that aims at ensuring key drivers of business(customers) are given first priority in terms of product. Quality and formidable services enhance customer’s loyalty (Fisk, Grove & John 2014, p. 36). It ensures FLT’s upcoming businesses focuses on utilisation of resources by engaging booming business models (Cianfrani & West 2009, p.69). Competitive Positioning Over the years, intensive competition in the contemporary flight market has increased considerably because of the quest to maximize profits. The flight industry as a service sector is seen as one of the sectors regularly prone to changes since it has high competition across the world, flexible demand and a lot of uncertainties involved (Heracleous & Pangarkar 2009, p.63). Based on global markets, the company has been undergoing structural and functional change (Agarwal 1986, p.17) Making strategic alliances and venturing into new international markets has been the key changes in the airline sector. Changes in organizational structure of flight centre company has brought in desirable elements such as trust, customer loyalty and satisfaction, improve service quality making the company out-performance related companies in the same sector as shown in appendix 1. Flight Centre reported first-half fiscal 2015 profit before tax (PBT) of AUD 141 million, within the projected range of AUD 136 million to AUD 142 million for December 2014. As predicted, the Australian Flight Centre recorded an 11% decline in statutory earnings before interest and tax (EBIT), offset by better performance in international businesses recording a 25 percent increase to AUD 25.3 million for the half year. Flight centre travel group outperforms its peers (appendix ii). The market share stands at$ 4,427 million as compared to $ 1,016 million from Matra Group Company. The dividend yield stands at 3.53% and 2.76% for Flight Centre Company and Matra Company respectively. A newly declared, fully franked interim dividend of AUD 0.55 per share remains unchanged from the previous financial year for Flight while Matra’s earning per share stand at 0.0000. Growth opportunities in foreign countries have enabled Flight centre Limited to penetrate a new market. Product innovation and argumentation have attracted new customers thus giving the company an edge in response to market demand and fierce competition (Kang 2009, p.13). The management plays a crucial role in FLT's success (Lussier 2008, p.15). Mr. Turner and his experienced board of Directors have ensured full management of resources and avoid the company incurring cost where not necessary. Low cost of production means high profitability (Ferrara 1996, p.20). The dividends per share of the company register an increase of 10.95% while earnings by share dropped by 15.86%. The five-year analysis (2010/14), registered average dividend yield of 4.18% and dividends growth rate of 76.00%. Financial Analysis Flight Centre Limited over the years has experienced drastic changes in both structural and operational perspective. Analysis of all the changes in the financial statement over a range of four years (2010 to 2014) is shown in (Appendix III). FLT those four years, revenues has been in an increasing trend, registering 1,673AUD million in 2010, 1,763 AUD million in 2011, an increase of 90 AUD million. In 2012 and 2013, it recorded 1,817 and 1,983 AUD million respectively, a rapid increase of 166 million. In the financial year 2014, it recorded revenue amounting to1, 945 AUD million showing a drop of 38 AUD million over the previous financial year 2013. This drop in revenue is attributed to one-off write-downs and $11 million fines from Australian Competition and Consumer Commission. Operational income fluctuated over the years recording a major increase in 2014 of $A270 million. This increment is attributed to both increases in market scope and share. During the years, percentage operating margin increase, recording 16.5% in 2014, being the highest record. Net income over the years under review shows a successive rise from 38,140,140,200 and 246 AUD million dollars for financial years 2010 to 2014 respectively. Overseas businesses contribute more income to the company. During 2011/12, EBIT recorded from abroad businesses accumulate to $60million of the group earnings. For the second consecutive year, all 10 major countries were profitable (EBIT). Notwithstanding the economic uncertainty in