EXECUTIVE SUMMARY..........................................................................................1 1 INTRODUCTION................................................................................................2 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 2 2.1 2.2 2.3 2.

4 2.5 3 3.1 3.2 3.3 3.4 4 4.1 4.2 4.3 4.5 5 ABOUT QANTAS.........................................................................................3 KEY AREAS OF PERFORMANCE.............................................................4 MAJOR COMPETITIORS............................................................................ 5 CHANGES IN OPERATIONAL STRATEGY.............................................5 FINANCIAL PERFORMANCE....................................................................6 FEATURES OF SHARE HOLDERS............................................................6 CORPORATE GOVERNANCE................................................................... 8 MANAGEMENT.. 9 OVERVIEW...................................................................................................... 9 FUNDS UTILIZED BY QANTAS..............................................................11 RECENT TREND OF LEVERAGE USED BY QANTAS........................13 PEER ANALYSIS....................................................................................... 15 QANTAS CAPITAL STRUCTURE AND OPTIMALITY.......................15 DIVIDEND HISTORY................................................................................16 DIVIDENDS COMPARED WITH SIMILAR FIRMS...............................18 OPTIONS ON DIVIDEND PAYMENTS...................................................19 OPTIMALITY OF THE COMPANYS DIVIDEND POLICY..................20 METHOD OF VALUATION......................................................................22 CALCULATION OF WACC......................................................................23 VALUATION OF QANTAS.......................................................................23 SENTIVITY ANALYSIS............................................................................25

CAPITAL STRUCTURE CHOICES.................................................................9

DIVIDEND POLICY.........................................................................................16

VALUATION..................................................................................................... 21

EVENT STUDY................................................................................................. 28 5.1 MARKET MODEL METHOD.....................................................................28 5.1.1EVENT PERIOD........................................................................................ 28 5.1.2EVALUATING ALPHA AND BETA FOR QANTAS............................. 29 5.1.3ABNORMAL RETURNS FOR QANTAS..................................................... 30 5.1.4CUMULATIVE AVERAGE RETURN(CAR)...............................................30 5.1.5STATISTICAL SIGNIFICANCE TESTING.................................................35

CONCLUSION...................................................................................................37

REFERENCES...........................................................................................................38 APPENDICES 39

EXECUTIVE SUMMARRY Qantas is the name and symbol of the world's third oldest And worlds large leading independent airline listed on the Australian Stock Exchange QAN. The principal activities of Qantas are air transportation services, Catering, Qantas Freight and Qantas Holidays. The main aim of this report is to give a detailed financial analysis of Qantas Airways Limited. It focuses on four key elements: capital structure, dividend policy, a valuation of the company, and an event study which examines the impact of an unexpected event on its share price. Qantas capital structure is neither completely equity based nor debt based. The capita; Structure of Qantas is almost equally equity and debt based as its debt/equity ratio was 1.07 in 2005 and is 0.95 in 2006. It is difficult to compare its capital structure with other airline companies because Qantas is the only international airline company in Australia and its unique in its type. The dividend payout ratio of 90% tells us that the company has exhausted its investment options or is not planing for any major investments in the forthcoming year. We valued the firm using DCF approach, 8-year moving average was used to forecast sales and the terminal value was calculated using a growth rate of 2.5%. We valued the firms share at $ 4.30 per share. We find that the share was undervalued as of 30 june 2006. The event study was conducted on share price increase, on May 1 st 2001 when Qantas announced its launch of domestic service in New Zealand owned and operated by Qantas. Cumulative average return (CAR) was calculated based on the market model method, and after calculating the T statistics for pre post and event day we find that there was no abnormal return before the event, but we find abnormal returns on the day of the event and the day after the event.

1. 1.1

INTRODUSTION ABOUT QANTAS

Qantas is an acronym for "Queensland and Northern Territory Aerial Service." Qantas is the name and symbol of the world's third oldest continuously running and worlds large leading independent airline listed on the Australian Stock Exchange QAN. The Qantas story is inextricably linked with the development of civil aviation in Australia. It begins with biplanes carrying one or two passengers and progresses to advanced Boeing 747s flying some 400 people half way around the world in a day to more than 80 destinations in about 40 countries and to some 20 cities in Australia. (www.qantas.com.au/info/about/history/index) Qantas has played a key role in the development of Australian and international aviation. In 1931 Qantas made its first link with Imperial Airways when it carried mail to Darwin as part of an experimental Australia-UK service. Qantas aircraft flew overseas for the first time when the first Qantas overseas passenger left Brisbane for Singapore in April 1935. (http://www.qantas.com.au/infodetail/about/FactFiles.pdf). The Company operates two Australian regional airlines, QantasLink and Jetconnect, and a domestic low-fare carrier, Jetstar. Overall, Qantas' fleet includes about 200 aircraft. In October 2003, Qantas announced it would launch a new low cost domestic carrier. Regional Airline Jetstar commenced operations on 25 May 2004, flying up to 88 flights a day from Sydney, Melbourne and Brisbane to 10 eastern Australian destinations. In October 2006, Qantas launched its newly established air freight subsidiary known as Express Freighters Australia. (http://www.hoovers.com/qantas/--ID__41393--/free-co-factsheet.xhtml) Today, Qantas is widely regarded as the world's leading long distance airline and one of the strongest brands in Australia. Qantas continues to provide outstanding service to its customers and is at the forefront of the international civil aviation industry. The future holds many challenges for Qantas - maintaining safe operations and world class product standards while building a feasible and competitive position long term for the airline.

