Draft ACCT13017 ASS#2 Steps 3-5

Please find the following links to my draft work and complete the feedback sheet:

Click here for a copy of my draft for ACCT13017 Assignment 2 Steps 3-5

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Click here for FEEDBACK SHEET

Feedback Sheets for ASS#2 Steps 3-5

PEER FEEDBACK SHEET: ASS#2 

Feedback From:             Sharon Field                                    

Feedback To:                 Iris Onvlee

	My Comments
Step 3	I researched the industry norms (this is the linkhttps://csimarket.com/Industry/industry_Efficiency.php?ind=1301)  for retail apparel and found the norm ATO ratio is between 1.71 – 2.19 but you have used percentages. It’s my understanding that ratios differ from industry to industry. According to the ratios in your spreadsheet, the ATO shows an inefficiency to generate sales. I agree the liquidity ratios look strong and above industry norm. Although debt ratios have significantly dropped, they are still within industry norms. I would expect the PPE ratio to be way off since no dividend paid and that’s all investors are entitled too. The ROE and ROOA is up and down almost like a response mechanism to the downturn with an increase following. The NBC is concerning with a negative result. The recent PM seems to be way above industry norm, I can’t help but think if this attempt to regain profit will be damaging in the future by putting off customers. It seems growth in all areas in the industry is crawling, as well as FCF which is not unusual to have negative results. You have made a thorough analysis, but I feel the future might be overly optimistic.
Ratios - commentary
Accounting drivers - commentary
Step 4 Economic & business drivers	I agree with your assessment of economic drivers. Brands are very important with fashion, I choose brand over price with many purchases. Logistics are also very important, especially with fashion when time is of the essence. It’s my opinion that the US trade war with China may eventually fizzle out, price is still important and if they can secure brands, they might be okay. You have a firm grasp on understanding your company and relate well to Martin’s examples. I love your sense of humour with row, row, your boat, it’s so fitting to your company’s future.
Step 5 Forecasting & valuation	Such a clever way to explain the company background and relate to GDP. It explains the peaks and troughs of the country and the industry too. I think you justify the change in WACC convincingly and I agree, there are some great risks involved. Therefore, I would not be convinced as an investor to invest.
Overall ASS#2 (Steps 3-5)	What a journey this has been for you. I love your never give up attitude. Your learnings have been bolstered by your approach to discussion and openness to comment. Your willingness to have a go without fear of ‘getting it wrong’ is commendable, inspiring too. You have produced a well thought out assessment. I wish you all the very best for the future.

PEER FEEDBACK SHEET: ASS#2

Feedback From:             Sharon Field                                    

Feedback To:                   Shalika King                .

	My Comments
Step 3	PM seems to be much higher than industry norms according to this link. I think that may indicate their product is high end/luxury. Debt/equity ratio is spot on in terms of industry and according to investopedia is a key indicator to investors and lenders. The current ratio sits higher than industry norms indicating a possible inefficiency in asset management, although difficult to assess in the automotive industry because it also might reflect a recent employment of capital for R&D. I agree their asset turnover reflects steady sales, inline with norms. The slight decline might be due to the slight decrease in general demand by customers across the industry. ROE is well below norm and concerning for investors, however, debt management is cost-effective and shows signs of improvement. I agree the most critical accounting drivers involve asset management as opposed to capital employment.
Ratios - commentary
Accounting drivers - commentary
Step 4 Economic & business drivers	Competition is fierce in the luxury car industry, are there new comers to the industry? Does Audi’s R&D give them an edge over competitors? What else might consumers be looking for in a luxury car? Would Audi consider catering to the mid-class or economy car markets?
Step 5 Forecasting & valuation	Investopedia suggests the automotive industry is a key indicator of economic health and consumer demand. It might be worth looking at GDP in Germany and China. I am concerned that the 8%WACC may be too low for your company as high amounts of capital is needed for R&D which may be slow to show returns. In my opinion, the cost of capital might be higher over the forecasted years long before any ROI. The estimated growth rate might be slightly inflated also, given the creeping growth and previous years decreases in revenue for the industry. You may want to consider apportioning with a decimal figure for accuracy.
Overall ASS#2 (Steps 3-5)	Your approach and layout of the assessment is logical and thorough. The amount of research and connections with learning outcomes are obvious. I have enjoyed your interactions and with others and this reflects well in your learnings also. This has been a significant assessment to tackle and you have risen to the challenge. It has been a pleasure to work with you. I wish you all the very best for all your future endeavours.

