Executive Summary
The report discusses various aspects relating to Air New Zealand Limited and The Warehouse Group where the objective is to issue a recommendation to the investors as which stock might offer better return to them. The report begins with a succinct discussion about both the companies which is then followed by assessment of their financial trend using their latest issued annual report and past three year stock price movement.
The next section deals solely with the financial aspects where we unearthed the capital structure of the companies, required rate of return, calculated their free cash flows and ascertained their intrinsic value using the Gordon growth model under the assumption of 10% dividend growth rate.
After a set of careful calculations, we found that while the outcome of Gordon growth model indicated relative undervaluation for both the stocks, other financial metrics such as stock price analysis, trend in the financial figures and free cash flows guided us to recommend Air New Zealand to the invetsors.
About the company
i)Warehouse Group
Founded in the year 1982, Warehouse Group is the largest retailer group in New Zealand. Officially styled as TW group, the group is engaged in the retailing of general merchandise, apparel, stationery, consumer electronics and home appliances. The company operates through multiple subsidiaries, The Warehouse, Warehouse Stationery, Noel Leeming, Warehouse Group Financial Services and Torepedo7 group.
ii) Air New Zealand Limited
Air New Zealand Limited is the national airline and flag carrier of New Zealand. Founded in the year 1940 as Tasman Empire Airways Limited, the company provides passenger and cargo services to Europe, Asia, United Kingdom and North America. The airline has been the member of Star Alliance since 1999.
Historical Performance of each company’s different securities related to events/information specific to the company and market
Before beginning with the intrinsic valuation of both the companies, we will be introducing the discussion on the relative financial performance of these entities and also about their stock performance. This discussion will design a crucial base for us to foresee the future trajectory of the company, i.e. through analysis of the revenue figures and profit numbers, we can decide as what could be the possible future trend in the company. Therefore, through meticulous analysis of the trend in each companies, we can take a prudent decision as which company can be possibly a good investment target for us.
-Financial Performance: Air New Zealand Limited
As for Air New Zealand Limited, over the past three years, the revenue figures of the company has been surging consistently, while the profit figures has increased by an impressive 433% in three years from AUD 56 million to AUD 243 Million. The trend is very optimistic for the investors as higher will be the earnings, more will be the dividend payout. In addition, the company has also registered a strong improvement in the operating cash flows that went up from AUD 372 million in 2012 to AUD 678 million in 2014. Important to note, having a strong cash position is more important as under the absence of sufficient leverage in hand, an entity may withdraw its dividend payments. Over the past three years, the dividend payment has surged by 25% from AUD 0.03 per share to AUD 0.04 per share.
-Stock Performance: Air New Zealand Limited
The stock performance of the company is in alignment with its financial performance, as over the period of three years, the stock price has rose impressively from AUD 0.75 in Jan, 2012 to AUD 2.40 by December, 2014.
-Financial Performance: The Warehouse Group
In contrast, The Warehouse Group witnessed a bearish financial run during 2014 as despite of sustainable surge in the revenue figures, the net income of the company plummeted from NZD 145 Million to NZD 78 Million. As a result, the dividend payment also witnessed a declining trend from NZD 0.22 to NZD 0.19 per share. The investors might also be concerned with the declining trend in the operating cash flow figures that decreased by 18.08% during 2014.
-Stock Performance: The Warehouse Group
Referring to the graph below, we can witness that while the stock indicated an impressive performance during 2012-2013, it lost its shine during 2014 and courtesy poor financial results, the stock was back on the bearish path
Capital investment portfolio and their financing.
-Air New Zealand
During 2014, Air New Zealand Limited acquired a further ownership in Virgin Australia and increasing their stake to 25.99%. While the alliance will enhance the network proposition of the company, it also provided the company with significant influence over the operations of Virgin Australia. Air New Zealand has also invested additionally on its network realignment with exits of Hong Kong- London- Auckland and Osaka. This investment is likely to increase the airline carrier capacity by 6 percent during 2015.
During 2014, the company also declared an additional investment of $2.2 Billion in aircraft for the next four years. The expenditure includes payment on aircrafts with an assumption of exchange rate between USD-NZD at 0.85. However, the investment of $2.2 Billion does not include maintenance expenditure of $59 Million and other related non-aircraft capital commitments. Moreover, additional investment on fleet modernization and fleet simplification will assist the company in achieving the cost economies.
-The Warehouse Group
During 2014, The Warehouse Group made a total capital expenditure of NZD 94 Million, majority of which was attributed to The Warehouse and Noel Leeming with the respective investment of NZD 56 Million and NZD 11 Million. Of the total capital expenditure, an amount of 44 million will be spent on setting up of new stores and also refurbishment of existing stores
However, the investment of NZD 94 Million was 2.08% less than the expenditure made in 2013.