1.2 KEY AREAS OF PERFORMANCE

The principal activities of the Qantas Group are operations of international and domestic air transportation services includes sale of international and domestic holiday tours. Along with the flying business, Qantas Group also operates in airline-related businesses. The Flying Businesses grouped under two major brands, Qantas and Jetstar. The core activity includes Qantas, QantasLink, Australian Airlines - the Australian Airlines brand will come to an end from July 2006. The Non Flying Business includes Qantas Engineering, Airports, Catering, Qantas Freight and Qantas Holidays, the provision of time definite freight services, and associated support activities. Qantas Airways Limited owns 44.5 per cent of Orange Star, which owns and operates the value-based intra-Asia airlines Jetstar Asia and Valuair, based in Singapore. Qantas also holds a 46.3 per cent shareholding in Air Pacific. (http://www.qantas.com.au/infodetail/about/FactFiles.pdf) International Network Domestic Network

www.privacyconference2003.org/.../michael%20mitchell/Presentation_Michael %20Mitchell.ppt

1.3 MAJOR COMPETITORS Qantas competitors are primarily in the Airlines industry. Qantas also competes in the Air Cargo Services sector. Qantas competitors include Singapore Airlines and British Airways. Singapore Airlines Limited abbreviated as SIA is the national airline of Singapore, with a strong position in Asia Pacific, Southeast Asia, East Asia, South Asia, and a major player on the competitive "kangaroo route" between Europe and Oceania. The airline operates into various markets including ground handling, aviation engineering, air catering, and travel tour marketing. (http://en.wikipedia.org/wiki/Singapore_Airlines ) British Airways is the largest airline of the United Kingdom and one of the largest in Europe, another competitor of Qantas. British Airways provides services mainly in Airline Industry. (http://en.wikipedia.org/wiki/British_Airways ) 1.4 CHANGES IN OPERATION There are some operational changes that took place in recent years. The Qantas used segmentation approach to reduce the cost which gave much more transparency to costs and performance in each part of the business. SYDNEY, 21 June 2006: Qantas decided retain its catering business and substantially restructure the operation. The first stage of the restructure provided a 45% increase on current Earnings Before Interest and Tax (EBIT) forecasts of $34 million. SYDNEY, 14 December 2005: Qantas selected the Boeing 787 as the cornerstone of its domestic and international fleet renewal program and declared that its selection of the Boeing 787 series of aircraft would provide substantial economic benefits for Australia. SYDNEY, 5 December 2005: Qantas declared change in travel agent base commissions for tickets sold in Australia from 1 April 2006. Under the new base commission structure Australian domestic, trans-Tasman and New Zealand domestic base commissions,

currently one per cent, would be discontinued; and International base commissions would be reduced from seven per cent to five per cent.

The chart below also shows that the performance of Qantas Airways Limited has been better than industry standards in terms of market returns.

Figure: 10yrs total return (Source: www.finanalysis.com.au) 1.5 FINANCIAL PERFORMANCE Judging from the Financial Statement of Qantas Airways Ltd. in 2006, it can be noticed that there is a steady growth in terms of the Sales and Operating Revenue but not in Net Profit. The sales and operating revenue for the year has been increased by 8.62% from $12563.9m to $13646.7m in 2006. The net profit (after outside equity interests/minority interest) of the consolidated entity for the year 2006 was $479.5 million decreased from $688.5 million in 2005. This Figure reflects the impact of the restructuring charges and fuel prices. Earnings per share have been decreased by 32.34% from 36.8cents to 24.9cents. The Directors declared a final dividend of $215.1 million (final dividend of 11.0 cents per

share) for the year ended 30 June 2006 as compared to 2005 final dividend of 10.0 cents per share. The final dividend will be fully franked and follows a fully franked interim dividend of $212.2 million (11.0 cents per share), which was paid during the year. Referring to the histogram diagram below for its six years performance, we can conclude that Qantas has been performing steadily throughout the six years.

Qantas Airways Limited

16000 14000 12000 10000 8000 6000 4000 2000 0 2000 2001 2002 2003 Years Revenue ( $Millions ) 2004 2005 2006

1.6 FEATURES OF SHAREHOLDERS Qantas Airways Ltd. currently has 1955 million ordinary shares on issue (as of 22 nd August 2006). The figure below lists the 20 largest shareholders, as well as the distribution of shares amongst the other security holder. The top 20 shareholders in the company hold about 75.18% (approx.) of the total equity.

Revenue($M)

60.00% of shareholders hold between 1001-5000 shares, indicating that they have a fair investment. This implies that most investors are trading in a fair good amount, and have intense interest in the companys performance.

1.7 CORPORATE GOVERNANCE PROVISION The Qantas Board of Directors is responsible for suitable corporate governance structure to ensure the formation, protection and enhancement of shareholder value. To support that the Board endorses each of the Australian Stock Exchange (ASX) Corporate Governance Council's Principles of Good Corporate Governance and Best Practice Recommendations. The Board comprises a majority of Independent Non-Executive Directors who, together with the Executive Directors, have extensive commercial experience and bring independence, accountability and judgment to the Boards deliberations to ensure maximum benefit to stakeholders including shareholders, customers, suppliers, employees, government regulators and members of communities where Qantas operates. The Qantas Constitution contains the following provisions required by the Qantas Sale Act to ensure the independence of the Qantas Board and to protect the airlines position as the Australian flag carrier: Head office must be in Australia; Two-thirds of the Directors must be Australian citizens; Chairman must be an Australian citizen;

