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Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
Page 1 of 93
Executive Summary
The thesis is motivated by the challenges faced by external investors when valuing companies. The
research question of this thesis is to estimate a fair value of Cimber Sterling Groups’ share price at
the 17th March 2010. The discounted cash flow model is applied based on its important place within
valuation theory in contemporary corporate finance. To answer the research question thoroughly
both a strategic and financial analysis is made as a foundation for the later use of the discounted
cash flow model. The strategic analysis reveals the most important strengths, weaknesses,
opportunities, and threats that each will affect the potential value creation to shareholders in the
future in a positive or negative way. The historical financial analysis reveals profitability and risk,
which have affected the value creation over the last three years. The profitability is decomposed to
identify the underlying reasons for the negative development.
By integrating the value drivers identified in the financial and strategic analysis a budget forecast is
estimated. The budget forecast is used to calculate a share price estimate using the discounted cash
flow model, which gives a fair price of DKK 11,07. The residual income model is used as a
calculation check of the DCF model. The theoretical share price is significantly higher than the
actual closing share price the 17th March of DKK 3,89, which suggest that the market undervalues
the share. The theoretical share price is examined through a sensitivity analysis and a peer group
analysis. The sensitivity and peer group analysis suggests a high level of uncertainty combined with
the theoretical share price. The thesis therefore stresses the vulnerability of the valuation models
used and their underlying assumptions.
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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Table of Contents
Table of Contents ...................................................................................................................................... 2
1. Introduction ........................................................................................................................................... 5
1.1 Motivation ....................................................................................................................................... 5
1.2 Problem Statement .......................................................................................................................... 5
1.3 Structure .......................................................................................................................................... 6
1.4 Delimitations and Assumptions ...................................................................................................... 7
1.5 Method ............................................................................................................................................ 7
2. Background Information ....................................................................................................................... 8
2.1 The Efficient Market Hypothesis .................................................................................................... 8
2.2 Theory of Valuation Models ........................................................................................................... 9
2.2.1 Theory of the DCF Model ........................................................................................................ 9
2.2.1.1 CAPM .............................................................................................................................. 11
2.2.2 Peer Group Analysis .............................................................................................................. 13
2.2.3 Conclusion Valuation Theory ................................................................................................ 13
2.3. Overview of Airline Industry ....................................................................................................... 14
2.3.1 Airline Industry ...................................................................................................................... 14
2.3.2 Brief Introduction of Cimber Sterling Group A/S ................................................................. 15
3. External Analysis ................................................................................................................................ 16
3.1 PEST ............................................................................................................................................. 16
3.1.1 Political-legal Environment ................................................................................................... 16
3.1.2 Economic Forces .................................................................................................................... 16
3.1.3 Socio-cultural ......................................................................................................................... 17
3.1.4 Technological ......................................................................................................................... 17
3.2 Five Forces .................................................................................................................................... 18
3.2.1 Threat of New Entrants .......................................................................................................... 19
3.2.2 Bargaining Power of Suppliers .............................................................................................. 19
3.2.3 Bargaining Power of Buyers .................................................................................................. 19
3.2.4 Threat of Substitute Products or Services .............................................................................. 20
3.2.5 Rivalry among Existing Competitors ..................................................................................... 20
3.2.5.1 SAS .................................................................................................................................. 21
3.2.5.2 Norwegian ........................................................................................................................ 21
3.2.5.3 Ryanair ............................................................................................................................. 22
4. Internal Analysis ................................................................................................................................. 24
4.1 Resources ...................................................................................................................................... 24
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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4.1.1 Tangible Resources ................................................................................................................ 24
4.1.2 Intangible resources ............................................................................................................... 25
4.2 The Initial Public Offering ............................................................................................................ 26
4.3 CSG’s Strategy .............................................................................................................................. 28
4.3.1 Vision, Strategy, and Business Model ................................................................................... 28
4.3.1.1 Vision ............................................................................................................................... 28
4.3.1.2 Strategy and Business Model ........................................................................................... 28
4.4 Critical Review of CSG’s Strategy ............................................................................................... 29
4.5 SWOT ........................................................................................................................................... 31
4.6 Preliminary Conclusion................................................................................................................. 33
5. Financial Analysis ............................................................................................................................... 34
5.1 Reorganizing the Financial Statements ......................................................................................... 35
5.1.1 Statement of Changes in Equity ............................................................................................. 35
5.1.2 The Balance Sheet .................................................................................................................. 35
5.1.3 The Income Statement ........................................................................................................... 37
5.2 Analysis of Profitability ................................................................................................................ 38
5.2.1 Decomposition of ROE .......................................................................................................... 38
5.2.1.1 Financial Gearing and Spread .......................................................................................... 39
5.2.1.2 Net Borrowing Rate ......................................................................................................... 41
5.2.1.3 ROIC ................................................................................................................................ 41
5.2.1.4 Turnover Rate of Asset and Profit Ratio .......................................................................... 42
5.2.1.5 Profit Ratio Drivers .......................................................................................................... 43
5.3 Airline Specific Key Ratios .......................................................................................................... 45
5.3.1 ASK ........................................................................................................................................ 46
5.3.2 RPK ........................................................................................................................................ 46
5.3.3 Load Factor ............................................................................................................................ 46
5.3.4 Yield ....................................................................................................................................... 47
5.4 Risk Analysis ................................................................................................................................ 47
5.4.1 Operating Risks ...................................................................................................................... 47
5.4.2 Financial Risks ....................................................................................................................... 48
5.5 Permanent Earnings ...................................................................................................................... 49
5.6 Preliminary Conclusion................................................................................................................. 49
6. Forecasting .......................................................................................................................................... 50
6.1 Forecast Horizon ........................................................................................................................... 51
6.2 Revenue Growth ........................................................................................................................... 52
6.3 Operating Costs Held for Sale ...................................................................................................... 53
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6.1.5 Rental and Leasing Expenses ................................................................................................. 54
6.1.6 The Effective Tax Rate .......................................................................................................... 54
6.1.7 Other Operating Profit (after tax)........................................................................................... 55
6.1.8 Depreciation, Amortization and Impairment ......................................................................... 55
6.1.9 Net Working Capital and Non-current Net Operating Assets ................................................ 55
6.1.10 NOPLAT .............................................................................................................................. 56
6.1.11 Net Operating Asset ............................................................................................................. 56
7. DCF Valuation .................................................................................................................................... 57
7.1 Estimation of WACC .................................................................................................................... 57
7.1.1 Target Capital Structure ......................................................................................................... 57
7.1.2 Return Demanded by Equity Investors - rEquity ...................................................................... 58
7.1.3 Return Demanded by Debt Investors - rD .............................................................................. 58
7.1.4 WACC .................................................................................................................................... 59
7.2 Calculation of Share Price Estimate from DCF Model ................................................................. 59
7.3 Sensitivity Analysis ...................................................................................................................... 60
7.3.1 Growth Drivers ...................................................................................................................... 61
7.3.2 Financing Drivers ................................................................................................................... 62
8. Peer Group Analysis ........................................................................................................................... 62
9. Conclusion .......................................................................................................................................... 65
References ............................................................................................................................................... 68
Appendices .............................................................................................................................................. 76
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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1. Introduction
1.1 Motivation
The process of choosing a topic for our bachelor thesis created many discussions, and many areas of
interest were considered. Our choice fell on a fundamental analysis of a company. The motivation
for choosing a fundamental analysis was primarily to get an understanding of the challenges that an
external investor and analysts have when estimating a fair value through the contemporary
valuation models.
Several companies were then considered for a fundamental analysis however one company
continuously came to our attention through massive media coverage. This company was Cimber
Sterling Group A/S (CSG), a Danish airline. The process of CSG’s initial public offering (IPO), the
fluctuating share price, and the media coverage that followed are all factors that have motivated us
to choose CSG. Furthermore it is a relatively small airline company in a very competitive industry,
which by nature implies great risk and great opportunities. The general shift towards low cost
carriers (LCC) worldwide has increased the competition within the industry dramatically. This shift
makes it harder for everybody to operate profitably, which makes CSG an interesting research
subject. What made it even more interesting was the fact that CSG was a family owned company
that had not publicly reported their financials before, and we therefore had a limited amount of
historical data to work with. By choosing CSG instead of a large company in a steady business it
will make our job difficult but more similar to that of an external investor or analyst.
1.2 Problem Statement
During the last weeks before CSG’s IPO, in November 2009, they were forced to lower their asking
price from the range DKK 20-24 to the range DKK 10-13. The closing price on the 17th of March
was DKK 3,89 (Nasdaq OMX Nordic, 2010). The extreme share price differences are the basis for
an investigation of the fair value of the share. Many different parties are interested in evaluating the
fair price of CSG, these among others include: Current and future investors, banks, creditors,
customers, suppliers, and collaborators. The approach of this paper is to evaluate CSG from an
external investor point of view. The problem faced by external investors today is to evaluate
whether the current price is fair in the light of the acquiring of Sterling A/S’ assets and the
mispriced IPO. On this background we want to make a fundamental analysis of the fair value of
CSG to reach an estimate of the share price after the turbulent IPO. On the 17th of Marts the 3rd
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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quarter report was released and it is thereby a natural cut-off date. No information that appears after
this date will be considered in the fundamental analysis.
Research question:
What is the fair value of Cimber Sterling Group’s share?
1.3 Structure
This paper will start with an introduction that contains: motivation, problem statement, structure,
delimitation and assumptions, and method. Following the introduction there is a section called
background information covering the efficient market hypothesis (EMH), theory of valuation
models, and an overview of the airline industry. Then a strategic analysis is carried out based on an
external and internal analysis. The external analysis includes a PEST and a five forces analysis. The
five forces analysis will include a review of CSG’s main competitors. The internal analysis focuses
on CSG’s resources, the recent IPO and a critical review of CSG’s strategy. The strengths,
weaknesses, opportunities, and threats identified in the strategic analysis will be summarized in a
SWOT matrix. After this, a financial analysis will be carried out, which will start with a
reformulation of the financial statements. Having done this, a profitability analysis containing a
decomposition of ROE is made. The financial analysis also contains an analysis of airline specific
key ratios and a risk analysis.
The strategic and financial analysis will then be used as a foundation for budget forecasting. The
budget forecast is then used to perform the actual valuation of CSG’s share by means of the
discounted cash flow (DCF) model. A sensitivity analysis is made to evaluate the certainty of the
share price calculated through the DCF model, and to identify the most sensitive value drivers. A
peer group analysis will be used in the end to find another share price estimate, which can also be
used to evaluate the certainty of the fair price calculated. The overall structure can be seen from
figure 1.
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1.4 Delimitations and Assumptions
This paper will only focus on the European airline industry, as CSG only operates in Europe. Hence
whenever “airline industry” or the “market for air travel” and the like are mentioned it will only
include Europe unless otherwise stated. Throughout the paper the focus will be on three main
competitors. In the section about the airline industry the reasons why these three companies are
used as the main competitors will be described.
The report will be made from the perspective of an external long-term investor and the only
information that will be used will be publicly available information. It is assumed that the market is
not completely efficient, since it would make limited sense doing a fundamental analysis if the
EMH is assumed true. The EMH is discussed in section 2.1
Deviations from the calculated firm value to the actual stock price can have multiple causes, one of
which is the psychological factors behind stock trading. These factors are not always rational, and
they are very difficult to predict. These psychological factors might result in an inefficient market,
and combined with the fact that the psychology surrounding stock market trading is worthy of a
whole assignment by itself, they will not be dealt with in this paper.
1.5 Method
This report sets out to estimate the objective fair value of CSG using fundamental analysis. This is
done with the assumption that there is only one objective fair value, and that an outside investor
cannot calculate the exact objective fair value due to asymmetry of information. We will try to get,
as much information as possible and at the same time be critical about the information used. Any
valuation will be subjective, as we will be influenced by all public information about CSG and other
companies, but we will try estimating the objective fair value of CSG using fundamental analysis.
Budget
Forecast
Financial
Analysis
Strategic
Analysis
Valuation
Figure 1: Own processing with inspiration from Ole Sørensen (2009, p. 21)
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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We will have a critical approach to reduce the personal bias that we will consciously or
unconsciously have towards CSG. We will focus on one model and get an in depth analysis of CSG
using this model, an alternative to a more broad analysis using several theories. This paper uses a
practical approach to the valuation, the emphasis is therefore not on an analysis of different
theories. The report will be composed of secondary data, which includes among other things books,
newspaper articles, annual reports, the prospectus, and scientific research reports. No primary data
will be collected as it is evaluated that an external investor or analyst will typically not collect this
kind of information.
2. Background Information
2.1 The Efficient Market Hypothesis
The EMH states that an asset is always traded at a price that incorporates all available information
relevant to that asset. Changes in asset prices only occur when the market receives new information
that cannot be predicted in a systematic manner. This means that a change in interest rate by the
central bank, which is expected by the market, will have no influence on the price of securities.
According to the EMH new information will be reflected in the price of an asset almost
instantaneously, and by using available information all market participants arrive at the same
“rational expectations” forecast for the future. It follows from this that if all relevant information is
incorporated in the price of the asset, and if all market participants are arriving at the same “rational
expectations” forecast, it must mean that there should be no trade. Trade implies that a seller
expects the price of the asset to decline, and a buyer expects the price of the asset to rise.
