Business Analysis and Valuation: Using Financial Statements – Asia Pacific Edition, 3e
Solutions: Part 4 Further case studies Case 1 Qantas Student responses will vary. Accordingly, certain answers provide guiding principles and/or a sample of potential responses. Solution. PART A 1. Analyse the competitive forces facing Qantas, using the ‘five forces’ framework from the strategy literature. Evaluate Qantas’ prospects for profitability and growth in the next five years. Threat of new entrants • Hard for new entrants due to airline industry being capital intensive (i.e., excessive costs to enter industry). • New entrants may bring in more innovation to add new value propositions. • Qantas needs to continually invest in innovation to tackle this threat. For example, new lounges and modern technology. • Aviation regulations may impact new entrants ability to successfully enter the industry. Threat of substitutes • Exceptionally low given planes are the fastest way to travel long distances • Pricing of airlines is comparable to that of alternatives (e.g., coach or train) • Airlines offer add-ons such as meals and Wi-Fi which appeal to customers when deciding how to travel Bargaining power of customers • High given service offerings differ between low-cost airlines and premium offerings. • Price cuts and discounts are common in this industry • Qantas relies on customer loyalty and its brand to improve its competitive positioning. Bargaining power of suppliers • Low in the airline industry as there are various suppliers from which to procure raw materials. • Suppliers in a dominant market position with a quality product may be able to dictate prices, which may impact Qantas’ margins. Competitive rivalry • Qantas rivals include: o Domestic: Virgin Australia o International: Singapore Airlines, Emirates, Etihad, Qatar • Price wars are common in this industry as consumers seek lower cost alternatives • Qantas introduced Jetstar as its low-cost carrier to serve the Asian tourist market.
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Domestically, Qantas relies on its strong brand to maintain its competitive advantage. For example, it sponsors various Australian sporting teams, positioning itself as the ‘Australian’ airline.
Prospects for profitability and growth Qantas needs to revise its cost structure to maintain profitability. It should invest in its low-cost carrier (Jetstar) for future growth as consumers have become more price sensitive following the COVID pandemic and rising levels of inflation. 2. Identify the limitations of this analysis. What other factors do and could affect Qantas’ competitive environment? Potential limitations include the scope of the industry and selecting a competitor. The analysis could be conducted individually on Qantas’ domestic or international operations, which would then change the way one looks at the five forces framework. Further to this, it is difficult to find a competitor comparable to Qantas, as there is no other Australian airline operating on the scale of Qantas. 3. Discuss Qantas’ competitive strategy since 2000. Is it successful, and is it sustainable? Qantas has pursued an integrated cost leadership/differentiation strategy since 2000. Whilst most firms struggle to do this, Qantas has focused on diversifying its products (e.g., business class, economy class as well as focussing on its brand/reputation) whilst also being able to offer customers products at low costs (e.g., Jetstar). Qantas has faced increased competition domestically (Virgin) and internationally (from various airlines). This is placing downward pressure on margins which can constrain future growth. 4. What is Qantas’ competitive advantage, if any? Apply a SWOT evaluation to it. Qantas’ competitive advantage is its strong brand reputation Strengths • Strong international and domestic presence. • Largest airline operating in Australia. Weaknesses • Limited international routes compared to other airlines (such as Emirates). • Susceptible to negative media attention (e.g., 2011 union disputes and recent delays post COVID). Opportunities • Growth into more overseas markets. • Further airline alliances. Threats • Rising costs (fuel, labour). Copyright © 2022 Cengage Learning Australia Pty Limited
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Increased competition within domestic market. 5. What has been Qantas’ corporate strategy across its domestic and international divisions since 2000? How has that strategy changed in response to market changes? Have any changes been initiated by Qantas?
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In response to competition domestically from Virgin, Qantas introduced Jetstar Airways in 2003 to target the low-cost market. Introducing Jetstar has reduced the dependency on the Qantas brand alone to generate profit. Further to this, it resulted in Qantas targeting price sensitive customers, whereas it traditionally pursued customers who were not sensitive to price. Internationally, Qantas’ market share has declined since 2000. As a result, it has introduced changes, such as moving its Asian hub to Singapore and introducing a non-stop PerthLondon route. 6. Prepare an executive summary of recommendations to the Qantas executive, based on your analysis. Identify three key changes to its structure and/or operations.