 Directors Meeting must include a majority of Directors who are Australian citizens; Maximum 49 per cent aggregate foreign ownership; Maximum 35 per cent aggregate foreign airline ownership; and Maximum 25 per cent ownership by one foreign person. 1.8 FEATURES OF MANAGEMENT BOARD

The Board of Qantas Airways Limited is responsible for overseeing the long term profitable growth of the company, it sets overall corporate policy and provides guidance for senior management. The Board currently consists of 12 members, including NonExecutive Director, Chief Executive Officer, Chief Financial Officer and Executive General Manager Strategy, Independent Non-Executive Director. The Board has established a number of committees to assist in the implementation of its duties and to allow detailed consideration of various issues, including people, Engineering, Fleet Strategy, Audit Committee Risk management and Remuneration Committee. Overall, the structure of Qantas Airways Limiteds Board is well demonstrated and defined. 2. 2.1 CAPITAL STRUCURE OVERVIEW

A company can raise funds through its debt facilities and/or equity facilities. Capital structure represents the proportions of a firms financing from current and long-term debt and equity; it includes long-term debt, common stock and preferred stock, and retained earnings. Capital structure is different from financial structure, which includes short-term debt and accounts payable. The main aim in any business is always to achieve the highest possible return; an appropriate debt-to-equity rate is one of the best ways of creating shareholder value. One advantage of using debt is that it has relatively lower costs, 2.2 FUNDS UTILIZED BY QANTAS

10

The following table displays a summary of Liabilities and Equities section of Qantas balance sheet of last 6 years. As shown in Table 1, The Qantas funding is supported almost equally by Debt and Equity parts. The sources of equities are issued capital, reserve and retained profit. On the other hand, Qantas current liabilities are relatively low due to the nature of its business. For year 2006, the total debt acquired by the company decreased by 2.35 percent, with about 92.37 per cent out of it being long-term debt; conversely, the total equity of the company has increased stably from 5525.70 million in 2005 to 6076.20 million in 2006 by 9.96 percents. Table 2.2-1 funds used by Qantas Capital Structure Qantas 2000 $M Total Current Liabilities 582.40 Total Non Current Liabilities Total Liabilities Contributed Equity Reserves 2,530.8 0 3113.2 1,882.0 0 54.00 2001 $M 974.70 2,355.6 0 3330.3 2,173.0 0 54.30 1,078.0 2002 $M 837.00 3,569.9 0 4406.9 2,946.6 0 56.30 1,239.1 2003 $M 971.10 5,391.9 0 6363 3,757.9 0 54.00 1,435.9 2004 $M 821.90 5,081.8 0 5903.7 3,994.9 0 54.40 1,776.3 2005 $M 315.00 5,599.7 0 5914.7 4,181.5 0 14.60 1,347.4 4,382.20 329.30 5,334.80 5775.6 2006 $M 440.80

Retained Profits 926.80 0 0 0 0 0 1,388.50 Total Equity 2862.8 3305.53 4242 5247.8 5825.6 5525.7 6076.2 Source of data: http://www.qantas.com.au/infodetail/about/investors/AnnualReports

2.3 RECENT TREND OF LEVERAGE USED BY QANTAS

11

Leverage is referring to the degree to which company is utilizing borrowed money. A good use of leverage resources could increase the shareholders return on their investment; and provides tax advantages from their borrowing. However, companies that are highly leveraged may at the risk of bankruptcy if they are no able to meet their debt obligations. Empirical evidences have been suggested that when announces on an increase in leverage, there is increase in firm value, when announces on a decrease in leverage, there is a decrease in firm value in the share market. Table 2.3-1: Financial Leverage Capital Structure Qantas 2000 $M Short Term Debt Long Debt Total Debt 582.40 Term 2,530.8 0 3,113.2 0 2,862.8 2001 $M 974.70 2,355.6 0 3,330.3 0 3,305.5 3 1.01 2002 $M 837.00 3,569.9 0 4,406.9 0 4,242.0 0 1.04 of 2003 $M 971.10 5,391.9 0 6,363.0 0 5,247.8 0 1.21 2004 $M 821.90 5,081.8 0 5,903.7 0 5,825.6 0 1.01 2005 $M 315.00 5,599.7 0 5,914.7 0 5,525.7 0 1.07 2006 $M 440.80 5,334.80 5,775.60 6,076.20 0.95 Data:

Total Equity 0 Debt/ Equity Ratio Source 1.09

http://www.qantas.com.au/infodetail/about/investors/AnnualReport2006.pdf The change of the Debt/Equity ratio did not have much impact on the company. Although the total debt has increased by 16 million, the total equity has increased at a larger margin which leaves the company out of financial distress and reduces the risk of bankruptcy of it. However the cost of capital may have increased, as the equity facilities are comparable more costly than debt facilities. The increase of the debt financing happened mainly since 20003.

12

DEBT/EQUITY RATIO 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2000 2001 2002 2003 Years Debt/ Equity Ratio 2004 2005 2006 1.09 1.21 1.01 1.04 1.01 1.07 0.95

As a result of this shift in debt/equity proportion of the company, the debt to equity ratio raised dropped insignificant from 1.07 in 2005 to 0.95 in 2006. Overall, the Qantas leverage ratio has remained at almost the same level throughout the six years. 2.4 COMPETITORS ANALYSIS

The graph and tables below compare the overall debt to equity ratio of Qantas Airways and its competitors. As we can see, Qantas Airways has comparatively very lower debt to equity ratio than British Airways and higher than Singapore Airlines. Singapore Airlines has the lowest debt to equity ratio throughout all 6 years and British Airways has a very high debt to equity ratio throughout the 6 years. In addition, Qantas is equally levered on its debt and equity. Graph 2.4-1: Debt to Equity Raito Comparison

