A Financial Statement Analysis of Sydney Airport - Case Study Example

FINANCIAL STATEMENT ANALYSIS FOR SYDNEY AIRPORT Student Course Date FINANCIAL STATEMENT ANALYSIS FOR SYDNEY AIRPORT Introduction The objective of financial statement analysis is to assess whether the market is pricing a firm’s shares fairly. It is done by studying the intrinsic characteristics of a firm in conjunction with the firm’s financial statements (Foster, 1987). This exercise should be done in a very careful way since the results of financial statement analysis can be applied in many different decision-making settings such as setting the credit rating of the company, valuation of mergers and acquisitions and Initial Public Offering (IPO) valuations (Foster, 1986). Financial statement analysis is also used to evaluate a firm’s current and past performance and to predict its future performance. The expected future performance is then used to measure the value of the firm’s shares. Investment decisions are made by comparing the estimates of the firm share value got from the financial statement analysis with the current market share price to determine whether the shares are overvalued or undervalued (Myer, 1969). We conduct a financial statement analysis of Sydney Airport and subsequent valuation for the last five years from the year 2010 to the year 2015. Also, we analyze the median analysts for the firm’s performance in the next two years 2016 and 2017. Sydney Airport is a major airport in Australia serving over 45 airlines with over 40% of international passengers passing through the airport each year. The firm’s shares were valued using four valuation methods as follows: i. Free Cash Flows and Discounted Cash Flow (DCF) Analysis ii. Residual Earnings Valuation iii. Abnormal Earnings Growth (AEG) Valuation iv. Implied Growth Rate Part A: Free Cash Flows and Discounted Cash Flow (DCF) Analysis for Sydney airport Required rate of return 10% 2009 2010 2011 2012 2013 2014 2015 Cash from operations 863.66 857.41 869.8 896.8 985.30 1005.2 Cash investments (88.97) 597.82 (234.1) (339.4) (296.4) (863.2) Free cash flow 774.69 1455.23 635.7 530.4 688.9 142 Discount rate 1.1 1.21 1.33 1.46 1.61 PV of free cash flows 852.16 1760.82 845.48 774.38 1109.13 Total present value to 2014 5341.97 Continuing value (CV)* 2840 Present value of CV(VE2009) 1763.98 Enterprise value 7105.95 Book value of net debt (4647.05) Value of equity (VE2009) 2485.9 Shares outstanding 1861.21 Value per share $1.32 Part B: Residual Earnings Valuation Residual earnings refer to the difference between the net earnings that analysts expect the company to earn and the expected return of the firm. It measures the earnings the company will generate for any given period that are over or below those expected by equity shareholders (return on capital employed).   YEAR   2010 2011 2012 2013 2014 2015 Comprehensive Income Available for common shareholders 51.60 (351.20) 121.70 (34.70) 48.90 296.10 Book Value of common Shareholders equity (at t-1)-Adjusted for outside equity 6,044.50 5,393.57 2,432.75 2,124.80 3,657.20 1,514.90 Required earnings 604.45 539.36 243.28 212.48 365.72 151.49 Residual earnings (552.85) (890.56) (121.58) (247.18) (316.82) 144.61 Present Value factors 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 Present value of residual income (502.59) (736.00) (91.34) (168.83) (196.72) 81.63 Sum of present value of residual income (1,613.85)                         Return for the year 51.75 (279.43) 158.10 47.10 57.20 281.10 Total Equity 5,393.57 2,432.75 2,124.80 3,657.20 1,514.90 1,315.00 Outside Equity 459.18 138.82 76.10 (0.60) (2.50) (4.40) Book Value of common Shareholders equity (at time t) 4,934.39 2,293.93 2,048.70 3,657.80 1,517.40 1,319.40 Return on Capital Employed (ROCE) 1.05% -12.18% 7.72% 1.29% 3.77% 21.31% The residual income model is similar to the P/B model. The present value of residual income is negative. This implies that the P/B based on fundamentals is less than one. Based on the above calculations, the shareholder's equity of Sydney Airport should be priced at a discount to their book value. In all the years except 2015, the Return on Capital