ACCT13017 Financial Statement Analysis                                       ASS#2

PEER FEEDBACK SHEET: ASS#2

Feedback From:   Sharon Field                                        

Feedback To:      Sarah Goodchild

 

	My Comments
Step 3 Ratios - commentary Accounting drivers - commentary	Compared to industry norms, PM seems low although it has been decreasing steadily across the board. Investopedia suggests seasonality to be a factor as well as fluctuating energy prices and economic downturn. The debt/equity ratio seems extraordinary compared to China Southern Air but not unrealistic considering the industry, high assets costs, unrealised revenue and the illusion of capital debt can distort figures as well as tax credits. However, this is very concerning given the leverage ratios compared to CSA are heavily reliant on equity and assets means a continued long-term negative ROE. ATO is well on track with industry norms and could mean their saving grace.
Step 4 Economic & business drivers	Would the effect of rising inflation affect passenger numbers if airfares stay the same? I agree creating more destinations would attract sales. Does this affect their operating expenses as runway taxi fees, hub and airport fees, tariffs, hanger and exchange rates would increase?
Step 5 Forecasting & valuation	Trends say profits are normalising but WACC will still be higher than other industries, which might be a factor in forecasting calculations. The airline industry is one of the most unpredictable industries. However, there is little doubt of the future need for airlines long into the future, which guarantees demand.
Overall ASS#2 (Steps 3-5)	You have presented a well thought out and thorough analysis. I am not convinced to invest in an airline as yet. I am compelled to think the existing investors of Air France may see the realisation of their ROI in the near future and won’t be disappointed. It has been a pleasure to interact with you and listen to your insights during class sessions. I wish you all the very best for a bright and fruitful future.

KCQ's Chapters 7 & 8

KCQ’s Chapter 7 - How to Predict the Future to Eternity

The basic principle of learning for me, fundamentally changed when I first decided to begin this tertiary academic journey. The idea that there was an alternative, more proficient way of learning than simply regurgitating what we are told and repetitively pounding that knowledge into our subconscious, was enlightening. Merely finding a personal connection, something we have already experienced and latching that new knowledge into where deep-seated erudition takes place, is a profound concept. Value is a very personal thing and it makes sense that we need to apply our own values to understand what is happening in our companies now and into the future. We use our subjective views to take risks every day, based on intelligent, educated and informative assessment and we can use the same techniques in our approach for our company’s forecast.

Putting the Guesswork into Eternity

I can see how studying Business Finance would have been a great advantage before tackling Financial Statement Analysis. Not only the familiarity with the current methods of analysing stocks and shares but also the theory behind the analysis. None the less, I can understand the concept of useful assumptions, since economic theory is based on the rational consumer, so it is not a stretch to understand finance theory assuming homogeneous expectation. My aspirations include becoming an investor…soon! I can be content earning a safe 9 to 5, provide my family with all the necessities and the occasional indulgence, however, I’m thinking my education, experience and ambition would give me an edge to achieve so much more. I don’t want to get caught up in the bull and bear of it all, but it would be nice to have financial windfall. In a nutshell, I want to be better than average and I’m starting to believe I can be. Using accumulated knowledge and experience to support a formidable margin of safety, I can also skew fortune to my favour!

Continuing Values

V_O^E = BV of Equity_O + Abnormal OI₁ + Abnormal OI₂ +…+ Abnormal OI_t + .   CV_t

                                            WACC                 WACC²                     WACC^t         WACC^t

This is a concept where I lack the confidence in my ability to make accurate guessimates in order to be convincing. How can I be sure that I’m making the right connections? What if I miss an important factor out? What do I know about real economic and business drivers? Well, the only way to get good at something, is to do a lot of it and this is my first go. I figure even if I get it wrong, it will still be a valuable learning experience. I have been gaining confidence in my discussions with others. Long discussions with my fellow college Chen from China gave so many valuable insights, online discussions with Iris, Hannah, Daniel and Kaidesha all exploring mutual ideas and making more sensible, intelligent associations with our company’s business and economic realities. All this increases my confidence to strengthen a convincing assessment. Speculations of economic drivers have translated as transactions in response to past, current and future issues which could be reflected in the accounting drivers.

CV_t = Economic profit_t+1 + OI_t+1 (g/RINOA)(RINOA-WACC)

                    WACC                            (WACC – g)

It follows logic that if we can predict the expected rate of return on new net operating assets and growth in operating income, we can predict the future value of the company. Taking all the factors involved into account can be time consuming. We have already used 11 weeks trying to gather and interpret a mere part of what would be considered an in-depth analysis. Time is money, but money can’t buy time. Somehow, we need to weed through the abundance of information and focus on those aspects which are clearly relevant. We can narrow down the extremes and analyse likelihood of scenarios and involve other people’s analysis for comparison and validation. Using these sensitivities to form intelligent judgements and assumptions.