13

Debt/Equity Comparison
Debt/Equity Ratio 10.00 8.00 6.00 4.00 2.00 0.00 2000 2001 2002 2003 Years Qantas Debt/ Equity Ratio Singapore Airlines Debt/ Equity Ratio British Airways Debt/ Equity Ratio 2004 2005 2006

Qantas Airways Limited Capital Structure Qantas 2000 $M Short Term Debt Long Debt Total Debt 582.40 Term 2,530.8 0 3,113.2 0 2,862.8 2001 $M 974.70 2,355.6 0 3,330.3 0 3,305.5 3 1.01 2002 $M 837.00 3,569.9 0 4,406.9 0 4,242.0 0 1.04 2003 $M 971.10 5,391.9 0 6,363.0 0 5,247.8 0 1.21 2004 $M 821.90 5,081.8 0 5,903.7 0 5,825.6 0 1.01 2005 $M 315.00 5,599.7 0 5,914.7 0 5,525.7 0 1.07 2006 $M 440.80 5,334.80 5,775.60 6,076.20 0.95

Total Equity 0 Debt/ Equity Ratio 1.09

Singapore Airlines Capital Structure Singapore Airlines 2000 2001 4,418.3 0 9,992.6 0 0.44 2002 5,248.7 0 9,846.6 0 0.53 2003 5,433.60 10,708.8 0 0.51 2004 5,608.80 11,455.1 0 0.49 2005 6,234.90 12,645.1 0 0.49 2006 6,666.90 13,866.90 0.48

Total Debt 4,273.80 Total 10,957.5 Equity Debt/ Equity 0 0.39

14

Ratio

BRITISH AIRWAYS: Capital Structure British Airways Total Debt Total Equity Debt/ Equity Ratio 3.21 4.81 5.11 4.60 3.88 8.67 5.43 2000 10,094.0 0 3,147.00 2001 10,209.0 0 2,121.00 2002 10,298.0 0 2,016.00 2003 9,457.0 0 2,058.0 0 2004 8,482.0 0 2,187.0 0 2005 10,274.0 0 1,185.00 2006 10,100.00 1,861.00

2.5 IS QANATS CAPITAL STRUCTURE OPTIMAL An appropriate capital structure is an important decision for any organization to be successful. The decision is important not only to maximize returns to various organizational stockholders, but also has an impact on an organizations ability to deal with the competitive environment. According to Modigliani and Miller (1958), in a world without tax, capital structure is not related to company value, however, in a world with tax-deductible interest payments, firm value and capital structure are positively related, an optimal capital structure exists which balances the risk of bankruptcy with the tax savings of debt. This capital structure should provide greater returns to stockholders than they would receive from an all-equity firm. Despite the theoretical appeal, management and researchers in financial management have been searched for the best way to manage an organizations debt and equity proportion in practice, but yet have not found a widely accepted optimal capital structure. It has been argued that even use of leverage may improve the performance of an

15

organization in short-term under some circumstances, it fails to meet the long-term survival of the organization, since in many instances; it can lead to financial distress and bankruptcy of the organization. It has also argued that each organization should have their unique core optimum leverage decision to deal with its own financial situation and competitive industry. With regard to Qantas, compared to its major competitors, the proportion of leverage in Qantas current capital structure is higher than Singapore airlines but is relatively very less than British Airways over the 6 years. The debt to equity ratio of Qantas is .98, Singapore Airlines is only 0.48 where as British airways is 5.43 in 2006. It is clear that British Airways has a relatively high debt/equity ratio. When in the aspect of current financial performance of the company, it has been suggested that the company have the ability to generate sufficient cash flows to support additional borrowing from the debt facilities. By examining Qantas Cash Flow Statement, it is clear that Qantas has generated enough cash flow to cover its interest payment which prevent the company from the financial distress resulting from heavily debt financing. 3 DIVIDEND POLICY 3.1 DIVIDEND HISTORY Qantas Airways Limited pays dividends twice a year, interim dividend is paid in April and final in October. Qantas Earning Per Share (EPS) was 24.9 cents in the year 2006 while they have paid total dividend of 22 cents during the year. There was a decrease of nearly 35% in EPS compared to 2005 still there was an increase of 10% in dividend. There is a clear trend regarding franking of dividends. The Company has announced fully franked final and interim dividend since 1997. In 2005, total dividend for the year was 20% which was increased to 22% in 2006 which shows companys faith in future growth and commitment towards the share holders. Dividend Payment History

16

Dividend ( Cents ) 12 10 8 6 4 2 0 Oct-95 Apr-96 Oct-96 Apr-97 Oct-97 Apr-98 Oct-98 Apr-99 Oct-99 Apr-00 Oct-00 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Years Dividend ( Cents )

(30/06/95 to 30/06/06)

Qantas Dividend Payout Schedule

Dividend ( Cents )

Dividend Paid by Qantas

17

Balance Date 30/06/06 30/06/06 30/06/05 30/06/05 30/06/04 30/06/04 30/06/03 30/06/03 30/06/02 30/06/02 30/06/01 30/06/01 30/06/00 30/06/00 30/06/00 30/06/99 30/06/99 30/06/98 30/06/98 30/06/97 30/06/97 30/06/96 30/06/96 30/06/95

Dividend Type Interim Final Interim Final Interim Final Interim Final Interim Final Interim Final Interim Final Special Cash Interim Final Interim Final Interim Final Interim Final Final