An example of key changes is summarised below: •
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Qantas needs to revise its staff costs. For example, Virgin flight and cabin crew earn up to 35% less than their Qantas counterparts, and airport check-in staff pay rates can be up to 18% less. Whilst this may be an incentive for staff to join Qantas, it enables Virgin to earn higher margins in the domestic market. A solution to this may be to employ casual labour during peak periods which will reduce ongoing staff costs. Introducing more non-stop routes. As technology advances, there is an opportunity for Qantas to introduce more non-stop routes (such as the flagged non-stop routes to New York). Customers who are sensitive to price may be persuaded to pay increased fares for the convenience of catching one flight rather than two. Review price structure during peak periods. New low-cost airlines are adopting flatter fare structures during peak periods, while Qantas may increase fares during the same period. Increased competition is making consumers less loyal to brands. Therefore, Qantas needs to find ways to revise its fare structure.
PART B 1. Select one accounting policy that was analysed in this case, and make an adjustment to the account of 10% of the recorded figure in either direction. Follow through the effect of this adjustment to the financial statements.
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Revenue Received in Advance (Current liabilities) ($M) Revenue Received in Advance (Noncurrent liabilities) ($M) Total
Reported figure per 2018 report ($M) 3,939
Adjusted for 10% increase 4,333
1,446
1,591
Comment
Total increase is 549
Effect of change: Effects of change
Reported figure per 2018 report ($M)
Cash and Cash equivalents ($M)
1,694
Revised figure for increase in Revenue Received in Advance 2,233
Total assets ($M)
18,647
19,196
Total liabilities ($M)
14,688
15,237
Net assets ($M)
3,959
3,959
Description
Journal entry is Dr Cash Cr Revenue Received in Advance To account for increase in cash To reflect increase in revenue received in advance No change in net assets given increase is reflected in assets and liabilities
2. Apart from the accounting policies identified in Part B, what are likely to be policies that should be closely watched by auditors and analysts for a company in the airline industry? Why have you chosen each of them? Examples of other significant policies include: •
Income tax
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o Given the recent downturn in the airline industry due to COVID, many companies suffered losses. Auditors would need to ensure any losses utilised are appropriate and in accordance with the relevant accounting/taxation policies. Assets and liabilities classed as held for sale o Companies in the airline industry may sell assets to limit losses. Auditors may look at valuation of these assets (see Notes 9 and 29(E) of Qantas’ 2018 Annual Report).
3. Update the accounting analysis in Part B for the most recent Qantas annual report available to you, and re-evaluate Qantas’s accounting policies for the current year. Examples of the updated accounting analysis are provided below for the 2022 Annual Report. Relevant policy Revenue received in advance
Staff costs
Property, plant and equipment (PPE)
2022 Annual Report analysis Revenue received in advance (current liabilities) increased significantly in 2022 ($5,863m) compared to 2021 ($3,277m). This represents a 79% increase. The increase could be attributed to more customers booking flights since the easing of COVID pandemic restrictions. Staff costs represented $3,024m in 2022. Redundancies and related costs amount to $5m, compared to $297m in 2021. Provisions for redundancies amount to $189m however, indicating these plans had yet to be fully realised. PPE was recorded at $10,224m in 2022. Aircraft and engines are the most significant depreciable asset, amounting to $7,966m or 79% of all assets. As per the 2018 Annual Report, these are depreciated over a period of 2.5-20 years with a residual value of 0-10%.
PART C 1. Evaluate Qantas’ financial performance and financial position at the end of 2018. Key points from the analysis and the 2018 Annual Report are summarised below: • • •
Qantas recorded record Underlying Profit Before Tax due to disciplined capacity management and its dual brand strategy. Net Debt for the 2018 year was lower than the bottom of the target range, providing Qantas with greater flexibility moving forward for its funding. Surplus capital was distributed to shareholders given the strength of the balance sheet Copyright © 2022 Cengage Learning Australia Pty Limited