Furthermore, even if a particular cause is expected by the market it does not mean that all
participants in the market has fully understood the effect it will have and thereby discounted it
(Shostak, 1997, p. 31). It would make less sense to make a fundamental analysis if we were to
assume the EMH to be true, since any deviation in value found would be derived from calculation
errors on our part. The degree to which the EMH is true can be said to influence the importance of
this valuation of CSG. However if the EMH is true then a fundamental analysis can still be used to
detect the implicit expectations that the market has for the given price (Sørensen, 2009, p. 28). It is
believed there are too many assumptions in the EMH that do not hold in the real world, and the
EMH is assumed not to be entirely true; the market is assumed to be semi-efficient.
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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31 2
2 3Equity value= ...
1 (1 ) (1 )E E E
DIVDIV DIV
r r r+ + +
+ + +
2.2 Theory of Valuation Models
There are many ways to value a company. Just for a single takeover bid or price setting of an IPO,
investments banks will normally use five to ten different valuation models (Palepu, Healy, &
Bernard, 2004, p. 7-1). Valuation models can broadly be categorized as relative or absolute. The
relative valuation models use a limited amount of information and budget forecasting is not
necessary, since price is estimated relative to other companies. The absolute models require a
budget forecasting based on all relevant information, since the price estimated is based on the
fundamental value of the company. An absolute model is used as the primary model in this paper as
it is believed that an in depth analysis of the entire company is needed to get the fair value. The
primary model used in this paper is the DCF model. It is chosen for several reasons: The focus on
the DCF model in contemporary literature and its prominent place in corporate finance theory
(Sørensen, 2009, p. 41). The method of comparables is used to find a share price estimate that can
be compared with the share price estimate from the DCF model. These two models will now be
discussed in detail to reveal strengths and weaknesses of each model.
2.2.1 Theory of the DCF Model
The basis for all absolute valuation models, including the DCF model, is the dividend discount
model (DDM). The DDM is based on the idea that the present value of all future dividends of a
company must reflect the equity value of the company. This can be expressed as follows (Palepu et
al., 2004, p. 7-2):
The dividend payoffs for each year are discounted at the cost of equity, which is the relevant
discount rate. The reason why the DDM itself is not widely used in practice is that dividend payoffs
do not necessarily represent the value creation of a company, but rather just a payout of value
(Sørensen, 2009, p. 41). The dividend model is unsuitable in the case of CSG, since dividends only
have been paid out in one year (2007/08) in the financial statements available, and no dividends are
expected for the coming years. Furthermore the dividend model can only be used when there is a
good relationship between the dividend payout policy and internal value creation in the company,
which cannot be concluded from the available information.
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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Terminal periodForecast period
1
1
Equity value(1 ) ( )(1 )
TNFLT
t Tt WACC WACC WACC
FCFFFCFFV
r r g r
+
=
= + −+ − +
∑
��������������
The DCF model is using forecasted free cash flows (FCF) instead of dividends. The DCF model can
be used in two ways, direct or indirect. The direct model estimates the equity value directly by
using free cash flow to equity (FCFE). FCFE is the FCF available for equity holders. The indirect
model is using free cash flow for firm (FCFF), which is the FCF available for the whole firm. The
indirect model estimates the enterprise value and deducts net financial liabilities to find the equity
value. The indirect method is chosen since it focuses on the operating activities and ignores
financing activities in relation to value creation (Sørensen, 2009, p. 313).
DCF Model:
The rationale behind the equation is that equity value is calculated by deducting net financial
liabilities from the discounted cash flows from a forecast period and from a terminal period. A
strength of the DCF model is that it incorporates the effects of the tax shield by using WACC. The
DCF model incorporates the tax shield by reducing the WACC (Koller, Goedhart, & Wessels, 2005,
p. 113).
The DCF model assumes that the free cash flows are all generated at the last day in the financial
year, which seems inconsistent with reality; the free cash flows will normally be generated
throughout the year. To get a more realistic picture of the real world the free cash flows are
discounted from the end of the year to the middle of the year; assuming that the free cash flows are
approximately normal distributed throughout the year. This is done by multiplying the share price
estimate with the square root of 1+WACC (Koller et al., 2005, p. 107).
The main criticism of the DCF model is the potential uncertainty when forecasting a company’s
profits. The available information, in form of historical financial statements and their quality, is one
factor that affects the accurateness of the forecasts made.
The value of the terminal period is estimated through perpetuity and it therefore makes up a large
part of the total value. The importance of the terminal period varies depending on the growth
expectations in the terminal period and the number of years forecasted before the terminal period.
This means that very small changes in the terminal period factors will have a significant impact on
the estimated share price.
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Forecasting is based on a mix of strategic and financial value drivers. A forecast will always be
subjective and express personal expectations for the future. According to Benjamin Graham, “(…)
the combination of precise formulas with highly imprecise assumptions can be used to establish, or
rather justify, practically any value one wishes (…)” (Graham, 1958, p. 17). This quote captures the
potential danger and weakness of fundamental analysis and emphasizes an important point. When
using any kind of valuation model to calculate a specific price it is important to see that price in the
light of the assumptions made to reach that specific price. Therefore: “Anchor a valuation on what
you know rather than on speculation” (Penman, 2007, p. 122). The idea of anchoring a valuation
only on what you know is good, but in practice it is seldom the case. CSG have recently had an
IPO, changed their strategy, and they had had negative earnings the last year. Vulnerable
assumptions therefore will be made when estimating value drivers. Forecasting CSG gets more
uncertain because of the limited available historical records. In a case like CSG it is therefore even
more necessary to have a good understanding of the company and its activities to reach a reliable
result.
WACC is an important variable when using the DCF model since it is used to discount all future
cash flows. WACC is calculated from the relation between a company’s capital structure, the debt
investors required return, and the equity investors required return. To estimate equity investors
required return the capital asset pricing model (CAPM) will be used and is therefore briefly
discussed here.
2.2.1.1 CAPM
CAPM provides us with equity investors required return and expresses the expected return from a
security as the relation between the risk free rate, the expected return from an average market
portfolio, and the riskiness of the company.
( ) ( ( ) )
: Risk free rate
: Sensitivity of a stock's return to the market portfolio
E(r ) : Expected return by investing in a market portfolio
E(r ) : Market risk premium
F M F
F
M
M F
CAPM E r r E r r
r
r
β
β
= = + −
−
The expected rate of return depends on two things: “Compensation for the time value of money (the
risk free rate rF) and a risk premium, which depends on beta and the market risk premium (E(rM)-
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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rF)” (Brealey, Myers, & Marcus, 2007, p. 304). It is thus based on the relationship between risk and
return. There are many assumptions behind the CAPM and they are often criticized for being
unrealistic. History has shown conflicting results on whether the CAPM is usable in practice or not,
however CAPM remains the leading model for estimating required returns (Brealey et al., 2007, p.
308). Despite its unrealistic assumptions CAPM is widely used and will also be applied in this
paper.
Beta and the market risk premium are difficult to estimate. They will therefore be discussed in the
following.
The market risk premium can change substantially when the market is experiencing a chock. The
market risk premium range from “3 percent to 9,20 percent in texts and research papers” (Penman,
2007, p. 112), which means that the estimation involves a high degree of uncertainty. Considerable
time will be used to find relevant historical risk premiums to reach an estimate of the market risk
premium in Denmark.
The estimation of CSG’s beta is even trickier, which can be emphasized by the following quote:
“No one knows the true beta and inevitably beta are measured with error” (Penman, 2007, p. 112).
Beta expresses the risk of a security in relation to the market portfolio, which will change in the
short run as well as the long run depending on the state of the company and its activities. Some
companies are selling beta estimates, but as the aim of this paper is to use only publicly available
information, these companies will not be used. The beta of a company can also be calculated from
historical records of returns from that company in relation to the return of the market, but with the
information available from CSG this is assumed to be too time consuming compared to accuracy of
the potential result. The beta of CSG is instead estimated by using a framework (Plenborg &
Gruelund, 2002, p. 59), which makes it possible to estimate beta from the degree of operating and
financial risk. This common sense method is believed to be a good approach in CSG’s current
turbulent situation.
An estimation of WACC requires estimation of multiple unknown factors, which increases the
uncertainty of the valuation. It can be emphasized by Penman who points out that "(…) estimates of
required returns are likely to be highly unreliable” (2007, p. 112).
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2.2.2 Peer Group Analysis
Peer group analysis also called the method of comparables is a relative valuation model. The main
idea behind the method of comparables is the “law of one price” (Brealey et al., 2007, p. 604)
meaning that in an efficient market two identical goods must have the same price. Two companies
with the same size, risk, growth opportunities, return, and so on should have the same value. As
already discussed earlier the EMH, supporting “the law of one price”, is based on vulnerable
assumptions that are questionable to hold in real life, especially on a short-term basis. The prices
estimated through relative valuation methods are: “(…) Not anchored in something fundamental
that tells us about value independently of market prices” (Penman, 2007, p. 77). This means that the
market prices set for the comparable competitors must be set right for the result of the valuation to
turn out right, which again is questionable. Relative valuation of a company that recently has had
their IPO will according to Kim and Ritter (1999) be less accurate than in the case of more mature
companies with steady growth rates (Kim & Ritter, 1999, p. 436). This makes sense since young
companies often have more growth potential whereas their future is more uncertain. It is therefore
conflicting that investment bankers often use the method of comparables to get a quick feel of how
the market will value the company (Penman, 2007, p. 77).
The idea behind the method of comparables is to compare relevant price multiples, such as P/E,
with comparable companies (peer group), that are already valued by the market, to arrive at a
relative price for the company under investigation (ibid., p. 76). The precision and applicability of a
relative valuation is primarily dependent on the ability to find an appropriate peer group and price
multiples.
Normally a peer group will be selected from companies within the same country to reduce the
effects of differences in competitiveness and accounting standards across countries. In the airline
industry and in a small country like Denmark it is not possible to find a national peer group.
Therefore international companies are used. The price multiples should be selected in a way so they
reflect CSG in the best possible way. The traditional price multiples can normally give a good
picture of an industry.
2.2.3 Conclusion Valuation Theory
The DCF model is used as the primary valuation model. The DCF model demands a comprehensive
analysis of the company, where all relevant information is considered. This will give us a better
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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insight into all aspects of CSG and on that basis estimate a fair share price. The residual income
model will be used as a technical control of the DCF estimate.
The relative valuation models are easy to use and you reach a result quickly since its use of data is
very limited. The possible inaccuracy arising from a heterogeneous peer group and inappropriate
price multiples is the most obvious weaknesses. The peer group analysis will be used for two
primary reasons. It will provide a share price, estimated from a peer group, that can be compared
with the result of the fundamental analysis and to evaluate whether is usable in real life. It will
thereby be a control of the validity of the fair price estimated through the DCF model and it can be
used to reflect on the assumptions made under each model.
The strategic analysis will now be conducted to identify non-financial value drivers.
2.3. Overview of Airline Industry
2.3.1 Airline Industry
The aviation market in Europe was deregulated by the European Union with three policy packages
agreed upon in 1988, 1990, and 1993. As a result full deregulation came into force in 1996-1997
(Consequences of E.U. airline deregulation in the context of the global aviation market.2001, p.
103-104), known as the “open skies” deregulation. The deregulation has changed the industry
structure. The main effects of the deregulation were identified to be: The massive growth of LCC
such as Ryanair and Easyjet, a rise of international airline alliances, an increase of carriers covering
the same routes. The focus on the Hub-and-spoke route system also increased with the deregulation.
The idea of a Hub-and-spoke route system is to bring together passengers from many small airports
to a central big airport (Hub) where connecting long distance flights are available. This can increase
efficiency and reduce costs (Open skies and flights of fancy.2003, p. 65-67). The downside is that
any problems with a Hub can create delays throughout the whole system, which makes it more
vulnerable. The traditional point-to-point route system is as the name suggests direct travelling
without the need for connecting flights.
The increased influence and market share of the LCC relative to the classic network carriers (NC)
characterizes the contemporary European airline industry. The European LCCs Air Berlin, Ryanair,
and Norwegian have performed remarkably in July 2009 with net profits of $142m, $373m, and
$67m respectively. The European NCs British Airways, Iberia and Air France KLM have on the
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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other hand performed disappointingly in July 2009 with net losses of $102m, $24m, and $219m
respectively (Dunn, 2009, p. 14).
A similar comparison is emphasizing this tendency. The three LCC’s Norwegian, Ryanair, and
Easyjet generated a compound annually growth rate (CAGR) of approximately 20% while the five
NC’s SAS, Lufthansa, Air France KLM, Finnair, and British Airways generated a CAGR of
approximately 3% (Cimber Sterling Group A/S, 2009g, p. 112). The LCCs share of the market for
European flights increased from 5% to 30% during the period 1998-2008, while the NC’ market
share during the same period dropped from 78% to 60% (Cimber Sterling Group A/S, 2009g, p.
113). The airline industry is undergoing some dramatic changes.
The general deregulation of the air traffic has lead to new market possibilities and a new market
structure, which can be emphasized by the dramatic increase in passengers transported by LCC.