Cents per share 11 11 10 10 8 9 8 9 8 9 11 9 11 11 37 8 11 6.5 6.5 6.5 6.5 6.5 6.5 3.5

Pay Date 05/04/06 04/10/06 06/04/05 28/09/05 07/04/04 29/09/04 09/04/03 01/10/03 10/04/02 02/10/02 04/04/01 03/10/01 29/03/00 04/10/00 13/12/00 31/03/99 01/12/99 01/04/98 02/12/98 03/04/97 03/12/97 04/04/96 06/12/96 08/12/95

18

3.2 DIVIDEND PAYMENT COMPARED TO OTHER FIRMS Some of the differences between Qantas and similar firms in same industry are as follows: How often are dividends paid out? British Airways used to give dividends twice a year but they have not paid any dividend since 31 July 2001. Singapore Airlines pay only final dividend once a year. Dividend payments by the companies

Year

Total Dividend Payments for the year Qantas (AUD) British Airways (GBP) 0 0 0 0 0 Singapore Air. (SGD) 15 15 25 40 45

2001-02 2002-03 2003-04 2004-05 2005-06

17 17 17 20 22

There is a common trend in terms of dividend payments Qantas and Singapore Airlines as both the companies have increased their dividends over last five years. British Airways has not paid any dividend since the company has chosen the policy of buy back stock rather than pay dividends. Qantas pays highest dividends if we compare dividend payout ratio. Annual EPS of Qantas in 2006 was 24.9 cents while total annual dividend was 22 cents (90%) compared to Singapore Airlines annual EPS of 101.7 cents and total annual dividend of 45 cents (45%).

19

Dividend growth rate in airline industry during last 5 years is (-18.34%). The dividend growth rate for last 5 years for Qantas is 1.92% while it is 11% for Singapore Airlines.

Dividend Comparison
Dividends ( In Dollars ) 50 40 30 20 10 0 2001-02 2002-03 2003-04 Years Qantas (AUD) British Airways (GBP) Singapore Air. (SGD) 2004-05 2005-06

(2001-02 to 2005-06) 3.3 OPTIONS ON DIVIDEND PAYMENT Qantas Airways Limited and British Airways have given the alternative of dividend reinvestment in shares of the company. British Airways does not pay a dividend and opt to buyback stock because that is more tax efficient for shareholders. Whereas, IGT, AGT and Konami corporation have not given the dividend reinvestment option to the shareholders in the year 2005. Average Return on equity for Qantas during last 5 years is aroung10%. There is not much movement in ROE of Qantas. ROE of Singapore Airline has increased from 6.4 in 2003 to 9.6 in 2006 which is nearly 50% jump in 3 years. The industry ROE is 12%. British Airways ROE was 24% which was almost double than the ROE of this industry. 3.4 IS THE DIVIDND POLICY OPTIMAL?

20

There is a clear upward trend in the dividend payments of Qantas if we check the graph 1.2 showing dividend payment histories of Qantas. The company has increased the rate of dividends consistently since 1995. There was constant improvement in the working of company since 2003 before sharp decrease in 2006. In 2006, the EPS of the company went down to 24.4 cents from 44.3 cents in 2005. Though the earnings dipped in 2006, still the company increased the total dividends for the year which was advantageous for the share holders. It also reveals the managements faith in future growth prospects and good expected cash flows of the company. There was a nominal increase in revenues of Qantas but at the same time expenses went up. That was the reason for the profits went down. Dividend payout ratio of Qantas is for more higher compared to industry average which is advantageous for the share holders. The share price of the company is negatively correlated with the dividend payout ration of the company because of the concerns of rising crude prices in international markets over the years. The gradual increase in dividends can act as a signalling tool to investors by indicating that the company is in good financial condition and expecting good future net profits and cash flows. Alternatives to Dividend policies 1) Dividend Reinvestment Plans (DRP) 2) Share Buybacks 3) Bonus Shares The Dividend Reinvestment Plan (DRP) was established at the time of the Qantas Public Share Offer both to benefit shareholders wishing to reinvest their dividends and to reduce financial leverage. The DRP was suspended in August 1999, but has since been reinstated so that it applied for the special dividend paid on 13 December 2000.

21

Under the Qantas Dividend Reinvestment Plan (DRP), dividends payable on Qantas shares participating in the DRP are reinvested (at no additional cost to the shareholder) in new shares at a 2.5% discount to the prevailing market price. It is companys policy to reinvest the dividends to buyback the shares of he company. The Board of Qantas declared 37 cents was fully franked special dividend to maximise returns to shareholders by distributing accumulated franking credits, which were then refundable to some shareholders if not utilised, and before the further reduction in the rate of corporate tax to 30 percent in the 2001/02 financial year. The fully franked special dividend paid following the reintroduction of the DRP. 4 VALUATION:

4.1 METHOD OF VALUATION The firms value as well the share price of Qantas for the year ended 31 st June 2007 is calculated using Discounted Cash Flow (DCF) technique, which involves discounting the future free cash flows into present terms. And for calculating the future free cash flows, the Statement of Financial Performance and Statement of Financial Position of the company are needed to be forecasted. Thus, for this purpose, we have forecasted the financial statements of Qantas for the next three years, i.e. 2007, 2008 and 2009. Most of the items in Statement of Financial Performance and Statement of Financial Position are sales driven. Therefore, Sales is to be forecasted with due diligence. In order to forecast the sales revenue of Qantas Australia Limited, the percentage increase in the sales for every year has been calculated and then the eight year moving average of that percentage increase is been used for the year 2007, 2008 and 2009. According to our forecast, the sales figures of Qantas will be increasing by 7.71%, 7.79% and 7.82% each year respectively. Most of the other items of Statement of Financial Performance and Position are forecasted on the basis of percentage of sales method. Although, Depreciation and Accumulated Depreciation has been forecasted on the basis of percentage of Property, Plant and Equipment (PP&E) as they are more related to PP&E rather than sales.

