This paper, establishing on information from BBA Aviations one-year studies, estimates the value of the company by utilizing both prospective pricing-earnings ratio analysis and free hard currency flow analysis. Significant differences between the estimated values and existent market value are found, and by exemplifying the jobs arisen in geting at ratings under those methods, failings and strengths of each theoretical account are found. It is concluded that with each technique involves different advantages and disadvantages there are additions to sing several attacks at the same time.
BBA Aviation, listed on the London Stock Exchange, is a taking planetary air power support and aftermarket services supplier. It focuses chiefly on serving aircraft in the concern and general air power flees. The Group has 11,000 globally and it has developed through a combination of organic growing and bolt-on acquisitions. ( BBA Aviation Annual Report 2011, 2011 ) BBA has a market-leading place in air power service industry which is straight impacted by the degrees of winging activity and the figure of hours flown. By utilizing two rating theoretical accounts to gauge BBA ‘s value, this paper focuses on three chief inquiries:
How the value calculated and what are the underlying premises?
Why differences occur when comparing BBA ‘s estimated value with existent market value?
What are the advantages and disadvantages of each theoretical account?
By exemplifying how fiscal rating theoretical accounts work in pattern and the jobs involved in, this paper aims to research the cogency and dependability of prospected P/E monetary value multiple theoretical account and discounted free hard currency flow theoretical account.
Prospected P/E monetary value multiple rating methods estimate ratios of current monetary value to forecasted net incomes for comparable houses. The benchmarks are so used to value the public presentation of the house being analyzed. Free hard currency flow method forecasts multiple-year hard currency flows that are available for distribution and so discounted at house ‘s estimated cost of capital to get at an estimated present value. This theoretical account defines the value of a house ‘s net assets as the present value of hard currency flows generated by these assets minus the investing made in new assets ( Investment ) , or, instead stated, as amount of the free hard currency flows to debt and equity holders discounted at the leaden mean cost of debt and equity. ( Palepu, 2010 )
5.1 Prospective pricing-earnings ratio analysis based on prognosis normalized net incomes
From Table 1 above, it ‘s obvious that figures in 2009 and 2011 are unnatural. In 2009, due to the hard economic clime, there was a continued cyclical downswing in BBA ‘s major concern. In 2011, there was a important addition in gross and operating net incomes because of the increased activity and aggressive acquisitions. It ‘s improbable that the growing in 2011 and the diminution in 2009 could be sustained. Therefore, establishing on 2010 ‘s gross, one-year gross growing and trading border from 2007 to 2011 are averaged to give a normalized gross net income, as seen in Table 2.
When normalize non-trading cost ( Table3 ) , unnatural points which appear on occasion are taken off, and normal points from 2009 to 2011 are averaged because these three old ages ‘ public presentations are most closely related to the current province of the company and they could reflect company ‘s public presentation in both downswing and upturn state of affairss. In add-on, investing income, fiscal cost and revenue enhancement are expressed as per centum of grosss and the normalized values are besides the 3-year norm. ( Table 4 )
Net income for the Period
Average P/E Ratio of Comparators
Following the procedure in Table 5 the concluding normalized net incomes is got and so the most recent net incomes and the market value of equity for three houses that do similar concern and have same size as BBA are found. All P/E ratios in Table 6 are based on their market values in Dec. 2011. Because the negative net incomes growing, Sats Ltd is unnatural net income profile, and therefore when cipher the mean P/E it is ignored. BBA is so valued by using the mean P/E for comparing houses to its normalized net incomes.
4.2 Free Cash Flow Analysis
As seen in Table 8 there was a important growing in 2011 compared to other old ages. ‘With the strengths of concern, organic growing, consolidation chances, and ongoing operational betterment, BBA is expected to bring forth superior returns over the long period ‘ ( Altamimi, 2011 ) . Based on this foregoing appraisal, although the immense growing rate in 2011 is difficult to prolong, the house could be assumed to prolong its competitory advantage in the undermentioned old ages. Consequently, BBA is assumed to growing at the old mean rate for five old ages until it has reached a steady province of public presentation in 2017. Based on this logic, I will repair 2017 as the terminal twelvemonth and so gauge its terminal value at that clip.
From 2012 to 2016, BBA is predicted to execute at old three-year mean rate as calculated in Table 8. After five old ages, under the competitory equilibrium premise BBA will go on to gain unnatural net incomes everlastingly, but there will be no unnatural net incomes on any incremental gross revenues beyond that degree. Then, the anticipation could be simplified by merchandising gross revenues as if they will be changeless at the terminal twelvemonth degree. In add-on, the fixed and working capital investing are besides assumed to be nil after 2017. Following the procedure shown in Table 9, BBA gets negative free hard currency flows from 2012 to 2016. This is rather usual for companies in high growing period since the capital investing demands are much larger than the net income.