2.3.2 Brief Introduction of Cimber Sterling Group A/S
Until 2008 when Cimber A/S purchased assets from the bankrupted company Sterling A/S it was a
relatively small airline with mainly domestic flights in Denmark. With the purchase CSG acquired a
license to operate larger aircrafts, as well as acquiring new routes going out of Denmark. CSG sees
themselves as a hybrid carrier, with two focus areas, as both a LCC and a NC (Cimber Sterling
Group A/S, 2009g). After the IPO in December 2009 there are now four main groups of equity
owners of CSG. The first and largest are the three former owners and children of Ingolf L. Nielsen,
the founder of CSG, Jørgen Nielsen, Lone Marie Koch, and Hans Ingolf Nielsen, who between
them own 39,57% (Cimber Sterling Group A/S, 2009b; 2009c; 2009d)of the shares, the other is the
Danish billionaire Karsten Ree who owns 11% of the shares (Cimber Sterling Group A/S, 2009e),
and the last is the Bitten and Mads Clausen Foundation, the founder of the Danish industrial giant
Danfoss which owns 6,59% of the shares (Cimber Sterling Group A/S, 2009a). The rest of the
shareholders own a smaller portion of shares.
On the 1st of January the former CEO and major shareholder Jørgen Nielsen took over CSG’s
business development activities and Jacob Krogsgaard took the position as CEO (Cimber Sterling
Group A/S, 2009f, p. 1).
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3. External Analysis
3.1 PEST
To understand the macro environment that CSG is operating in, a PEST analysis will be carried out.
The macro environment is important since it has an effect on CSG’s ability to create value
(Sørensen, 2009, p. 82). The PEST framework consists of Political, Economic, Socio-cultural, and
Technological factors of the macro environment (Lynch, 2008, p. 82), and it will be applied to
Europe, our area of interest. The PEST framework is a tool, which ensures that the most important
aspects of the macro environment are covered. It will in this paper be used very selectively. This
means that more time will be used on the factors that are seen as most important according to an
understanding of the macro environment in relation to the main purpose of the paper – a valuation
of CSG.
3.1.1 Political-legal Environment
In today’s environmentally friendly world politicians try their best to minimize the impact that
different industries have on the environment. As the airline industry is polluting through CO2
emissions (Gross & Schröder, 2007, p. 193), politicians from all countries discuss what can be done
to minimize this pollution. The European Commission is working on ways to impose taxes on
airlines to get them to lower their CO2 emissions (European Commission, 2005). There is much
uncertainty combined with the future political regulations made in relation to CO2 emissions for the
airline industry, but there is a clear tendency towards regulations supporting sustainability of the
environment, which might increase the competition from for example the rail network in Europe
that are a more environmentally friendly transport form. The rail network in Europe will be further
discussed in section 3.1.4.
3.1.2 Economic Forces
The developments in the national and international economies play an important role for the
profitability of airlines. As can be seen from appendix 16 the airline industry is very sensitive to
market fluctuations. The effect of the 9/11 terrorist attack and the financial crisis can be seen on
both graphs; air traffic and GDP growth is correlated. Therefore GDP growth is an important factor
to consider. The financial crisis that became apparent with the collapse of Lehman Brothers on the
15th September 2008, has affected the world economy dramatically (Wearden, Teather, & Treanor,
2008). In Europe it can be emphasized by the GDP development that can be seen from appendix 16.
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From 2007 to 2008 the GDP in Europe1 only grew 0.8%, and from 2008 to 2009 the GDP decreased
4,2% (Eurostat, 2010c). The GDP growth forecast for 2010 is an increase of only 0.70% and 1.60%
for 2011. The non-existent or slow growth will therefore continue to affect the airline industry’s
value creation for the coming years in a negative way.
The European Central Bank’s (ECB) interest rate, hence the prize of money, was 2,50% in 2008
(Eurostat, 2010b). The interest rate has been at a record low 1% (European Central Bank, 2010)
since the 13th May 2009. The lowered interest rate from 2008 to 2010 expresses the ECB’s
intervention during the financial crisis to maintain price stability in the European Union. Greece’s
current financial debt crisis has questioned the survival of the euro currency (Greek tragedy; the
indebted economies of southern europe threaten the financial stability of the eurozone. the need for
a bailout illustrates the flaws in monetary union.2010). The debt crisis in Greece can potentially
spread to the whole European region, with a decrease in financial activity and thereby also affecting
the interest rate level. Interest rates are hard to predict, but will have an impact on the general
economic activity and on the airline industry.
3.1.3 Socio-cultural
The increased integration and interdependency of economies and people across the world and
specifically in Europe has an impact on several social and cultural factors. First and foremost the
EU and its internal market are making it easier for people to work in other EU countries. The time-
space difference is getting smaller and this convergence between countries is changing the
consumer habits. More people travel and work abroad, which can be emphasized by the general
increase in carried air traffic passengers over the last 10 years (Eurostat, 2010a). This increase is a
good opportunity for CSG.
3.1.4 Technological
The development of the Internet has changed almost all businesses in some way. The airline
industry has seen a change in their communication with customers, which has changed from being
through travel agencies and by phone to rely more on e-mail and online ticketing. The Internet has
increased the price transparency and increased competition. It is hard to imagine that the importance
of the Internet will decrease, and new online services for airline passengers are invented all the
1 European union, 27 countries
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time. It is important for CSG to be aware of technological changes and this development should not
be underestimated as it might lead to a competitive disadvantage.
The rail network in Europe has been and will be strengthened by the European Commission. The
focus of the European Commission is a general deregulation of the rail network to increase
competitiveness, improving safety, and a further development of the rail transport infrastructure
(European Commision, 2010). A more competitive rail network demands large investment in the
infrastructure, which to a large degree depends on political willingness, but if heavy investment is
made, “(…) trains in Europe will be able to compete with the airline traffic in the longer run”
according to Adler (Adler, Pels, & Nash, 2010, p. 1). Depending on the degree to which a rail
network will be able to compete with the airline industry it can have a small or heavy impact on the
airline industry in the future. Another scenario is that the airlines and rail network operators will
merge and combine their air and rail transport service to a higher degree than we see today. The
combination of providing air and rail network services is already under planning from the NC Air
France-KLM, which is planning a high speed train connection between Paris and London, but the
plans has been grounded in the start of 2010 by French government regulations, which show the
importance of political willingness (Wright, 2010). It can be said that there are several possibly
scenarios for the future of high-speed transport within Europe, but it seems that the airline industry
will see an increased competition from the rail network throughout Europe.
The PEST analysis has identified value drivers that will influence the macro environment for the
airline industry in the future. In the following, Porters five forces are used to identify the
competitive environment within the airline industry.
3.2 Five Forces
The five forces model, introduced by Michael E. Porter in 1979 (Porter, 2008, p. 79), is a
framework that focuses on the attractiveness of a specific market (Kotler & Keller, 2008, p. 334) by
analysing five specific market forces: Threat of new entrants, bargaining power of suppliers,
bargaining power of buyers, threat of substitute products or services, and rivalry among existing
competitors. CSG’s ability to create value is influenced by these five forces and they are therefore
investigated below.
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3.2.1 Threat of New Entrants
The threat of new entrants is linked to the entry barriers in an industry. There are multiple entry
barriers in the airline industry. The route entry barrier is connected to the limitation on number of
routes from an airport to the same destination; the so-called slots2. Cimber A/S’s acquisition of
Sterling A/S’s assets included Slots for several international routes and technical documentation and
manuals in relation to acquiring and maintaining a B737 AOC, which meant that CSG could start to
operate international flights (Cimber Sterling Group A/S, 2009g, p. 31).
Another entry barrier is that the initial costs when entering the airline industry is high – the industry
is capital intensive. Normally a capital intensive industry would imply a low degree of new entrants,
but according to Michael E. Porter financing of expensive aircraft’s are usually available for
aspiring airline companies because of their high resale value, which is one of the reasons why: “(…)
there have been numerous new airlines in almost every region” (Porter, 2008, p. 81).
It seems that slots and required documentation for operating an airline company is an entry barrier
with low significance, which can be emphasized by the entrance of a significant amount of LCCs in
the past 10 years.
3.2.2 Bargaining Power of Suppliers
The primary supply need and a concern for an airline company is fuel, this also applies to CSG
“Cimber Sterling is exposed to risks associated with the price and availability of aircraft fuel”
(Cimber Sterling Group A/S, 2009g, p. 22). There are numerous reasons for price and availability
fluctuations, one of them are the bargaining power of suppliers. Oil producing countries are
powerful for several reasons. They are concentrated and organized in OPEC, through which they
are able to influence, or even dictate, the oil prices. There are no product substitutes for aircraft fuel
and aircraft fuel is a critical input for airline companies. The bargaining power of oil companies is
significant and reduces the airline industry’s profitability (Porter, 1979, p. 140).
3.2.3 Bargaining Power of Buyers
For several reasons bargaining power of buyers is high in the airline industry. Buyers often face
limited or no switching cost since their previous travels have little or no influence on their future
travel, also it is easier than ever to compare prices between the different airlines through their own
2 Slots are allocated departure and landing times
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websites or through websites dedicated to comparing airline prices. The development of LCCs in
Europe implies that a lot of people do not want to pay extra to get a free soft drink and a snack.
3.2.4 Threat of Substitute Products or Services
According to Michael E. Porter “A substitute performs the same or a similar function as an
industry’s product by a different means” (Porter, 2008, p. 83). Trains, busses, and cars are three
obvious substitute products. The increased focus on high speed trains in Europe has been discussed
in section 3.1.4 in PEST. Bus transport is a substitute product for especially CSG’s domestic flights.
The main factors that speaks in favor of choosing air travel instead is the speed (travel time) and
convenience.
Another substitute product for airline traffic is videoconferencing (Porter, 2008, p. 84), especially
for business travellers. It is hard to forecast to what degree videoconferencing can replace face-to-
face meetings in the long term future, but we do not believe that it will have a significant impact on
air traffic the next decade. Airline transport is a unique form of traveling and we believe that
substitute products in general will increase the competition for the airline industry, but the airline
industry is unique and will continue to be the most important transport form over longer distances.
3.2.5 Rivalry among Existing Competitors
Out of the competitors that CSG have, we will focus on three that we find most relevant. These
three are SAS, Norwegian, and Ryanair. We have chosen SAS as they are CSG’s main competitor
on the Danish market for domestic flights and they also fly to some of the same destinations in
Europe as CSG. We have chosen Norwegian because they are expanding rapidly on the Danish
market for domestic flights and have been gaining market share in Denmark, on top of that they also
fly to some of the same European destinations as CSG. Ryanair was chosen because they are an
industry leader when it comes to LCCs and they move more people than any other international
airline in the world (Ryanair, 2009). Ryanair also serves some of the same destinations as CSG. We
have chosen not to look at the second largest LCC Easyjet because they only have six routes from
Denmark; they only fly from Copenhagen, only three of their routes serve the same destinations as
CSG, and they are not planning to open any new routes from Denmark in 2010 (Easyjet, 2010). The
alliances within the airline will also be discussed.
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3.2.5.1 SAS
In 1946 three small Scandinavian airlines, Det Norske Luftfartselskap, Det Danske Luftfartselskab,
and Swedish Intercontinental Air Traffic, formed a partnership, which they called SAS. The idea
behind the merger was to offer intercontinental flights, and on September 17th 1946 their first
commercial flight to New York took off (SAS Group, 2010b, p. 15). Two years later the
cooperation was extended to all European flights and in 1950 all operations from the three
companies were transferred to SAS. In the following decades SAS introduced several new routes
and initiatives. In 1984 SAS was awarded the ‘Airline of the Year’ award by Air Transport World
(SAS Group, 2010b, p. 17). In 1996 SAS was serving 103 destinations in 34 countries and
celebrated its 50th anniversary. In 2001 SAS was listed on the stock exchanges in Stockholm, Oslo,
and Copenhagen. From 2004 to 2009 several new routes were introduced from Copenhagen and
Stockholm.
Today SAS offers around 70 destinations in Scandinavia alone and they are therefore having the
strongest route network in Northern Europe (SAS Group, 2010b, p. 9). The three main hubs of SAS
are Copenhagen, Oslo and Stockholm. In the recent years SAS has realized huge losses and their
strategy is now focusing around the “core” concept, which is focusing on streamlining the
organization and cost reduction (SAS Group, 2010a). Profitability has thereby replaced growth as
the main focus for SAS.
3.2.5.2 Norwegian
Norwegian Air Shuttle ASA (Norwegian) was founded in 1993. The first 9 years of operation were
focused around regional flights on the West Coast of Norway. A merger between SAS and
Braathens3, Norwegian’s primary partner, forced Norwegian to follow a new strategy to avoid
closure. The new strategy was to serve the whole Norwegian domestic market. Norwegian started
routes at the four busiest airports in Norway in direct competition with SAS Braathens in 2002. 13
additional routes were added before the end of 2003. Norwegian continued to expand, and from
2003 to 2007 revenue increased by 341% and they transported 462% more passengers (Norwegian,
2010a). On December 18th 2003 Norwegian was listed on the Oslo stock exchange, where they
raised 250 million NOK in an oversubscribed offering. The 31st of July 2007 Norwegian bought
FlyNordic, a Swedish based subsidiary of Finnair, and rebranded the whole company as
3 Now known as SAS Norge
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Norwegian.se. After Danish based Sterling A/S’ bankruptcy in October 2008 Norwegian announced
that they would open several new routes from Copenhagen Airport Kastrup. In May 2009
Norwegian operated 23 routes from Copenhagen Airport Kastrup (Norwegian, 2010a).
Norwegian strategy is focusing on growth, which can be supported by the increase in number of
passengers transported in the past 7 years (Cimber Sterling Group A/S, 2009g, p. 112). From
Norwegians vision it can be seen that they want to: “(…) give everybody the possibility to travel by
air [by] a reduction in the price” (Norwegian, 2010b). Norwegian will continue to follow their cost
leader strategy.