22

In this report, Weighted Average Cost of Capital (WACC) has been used as the discounting factor. It is calculated on the weighted average of the cost of equity and cost of debt. As, Qantas is assumed to be a going concern entity, we have calculated the terminal value of the company by making use of future free cash flows. The Free Cash Flows for the forecasted years 2007, 2008 and 2009 were 4181.9, 551.5, 516.8 ($ Million) respectively. On the basis of this, the firms terminal value was calculated to 11576.2 ($ Million). On discounting the Free Cash Flows to the Present Value at the rate of 7.29% (WACC) the total NPV as on 31 December 2005 was arrived at 4181.9 ($ Million). The firms debt for the year 2005 when deducted from the NPV gave us an equity value of 8415.42 ($ Million). When dividing this with the number of shares (1955 Million) that Qantas Australia holds gives us the share price for the firm. The Value of a share was found to be $4.30. SALES FORECAST:

23

Apart from the quantitative model used, there are certain other qualitative factors that indicate that the sales in the airline industry are likely to be robust over the next few years. They are, 1. Many passenger airlines are entering the extremely profitable air cargo market, which is largely controlled by traditional freight companies.(Airline Business, September 2006, Vol. 22, Issue 9) 2. Qantas has had a good experience with its low cost carrier, Jetstar, expanding the domestic market and boosting revenues. The operating margin for Jetstar was 8.8% in 2005.( Knibb, D. August 2006, Vol. 22, Issue 8) 3. Tourism is one of the largest industries in Australia and has been continuously growing over the years. Qantas, with a virtual monopoly in both the domestic and international air travel market, to and from Australia, is one of the largest beneficiaries of this boom. (Australian Social Trends 2004, Australian Bureau of Statistics)

4.2 Calculation of Weighted average Cost of Capital: The discount rates adopted for the purpose of this analysis are derived on the basis of a weighted average cost of capital (WACC) and have been applied to ungeared after-tax cash flows. WACC has been calculated on the weighted average of the cost of debt and the cost of equity. WACC = E/V*Ke + D/V*Kd * (1-T) Where: E = Total equity D = Total debt V = Total equity + Total debt Ke= Cost of equity Kd = Cost of debt Tc = Corporate tax rate

24

Cost of equity is derived from the application of capital asset pricing model (CAPM) methodology. CAPM is the most widely accepted methodology in determining the cost of equity. CAPM reflects the systematic risks of investments in the business. The cost of equity under CAPM is estimated by applying to the market risk premium a measures of systematic risk described as the beta factor. The beta for an investment reflects the covariance of the return from that investment with the return from market as a whole (Samuel, pg-100). Cost of equity = Risk free rate + Beta * (Expected market return Risk free rate). The risk premium = Expected market return Risk free rate The rate of return on the commonwealth bonds can be regarded as the risk free rate. Risk premium reflects the extra return that the investors require to invest in the equity securities of the company. Risk free rate is taken to be 5.75%( 20/10/2006 bloomberg). Risk premium is taken to be 7% ( given) and a beta of 0.78 (20/10/2006 bloomberg). By putting these numbers in the formula, cost of equity is obtained which is 11.22%.

Cost of debt can be found out by dividing the Interest expense by Interest bearing liabilities. For Qantas the cost of debt is 4.08% WACC: The total debt taken for the calculation of WACC consists of both the current and non-current interest bearing liabilities. Total equity taken for the calculation of WACC is the contributed capital at book value. By substituting all the above figures in the formula, WACC can be calculated which gives a discount rate of 7.29% .

Calculation of Weighted Average Cost of Capital

25

Cost of Equity Cost of Debt WACC Valuation of QANTAS:

11.22% 4.08% 7.29%

Qantas is valued using discounted cash flow model. Discounted cash flow valuation involves predicting companys free cash flow and then discounting it by the rate of return. In this report WACC has been used to determine the rate of return. Positive free cash flow reflects the amount available for the business activities after allowances for financing and investing requirements to maintain productive capacity at current levels. Free cash flows are computed by inserting the values in the following format: Net profit after tax Add: Depreciation expenses Add: After tax net interest payments Less: Increase in current assets Add: Increase in current liabilities Less: Increase in fixed asset at cost In this report, Qantas is assumed to be a going concern entity which gives rise to the need for the calculation of Terminal value. For calculating Terminal value a constant growth rate needs to be assumed. The perpetual growth rate has to be assumed to calculate the terminal value. The following points were taken into consideration while selecting an appropriate growth rate. A brief informal interview with Mr. Ian Douglas, Lecturer in the School of Management at UTS revealed that the airline industry growth could be approximately 4% in the near future. Mr. Douglas has had a long career in International Aviation. His industry experience includes revenue management,

26

pricing, alliance management, and fleet planning. He continues to consult on revenue management and pricing to the aviation and tourism industries. An article by aviation analyst Chris Tarry (2005) suggests that airline revenues appear to be growing more or less at the same rate as nominal GDP growth in developed nations.(Tarry, C. 2005). The average GDP of most developed nations, such as United States, United Kingdom, Germany and Australia is roughly 2%. (www.cia.gov) The future of Qantas also depends on Australian Governments aviation policy. If it opens air routes in Australia to other airlines, such as Singapore Airlines and Cathay Pacific, then the robust growth rates that Qantas reports could be a thing of the past. ( Knibb, D. 2005). A perpetual growth rate of 2.5% has been assumed to calculate the terminal value based on the points stated above.