Risk

Risk is something we face each morning. I’m often asked why I smile so much in the morning, it’s because I survived the night and happy to be alive! Some companies are lucky, some increase their luck with intelligent, informed analysis and good judgment. I err on the safe side but, I increase my confidence little by little and take risks that more often than not pay off. I have learnt you can stay in the safe zone but, then you really don’t go anywhere, you stagnate and that to me is not living efficiently. If I was running a company, I’d want to grow to full potential and beyond and that means taking risks. The same when I become an investor, I want my investment to reach full potential and more. I realise that studying business finance will give me a more positive balance of probabilities and I look forward to gaining that knowledge. For now, I can digest the nondiversifiable risk or the systematic risk of a firm from investor information to roughly calculate my company’s beta. This takes other people’s opinions into account. However, we make our own analysis, never rely on other people’s judgements.

Margin of Safety

‘A rational intelligent response to the reality of risk’. This makes the most sense to me. I have a statistical mind and can visualise the central tendency and dispersion graphically in a graph. This really helps form a clearer picture of all these calculations for the future. So, I can understand that the safety margin is the spread between our best estimate of the value of the company and the market value and the wider the spread, means the better response to business risk. I already have so many scenarios relating to my company’s business and economic realities and the possibilities for the future. I just worry about piecing them all together to make a useful, convincing analysis. I also worry that my personal bias and the perceived bias of other investors concerning the airline industry will somehow distort a rational analysis. There are so many things that need to be carefully considered.

KCQ’s Chapter 8 - Going Forward

‘I write the songs’ sung by Barry Manilow was not actually written by him or for him, it was written by Bruce Johnston for David Cassidy. The point is, although it sounds good, the contents and intentions are not what they seem. I find this is similar with financial statements and annual reports. I am learning that accounting isn’t so much about the numbers but, as much about the stories they tell that matter most. The average person would find bookkeeping and financial statements quite boring but, the stories they can tell are quite fascinating.

Two Frameworks

The DCF and Economic profit frameworks have shown me the strength of a firm’s ability to respond to past, current and future economic and business events. It’s my understanding that they are useful tools in determining the business performance now and into the future, which entices the equity investor to invest. It’s all about the value add. How does investing in this particular firm add value not only to my investment, but to my soul as well? It is possible to get more than expected returns on an investment, more than just dividends, for an extended period of time. We can express the material value in the economic profit model:

V_E = BV₀ + PV of AE

If the firm does not materially add value from their financial activities, it can be restated as:

V_E = BV₀ + PV of Abnormal OI

Therefore, the two models can show the expected future dividends and expected future cash flows using the book value, present value and economic profit. This changes our thinking about value, involving the cost of capital and utilizing assets to generate return on investment. It is that bit extra that we are most interested in, the returns above and beyond the expected, there in lies the real value add. We need to be able to assess this in a timely fashion. Much like my decision to pursue a tertiary qualification, I had to weigh up factors of time and earning. Would it be worthwhile gaining the skills to earn the money and how much time do I have before the pay off before I die? I will always pick yes, because the education adds more value to me than just the financial reward and there is the possibility of earning much greater rewards above and beyond my initial endowment. This journey reaches beyond financial rewards and into my soul and the soul all that care about me, the stakeholders in my life. That is the added value of my decision to study.

Price Multiples

“Price is what you pay, value is what you get”. I like this analogy; the logic resonates with me. I don’t like to part with money lightly and when I perceive the value expected, it is comforting, but it’s when I receive value above my expectations, such as the extra fries in the bottom of a McDonalds paper bag, that I experience real joy. That is of course the instant gratification, over time you realise others receiving the extra fries and the joy wanes, you compare the fries with the chips from the chip shop and suddenly it does not seem valuable anymore. Value can be smoke and mirrors. We need to rely less on other people’s opinions of value to experience the joy. Basing decisions on grounded theory and  incorporating our own judgements and assumptions will clear the smoke and reflect a truer image. We could give up; crystal ball theory has no real answers about the future. Though, I am not a quitter and I want to make informed, intelligent decisions for the future now. Each step into the future doesn’t have to be so random, we know where we now and where we want to be in the future.

