HA1022: Principals of Financial Markets - Taxation Law - Assessment Answer

Financial markets Assignment

Assignment Task

The assignment comprises two related sections:

1. Conduct a Top Down analysis of the overall economic environment and consider how forecast changes in economic fundamentals will impact on the performances of companies in the industry your group has chosen. Consider questions including, but not limited to: What is the current interest rate? What is the current value of the $AUD? What is current GDP etc?
2. Conduct a Bottom Up analysis of companies’ current financial situation. Consider accounting ratios and measures of a firm’s performance, how these need to be compared to the industry and company history,

• All of the required information for calculation and often the actual ratio/number can be found on various websites on the internet.
• https://www.investsmart.com.au/

Note: When your group is performing the fundamental analysis take a less is more approach. Select a few key performance measures then define each measure; explain what the measure is supposed to show and then what it is showing for the industry/your companies.

Refer to both your textbook and information available on the internet. This assignment involves research to finding the information and then analysing this resulting information.

When writing the report, imagine that your audience are people that know nothing about finance or the financial markets. At each stage you will need to carefully explain what do are analysing and why. Do not think that just because your lecturer will know what this ratio means that you do not have to define it.

You should also give a brief introduction of the industry and the history, mission statement of your chosen companies. Your paper should conclude with a summary of your findings and recommendations for each of your companies.

Introduction

Australia is a small economy currently disturbed by financial market dislocations, stunted growth, slow development of related economies and growing uncertainty on the future course of action. The economic outlook of Australia reflects that the GDP growth for the second quarter grew by 0.5% quarter on quarter which is less than the achievement in the first quarter of this year. ("Australian Economy Snapshot , 2016")

The negative drag can be attributed to lower household consumption and a negative contribution from the external environment too. However the Australian economy has concluded 25 years of growth without accounting for recession in this period. The expectation for the next half of the year shows mild improvement and lowering unemployment rates with a new level of 5.6%. The direct influence can be seen in the growing business confidence. The aviation sector of the economy is characterized by intense competition as the major chunk of customers is from airline sector. Australia being an island gets the location advantage in order to earn more from the aviation sector. Almost more than 90% of the tourist comes from the air route to the country. The country has flourished itself as a tourist attraction and also an educational hub with foreign customers coming to the campus from their homeland. Qantas and Virgin are two airline firms that operate in the Australia and are fierce competition for each other. A fundamental analysis of both the firms puts forth the strengths of the firm in terms of their operations, management capabilities and capital flows. This analysis guides the share prices of the firm for an investor. Past results and performance of the current year gives the investor an idea of the firm’s future course of action and profitability. Since this profitability and expectations of the shareholders get reflected in the market sentiments and share price of the firm, it is utmost important for investors to completely evaluate the firm, economic situation of the economy and the performance of the rival competing firm in order to understand the company functioning better.

A shareholder is always keen in earning profit by investing in a company. The selection of this firm is done with extreme caution to prevent room for any errors. An investor intends to earn profit and capital appreciation by investing in a stock. The fundamentals of the firm provide avenues for the shareholder to understand the company – its mission, vision, aim, structure, modus operandi and performance. This leads to an estimation of the company’s performance for a short time frame. This judgment helps the investor to invest their hard earned money with complete knowledge. However this complete information also leads to enhanced responsibility for the firm to perform and prove the investors sentiments to be trustworthy for them.

The following sections of the report evaluate the general economic environment of the Australian economy and its interpretation to the aviation industry. The bottom up approach which includes the analysis of key financial ratios helps in making effective choice amongst the top performers of aviation industry.

Top down Analysis

Economic environment of Australia:

1. GDP Growth: The GDP growth as expected from 2016 is 2.7%. However the growth could have boosted if the economy did not suffer from the decline in the resource investment cycle. The key driver sectors remain the services and employment. (Australian Economy Snapshot)
2. Services: With the weakening dollar the economy strives to growth by the contribution of services sector. Services contribute to almost 53% of GDP growth in 2015 by having a 36% of total business investment of the economy. The major potential sectors are tourism and educations which if gain from favorable exchange rate are bound to play a key role in enhancing services. (Mckenna, 2016)
3. Unemployment: The year 2015 added 126,000 new jobs. The year 2016 is expected to witness job losses in sectors of construction and resources. However the impact of the same shall depend on the fastness of decline of construction cycle. The unemployment rate stands at 5.7% in the second quarter of 2016. (Mckenna, 2016)
4. House prices: house price growth is expected to slow down in 2016. Modest price declines, clampdowns on lending, high dwelling prices are few of the risk clouding the sector.
5. Construction: the level of construction has peaked across the economy. The only uncertainty lies in the decline of this level. Though the government approved to a lot of projects, the sector could not contribute more than 0.9%. a lot of work in progress is there in the economy. Timely completion of the same is bound to impact the housing sector adversely as house prices shall fall with over supply. (Mckenna, 2016)
6. Consumption: a strong growth in services sector along with a rise in employment levels shall provide the consumer with disposable incomes to spend. However the average wage of the economy is not expected to be lively and the wage growth is expected to be around 3-4%.
7. Inflation: inflation rate of 2.7% is expected in the fiscal year 2016. Weak wage growth along with low demand is expected to keep the inflation rate at a control. Imported food prices shall witness a growth from 26% over the past years. (Mckenna, 2016)
8. Australian dollar: the Banks of Australia are assuming the Aussie dollar to drop to US$0.65. The Australian dollar has been a contributing factor in facilitating the growth and development of the economy with a strong emphasis on export sectors. The leading banks of Australia predict that this weakness shall not be there only for the US dollar but would be across all the trade partners of the economy. The only negative aspect here is the volatility arising from the Chinese economy. (Mckenna, 2016)
9. Government: The government will have to impose strict decisions on the economy. The budget deficit of $40billion would propagate the government to impose higher tax rates in existing tax structure or introduce new taxes in order to cover the deficit. The companies in such a scenario would move off shore to reduce the tax liability. (Mckenna, 2016)
10. Interest rates: interest rates are not expected to increase this fiscal year. The stable unemployment rates with strong business confidence are seen to be factors for only slight adjustment to interest rates. However in the event of any global trend spurring any form of risk shall force the government to lower the interest rates again. Major risk here is the lowering US interest rates. A fall in US interest rate shall push high the Aussie dollar prompting a response from the government to adjust the interest rates considerably.