Beta and the required return
Beta of Warehouse = 1.20
Beta of Air New Zealand = 0.99
Return on market = 10.75%
Risk Free Rate = 3.18%
Rs=Rrf+(Rm-Rrf)β
=0.0318+ 0.1075-0.0318×1.20
= 12.26%
Rs=Rrf+Rm-Rrfβ
=0.0318+0.1075-0.0318 ×0.99
= 10.67%
As we can see from the above calculation, Warehouse Group has higher expected return as it has higher beta value of 1.20 compared to Air New Zealand Limited with the beta value of 0.99.
Valuation of each company’s shares
In order to ascertain intrinsic value of the stocks, we will be using the Gordon Growth Model where we assume that dividend will grow constant throughout at an average rate of 10%
i)Valuation of Air New Zealand Limited
Value of stock= D(1+growth rate)/(Cost of Equity- Growth Rate)
= 0.04(1.10)/(0.1067-0.10)
= 0.0440/0.0067
= $6.56
ii) Valuation of Warehouse Group
Value of stock= D(1+growth rate)/(Cost of Equity- Growth Rate)
= 0.19(1.10)/(.1220-.10)
= $9.50
Free Cash Flow Calculation
Free Cash Flows: CFO+ Interest(1-tax rate)- Capital Expenditure
i) Warehouse (Amount in ‘000s):
FCF for the year 2014:
= 7,254 + 51,349 + 13878(1-.28)
= $68595.61
FCF for the year 2013:
= 145,328 + 44,225 + 11675(1-.28)
= $197959
ii) Air New Zealand ($M):
FCF for the year 2014:
= 262 + 436 + 90(1-.28)
= $762.05
FCF for the year 2013:
= 181 + 411 + 91(1-.28)
= $657.70
Capital Structure of the company
i) Air New Zealand( Amount in million)
Debt = Short term borrowings+ long-term borrowings
= 190 + 1,543 = 1,733
Equity = 1872
Wd=DebtDebt+Equity
= 1,7331,733+1872
= 48.07%
Therefore, We = 100- 48.07%= 51.93%
ii) Warehouse Group( Amount in ‘000s):
Debt: Short term borrowing+ long-term borrowings
= 104,896 + 142,740 = $247,636
Equity: 523916
Wd= DebtDebt+Equity
=247,636247,636+523916
= 0.3210 Or 32.10%
Therefore, We = 100- 32.10%= 67.90%
Weighted Average Cost of Capital (WACC) Calculation
i) Air New Zealand Limited
Cost of Debt:
Rd=Interest expense D
=901,733
= 5.2%
Wd = 48.07%
We = 51.93%
WACC=Wd ×Rd 1-T+We ×Re=0.4807 ×0.0521-0.28+0.5193 ×0.1067
= 7.34%
ii) The Warehouse Group
Rd= Interest ExpenseD
=14,181247,636
= 0.057 Or 5.7%
Wd = 32.107%
We = 67.90%
WACC=Wd ×Rd 1-T+We ×Re=0.3210 ×0.057 1-0.28+0.6790 ×0.1220
= 9.60%
Valuation of each firm (using EBIT, tax rate and rs, or any other method)
i)Valuation of Air New Zealand Limited
EBIT= $403,000,000
Tax Rate= 28%
WACC= 7.34%
VL of Air NZ= 403,000,000 (1-028)0.0734
= $3953133514
ii) Valuation of Warehouse Group
EBIT= $118627000
Tax Rate= 28%
WACC= 9.60%
VL of Warehouse= 118,627,000 (1-0.28)0.0960
= $889702500
Recommendation: Invest in Air New Zealand
On the basis of above calculations where we ascertained various financial multiples for both the companies, we hereby recommend our investors to invest in Air New Zealand. Important to note, although both the stocks have indicated undervaluation according to Gordon Growth Model, however, considering other aspects, Air New Zealand has indicated optimistic financial trends and also a lucrative stock price movement over the period of past three years. In addition, the capital investment trajectory of the company and access to low cost of capital provides us a reasonable assurance that the stock will continue to run on its bullish path.
References
Air New Zealand Limited. (2014). Annual Report 2014. Air New Zealand Limited.
Air New Zealand Limited. (2015, June 27). Retrieved from Reuters: http://www.reuters.com/finance/stocks/overview?symbol=AIR.NZ
Annual Financial Results. (n.d.). Retrieved from http://www.airnewzealand.co.nz/assets/PDFs/2014-annual-analyst-presentation.pdf
Frijns, B. (n.d.). Long Run Performance of the New Zealand Stock.
Profile : Air New Zealand Ltd. (2015, June 27). Retrieved from Yahoo Finance: https://nz.finance.yahoo.com/q/pr?s=AIR.NZ
Profile: Warehouse Group Limited. (n.d.). Retrieved June 27, 2015
Risk Free Rate. (2015, June 27). Retrieved from Treasury of New Zealand: http://www.treasury.govt.nz/publications/guidance/reporting/accounting/discountrates
The Warehouse Group. (2015, June 27). Retrieved from Reuters: http://www.reuters.com/finance/stocks/overview?symbol=WHS.NZ