3.2.5.3 Ryanair
Ryanair Holdings Plc (Ryanair) started in 1985 with just one airplane going daily from Waterford in
Ireland to London. In 1986 they got permission to operate the route between Dublin and London
and they increased the number of passengers they carried considerably. Over the next couple of
years they grew rapidly but had difficulty making money. In 1990 they had accumulated losses of
£20 million and the Ryan family restructured the company and invested a further £20 million. In
1991 Ryanair reported a profit for the first time. Ryanair continued to grow and in 1993 they
reached 1 million passengers in one year for the first time. Ryanair kept expanding and two years
later, in 1995, they had doubled the number of passengers they served per year. In late 1996 the EU
completed the “open skies” deregulation, and in 1997 Ryanair opened their first European routes.
Up until then Ryanair had only operated routes in the UK and Ireland. Also in 1997 Ryanair became
a public company on the Dublin and NASDAQ (New York) stock exchanges. In 2000 Ryanair
launched their website, which later became the main base for ordering Ryanair tickets, and they
transport more than seven million passengers. Ryanair continue their rapid growth and by 2006 they
carry 42.5 million passengers, becoming the first airline in the world to carry four million
passengers in one month. In 2008 Ryanair traffic grew 15% to more than 58.5 million passengers
they open 223 new routes, and bring their entire fleet to 181 aircrafts. Ryanair is the largest
international airline in the world today (Ryanair, 2009).
Ryanair’s strategy is focused around heavy expansion and cost minimization on all business areas.
Their objective is to: “firmly establish itself as Europe’s leading low-fares scheduled passenger
airline” (Ryanair, 2010). They are cutting all costs associated with any form of service and focuses
solely on providing the cheapest fares in the industry.
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The rivalry is also affected by alliances. NC have alliances with similar companies in other parts of
the world, which make them capable of having a global route network without operating all routes
by themselves; code sharing and interlining agreements. There are also the more broad alliances:
Star Alliance, One World Alliance, and Sky Team Alliance. These alliances all create strategic
groupings worldwide, but its impact on the rivalry in Europe is considered less significant. CSG has
an alliance with SAS on some of its routes and with the new routes in Europe other alliances could
be an opportunity in the future.
The airline industry has become even more competitive than it has previously been, and as more
LCCs enter the European market, capacity increases and there will be a downward pressure on fares
(Cimber Sterling Group A/S, 2009g, p. 20). The rivalry among airlines is of a destructive kind, as it
gravitates solely to price. When companies compete solely on price, it is easy for competitors to see
and match, making sequential rounds of price reductions, thereby transferring profit directly from
the industry to the customers (Porter, 2008, p. 85). As there is already excess capacity in the airline
industry and as airlines keep opening new routes and fly with a higher frequency on existing routes
there is a further pressure on fares (Cimber Sterling Group A/S, 2009g, p. 21). In January 2010
CSG’s competitor Norwegian offered special tickets at DKK 1 between Copenhagen and Karup,
where CSG and Norwegian are both operating. CSG employees bought more than 650 of these
tickets under fake names as: Donald Duck, Bjørn Kjos (Norwegians CEO), Queen Margrethe II,
and others. When none of CSG’s employees showed up for departures, Norwegian realized what
was going on. According to Professor Anders Drejer from Aarhus School of Business this is highly
amoral (Dagbladet Politiken, 2010). The “Donald Duck stunt” is adding to an already low level of
brand image. The stunt is also a sign of the fierce competition in the airline industry. This
increasing focus on fares is a large risk for CSG as they face competitors with greater capital
reserves and better-known brands.
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4. Internal Analysis
4.1 Resources
CSG’s tangible and intangible resources will be analyzed to explore to which degree the resources
are value creating in relation to their competitors and identify competitive advantages4. Furthermore
the analysis of resources will contribute to the identification of strengths and weaknesses.
4.1.1 Tangible Resources
As expected the primary resources are aircrafts and aircraft components, which amounted to TDKK
727.800 at the end of first quarter in the financial year 2009/10, which is July 2009. This is
approximately 95% of CSG’s tangible assets. Land and buildings; other plants and equipment; and
property, plant, and equipment under construction constituted TDKK 15.500, 17.100, and 6.100
respectively. The focus will therefore be on aircrafts and aircraft components.
CSG’s fleet is composed of nine ATRs5, thirteen CRJs6, and five B7377. CSG is only using
seventeen of these aircrafts for its domestic and international operations, while the remaining ten
aircrafts are operated by other airlines on leasing agreements. The three different aircraft types
serve different needs. The idea is to have the right fit between number of seats and passengers to
minimize the cost per passenger on each route. The ATRs and CRJs are primarily used for short and
medium distance routes, which mean domestic and Nordic destinations. The B737 is used for longer
distance routes and whenever there is sufficient passenger volume on shorter distance routes
(Cimber Sterling Group A/S, 2009g, p. 42). On page 8 of CSG’s interim report for the third quarter
of 2009/10 it is stated that CSG will return two of their CRJ200 jets to their owner, two B737 that
were planned to be leased will not be leased, and one ATR72 is expected to remain on lease instead
of being used by CSG.
Many of CSG’s competitors are focusing on one type of aircraft and then they rely on a high load
factor for its specific volume. CSG’s diversified fleet of large and small aircrafts enables them to
operate flights with both relatively high and low passenger volume, which compared to some of
4 The analysis of resources is written with inspiration from: Ole Sørensen page 90.
5 Short-haul turbo prop aircraft used by a number of regional airlines.
6 Short/medium haul small to mid-sized commercial jet aircraft used by a number of airlines.
7 Boeing 737; the world’s most widely used commercial short and medium-haul jet aircraft. Used by a large number of
airlines worldwide.
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their competitors is an advantage. With an average age of 11,84 years and most of the airplanes 10
years or older CSG’s fleet is very old compared to its competitor Ryanair, which has a fleet with an
average age of 2,77 years and with no airplane older than 8 years (Ryanair Holdings plc, 2009, p.
57).
4.1.2 Intangible resources
To identify if CSG has a competitive advantage over their competitors it is important to look at the
intangible assets, since they are a big part of the value creation in a company. Some of the resources
identified in the following section are unique to CSG and some are not, since the most important
parameter the airline companies compete on is price, there will be more resources that are common
to most airlines and only a few that are unique. CSG has a number of different IT systems that
handle everything from the financials to crisis management; since we assume that most airlines
have the same or similar systems we will not go into detail about them (Cimber Sterling Group A/S,
2009g, p. 48). CSG is a member of International Air Transport Association (IATA) and therefore
they also have the IATA Operational Safety Audit (IOSA) safety certification. Only SAS among
CSGs closest competitors have the same certification (IATA, 2010). The certification means that
every other year CSGs safety procedures are thoroughly gone over to make sure that CSG live up to
the highest international safety standards. This certification is a strength for CSG as it proves to its
passengers that safety is a top priority. CSG has interline agreements8 with 31 different airlines
generating about 20% of the total number of tickets sold, this is a big strength since it doesn’t take
much work on CSGs part to get these sales. CSG has registered 20 trademarks and has yet to
experience any of them violated. On top of the trademarks CSG have a series of online domains.
These domains are very important to CSG as 36% of the tickets sold in the first half of 2009 came
from these websites. CSG purchased an Air Operator Certificate9 (AOC) together with some
international routes from the bankrupted Sterling. This certificate is the basis for the expansion into
the European market as the smaller aircrafts that CSG was operating when it was mainly a domestic
airline are not large enough for this expansion.
The employees of CSG constitute an important part of the intangible resources. One example has
shown that the employees have confidence in the management, are flexible, and are willing to fight
8 Interline agreements are agreements where airlines accept each other’s tickets and documents and a passenger can
have their baggage checked in for a whole journey even though they fly with different carriers throughout the trip.
9 An Air Operator Certificate is the right of an airline to operate a certain aircraft.
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for the company. They have accepted a 10% reduction in salary with effect from 2010 (Cimber
Sterling Group A/S, 2010b, p. 1).
CSG’s initial public offering is discussed individually in the section below, as it contains several
important aspects in relation to the future value creation.
4.2 The Initial Public Offering
An initial public offering (IPO) can be defined as the: “first offering of stock to the general public”
(Brealey et al., 2007, p. 374). An IPO means that a company goes public. CSG went public on the
Copenhagen stock exchange10 on the 1st of December 2009. Before the idea of an IPO was raised,
CSG tried to raise capital through private investors, but apparently no one was interested (Hansen,
2010), which can be interpreted as a warning sign for investors. The shares offered were both new
shares and shares sold by the existing owners. The sale of existing shares does not raise any new
capital to the company.
When CSG decided to go public they needed help in form of an underwriter. SEB Enskilda11 was
chosen. Usually the underwriter will buy the shares from the company at a certain price and resell
them at a slightly higher price – the difference between what they buy and sell for is called the
spread. In more risky cases, like CSG’s IPO, the underwriter is not willing to take the risk of buying
the shares at a certain price from the company. CSG’s IPO was therefore handled on a “best effort
basis” (Brealey et al., 2007, p. 375), where SEB Enskilda did not hold the risk of for example low
demand. CSG and its underwriter produced a prospectus that provided potential investors with
relevant information about the company. An important function of the prospectus is to warn
investors about the risks involved in any investment in the company (ibid.). The initial share price
“offer range” was set at DKK 20-24 in the prospectus. The book building method was used to arrive
at share price according to the bids given by investors. The book building method is using the
demand in the market to arrive at a share price. Low investor demand during the start of the “offer
period” starting on the 17th of November and ending on the 25th of November forced CSG to cut its
share price to a level of DKK 10-13. Eventually the share sold for DKK 10. The shares were
thereby sold at around half the price initially expected. Furthermore the share price dropped steadily
10 Copenhagen stock exchange is a part of Nasdaq OMX Nordic
11 SEB Enskilda is a subdivision of SEB, which is a North European bank and pension concern with five million
customers and approximately 20.500 employees in more than 20 countries.
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in the months after the IPO. The average share price on the 4th of January 2010 was DKK 7,30 and
during the day on the 26th of February 2010 the share hit a record low of DKK 2,80 (Nasdaq OMX
Nordic, 2010). Already the 17th of December, only a few weeks after the IPO, the first downgrade
of expected earnings was made (Cimber Sterling Group A/S, 2009f, p. 1). It was justified by CSG
with the general economic slowdown. Stock exchange- and industry experts afterwards claimed that
a downgrade that fast after an IPO might be illegal according to IPO regulation, since the
information given in the prospectus then might have been misleading (Dagbladet Børsen A/S,
2010). It is hard to say whether the parties involved in the IPO knew that the price was
overoptimistic, or if their estimated offer price range was simply the result of a poor research
resulting in a misleading valuation. Stock exchange expert Paul Krüger Andersen from Aarhus
School of Business encourages the Copenhagen stock exchange to investigate the case because of
the seriousness of the allegation the stock exchange has so far not announced any investigation
(ibid.). The share price proposed by CSG and SEB Enskilda was thereby heavily overpriced, which
is unusual for an IPO. Historically IPOs have been underpriced. Some research has found that IPOs
in USA are underpriced on an average of 15% (W.P. Carey, 2008). An underpriced IPO means that
investors cash in profits at the expense of the company, which at first glance seems irrational from
the company’s point of view. There has been substantial research on why IPO’s are underpriced.
One of the most used arguments for underpriced IPO’s is that investors demand a premium for the
risks they are taking when investing in a company with no or little track record of performance
(ibid.). Another argument that favors under pricing of IPOs is that it signals firm quality and
establishes a good relationship between investors and the company(Ljungqvist, 2006, p. 36). This
also gives the company a better foundation to raise equity in the future. Much debate has therefore
risen from CSG’s heavy overpricing. The IPO gave CSG approximately TDKK 251.000 in net
proceeds together with a considerable amount of angry investors.
It is now relevant to look at CSG’s vision, strategy, and business model to understand how they
plan to be more successful than their competitors. The section will end with a discussion of whether
the strategy is sustainable, given CSG’s internal resources and external environment
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4.3 CSG’s Strategy
4.3.1 Vision, Strategy, and Business Model12
The Sterling transaction transformed CSG from being a mainly Danish regional airline into a
European airline based in Denmark. This transformation also required a new strategy.
The next section will investigate the consequences of CSG’s new vision, strategy, and business
model and its impact on CSG’s future value creation. First we will briefly describe the strategy that
CSG has chosen and afterwards comment and discuss implications.
4.3.1.1 Vision
CSG’s vision is to be Denmark’s leading airline. They want to achieve this vision through three
focus areas: To be the market leader in the Danish market for domestic air services, to be a focused
airline serving major European cities, and to be the preferred airline in Denmark for leisure
travelers.
4.3.1.2 Strategy and Business Model
CSG has a defined strategy of being a hybrid carrier meaning that they want to be able to act both as
a NC and a LCC. This strategy is in alignment with CSG’s diversified aircraft fleet that is composed
of different sized aircrafts to obtain maximum flexibility.
CSG’s business model, supporting the strategy of being a hybrid carrier, is based on four core
services: domestic routes, focused European routes, leisure routes, and as a provider of capacity.
The domestic routes involve connection to own routes and connection to other airlines trough code
sharing13 and interline14. European routes involve service to major European cities and connection
to other airlines through code sharing and interline. The capacity should be optimized by the use of
a mix between the ATR/CRJ/B737 aircrafts on both domestic and European routes. The leisure
routes focus on low cost and high volume and only the B737 aircrafts are used. Travel agencies are
used widely for the sale for leisure routes. Leisure routes also involve connection to other airlines
through code sharing and interline. The last core service is provider of capacity to other airlines.