Aviation industry of Australia

The aviation industry of the country has grown to a considerable size due to the location advantage of an island. Being a thriving economy the country employs two forms of airlines: defunct airlines and planned airlines. As Australia is an island the major traffic of the tourism industry takes the air route to visit the country. Since more than 90% of the visitors follow the air route to Australia, government has actively structured the industry in order to make it more efficient. The direct contribution of aviation and tourism industry on the GDP was 2.7% in 2014 and 3.9% in 2015 with investment of total 4.7% in 2014 and 5% by 2015. (Turner, 2015)

The two companies selected from the aviation sector are Qantas and Virgin Australia Holding Limited. The economic condition of Australia presently is going to boost the transportation sector tremendously as clientele based on tourism and business both would like to explore Australia. In the light of the present economic situation the economy provides for great environment to work and thrive.

Bottom up Analysis

Qantas (Queensland And Northern Territory Aerial Services Limited), registered and headquartered at Queensland in 1920, is one of the largest domestic and international airline. Branded as a strongest firm in airline sector the firm is the world’s long distance airline carrier. Qantas has built this reputation due to its commitment in safety, operational dependability, engineering and maintenance and client service. Using two complementary brands, Qantas and Jetstar the firm is a pioneer in transportation of customers. ("Our Company | Qantas", 2016)

Virgin Australia Airlines Private Limited was known as Virgin Blue Airlines and is the second largest airline after Qantas. Based in Bowen Hills, Brisbane the airline is a part of Virgin group. The specialization with which it serves its customers is low cost and “no frills”. ("Virgin Australia History | Virgin Australia", 2016)

Fundamental analysis of the firms

A look on the financial ratios for both the companies reveals the following:

• Current ratio is a liquidity ratio that is a indicator of the firm’s ability to pay off its short term liabilities. The ideal ratio of the industry is 1. If the current ratio stands below 1, it implies that the firm is not liquid enough to pay off its short term liabilities. The current ratio of Qantas for the year 2015 is 0.68 and for Virgin Australia Airlines is 0.62. Both the firms are not efficient enough to fully pay its short term obligations.
• Net margin ratio is a ratio that compares the net profitability of the firm after deducting all expenses. The net margin ratio of Qantas stood at 3.59% as against -2.35% of Virgin Australia Airlines. This indicates that Qantas has been able to prove itself by its profitability whereas Virgin group has recorded a net loss.
• Return on assets is a profitability ratio that indicates the profitability of a company in contrast to its total assets. This ratio gives a complete picture about the company’s efficiency to use its assets for generating incomes. Qantas recorded a ratio of 3.20 in 2015 as against -2.12 of Virgin group. This implies that Qantas is more profitable than Virgin. The management composition of Qantas uses its assets in efficient manner to earn profits effectively.
• Return on equity is a profitability measure that compares the efficiency with which the management is employing the shareholders fund to generate the net profits. Qantas recorded a ROE of 17.67 as compared to -10.43 of Virgin group. This implies that the shareholders fund is not being used efficiently by the Virgin group to be profitable.
• Interest coverage ratio is a debt related ratio that is used to measure a firms ability to pay its interest expenses on the debt. Qantas has recorded a ratio of 3.26 as compared to -0.23 by the Virgin group. This implies that the Virgin group needs to work on it overall profitability in order to be efficient.
• Asset turnover refers to the ratio that measures the firm’s efficiency of a firm’s utilization of its assets to generate sales revenue. Companies with low profit margin shall have a high asset turnover while the firm with high profit margin would have low asset turnover. Asset turnover ratio for Qantas was 0.89 for 2015. Virgin Australia Airlines recorded an asset turnover of 0.90.
• Inventory turnover ratio is a turnover that measures the number of times inventory is sold in a given period of time. Higher the ratio means higher I the activity of the firm resulting in greater profits. Qantas recorded a inventory turnover of 22.36 in 2015 in contrast to 30.87 of virgin group. This implies that the net profit of Virgin group may be less in contrast to Qantas but the activity recorded in terms of number of transactions is more of Virgin. Due to its low cost efficiency the Virgin group has been able to capture its market share.

Findings and Recommendations

Both the firms have been serving the airline industry with passion and dedication. Qantas has been recording net loss for the past years. 2015 saw a turnaround in the management and the firm started earning profits. The interpretation of ratios of both the firms shows that both the firm holds the promise of a bright future. However Qantas shows a better promise of future and with the coming years the firm is bound to excel in its operations. Virgin Australia Airlines is not profitable in the present but its concept of low cost specialization is bound to earn a great market share in the near future. The only way by which the firm can earn profits shall be by obtaining the benefits of division of labour in the coming years.

Qantas should focus on its quality and cost efficiency in order to earn more profits. At the same time Virgin Australia Airlines can leverage its differentiation to earn more customers and a large market share. Currently it would be wise to choose

Conclusion

Qantas for investment in their shares as they have performed positively and their efforts of revamping themselves is bearing positive results. In such a scenario the investor is bound to earn profits and enjoy capital appreciation.