Europe, USA recorded $10 Million after trailing more than $60million three years in the past doubling the predicted target of $5Million for the year. UK EBIT improved by 53% in Australian dollars (Buti & Sapir 2002, p.81). FLT’s global shop network reveals a growth of a range of 6-8%. This saw the company increases its sales global workforce by 1,000 and further increase its shop and businesses to about 2,500 outlets. The company recorded Net Profit after Tax (NPAT) of $263.6 Million during 2014 fiscal year. It is projected to increase gradually in the subsequent years. In 2015, it is expected to record $268.7 million and $296.2 million in 2016 financial year (appendix I). The Return in equity is always analyzed as the net income subdivided by its mean share-holder equity. During December 2014 financial year FLT’s recorded $201 Million as quarterly net income while average shareholders’ equity for the quarter of the same period stands at $1,120 Million. Therefore, annualized return on equity for the company in the quarterly period that came to a close in Dec.2014 was 17.91%. Fluctuations in the company business cycle or earnings can have an effect on the ratio considerably. It is necessary to en route for leverage ratio before any investments can be done in companies having high ROE. This is because a company is capable of increasing its returns on equity through additional financial leverage (Appendix IV). ANALYSIS AND VALUATION USING DDM MODEL The intrinsic value of Flight Centre Limited is calculated using the Dividend Discount Model (DDM). From this model, the present value of a constant flow of dividends that are increasing at a constant rate is given. The model consists of three methods that can be used to analyse the valuation of the company; constant growth, two-stage and the three-stage model (Reilly & Norton 2006, p.463). The constant growth model is used when a company’s dividends are growing slowly, properly at a constant rate, and remain at the same rate over a longer period (Brigham & Houston 2009, p. 283). Two-stage and three-stage can only be applied when the performance of the company is picking up speedily as compared to economic growth rate of the same industry. FLT, analysis manifests greater required rate of return than the expected dividend growth rate, therefore, the constant growth model is appropriate for the valuation, then the value of stock is computed as; D1 / k – g =0.97/ (1-0.028) =0.09979 To estimate k, the Capital Asset Pricing Model is applied basing on the rates of return of every month on the market and FLT's shares over a time period of 4 years (2010 to 2014). In this step, the arithmetic mean is adopted as the averaging technique to estimate the average returns as a means of calculating the variance of the market, and deriving the value of CAPM of Flight limited. The risk-free rate is applied to the CAPM model that is considered suitable for our period of analysis as ten year Treasury bond considered risk free rate and used to compute return’s rate. Thus; the Cost on Equity= the Risk- The Free Rate in Return + Beta of the Asset* (The Expected Return on the Market- the Risk- the Free Rate in Return) In this case, risk-free rate is 2.18% and the beta of FLT stands at 1.64 and market rate of return is 7.5% (Economic indicators).Cost of Equity = 2.18% + 1.64*7.5% =14.48%. The cost of debt is ($22.7326/31.9928) is equal to 71.055% and the average tax for the period 32.81% meaning the weighted mean cost in capital (WACC) is analyze as; =WACC= E/ (D+E)* Equity Cost + D/ (D+E)* Debt Cost*(1- Rate Tax) = 0.9897* 14.48% + 0.0103*71.055 %*( 1-32.81%) =14.82% Since Flight centre Travel Group Limited return on invested capital is 1156.41, compared to WACC of 14.82%, meaning returns generated are high on investment than costs incurred on coming up with capital required. Thus, the company earns excess returns. Valuation The Free flow cash to Equity model tries to find out the amount of free cash that flows and is available to be paid back to ordinary shareholders after meeting the company’s reinvestment plan and making a debt payment. If the calculated intrinsic value is greater than the stock’s present market price, then the stock is considered to be undervalued. But if the value is below the stock current market price, then the stock is overvalued by the market and thus the company should not acquire (Damodaran 2002, p. 