12 The section is written with information from the Prospectus page 32-34
13 Refers to a practice in which a flight operated by an airline under its own code (the operating carrier) is also marketed
under the codes of one or more other airlines (the marketing carriers).
14 Agreement between airlines regarding air travel for which one ticket covers several legs of the journey operated by
different airlines and the baggage can be checked through to the final destination.
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In the interim report for the second quarter of 2009/10 CSG introduced two new initiatives: Odin
and Thor. Odin is established to support growth through implementation of more and broader
marketing activities and other revenue generating activities. Thor is a program established to
minimize costs through renegotiation of supplier and creditor agreements and increased focus on
utilization and continuous adjusting to market demands. CSG estimate that the effect of the
programs will be seen in the coming years (Cimber Sterling Group A/S, 2009f, p. 6).
4.4 Critical Review of CSG’s Strategy
It is clear from CSG’s vision and strategy that they are focusing on different market segments;
domestic flights serving primarily business customers and leisure flights from Denmark serving the
major European cities. The strategy is very aggressive since CSG wants to conquer the Danish
market and expand significantly with European routes knowing they are facing severe competition
on both fronts against bigger and more capital intensive airlines. CSG and its competitors are in
figure 2 placed according to their strategy and business model.
Ryanair is the company that has followed the LCC business model, invented by Southwest airlines,
most strictly (Alamdari & Fagan, 2005, p. 378). The Southwest business model is focused around
specific features: point-to-point, high frequencies, single type fleet, and no free meals or drinks to
mention a few. Ryanair’s strategy is basically based on the Southwest business model and is
therefore placed in the left side in figure 2. Norwegian is a LCC with some product features of a
Figure 2: Own processing with inspiration from Gross (2007, p. 13)
Area of Growing Competition
SAS Norwegian Ryanair
CSG
Standard Basic Budget Premium
No Frills Few Frills Many Frills Extensive Frills
Low Cost Carrier Network Carrier Hybrid Carrier
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hybrid carrier. They provide few frills and limited service, focusing on massive expansion through
cheap fares. CSG is a Hybrid carrier placing them in the middle of the spectrum. They have
recently changed their product features slightly by a decrease in frills. Food onboard has been cut
away and luggage in excess of hand luggage is charged extra (Cimber Sterling Group A/S, 2010a).
This change is seen as a move towards the product features of LCC, which is emphasized by the
arrow in figure 2. SAS is a classic NC with many frills. In recent years SAS has also introduced
initiatives moving them towards the product features of hybrid carriers. The initiatives are low fare
initiatives, which were mentioned in section 3.2.5. The strategy and product features of CSG –
being a mix between LCC and NC – is becoming less unique as there is a general trend moving the
airlines closer to LCC strategies with less frills and more focus on cost minimization. As it can be
seen from figure 2 this trend is placing CSG in an area of growing competition. The general
movement towards the classic product features of LCC’s is supported by a study made by Alamdari
and Fagan, which has: “(…) demonstrated that although an increasing number of ‘hybrid’ low-fares
models are achieving low operating costs, offering low fares and returning attractive operating
profit margins, the adherence to the original model, based on cost leadership strategy, could
potentially ensure greater profitability” (Alamdari & Fagan, 2005, p. 391). It can be argued that
CSG will face difficulties with its strategy against the strategies that focus more on low fares and no
or very few frills. As it can be seen from figure 2 CSG’s strategy is “stuck in the middle”. In the
prospectus CSG has emphasized the benefits of being a hybrid carrier serving different customer
segments, by arguing that business customers and leisure customers will ensure a high utilization
throughout the year; minimizing the seasonal fluctuations. However with a hybrid strategy CSG is
focusing more on service than its LCC competitors, which can be seen as a weakness since:
“Passengers are far more sensitive to price than service” (Chiou & Chen, 2010, p. 228). Michael E.
Porter also argues that it is dangerous to be stuck in between different generic strategies (Kotler &
Keller, 2008, p. 94). CSG is trying to deliver a good service for business customers, but on the other
side they are trying to compete on fares with LCCs. It can be argued that the strategy of CSG is
focusing on too many business areas and different activities. The “Strategic fit among many
activities is fundamental not only to competitive advantage but also to the sustainability of that
advantage” (Porter, 1996, p. 1). CSG arguing of potential of high utilization through a diversified
fleet and different customer segments, which is a competitive advantage. They have also recently
introduced the new initiatives Odin and Thor, which should help to minimize cost and increase
growth. History has shown that LCC yield greater profitability and outperform their competitors
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and CSG is in direct competition with LCC on both domestic and international flights. In the light
of the Odin and Thor initiatives it is believed that CSG’s strategy will be able to create value for its
shareholders through a continuous adjusting of their strategy to the changing market conditions.
4.5 SWOT
In figure 3 the strengths, weaknesses, opportunities, and threats identified throughout the strategic
analysis is summarized to provide an overview of our findings.
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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4.6 Preliminary Conclusion
The most important value drivers from the macro environment identified in the PEST analysis will
be summarized here. The Airline industry’s growth is heavily dependent on the general GDP
growth. The GDP growth forecast for 2010 and 2011 is 0,7% and 1,6% respectively. The slow
growth will continue to affect the airline industry’s value creation for the coming years in a negative
way. The increased globalization and interdependency especially within the euro zone is a factor
that supports good opportunities for increasing airline passenger traffic, though competition from
high speed trains connecting major cities in Europe is a threat to the airline industry in the long run.
In relation to this competition, the aircrafts’ relatively high CO2 emissions might be a disadvantage
in connection with the increased focus on decreasing CO2 emissions in EU and worldwide.
The five forces analysis has identified the competitive situation in the airline industry, where CSG
is operating. The threat of new entrants is moderate. There are some entry barriers, but the high
resale value of aircrafts makes it easier for new airlines to acquire capital from investors. The
bargaining power of suppliers – mainly oil companies – is high and reduces the profitability of
airlines. The bargaining power of buyers is very high, since there is almost no switching cost when
choosing another airline. The threat of substitute products is not considered very high in the nearby
future, since no substitute products are able to compete with the time efficiency of air travel though
in the long run high speed trains might affect the industry. The rivalry among existing competitors
was analysed through CSG’s three main competitors: SAS, Ryanair, and Norwegian. The analysis
of competitors has shown that CSG is fighting against competitors with different history and
different strategies. The difference between failure and success in the airline industry is small,
which can be emphasized by the historical success of SAS and its current struggling with
profitability and liquidity. Both Norwegian and Ryanair have shown that significant growth in a
short period of time is possible in the airline industry with the right strategies. The rivalry among
existing competitors is extreme with excess capacity and very low or negative profits in the
industry.
The internal analysis showed that CSG has a diversified fleet that is supporting their strategy of
being a hybrid carrier. The average age of the fleet is high compared to competitors, which is a
disadvantage in relation to maintenance costs. They have flexible employees that are loyal to the
company.
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The IPO in December 2009 decreased the brand loyalty and investor trust. First the initial offer
price was cut in half, from DKK 20-24 to DKK 10-13, and once on the stock exchange the share
price was again reduced by more than half within a very short time. The brand image of CSG has
been weakened in relation to current and potential investors. The overestimated initial share price
combined with the fast downgrade and claims of the downgrade being illegal can be seen as a
significant weakness for CSG. Investors realized a loss on their investment instead of a risk
premium covering their risky investment.
The critical review of CSG’s strategy identified both strength and weaknesses of the strategy. The
potential value creation from the current strategy is uncertain, but it is believed that the two new
initiatives Odin and Thor will be able to create value for shareholders together with a continuous
adjustment of the strategy to the changing market conditions.
5. Financial Analysis
The financial analysis is carried out to investigate CSG’s historical economic performance. Based
on the information available we have chosen to use the financial statements of 2006/07, 2007/08,
and 2008/09, which are conducted with International Financial Reporting Standards (IFRS). The
financial statements of 2004/05 and 2005/06 are available, but they are not used for several reasons:
The different accounting format, Danish Financial Statements Act (DFSA), is used, figures are
rounded to millions (less accurate), and they are assumed to be less relevant in the light of the
recent restructurings from the acquisition of parts of Sterling A/S and the IPO. To gain insight into
the effects of the recent restructurings just mentioned the key figures and results from the unrevised
financial statements from the first three quarters of 2009/10 are used.
First the financial statements of 2006/07, 2007/08, and 2008/09 are reorganized in a valuation
perspective. Secondly profitability of CSG is analysed through a decomposition of ROE. Key
results from the first three quarters of 2009/10 are used to show the development until the end of the
3rd quarter. Lastly the airline specific key ratios are analysed. In this way a comprehensive picture
of the main financial indicators will be revealed. The financial analysis is done using primarily Ole
Sørensen’s framework (2009).
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5.1 Reorganizing the Financial Statements
The financial statements are used by all parties that are interested in the company. These could be
creditors, suppliers, customers, competitors, investors and others. For this assignment we will use
the financial statements as if we were an external investor. The financial statements are reorganized,
with the aim of making a better foundation for the analysis of CSG’s performance. The primary
goal of reformulating the balance sheet and income statement of CSG is to identify the main drivers
behind ROE and growth. The primary goal of reformulating the statement of equity is to identify
the comprehensive income. The cash flow statement is not reformulated as it is considered the least
important statement to reformulate. The FCF is instead calculated from the balance sheet and
income statement. In a more general perspective the financial statements of CSG is reformulated to
improve the basis for better forecasting estimates later in the paper.
5.1.1 Statement of Changes in Equity
The statement of changes in equity describes, which changes there has been to the equity during the
year, meaning how the shareholder’s part of the assets changed and what has caused this change. It
shows the profit/loss for the year, payments to shareholders in the form of dividends and buyback of
shares, and sale of shares in the form of new issues or sale of the company’s holdings of own
shares. It also shows activities that are recorded directly on the equity. The statement of changes in
equity is reformulated to give a better overview as the official statement is unnecessarily complex
(appendix 6). The most important information that is given in the statement of changes in equity is
the Comprehensive income for the year. This gives a better representation of the actual profit or loss
the company has made during the year, since it includes all income/expenses the company has had
during the year including the income that is recorded directly to equity. These transactions are
denominated dirty surplus accounts (Sørensen, 2009, p. 134).
In CSG’s case there has been one transaction with the shareholders in 2007/08 with the payment of
extraordinary dividend, but besides that there have been no transactions with shareholders. The
most important transaction on the statement of changes in equity is the value adjustments of
hedging instruments; this is CSG’s dirty surplus account. There are though few changes in the
equity statement and an insignificant development in the equity.
5.1.2 The Balance Sheet
An official balance sheet separates assets and liabilities by the use of time horizons - long or short
term. The balance sheet tells us which assets the company has and how these assets are financed,
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either by shareholders equity or liabilities. The balance sheet is used to analyze which assets and
liabilities the company has as well as the company’s financial gearing. It also shows the part of the
assets and liabilities that have to be settled within one year, as well as the cash and cash equivalents
the company possesses.
For the purpose of this paper, the balance sheet is reformulated into operating assets, operating
liabilities, financial assets, and financial liabilities (appendix 4). Operating activities are thereby
separated from financing activities, which make it possible to analyse the dynamics of each activity
within CSG. The most important issues and considerations concerning the reformulation of CSG’s
balance sheet are listed in the following:
Cash at bank and in hand consist of both operating and financial liquidity. According to Ole
Sørensen the operating liquidity can be estimated by taking between 0,5-1% of net revenue an
allocating it to operating liquidity. In the light of the limited liquidity in the financial years 2007/08
and 2008/09, representing less than 0,5% of net revenue in both years, all liquidity will be allocated
to operating activities. In the financial year 2006/07 0,5% of net revenue is allocated to operating
liquidity, this still amounts to a higher operating liquidity than the two following financial years.
CSG’s Operational leasing activities of planes and buildings is an important part of CSG operating
activities. Therefore it can be discussed whether the operational leasing should be reclassified as
financial leasing and thereby be visible as an operating asset on the balance sheet. In this paper a
reclassification is considered too time consuming in relation to what it might bring of accuracy to
the final valuation. Instead rental and leasing expenses is moved up right under production costs to
be deducted before the gross margin is calculated.
Derivative financial instruments are categorized as operating assets, as it is assumed that the
hedging activities are primarily focused on aircraft fuel and not DKK/USD exchange rate. The
assumption is based on the fact that fuel constitutes a substantial part of airline costs (Cimber
Sterling Group A/S, 2009g, p. 22) and also that the price of aircraft fuel has historically been
subject to relatively large fluctuations (ibid., p. 100).
The most important accounts in the reformulated balance sheet are explained below:
Net operating assets are operating assets, such as aircrafts and property, minus the operating
liabilities such as trade payables. This figure is later used to investigate ROIC.
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Net financial liabilities are financial liabilities minus financial assets. This figure constitutes
together with the equity of shareholders the amount invested in “net operating assets”.
Equity is an important account in a valuation perspective, since it shows the owners share of the
assets (Sørensen, 2009, p. 124).
5.1.3 The Income Statement
The income statement shows us at the top how much revenue the company generated on its
activities, and then it follows what expenses the company has had during the year. The income
statement is used to analyze how good a company has been at generating revenue, controlling its
costs and finally how much money the company made/lost in total. The income statement is
reformulated in a way that divides income into the two primary activities – income (expenses) from
sale and financial income (expenses) (appendix 2).