V_E = BV₀ + PV of Abnormal OI

     = BV₀ + Abnormal OI₀

                      (WACC -1)

Allowing for drift:

V_E = BV₀ + PV of Abnormal OI

     = BV₀ + Abnormal OI₀

                  (WACC -1) – g

The crystal ball theory can become even more clearer with real engagement of our company’s business and economic realities. We will never be spot on perfect, but we can be in the range of useful expectation. The real connection of facing our fears, intelligently with courage and conviction and take the leap of faith.

Forecasting

We know that company’s do not last for eternity. The likelihood of air travel being replaced with superior technology is still a long way off…or so we expect. The likelihood of new entries of competition is more likely, rising fuel prices are inevitable and the increasing population means more passengers are likely to be buying airfares. There are limitations to  forecasting but, we can apply degrees of probability and include them in our calculations. The beta β of a firm is the expected erosion of abnormal earnings over time, because nothing lasts forever.

V_E = BV₀ + β Abnormal OI₀

                     (WACC – β)

Things are beginning to fall in place. Why do we need to restate the financial statements? To save time and redirect our focus on the business realities. Why do we need to know the accounting drivers of a firm’s performance? Because this is where the firm is currently deriving value and the ability derive value in the future. Why do we need to link the accounting drivers with the actual economic and business drivers?  Because this is the firm’s real value. This is where the prospect of a firm’s future value is revealed.  The real value is in the forecasting. The real value lies in our ability to convert forecasts into a practical assessment with an acceptable margin of safety.

It is Now Up to You

I know this is just the beginning, but I am excited to use these skills to practice into the future and possibly ‘get really good at it’! I am concerned that being my first time, I won’t get it right. I am concerned that my forecasts will be way off to be considered useful. But I will never give up. I want to grow and develop, and I want my children to have those skills too. There are so many more dreams and possibilities that are closer to be a reality. This has been an incredible journey. I feel more equipped than ever to handle the future. My mind is open, and the future is a blank canvas but, I have the paint and equipment to paint a beautiful, stimulating picture and share it with the world.

∞

Reflections on Ratios for China Southern Airlines

Sales:

The first thing I looked at with China Southern Air (CSA) was what is happening with sales. Sales have been steadily increasing over the past 4 years. To me, this means that customer numbers are growing, more airfares, more cargo and freight are being sold…and are expected to be increasing. So, it makes me curious if sales are increasing, why is net profit decreasing? Net profit after tax was steadily increasing from 2015 to 2017, then there was a dramatic dip in profits in 2018, from $6,898 mill RMBs to $3,364 mill RMBs. What happened to cause this drop? What else affects profits besides sales? My immediate assumption was an increase in expenses, but what expenses and why?

Profit Margin:

I didn’t really understand what profit margin meant or what a good measure is supposed to be. So, I did a quick Google search and found that it tells you how well a firm uses its income. In a nutshell, profit margin shows how much profit is generated per each dollar of sales. A high profit margin is considered to 20%, or 20cents of profit is made from each dollar of sales, 10% is about average or ‘good’ and 5% is low. CSA has a terrible profit margin over the past 4 years but, currently it is the worst. In 2015 at a rate of 4.3%, CSA slowly increased its margin in 2016 at 5.1% and 5.4% in 2017. However, something triggered a dramatic drop in 2018 to create a profit margin of just 2.3%. Yes, last year they were only making 2.3cents of profit to each dollar of sales. Why??? Again, I began thinking about the cost of operations, expensive new planes, increasing fuel prices and load factors from passengers and cargo. Looking at the financial statements revealed so many factors that potentially could be influential.

NOA and ATO:

I then chose to see what’s happening with assets. CSA has progressively increased NOA over the past 4 years. The most recent increase occurred recently from $168,478 mill in 2017 to $192,005 mill 2018. The total asset turnover ratio is high, holding steady at 0.6 over the past 4 years. Their current asset turnover is even higher, from 8 in 2015 and 2016, slowly declining from 7 in 2017 to 6 in 2018. ATO has ratios from 77% - 80%, I interpret this to mean the company is good at generating sales from its assets, or in other words, use their assets very efficiently. But what does that mean in terms of profitability?

RNOA:

The return on net operating assets (RNOA) reveals very low percentages, which doesn’t look good for efficiency. Rising from 4.3% 2015 to 4.9% 2016 to 5.3% 2017 and then another dramatic drop in 2018 to just 3.1%.  I will need to compare other ratios in the airline industry to see if this is normal or not. If anyone reading this has an airline, please leave your comparisons in the comments or feel free to contact me via email. There is no doubt in my mind that assets are a major factor of the economic and business drivers for CSA, but I also know that there is more to the story.