234). In order to determine the FCFE available to stockholders, historical data of company is used to get net income and less the firm reinvestment requirement, derive as shown in Appendix V. In the calculation the value of equity is 1076.157. Relative valuation The P/E multiples as a comparable methodology is applied in Relative Valuation. P/E Valuation Value Current Price $39.30 Trailing EPS $1.92 Estimated EPS $0.82 Leading P/E 16.76x The DCF valuation gives us intrinsic value of FLT's as $ 45.30 per share compared to a current market price of exactly $39.30, which is believed to market fairly in values stock. We recommend HOLD for FLT based on the intrinsic value, 24.2% margin safety and current share price of $39.30. Table 1: Intrinsic values based on margin of safety Margin of Safety (24.2%) Intrinsic value 45.30 24.2% above intrinsic value 56.26 24.2% below intrinsic value 34.33 Current market share price 39.30 Recommendation HOLD . Scenario and Sensitivity Analysis The top down approach method used to estimate revenue of FLT is corresponding to the exchange rate between AUD and EUR. We estimate network sales in Europe based on Revenues and market share in other countries mainly Australia. The revenues generated in each market are affected by exchange rate fluctuations, which in turn affect our target price. The base Exchange Rate (EUR/AUD) that we use is 0.7899 and target price of $45.30. Table 3: Sensitivity analysis EUR/AUD Rate % Change vs Current Forecast Target Price (AUD) 0.8373 6% $48.01 0.8215 4% $47.11 0.8057 2% $46.20 0.7899 0% $45.30 0.7741 -2% $44.40 0.7583 -4% $43.49 0.7425 -6% $42.58 Investment risk Promotional risk In a highly dynamic and competitive environment, unsuccessful promotions of the company’s products can significantly ruin FLT’s business. Even though one of the most important marketing tools to the company is the promotion, caution should be taken to ensure adequate market research is carried out prior launching and promoting new products. Competition Competition is a major threat to FLT’s performance. The company, therefore, should study and look for ways to counter new competitors based on customer satisfaction. Cost Over time, the company has faced an incremental cost of doing business. It is important for the cost company to look for ways of mitigating high cost which translates to shrink profits. Exchange rate fluctuations Flight Group Company limited operates across a number of countries. The exchange rate in each country changes regularly. Based on 5 years valuation data, a variation of exchange rate stands at 10% for the Euro to AUD. Due to this evidence, Europe is experiencing fluctuating unstable exchange rate against AUD, manifesting future uncertainties. References Agarwal, R. D 1986, Organization and management, McGraw-Hill, New Delhi. Belobaba, P, Odoni, A & Barnhart, C 2009, The Global Airline Industry, John Wiley & Sons, Chichester. Brigham, E. F & Houston, J. F 2009, Fundamentals of financial management, South-Western Cengage Learning, Mason, OH. Buti, M & Sapir, A 2002, EMU and economic policy in Europe the challenge of the early years, Edward Elgar Publishing, Cheltenham, UK. Cianfrani, C. A & West, J 2009, ISO 9001:2008 explained, ASQ Quality Press, Milwaukee, Wisconsin. Damodaran, A 2002, Investment valuation: Tools and techniques for determining the value of any asset, 2nd edn, John Wiley & Sons, New York. Ferrara, W. L 1996, Managerial cost accounting: planning and control, Dame Publications, Houston, Texas. Fisk, R. P, Grove, S. J & John, J 2014, Services marketing: an interactive approach, South-Western, Mason, OH. Flight Centre 2014, 2014 Annual Report, retrieved 10 May 2015, Heracleous, L. T, Wirtz, J & Pangarkar, N 2009, Flying high in a competitive industry: secrets of the world's leading airline, McGraw Hill, Singapore. Hernon, P & Whitman, J. R 2000, Delivering satisfaction and service quality: a customer-based approach for libraries, American Library Association, Chicago. Lussier, R. N 2008, Management fundamentals: concepts, applications, skill development, South-Western/Cengage Learning, Mason, OH. Rajola, F 2013, Customer relationship management in the financial industry organizational processes and technology innovation, Springer, Berlin. Reilly, F. & Norton, E. A 2006, Investments, 7th edn, South-Western, Mason, OH. Security Valuation: Student Research 16th May 2015 Read More