The Rental and leasing expenses is include as part of operating costs since a large part of the leasing
expenses are mostly related to the leasing of planes, and it is considered to be part of the operating
activities. The tax shield is included as part of the tax expense in order to analyze the operating
profit from sales (after tax) as if CSG did not have any debt at all. By doing this the profitability of
sales activities can be calculate no matter what financial gearing CSG has, thus a more “pure” profit
ratio from sales is reached. In the reformulation the tax expense is also split into two parts, one part
relates to operating profit from sales, and the other relates to other operating profit.
The most important accounts in the reformulated income statement are explained below:
Operating profit from sale (before tax): This account shows how much CSG earns from sales
activities only, meaning revenue less costs held for sale and less rental and leasing expenses. It
should be noted that rental and leasing expenses are not only planes but also include buildings and
plant and equipment, but since these are such a small part of the total, it is assumed that they are
essential for sales activity and they are all included in our operating costs.
Net operating profit less adjusted tax (NOPLAT): This account shows the operating profit for the
year without financial expenses but including the dirty surplus account value adjustments of
hedging instruments.
Comprehensive income for the year: When looking at the comprehensive income for the year, it can
be seen that it is the sum of the profit/loss for the year and the dirty surplus account discussed in the
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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equity section. The comprehensive income for the year gives us a better representation of the actual
profit/loss since it includes all income/expenses the company has had during the year including the
income that is recorded directly to equity.
5.2 Analysis of Profitability
The return on equity (ROE) measures the profitability to shareholders of a company after all other
creditors have been considered (Sørensen, 2009, p. 256). Put in another way ROE measures a
company’s profitability by revealing the amount of profit a company generates with the money
shareholders have invested. From figure 5 it can be seen that in 2006/07 and 2007/08 CSG have
shown significant returns for shareholders with 13,64% and 27,77% respectively. In the 2008/09 the
picture changes completely with an ROE of -32,48%. In the first three quarters of 2009/10 EBIT
showed a loss of DKK 176 millions (Cimber Sterling Group A/S, 2010b, p. 1), which implies an
increasingly negative ROE.
ROE from 2006/07-2008/09 is decomposed to identify the underlying variables that have affected
profitability. In the first three quarters of 2009/10 market conditions and CSG’s IPO have had a
considerable impact on CSG’s financial situation. It has not been possible to reformulate these three
quarters, but the most important developments in this period will be mentioned and related to the
past three years in the best possible way, whenever appropriate. This is done to ensure that the most
present available information can be used for the budget forecasting later.
5.2.1 Decomposition of ROE
To evaluate the profitability and underlying variables more accurate the ROE is decomposed into
several factors based on the following formula(Sørensen, 2009, p. 256):
ROE = ROIC + [FGEAR * (ROIC – r)]
A graphical overview of the model used as guideline for the decomposition can be seen from figure
4:
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Figure 4: Own processing with inspiration from Ole Sørense (2009, p.255)
2008/09 2007/08 2006/07 Formula
Net income
average equity
Operating profit after tax (NOPLAT)
Net operating assets
Net financial liabilities
Equity
Net financial expenses (after tax)
average net financial liabilities*
ROIC 5,19% 5,86% 8,34%
ROE -32,48% 27,77% 13,64%
FGEAR 2,98 2,48 1,49
Net borrowing rate (r) -14,58% 0,40% -3,88%
ROIC - r
*In the 2006/07 figure we have used a number from the yearly report from CSG where the number is calculatet using
DFSA, and the number is rounded to millions
Spread 4,46%5,47%-9,39%
Figure 5: Own processing
There is no need to reformulate FGEAR since there are no minority interests in CSG. The
decomposition of ROE will enable us to identify the reasons for the extreme development. In the
following table ROE is decomposed:
5.2.1.1 Financial Gearing and Spread
Financial gearing is a double edged sword, if a company is earning money a high financial gearing
will increase the earnings, on the other hand if a company is losing money a high financial gearing
ROE
FGEAR ROIC Borrowing
rate (r)
SPREAD
Profit ratio TRA
Profit ratio
(from sale)
Profit ratio
(other)
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will further increase the losses. It is ironic that a company in a bad financial situation is often in
need of more debt financing, and that by acquiring more debt it increases their financial gearing and
often further worsen their situation.
Financial gearing expresses the relationship between a company’s interest carrying debt and equity.
Financial gearing can create a higher ROE if a company’s return on operating activities is higher
than its borrowing rate - a positive spread. If spread is positive a company will earn money with
higher gearing. A negative spread will on the other hand contribute to a lower ROE.
The financial gearing in CSG has developed towards a larger amount of debt in relation equity –
therefore a higher gearing. The gearing in 2008/09 was 2,98 meaning for every DKK 1 of equity
invested in CSG an amount of DKK 2,98 was invested through debt. This means that approximately
25% of the assets are equity and 75% are debt.
The combination of a positive spread and high FGEAR in 2006/07 and 2007/08 has contributed
positively to ROE.
The spread in 2008/09 of -9,39% means that the return on operating activities is far less than the net
borrowing rate paid for debt. The combination of a high financial gearing and a negative spread has
contributed significantly to the 38,48% negative ROE and thereby the negative comprehensive
income of DKK 38 millions in 2008/09.
The financial gearing for the first three quarters of 2009/2010 cannot be calculated on the same
basis as the previous years because of the limited amount of available information. An indication of
the financial gearing is derived from the available information in the following. The equity on the
31st of January 2010 was DKK 280 millions and the equity ratio was 26%. This equity ratio
represents both financial liabilities (interest bearing debt) and operating liabilities (for example
trade payables). The actual financial gearing is therefore expected to be a bit lower, since operating
liabilities should be deducted for making it comparable with the previous years. This means that
around 20-26% of CSG’s asset are financed by equity in 2009/10. CSG has tried to work towards a
lower gearing, less proportion of interest bearing debt to equity, with their IPO in December 2010
but this was offset by a significant negative EBIT.
The same effect is assumed in 2009/10. The capital structure of CSG, with a high degree of debt
financing, increases the financial risk, but also the potential profitability. The financial results of
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CSG will be more extreme with this high financial gearing than if CSG was financed with a larger
amount of equity.
The above calculations show that in the financial years 2006/07 and 2007/08 CSG has had a high
ROE as well as having a financial gearing of 1,49 and 2,48 respectively, with the positive spread in
these two years CSG has earned money on their debt. In 2008/09 they had a gearing of 2,98 and a
negative spread of 9,39% this combined means that they lost money, which in the end resulted in
the need for an IPO because of a liquidity crisis. FGEAR and Spread have had a significant impact
on ROE in all three years.
5.2.1.2 Net Borrowing Rate
In 2007/08 the net borrowing rate was -0.4%. The reason for this negative borrowing rate, that is a
positive net percentage, is that CSG received interests of VAT amounting to TDKK 24.148 this
means that in total CSG received more interest payments than they paid (Cimber Sterling Group
A/S, 2009g, p. 165). This extraordinary receivable has a significant impact on CSG’s net borrowing
rate in 2007/08. If the interest on VAT is excluded from the calculation the net borrowing rate in
2007/08 is 5,62%. This borrowing rate gives a better representation of the actually level of the net
borrowing rate. We will be aware of this difference and its impact on our later forecast estimates. In
2008/09 the net borrowing rate was 14.58% a sizeable increase from the previous year. The increase
can mainly be credited the worsened financial situation and a large foreign exchange loss. The net
borrowing rate in 2009/10 is assumed to be a bit lower than 2008/09 since CSG’s liquidity situation
has not improved and the foreign exchange loss cannot be predicted – the positive IPO effect has
been nearly offset by a significant negative EBIT of TDKK 176.400 in the first three quarters and
the financial situation could be better.
5.2.1.3 ROIC
ROIC expresses the profitability from all invested capital. The strength of ROIC is its focus on
operating activities and their profitability; opposite to ROE that mixes financing and operating
activities. ROIC has developed negatively in the past three years, though not as extreme as the
negative ROE development. Starting at 8,34% in 2006/07, decreasing to 5,86% in 2007/08, and
again decreasing to 5,19% in 2008/09. It can therefore be seen that the negative ROE in 2008/09 of
32,48% is primarily coming from the negative spread together with the negative net borrowing rate
and high FGEAR. The effect of ROIC on ROE is therefore less significant, but the underlying
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2008/09 2007/08 2006/07
NOPLAT
Revenue
Revenue
Net operating assets
1
Turnover rate of assets0,50020,60730,4979
2,01
Profit ratio (OG) 2,58% 3,56% 4,17%
Turnover rate of assets (AOH) 2,001,65
Inverse value of Turnover rate of assets
Figure 6: Own processing
drivers of ROIC are very important when forecasting and they are therefore analysed in the
following.
To identify where the decrease in ROIC is coming from ROIC is decomposed into profit ratio and
turnover rate of assets:
ROE = ROIC + [FGEAR * (ROIC – r)] �
ROE = (Profit ratio * Turnover rate of assets) + [FGEAR * (ROIC – r)] (Sørensen, 2009, p. 261)
Profit ratio and turnover rate of assets is therefore now examined individually.
5.2.1.4 Turnover Rate of Asset and Profit Ratio
The turnover rate of assets expresses how much revenue is created for every DKK 1 that is invested
in net operating assets. The turnover rate of asset is affected by different variables for example
marketing efforts. Profit ratio expresses the company’s ability to create profit, that is, how much
profit the company earns every time it has DKK 1 of sale. Profit ratio can be improved by for
example cost reductions.
A mass producer like LEGO can produce a very large amount of goods with relatively cheap
production facilities. They will have a relatively high turnover rate of assets and a relatively low
profit ratio. A more specialized and tailor made production like Vestas will produce few units with
an expensive production facility. They will have a relatively low turnover rate of asset and a
relatively high profit ratio.
It is important to note that CSG is a service company and therefore the concepts cannot be used, as
intuitively as for a production company – it is more abstract. It should be noted that a lot of CSG’s
aircrafts and buildings are not included in net operating assets, since they are leased on an
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2008/09 2007/08 2006/07
Profit ratio drivers (% )
production cost
Revenue
Other external costs
Revenue
Staff costs
Revenue
Rental and leasing expenses
Revenue
9,83% 10,22%
-6,59%-6,09%
7,10%
-4,49%
-48,52%-47,83%-51,90%Production cost
-30,96% -31,05% -29,75%
-4,93%-5,21%-5,56%
Staff costs
Other external costs
Rental and leasing expenses
100%-(production costs+Other external costs+staff costs+Rental and leasing)Profit ratio from sales (before tax)
Figure 7: Own processing
operational lease contract. This means that some of the most important assets used, airplanes and
buildings, are not included.
CSG’s turnover rate of assets saw a slight decrease in 2007/08 but returned to a stable level in
2008/09. The turnover rate of assets has thereby not been affecting ROIC much.
The profit ratio of CSG has decreased over the last three years. CSG’s ability to earn a profit on its
services has thus decreased over the three years. This decrease can be supported by the findings
from the strategic analysis, which showed that there has been an increase in competition on the
market that CSG is operating. It might also reflect the financial crisis and the fact that people are
not flying as frequently during the financial crisis.
One of the reasons for the negative development in ROIC is coming from the decreased profit ratio.
Therefore the profit ratio drivers are examined to identify, which drivers caused the negative
development of ROIC.
5.2.1.5 Profit Ratio Drivers
First we will analyze the drivers of the profit ratio that is related to operating activities.
Overall most of the profit ratio drivers have been relatively stable in relation to revenue over the
past years. The most critical development, which has caused the profit ratio from sales (before tax)
to decline, is the increase in production costs and other external costs.
Production costs comprise different costs associated with operating activities these include costs
associated with the operation and maintenance of the fleet and costs such as handling, catering, and
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booking. There has been an increase in these expenses during the last three years, meaning that
costs have risen faster than revenue. CSG explains this increase in production costs with the
opening of new routes to larger airports which generally have higher airport charges, together with
increased maintenance costs(Cimber Sterling Group A/S, 2009g, p. 87).
Other external costs have developed negatively during the period. It is however difficult to say what
has caused this negative development since this account comprises everything from marketing to
write-downs of trade receivables and goods for resale and administration. We do although expect
that part of this increase stems from increased marketing expenses due to the heavy expansion CSG
has seen and the increased competition.
Staff costs have been steady throughout the whole period and have therefore not had a large effect
on the profit ratio from sales (before tax). It should however be noted that the employees of CSG
have agreed to reduce their salary with effect from the financial year 2010/11. This will be further
discussed in the later forecast section.
Rental and leasing expenses have decreased as a part of revenue during the period, this might be
due to the financial crisis and the fact that leasing prices have decreased dramatically, especially for
out-of-production models (Wall & Flottau, 2009, p. 44). As all of CSG’s airplanes are out-of-
production models this can be the reason why leasing expenses as a part of revenue is lower. From
the third quarter report we can see that rental and leasing expenses as a part of revenue have
increased again, and we expect them to be above 7% for the financial year 2009/10.
The profit ratio from sales (before tax) has developed negatively from 2006/07 to 2008/9 with
10.22% and 7.10% respectively as a part of revenue. The negative development in the profit ratio
from sales (before tax) does not have a single driver, but is caused by a smaller negative
development in the underlying drivers, and even though rental and leasing expenses has developed
positively it could not offset the development in the other drivers.