Terminal value at the end of year n Terminal value as on 31 may, 2009

= FCFn * (1 + growth) / WACC growth = 516.8(Million)* (1 + 2.5%) / 7.29% - 2.5% = $ 11576.2(million)

Terminal value is added to free cash flows of 2008. The resultant free cash flows are discounted at 7.29% (WACC) to get the net present value of the free cash flows. Value of firm is found by subtracting the total interest bearing debt from net present value of free cash flows. Value per share as on june 2006 is found by dividing the value of firm by number of shares. This is shown in the following table.

27

4.6 Sensitivity Analysis: The basic idea of sensitivity analysis is to freeze all the variables and change one particular variable and detect how sensitive the valuation of the firm is to that variable. In this report the effects that the assumed growth rate of the revenue and the growth rate of the industry have on the valuation of the firm and consequently the value per share is considered. We see that for one percent decrease in growth the share price falls around 20% but for 1% increase in growth the share price increases by 30%, showing a non linear relationship. Growth Rate 0.50% 1.50% 2.50% Share Price 9 8 0 % Change in Share Price $2.8 -16.95% $3.4 -19.07% $4.3 0.00%

28

$5.5 3.50% 4.50% 7 4 29.53% $7.7 38.96%

Inference: Based on our valuation we know that $ 4.30 is the right share price of Qantas as of june 30, 2006. On this day Qantas was trading at $ 2.90. Today Qantas is trading around $ 4.20 we is approximately our estimate so feel that it would be a hold situation on Qantas shares.

29

5 EVENT STUDY Introduction: The event study is an important research tool in the field of economics and finance. The purpose of an event study is to measure the effects of an economic event on the value of firms. Event study methods exploit the fact that, given rationality in the marketplace, the effects of an event will be reflected immediately in security prices. Thus the impact can be measured by examining security prices surrounding the event. Further, an event study is an empirical study of prices of an asset just before and after some event, like an announcement, merger, or dividend. It can be used to discuss whether the market priced the information efficiently, whether there was private information, etc. (Source URL: http://economics.about.com/library/glossary/bldef-event-studies.htm Viewed on 29th October 2006) The event that affects a firm's market value may be within the firm's control, such as the event of the announcement of a stock split. Or the event may be outside the firm's control, such as the event of a legislative act being passed, or a regulatory ruling being announced, that will affect the firm's future operations in some way. On 1st May 2001 Qantas Airways announced to lunch domestic service in New Zealand owned and operated by Qantas. This announcement lead to increase its share price by 26.56% with 10% increasing in share trading volume at the end of the day. This event study will test the significance of this event on the share price of Qantas. There are several methods of event study. For our study we used Market Model Method.

30

5.1 Market Model Method: Event Periods This event study uses the Market Model Method to analyse the abnormal returns on and around the date of the event. The data is divided into three different time periods: The event window: A three-day period from one day prior to the event, to one day after the event. Day 1 30th April 2001 Event day 1st May 2001 Day + 1 2nd May 2001 The clean period: The period between days -231 to day-31 prior to the event window. Day - 231 Day - 31 31 May 00 14 March 01

The event period: Thirty days prior and sixty days after the event day (i.e. day 0), including the event day. Day - 30 Day + 60 15 March 01 26th July 2001

5.3 Evaluating Alpha and Beta of Qantas Using Qantas Stock prices over the Clean Period, a continuously compounded daily return was calculated (Ra). Similarly, the daily market return (Rm) was assumed to be the daily return of the All Ordinaries Index (AOI). Then a scatter plot of Ra versus Rm was charted and a regression line was drawn through the plot using excel. equal to 0.00265 (intersection with y-axis). The regression line gives the expected daily return on Aristocrats share price: Ra (t) = 0.00265 + 0.765597x Rm (t) This regression line estimated the Beta equal to 0.765597 (slope of regression line) and Alpha

31

Where, Ra (t) is the expected daily return on Aristocrat shares and Rm (t) is the actual daily return on the market taken as the All Ordinaries Index. 5.4Abnormal Returns for Qantas The Regression model looks at giving an estimated value of the Return on the Qantas share price (Ra) with respect to the Return on the All Ordinaries Index. The difference between the actual daily return (Ra) and the Estimated Ra will be the residual (abnormal) return at time t. This report has focused on the residual returns for the event period [30day, +60day] to see how the event that occurred on 1 st May 2001, affected the share price return. On the event day the Abnormal Return observed 23.56%.

Cumulative Average Returns (CAR):

CAR -30 to +60 days 15.00% 10.00% 5.00% 0.00% CAR 0 -5 5 10 20 35 40

CAR -30 to +60 days

55

15

25

30

45

50

-30

-20

-15

-5.00% -10.00% -15.00% -20.00% -25.00%

-10

-25

Time

The Cumulative effect of Residual returns (CAR) over the various periods taken within the event period will be highlighted in this section. The Cumulative Average Return provides for the effect of all other influencing factors on Qantas share price taken over the entire Event Period [Day 30, Day+60].