Competitive Equilibrium Premise
Operating Net income
OCF ( OP-Tax )
Fixed Capital Investment % of Gross saless Changes
Working Capital Investment % of Gross saless Changes
FCF ( OCF-FCI-WCI )
Less Net Debt
Value of Equity
To dismiss the future free hard currency flow back to the present value, WACC ( Table 11 ) is calculated by burdening the cost of debt and equity capital harmonizing to their several market values ( Table 10 ) :
Retirement benefit duties
Equity per BS
Deferred revenue enhancement
Debt + equity
Estimating the WACC
Cost of debt
Cost of Equity
Value of Debt
Value of Equity
To gauge cost of debt, it is assumed that capital construction is unchanged, and so current involvement rate on debt will be a good placeholder. To gauge the cost of equity, the Capital Asset Pricing Model is used. Under CAPM, the beta factor is estimated by regressing the BBA ‘s stock returns over some recent clip period against the return on FTSE-250. At the terminal of 2011, ten-year authorities bonds yield was close to 4 % and it is assumed to be riskless rate. ( Eurostat, 2012 ) The five twelvemonth norm return on FTSE-250 is 6.1 % which is estimated as return on market. ( FTSE, 2012 ) Then the CAPM-based estimation of BBA ‘s cost of equity is calculated as shown in Appendix A. Having known the WACC, the estimated value of 7712.66m is calculated as shown in Table 9
5. Comparison and Discussion
When compare the estimated values with the market value of BBA, significant differs are found, as seen in Table 12. This is because rating may affect a significant figure of premises and each method has its defects.
MV=Share Price X No. of Shares
In geting at ratings under prospective price-earnings ratio analysis, many jobs involved when placing comparables with the same operating features because no two houses are precisely likewise. Firms such as Sats Ltd, Gemina S.p.A and Airports of Thailand within the air power service industry are rather similar to BBA in size and merchandise, but these houses are from different states. A assortment of factors that influence P/E ratio may differ across states. For illustration, the cost of equity, which is reciprocally related to the price-earnings multiple, is affected by the riskless involvement rate. Consequently, international differences in riskless involvement rates lead to international differences in price-earnings multiples. ( Palepu, 2010 ) Besides, BBA besides does military air power service concern, but Gemina S.p.A and Airports of Thailand merely do commercial concern. This difference in merchandise mix makes their operation features different from each other. A failure to command for these differences leads to the inaccurate consequence. To better the quality of rating, the averaged industry P/E ratio could be used to do assorted beginnings of non-comparability naturals each other out, but with more rivals involved there will be less homogenous. ( Penman, 2010 )
It can be seen that although the P/E based rating seems to be simple and consecutive forward, in pattern it ‘s non every bit simple as it would be. Method merely produce valid monetary values if the comparators are to the full appropriate, but designation of ‘comparable ‘ houses is frequently rather hard. Even if good comparators are found, the usage of individual twelvemonth figures oversimplifies net incomes form. Besides, understanding why P/E ratios vary across houses, and how applicable another house ‘s P/E ratio is to the 1 at manus, requires a sound cognition. Furthermore, establishing rating on accounting Numberss makes the consequence suffers from the distort finanicial statements and the differences in accounting policy. In add-on, the estimated value depends on market pieces. It regards the market is efficient in puting monetary values for the comparables. However if this is the instance, why do n’t utilize BBA ‘s market monetary value straight? If the comparables are mispriced, so the exercising is besides dubious.
However, P/E ratios analysis is widely used due to its simpleness and therefore portion monetary values may reflect PERs even if they are non right theoretically. Since analysts want to calculate alterations in existent portion monetary value alternatively of the theoretically right one, it is reasonable to utilize the method.
In geting at rating under forecast free hard currency flow method, the chief job comes from the making of significant premises and anticipations. In this instance, there are many hapless estimates to world. For illustration, changeless growing rate, fixed investing to growing in gross, unchanged revenue enhancement rate, fixed pitching ratio and changeless WACC. Besides, the CAPM theoretical account is uncomplete to gauge the cost of capital. Factors like size consequence beyond systematic hazard seem to play more functions in explicating fluctuation in long-term mean return. ( Palepu, 2010 ) With the company turning over times the cost of equity is altering. And, when making arrested development analysis merely 15 yearss figures are used and this cause great inaccuracy. Furthermore, the immense difference between BBA ‘s market value and estimated value may come from the incorrect premises on gaining form and reinvestment beyond terminal twelvemonth. It ‘s difficult to foretell future public presentation accurately. The BBA may non keep unnatural net incomes with no reinvestment for long period, so the hard currency flow beyond terminal twelvemonth is overestimated.
Therefore, from the procedure of calculating free hard currency flow, it could be found that do non like P/E ratio analysis, under this method, elaborate multiyear prognosiss of a figure of parametric quantities such as growing, profitableness, reinvestment rate and cost of capital are needed. All the anticipations made need sound implicit in premises, and therefore a batch of complexnesss and inaccuracies involved. Besides, it ‘s non aligned to calculate net incomes when meaning to acquire the hard currency flow figure. And when predict future income statements and balance sheets, the usage of depreciation as a placeholder for current outgo on replacing bing assets is of limited cogency. In add-on inaccuracy involved because free hard currency flow does non mensurate value added in the short tally and it is partially a settlement construct.
However, although disadvantages exist, unlike P/E analysis discounted free hard currency flow is more dependable. It cuts through much of the flightiness and “ guestimates ” in reported net incomes by concentrating on hard currency flows which are difficult to falsify. And, unlike P/E analysis, it depends on future outlooks instead than historical informations. If premises are made accurately, theoretically talking DCF could be the most sound rating method since it clearly reflects the basic rule of finance. The value of an plus or investing is the present value of the net hard currency final payments that the plus generates.
With jobs involved in BBA Aviation ‘s rating procedure, it could be found that both prospective pricing-earnings ratio analysis and free hard currency flow analysis have the hazard of being misused. To acquire the accurate consequence under rating theoretical accounts, great attempts are needed when doing good anticipations and premises. Because each technique involves different advantages and disadvantages there are additions to sing several attacks at the same time.