The second part of the drivers is not directly related to operating activities but are still important
drivers of the profit ratio. As can be seen below all three drivers (tax, value adjustments of hedging
instruments, and other accounts (after tax)) fluctuate quite heavily during the period, and it is
difficult to generally say in which direction they develop. The tax as a part of revenue has limited
meaning here as tax does not have anything to do with revenue but is related to how much profit
CSG generates. Value adjustments of hedging instruments are also hard to analyze since they use
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2008/09 2007/08 2006/07
Tax of operating profit from sale
Revenue
Value adjustments of hedging instruments
Revenue
Other operating profit (after tax)+Depreciation,
amortisation and impairment
Profit ratio from sales (after tax)+other accounts (after
tax)Profit ratio 4,17%
-4,70%
3,56%
-4,40%
2,58%
-7,23%Other accounts (after tax)
Profit ratio from sales (after tax) 8,76%9,14%8,21% Profit ratio from sales - tax
1,46%0,69%-1,11%
Value adjustments of hedging
instruments0,11%-1,17%1,61%
Tax
Figure 8: Own processing
hedging to reduce uncertainties in future revenue, and from a business perspective this is a sound
thing to do, even though it might seem that they sometimes lose a lot of money on it and other times
they gain a lot on it. It seems that other accounts have risen dramatically from 2007/08 to 2008/09
but this should be seen in light of the other operating profit (after tax) that CSG received in
2007/08; without that extraordinary income other accounts (after tax) would have been close to the
2008/09 level. We can see that depreciation, amortization, and impairment have increased a lot
from 2006/07 to 2007/08. CSG does not give any specific reason why this rise occurred, but it
might be due to an increase in property, plant, and equipment and the purchase of four CRJ and
three ATR airplanes(Cimber Sterling Group A/S, 2009g2009, 89). Overall we cannot make a
general conclusion on how these different drivers have affected the profit ratio, but they have
cancelled out some of the negative development we saw in the profit ratio from sales (before tax).
5.3 Airline Specific Key Ratios
To get a better understanding of the value drivers that affect the revenue and profitability of CSG,
we will now analyze some airline specific key ratios. CSG is benchmarked with Norwegian,
Ryanair, and SAS. The aim of this benchmarking is to identify overall tendencies and to get a
feeling of CSG’s performance relative to its nearest competitors. For this purpose available seat
kilometers (ASK), revenue passenger kilometers (RPK), and load factor will be analyzed.
It should be clarified that the financial years are different. The financial year of CSG is starting in
May, Ryanair’s financial year in April, and Norwegian and SAS’s financial year in January. It is
assumed that these differences will not affect the larger picture, which is the aim of this comparison,
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as all financial statements have the seasonal fluctuations included. The airline specific key ratios
can be seen in appendix 8.
5.3.1 ASK
ASK is a measure of capacity, which is calculated by the number of available seats multiplied by
the distance flown. It is the total supplied capacity, which continuously should be adjusted to
demand to optimize the operating activities.
From 2007/08 to 2008/09 CSG has had an increase of 38,10% in capacity. Norwegian – a
competitor that also expands heavily in Europe – increased their capacity with 52,9% in the same
period. SAS, another close competitor, decreased their capacity from 2007/08 to 2008/09 with
16,30%, which is a good example of the need for capacity adjustments. When looking at actual
capacity it can be seen that CSG is a very small player compared to its competitors. In 2008/09
CSG’s capacity only amounted to 7,4% of Norwegians capacity15.
The three first quarters of 2009/10 has shown a 123% increase compared to the same three quarters
in 2008/09. CSG is thereby still increasing their capacity significantly.
5.3.2 RPK
RPK is a measure of passenger traffic, which is calculated by the number of occupied seats
multiplied by the distance flown.
From 2007/08 to 2008/09 CSG had a passenger traffic increase of 27,67%. With a capacity increase
of 38,10% in the same period it is obvious that CSG has overestimated the level of passenger traffic
for the period. There is an inconsistency between actual capacity and traffic; this has also affected
the profit. Norwegian had passenger traffic growth of 49,76% in the same period, which far better
fits their capacity growth of 52,49%.
5.3.3 Load Factor
Load factor describes the utilisation of the available seats. It is calculated as RPK divided by ASK.
It is thus the ratio of passengers to the number of available seats per flight. Load factor tells us how
well an airline utilizes their capacity, and in general a high load factor would indicate an airline that
is very good in filling their planes, however, the load factor does not take into account the price of
the tickets sold. The load factor can therefore not be taken into account separately but should be
15 Appendix 8: Airline Specific Key Ratios: 857994/11530000 = 7,4%
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considered together with the yield. An airline can increase its load factor by lowering its prices, but
that would reduce the yield and thereby the profit of the airline. As can be seen from appendix 8
CSG has a considerably lower load factor than all of their closest competitor. CSG’s load factor
decreased from 59,40% in 2006/07 to 56,60% in 2008/09. Norwegian on the other hand had a load
factor of 79% both years, and the average passenger load factor for SAS from 2002 to 2009 was
70.9% (SAS, , p. 1).
The low load factor can have several causes. One could be that CSG is not as good as its
competitors at filling the planes. Another cause could be that CSG has chosen to have a higher yield
than its competitors, thereby accepting a lower load factor and instead earning more on each
passenger. It can also be a combination of the two.
5.3.4 Yield
Yield is the total revenue from passenger carriage relative to RPK. It is calculated by taking the
total revenue from passenger carriage and dividing it with RPK. The historical data of yields is very
limited since CSG did not report their yield before the semiannual report covering May to October
2009. The yield is however a very important factor to look at, especially together with the load
factor. Neither the yield nor the load factor makes any sense to look at separately, since the load
factor does not take into account how much was paid for the seats, and the yield does not take into
account how many people were on board. In the interim report for the third quarter it can be seen
that CSG has seen a decline in its yield over the past nine months; this is due to an increased
competition and because of the new leisure routes that have a lower yield than the usual high
frequency short distance routes that CSG has previously had focused on. It can also be seen that
CSG has not increased its load factor despite its lower yield. When looking at the yield and the load
factor together it can be seen that CSG is transporting the same amount of people on each plane, but
each passenger is paying a lower price for their ticket.
5.4 Risk Analysis
The risk analysis will identify the risk factors that will affect CSG in the future.
5.4.1 Operating Risks
A major operating risk for CSG is the development in the Danish market for its domestic flights and
in the European market for its European flight. The demand conditions on these markets can be
affected by a lot of factors for example an increased focus on high-speed trains, increased
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competition, terrorist attacks, or another event that can have dramatic impact on CSG’s profitability.
In the Danish market CSG is fighting for market shares primarily with Norwegian and SAS, and in
the European market CSG is fighting against many different competitors.
As mentioned in the five forces analysis, under rivalry among existing customers, the increasing
focus on fares is a large risk for CSG as they face competitors with greater capital reserves and
better known brands.
5.4.2 Financial Risks
The financial risk regarding FGEAR and spread has been treated in the decomposition of ROE. In
general it can be summarized that as long as spread is positive a higher FGEAR will be
advantageous, but a high FGEAR will always mean increased financial risk.
CSG makes considerable purchases in US Dollars: Fuel, spare parts for aircrafts, and lease
payments (Cimber Sterling Group A/S, 2009g, p. 174). Fuel prices have historically faced
significant changes. According to the prospectus fuel prices have only very limited been hedged but
they have announced that they will use some of the proceeds from the IPO to (ibid., p. 119).
Because of these liabilities in USD exchange rate risk is another factor to consider (ibid., p. 22).
Revenue is primarily received in Danish Kroner and Euro, which means that CSG is facing
exchange rate risks. At the end of the first quarter CSG had TDKK 470.700 in debt with a floating
interest rate (ibid.). A small change in interest rate will have a high impact on the interest paid on
bank debt. No information on hedging of the interest rate is available. The floating rate loan might
be a calculated risk by management to get cheaper loans here and now, but with an interest rate that
is historically low it is a considerable risk.
The use of primarily operating leasing agreements regarding aircrafts is reducing the risk compared
to companies that either own all their airplanes or are using financial leasing agreements. There are
also risks combined with creditors in relation to trade receivables. Business partners and large
customers are continuously evaluated to avoid large losses on creditors (ibid., p. 176). CSG has
historically used a number of derivative financial instruments to prevent currency, interest, fuel
price risks, though only by limited amount or not at all in some areas.
In 2006/07, 2007/08, and 2008/09 the effect of hedging instruments is TDKK 1.100, TDKK -
12.400, and TDKK 8.500 respectively (ibid., p. 80). The liquidity of CSG is a vital concept. The
IPO in December 2009 was made to ensure a better liquidity of the company. The capital injection
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has nearly been offset by a negative EBIT of TDKK 178.100 in the first three quarters of
2009/10(Cimber Sterling Group A/S, 2010b, p. 6). From the third quarter interim report is can be
seen that CSG has cash resources at approximately TDKK 100.000 at 31 January 2010 (ibid., p. 7).
This low level of cash resources is extremely risky, since a single negative unforeseen event that
potentially can cause a decrease in earnings will push CSG close to bankruptcy.
5.5 Permanent Earnings
Permanent earnings are the relevant earnings when making forecasts of future earnings.
Extraordinary earnings are as the title suggests extraordinary and will not be repeated. Normally it
would be necessary to split permanent or core earnings from extraordinary earnings. In the case of
CSG only few extraordinary items have been identified: Other operating profit of TDKK 44.854 in
2007/2008, which was a refund of VAT and financial income of TDKK 24.148, which was interest
received from the VAT case. The significance of these items is small but they will be considered
when forecasting growth.
5.6 Preliminary Conclusion
With the reformulation of the financial statements the most important accounts have been identified
and were used for the purpose of calculating and decomposing ROIC. Both the income statement
and the balance sheet was separated into items relating to operations and items related to financing
it gave a better view of how CSG is financed and how they make/lose money. In the following the
decomposition of ROE and ROIC is comment on.
ROE has seen a large decrease during the period, which means that the return to shareholders has
been negative for the financial year 2008/09. The decrease is caused by a decrease in both the net
borrowing rate and ROIC. The net borrowing rate mainly decreased because of a sizeable amount of
foreign exchange losses in 2008/09 as well as a smaller increase in interest expenses. The financial
gearing increased during the period, the increase might be attributed the increase in activity that
have increased the need for new investments and hence more borrowing. The spread decreased a lot
from 2008/09 due to the increase in net borrowing rate. The spread together with the gearing was
the main driver behind the negative ROE.
ROIC was decomposed to evaluate the main drivers behind the negative development as well as to
find the value drivers to be used in the subsequent forecast. The main driver behind the negative
development in ROIC was identified to be the profit ratio. Since the profit ratio showed to be such
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an important driver of ROIC it too was decomposed to see which drivers affects it. We saw an
increase in production costs and in other external costs together with a decrease in rental and leasing
expenses it all amounted to a decrease in the profit ratio from sales (before tax), which was
identified as the main reason the profit ratio decreased. It is hard to conclude on the effect of the
drivers not relating to operations as they seem to fluctuate a bit randomly, the only thing we can
conclude is that depreciation, amortization, and impairment has increased over the period probably
due to the increased activity and hence investments which was also the driver behind FGEAR.
CSG has increased its capacity considerably more than has been justified by the increase in their
passenger traffic. This smaller increase in passenger traffic compared to capacity growth could be
considered a normal part of expanding so rapidly into new markets, since the customers need to be
informed about this shift before they will change their habits and as soon as people become aware
of this new focus, it is expected that the load factor might increase without much change to the
yield. The yield has decreased over the past three quarters because of the increased competition.
CSG’s load factor is still significantly lower than that of its closest competitors and with the
increased pressure on CSG’s yield, it could become a problem for CSG. With the relatively low
load factor and the decrease in the yield it can be argued whether CSG is able to exploit the synergy
effects between business and leisure travellers, which they say is one of the strengths of their hybrid
carrier strategy.
CSG is facing significant risk in different areas of its operations. Like all other airlines they are
exposed to significant risk in relation to fuel prices, which have historically fluctuated considerably,
on top of that there is the risk related to the USD/DKK exchange rate, which can either increase or
decrease the effect of changes in fuel prices. Though CSG plans to hedge both of these risks with
some of the proceeds from the IPO, they will not have enough money to hedge all of the risk. CSG
also faces risks that are more company specific. They have a substantial amount of floating rate
loans, which makes them vulnerable to changes in the exchange rate. CSG has reduced some of
their risk by leasing a large part of their fleet with operational leases, which mean that they can
return some of the aircrafts if they have overcapacity.
6. Forecasting
The budget forecasts are in the following estimated from the financial and strategic analysis.
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The vulnerability of the financial analysis will be taken into consideration by placing more
emphasis on the strategic analysis, and especially the macro economic trends. The vulnerability of
the financial analysis can be emphasized by the following quote: “Following the completion of the
Sterling transaction, Cimber Sterling’s profile has changed significantly, and comparisons over time
may therefore be difficult” (Cimber Sterling Group A/S, 2009g, p. 19).
Some accounts are excluded from the budget forecast, either because it is impossible to forecast or
irrelevant. Focus will be on the relevant accounts and their estimates. All relevant accounts for the
income statement and balance sheet will now be estimated in relation to the value drivers from the
financial and strategic analysis.