Employed (R.O.C.E) is less than the return expected by the equity shareholders (cost of equity) of 10%. This implies an unsatisfactory use of capital since the projects in which such capital is invested are not generating the expected returns. As a result, common equity-holders do not get the expected return on their investments. This could be due to internal factors such as the management style and policies adopted by the company or external factors such as unfavourable operating environment. Part C: Abnormal Earnings Growth (AEG) Valuation Calculation of Dividend growth rate: where Dn is the DPS for year n and D1 is the DPS for year 1 Year DPS 2015 25.50 2014 23.50 2013 22.50 2012 21.00 2011 21.00 2010 21.00 The dividend growth rate is calculated based on the assumption of continuous compounding. The time horizon used as the basis for calculation of the growth rate was 5 years (from 2010 to 2015). The dividend growth rate calculated was assumed to be constant for the two years under forecast (2016 and 2017). Dividend Payout Ratio Rate of return 10.00%           DPS Growth Rate 3.96%                           2015 2016 2017       DPS 25.50 26.51 27.56       EPS 12.74 13.2 14.5       Dividend Payout Ratio (%) 200.16% 200.83% 190.07%                     Zero Earnings Growth               2017 2018 2019 2020 2021 2022 EPS (zero growth) 14.5 14.5 14.5 14.5 14.5 14.5 DPS(Assuming the 2017 DPR) 27.56 27.56 27.56 27.56 27.56 27.56 Book Value 145 145 145 145 145 145               Cum-dividend Earnings 39.30 39.30 39.30 39.30 39.30 39.30 Normal Earnings 15.95 15.95 15.95 15.95 15.95 15.95 Abnormal Earnings Growth (AEG) 23.35 23.35 23.35 23.35 23.35 23.35                             4% Growth in Earnings               2017 2018 2019 2020 2021 2022 EPS (4% growth) 14.5 15.08 15.6832 16.31053 16.96295 17.64147 DPS(Assuming the 2017 DPR) 27.56 28.66 29.81 31.00 32.24 33.53 Book Value 145 150.8 156.832 163.1053 169.6295 176.4147               Cum-dividend Earnings 39.30 40.88 42.51 44.21 45.98 47.82 Normal Earnings 15.95 16.588 17.25152 17.94158 18.65924 19.40561 Abnormal Earnings Growth (AEG) 23.35 24.29 25.26 26.27 27.32 28.41 The likely reason for the increase in the abnormal earnings is the growth in earnings by 4%. Also, the cum-dividend earnings increased due to increase in the return from re-investment of dividends. Part D: Implied Growth Rate Growth in Residual Earnings         Rate of return 10.00%     DPS Growth Rate 3.96%               2015 (Actual) 2016 2017 DPS 25.50 26.51 27.56 EPS 12.74 13.2 14.5 Forecasted P/E 49.84% 50.40% 46.00% MPS 6.35 6.65 6.67 Book Value per share 0.59     Solving for g: Analysts can use the graph to make buy/sell decisions. The area below the line (equation) is the sell region while above the line represents the buy region. Conclusion After the analysis of the financial statements of Sydney Airport conducted above, it was found that a look at the firm’s residual incomes shows that the firm’s shares are quoted at a premium to their book value. However, the correct position is that they should be quoted at a discount to their book values. This is because the firm exhibits a negative value of the sum of the present value of residual incomes (Woelfel, 1988). Also, the firm performed below shareholder’s expectations in the years 2010 to 2014. This is shown by a Return on Capital Employed (calculated after adjusting for abnormals) that is lower than the required cost of equity. This makes the stock fairly undesirable for new investors since they will fear that they may not get value for their money. The free cash flows valuation method shows that the company’s shares are over-valued by a great margin. From a current market price per share of 6.35, the calculated value per share is 1.32. Generally, all these valuation methods point at a company that is highly over-valued as opposed to its intrinsic/real value. Works cited Foster, G. (1986). Financial statement analysis. Englewood Cliffs, N.J., Prentice-Hall. Myer, J. N. (1969). Financial statement analysis. Englewood Cliffs, N.J., Prentice-Hall. Woelfel, C. J. (1988). Financial statement analysis. Chicago, Ill, Probus Pub. Co. Read More