32

60

Examination for the CAR period -30days to -2 days: On examining the CAR data for the specified range we couldnt find any relevant information for the fluctuations in the CAR. There were some gradual movements over the period CAR -30 Days to -2 Days

8.00% 6.00% 4.00%

2.00% 0.00% -2.00% -4.00%

-6.00% -8.00% -10.00% -12.00%

-14.00%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Examination of the CAR for the period -1 to +1: On the event day 0 (1st May 2001) the company made a media release and came out with an announcement that Qantas would lunch a New Zealand Domestic Service owned and operated by Qantas. This appeared to be a strong move to the investors which caused the big increase. We found that on 30th April 2001 (Day -1), there was a slight decrease in the share prices, which lead to decrease in CAR. There was an increase in the share price on the event day 1st May 2001 (by $0.68, 26.56%), because of the news of the business operation expansion. However there was not a significant rise in the share price over the couple of days, Day +1 being -$0.25 ;-7.71% down to an adjusted close of $2.99. The volume of trading on the event day increased significantly by 41,756,038 from Day -1, and decreased by 1,120,172 on Day +1, from the event day 0 though a big change from day -1. This means that the decision of business operation expansion was considered good for the company and the investors supported it

33

CAR -1 to + 1 Day
15.00%

10.00%

5.00%

0.00%
CAR

-5.00%

-10.00%

-15.00%

-20.00% Day -1 Day 0

Day

Day +1

Share Price over the Event Period

$3.50

$3.00

$2.50

Pri ce

$2.00

$1.50

$1.00

$0.50

$0.00 Day -3 Day -2 Day -1 Day 0

Day

Day + 1

Day +2

Day +3

Trading Volume over Event Period

34

50,000,000 45,000,000 40,000,000 35,000,000

Volume

30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 Day -2 Day -1 Day

Day

Day + 1

Day +2

Examination for the CAR period +2 to +60: A gradual fluctuation observed in CAR in period + 2 to + 60. An upward trend in share price observed with mostly positive CAR over this period. CAR + 2 to + 60 Days
QANTAS AIRWAYS LTD CAR AFTER THE ANNOUNCEMENT PERIOD +2 DAYS TO +60 DAYS

1 2.00%

1 0.00%

8.00%

6.00% Series1 4.00%

2.00%

0.00%

-2.00%

Statistical Significance Testing: This significance test will prove or otherwise the significance of the event using the sample of thirty non-event three day residual returns. An average value of residual return is taken over each three-day sample of residual returns. This provides a sample of 30

35

average residual values with 15 pre-event and 15 post event [-15, +15] excluding the three-day event window. Null Hypothesis would suggest that the average daily residual (AR) of sample of 30 residuals returns [-15, +15] is equal to zero, the significance test will suggest whether or not this is statistically significant at 95% confidence level. H0: AR = 0 H1: AR 0

Summary of T-Statistics Test Average Return on Three Day Event Window Standard Deviation Significance Level of T-stat Test (Value at df=30 Critical Value of T-stat (@ 5% significance & df=30) Result of T-stat test Inference 0.49 0.020098 5% 1.96 1.3488 Significant

Hence, t = 1.3488 is between the null hypothesis acceptance range of -1.96 < z < 1.96 for confidence level of 95%. Therefore, we accept the null hypothesis (H0) that Average Residual Return is statistically significant Confidence Interval of 95%. 3- day significance test: DAY -1 0 1 T-TEST -.59 11.73 -4.04 RESULT No Abnormal return Abnormal return Abnormal return

After the analysis of the entire period and the event day we arrived at the conclusion that market reacted to the announcement of Qantas on 1st May 2001, to lunch domestic service in New Zealand owned and operated by Qantas, resulting in abnormal returns, statistically different from zero, as confirmed by the three day significance test.

36

Conclusions: Qantas capital structure is neither completely equity based nor debt based. The capita; Structure of Qantas is almost equally equity and debt based as its debt/equity ratio was 1.07 in 2005 and is 0.95 in 2006. It is difficult to compare its capital structure with other airline companies because Qantas is the only international airline company in Australia and its unique in its type. The dividend payout ratio of 90% tells us that the company has exhausted its investment options or is not planing for any major investments in the forthcoming year. We valued the firm using DCF approach, 8-year moving average was used to forecast sales and the terminal value was calculated using a growth rate of 2.5%. We valued the firms share at $ 4.30 per share. We find that the share was undervalued as of 30 june 2006. The T statistics for pre post and event day we find that there was no abnormal return before the event, but we find abnormal returns on the day of the event and the day after the event. From this we can conclude that the market is semi strong form efficient.

References

37

Anonymous 2006, Competition heats up cargo market Airline Business, September 2006,
Vol. 22, Issue 9

Australian Bureau of Statistics 2004, Australian Social Trends, 15 September 2004, viewed 23 October 2006, http://www.abs.gov.au/ Knibb, D. 2006, Growing up, Airline Business, August 2006, Vol. 22, Issue 8 Douglas, I. 2005, Air travel in Asia after SARS - facing low cost carrier competition, Proceedings of the Global Business in Service Conference, Trisakti University, Indonesia. Knibb, D. 2005, Australia deliberates over open skies, Airline Business, June 2005, Vol. 21, Issue 6 Tarry, C. 2005, As good as it gets, Airline Business, June 2005, Vol. 21, Issue 6, pp.7879 http://www.singaporeair.com/saa/en_UK/content/company_info/investor/financials.jsp? http://www.aspectfinancial.com.au.ezproxy.lib.uts.edu.au/af/sectoranalysis?xtmlicensee=finanalysis http://www.qantas.com.au/info/about/investors/dividendHistory http://www.bashareholders.com/phoenix.zhtml?c=69499&p=irol-dividends http://quicktake.morningstar.com/Stock/Diagnostics.asp? Country=USA&Symbol=BAB&stocktab=interpret http://stocks.us.reuters.com/stocks/lookup.asp?symbol=qan

38