6.1 Forecast Horizon
The forecast period is typically between five to twenty years depending on various considerations in
relation to the company under investigation. The length of the forecast period depends on when
CSG will reach their steady state of growth and also on an assessment of the reliability of
estimating variations in underlying variables in future (Sørensen, 2009, p. 316). In the terminal
period constant growth is expected and all other forecast assumptions will remain unchanged, which
is done by using revenue growth as the primary value driver. All other value drivers are then
forecasted in relation to revenue growth, which ensures a link between all forecasted value drivers.
We have chosen a forecast period that comprises the coming five financial years as it is believed
that CSG has reached its steady state within five years (Sørensen, 2009, p. 315). We also believe
that variations in underlying variables can be estimated reasonable for five years. The airline is
mature and there are few company specific competitive advantages, which imply that the forecast
period should be approximately five years according to Ole Sørensen (Sørensen, 2009, p. 318).
Detailed forecast over a longer period is avoided with the forecast period of five years. The airline
industry is heavily affected by the macroeconomic tendencies, which are not possible to estimate in
the long run. The fluctuation of earnings made by CSG and its competitors over the last five years is
supporting that the airline industry is rapidly changing and to a large degree following the macro
economic trends.
As can be seen below we expect CSG to reach its long-term growth rate in year 2014/15. The first
forecasted year (2009/10) is heavily influenced by the interim reports from the first three quarters.
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2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
Revenue 18,27% 13,03% 23,00% 16,00% 8,00% 7,00% 5,00% 4,00%
Figure 9: Own processing from Appendix 10
The following years are based on CSG’s historical financial performance and on the estimated
effects of their chosen strategy.
6.2 Revenue Growth
Revenue growth is estimated as follows:
The estimates are based on the following:
From the CSG’s third quarter interim report a revenue growth rate of approximately 23% is
expected. This high level of revenue growth originates primarily from the expansion of the aircraft
fleet and new routes. The best predictor of the revenue growth of 2009/10 is assumed to be the
revenue growth of the first three quarters. It is believed that the extreme growth CSG has seen over
the last couple of years should be seen in the light of a heavy expansion in the world economy and
recently the expansions made with the assets from Sterling A/S. The return of the two CRJ200 jets
to their owner, the two B737 that were planned to be leased will not be leased, and the one ATR72
that is expected to remain on lease instead of being used by CSG, combined with the effect of the
financial crisis and the continuing intense competition in the airline industry means that we believe
CSG will not be able to maintain the historically high growth rate. We expect the focus in the
coming years to be on making the existing routes profitable via the two new initiatives Odin (sales
promoting) and Thor (cost reducing) (Cimber Sterling Group A/S, 2010b, p. 7). Revenue growth in
2010/11 is estimated to be 16%. The growth is expected to rise from late effects of the heavy
expansion, increased load factor, and optimization of the summer traffic program 2010 (Cimber
Sterling Group A/S, 2010b, p. 9). CSG’s load factor is currently very low compared to its closest
competitors and with their hybrid carrier strategy, which should increase their utilization it should
be possible get a load factor closer to its competitors. The revenue growth in 2011/12, 2012/13, and
2013/14 is estimated at 8%, 7%, and 5% respectively. The revenue growths in these years’ stem
from a general increase in economic activity (increased passenger traffic) and the effect of the
growth initiative Odin.
We expect the revenue growth rate to reach its steady state in 2014/15 at 4%. A GDP growth of 4%
is expected. The revenue growth rate of 4% is supported by the estimates of the aircraft
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Figure 10: from Appendix 10
2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
- Operating costs
held for sale -84,08% -88,41% -100,50% -95,00% -91,00% -87,00% -87,00% -86,00%
manufacturer Airbus, who expect a European passenger growth rate of 4,30% over the next 20
years (Airbus, 2010).
6.3 Operating Costs Held for Sale
For the first three quarters of 2009/10 the operating costs held for sale amounts to approximately
100,5% of sale16. Operating costs held for sale thereby exceed revenue in the first three quarters.
This is primarily because of expenses to IPO, increased competition, and a cold winter with many
delays and cancellations. Operating costs held for sale in 2009/10 are estimated to 100,5% of
revenue based on the first three quarters of the year. For the following years a slow decrease in
operating costs held for sale as a part of revenue is expected. This is based on several value drivers:
the Thor initiative (cost reducing), staff costs is cut by 10% with effect from 2010/11, and better
utilization from the diversified fleet. In the analysis of airline specific key ratios it was seen that
there is room for improvement for CSG compared to its competitors, which supports that the value
drivers identified will have the positive effects. It should be noted that several factors in operating
costs held for sale, which are not estimated but held constant in relation to revenue might have a
large impact in the future. An example is the fluctuations in aircraft fuel prices and a possible tax
imposed airline companies from their CO2 emissions to mention a few. It should be noted that
operating costs held for sale has many important variables that could potentially change the forecast
dramatically.
16 Other external costs is included in EBITDAR and not in operating costs held for sale, but it is such a small amount
that it does not affect the calculation remarkably.
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2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
Rental and leasing
expenses -6,09% -4,49% -7,26% -7,00% -7,00% -7,00% -7,00% -7,00%
Figure 11: from Appendix 10
6.1.5 Rental and Leasing Expenses
The rental and leasing expenses have been very low in 2008/9. The low level in rental and leasing
expenses can be supported by the expected overcapacity of airplanes, that originated from the world
financial crisis: “There are instances now where lessors are leaving the asset with an airline even
without a lease payment, just as long as the carrier does not return it and keeps up maintenance”
(Wall & Flottau, 2009, p. 2). From the half year report of 2009/10 it can be calculated that the rental
and leasing expenses amounted to 7,26%, which is used as estimate for the whole year 2009/10. For
the following years a constant level of 7% is estimated. The level of 7%, which is a bit lower than
currently, is based on the fact that CSG will not renew two CRJ aircrafts in April 2010.
Developments in rental and leasing expenses will follow the development in revenue, which is
another reason that a constant level is estimated. The outcomes of the leasing agreements that in a
few years are to be renegotiated are hard to predict (Cimber Sterling Group A/S, 2009g, p. 17). A
substantial part of CSG’s leasing contracts has to be renegotiated/renewed within 3 years (ibid., p.
180). The outcome of the renegotiations of leasing agreements is again vulnerable for our valuation.
Profit ratio from sale (before tax) can know be estimated by subtracting operating costs held for sale
and rental and leasing expenses from revenue.
6.1.6 The Effective Tax Rate
The effective tax rate is estimated from historical efficient tax rates and from the knowledge that the
company tax rate in Denmark is 25%. From the income tax note on page 166 in prospectus it can be
seen that the three previous effective tax rates have been 25,60%, 19,20%, and 27,80%. Our best
estimate, based on the actual tax rate and the historical tax rates, is a tax rate of 25%.
From 2009/10 – 2010/11 the effective tax rate is listed in appendix 11 with a minus because of
negative operating profit from sales (before tax - deferred taxes in these three years.
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6.1.7 Other Operating Profit (after tax)
Value adjustments from hedging instruments are the dirty surplus account from the statement of
equity. Forecasting the effect of hedging adds complexity but not necessarily accuracy. The effect
of hedging will vary from year to year, and an average of zero is forecasted.
By nature other operating profits is hard to estimate and it is therefore set to zero. In the case of
CSG this accounts, will primarily be affected by losses and gains on hedging contracts. The main
reason for hedging is unpredictability in the product being hedged. Therefore it makes absolutely no
sense to guess future outcomes of this account. Another point is that gains and losses will cancel
each other out in the long run. Other operating profit (after tax) is estimate to be 0% of revenue.
6.1.8 Depreciation, Amortization and Impairment
Depreciation, amortization and impairment are not estimated in our budget. Since depreciation,
amortization and impairment are simply an accounting loss, which do not have any cash effect.
Instead we are using the turnover rate of assets to forecast net operating assets, this way we
incorporate depreciation without estimating it directly.
6.1.9 Net Working Capital and Non-current Net Operating Assets
To forecast turnover rate of assets we have to first forecast net working capital (NWC) and non-
current net operating assets. As can be seen from our budget NWC is estimated to be negative
throughout the whole budget period. This is done on the basis of the historical negative NWC,
which means that CSG at first sight cannot pay their bills. The reason that CSG actually can meet
their current obligations is that they receive payment from customers in advance. There is a risk
with having negative NWC, as CSG will be dependent on receiving enough payment from
customers in advance to be able to meet their current obligations (Morrell, 2007, p. 156). This is a
real risk faced by CSG as the airline industry is very seasonal, and unexpected events such as the
terrorist attack in 2001 can have a large effect on CSG. In an event like that they might not have
enough liquidity to meet their current obligations. If CSG manages its liquidity well it can be an
advantage to have a negative NWC, since it increases profitability.
The recent acquiring of new routes and aircrafts through the acquiring of parts of Sterling A/S is
expected to fulfil the capacity needs. There is therefore no reason to believe that CSG will need to
increase its investments in terms of aircrafts, land and building, and other operating assets to
maintain growth in revenue at our suggested level. New big investments are therefore not expected.
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
NOPLAT -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK
Figure 12 from Appendix 11
2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
Net operating assets 697.330DKK 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK
Figure 13 from Appendix 11
Especially for next 3 years a better capacity utilization of the non-current net operating assets is
expected because of late synergy effects from the acquisition of Sterling A/S. Non-current net
operating assets are estimated to grow together with revenue as it is evaluated that CSG will not
need to invest heavily in non-current operating assets. It is estimated that they will need more
inventories of for example aircraft components as their activities increase and planes are worn out
faster. A general adjustment of NWC and the non-current net operating assets to a constant level
relative to revenue is expected for the budget period. Therefore the turnover rate of assets is
assumed to remain constant relative to revenue for the whole budgeting period.
6.1.10 NOPLAT
From the forecasts it is now possible to calculate NOPLAT the calculations can be seen from
appendix 11. NOPLAT will be used later to calculate free cash flows that are discounted back in
time to reach a value of CSG. As can be seen we have estimated a loss in both the financial years
2009/10 and 2010/11, this is actually close to the estimates CSG has come with. For the financial
year 2009/10 a loss of approximately TDKK 93.000 is forecasted. This number is based on the
actual numbers for the first three quarters of 2009/10 and it is therefore believe to be a fairly good
estimate. After the first forecasted year an improved profitability is estimated as they get the new
routes up and running. This forecast is well in line with the fact that CSG is not increasing its fleet
and the rollout of the cost minimizing Thor program and the sales increasing Odin program.
6.1.11 Net Operating Asset
From the estimates of net working capital and long term net operating assets it is possible to
calculate the estimate of net operating assets. As can be seen from appendix 11 the forecast is based
on the Net working capital and the non-current net operating assets to both remain constant relative
to revenue. This is done because it is believed that the underlying operating assets and operating
liabilities will generally increase together with activities; it makes sense because they are all tied
together with operations. This means that the net operating assets will grow together with CSG’s
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revenue. Net operating assets might deviate slightly from our forecast, but the most important
observation is that there will not be a systematic deviation.
The budget forecast can be seen in appendix 11. In the following the cost of capital will be
estimated.
7. DCF Valuation
7.1 Estimation of WACC
“The company cost of capital is a weighted average of the returns demanded by debt and equity
investors” (Brealey et al., 2007, p. 325). All investors will demand a return for their investment.
Shareholders typically demand the highest return, since they will be the last to be considered at a
bankruptcy. Financial institutions and other debt investors will demand a return in relation to the
specific risk of a company. Credit rating agencies, such as Standard and Poor’s and Moody’s, are
often used to identify the level of risk of a company. It has not been possible to get a rating on CSG
from any of these agencies.
7.1.1 Target Capital Structure
When estimating target capital structure it is normally most correct to use the market value of equity
and debt, but since the market value of equity is the goal of a fundamental analysis it makes no
sense to use market value in calculations that should lead us to market value. The concept of target
capital structure is therefore used. The idea is to estimate the capital structure that we believe that
CSG will be aiming for – their target.
For the past three financial years, 2006/07, 2007/08, and 2008/09, equity to the total balance sum
has been 23,20%, 19,17%, and 14,89% respectively. The IPO in December 2010 has added
approximately TDKK 251.000 to CSG’s equity, which have changed the capital structure
significantly. Said in other words, approximately 26% was financed through equity and 74% debt.
This is supported by a listed solvency ratio of 26% (Cimber Sterling Group A/S, 2010b, p. 7). The
equity on the 31st of January 2010 was TDKK 280.000 and the balance sum was TDKK 1.083.000.
The target capital structure is assumed to be with 25% equity and 75% debt.
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7.1.2 Return Demanded by Equity Investors - rEquity
The required rate of return on equity is estimated by the use of the Capital Asset Pricing Model
(CAPM) (Brealey et al., 2007, p. 304):.
A survey covering 1000 professors in Europe suggests an average market risk premium of 5,3% in
Europe (Fernandez, 2009, p. 2). The market risk premium average in Denmark has been estimated
to approximately 5% from 1970 to 2002 (Saabye, 2003, p. 73). In the mentioned historical research
dividends are included, which should give a far more accurate number according to Niki Saabye
(ibid.). Market risk premium is estimated to be 5,3%, which is supported by the survey from 2008.
Beta will be estimated through a common sense method of evaluating operating and financial risks.
The strategic analysis showed us that CSG is facing many threats and some weaknesses (see SWOT
section 5.6). Based on this a high level of operating risks is expected. The risk analysis performed
under the financial analysis supports a high level of operating and financial risk as well. The capital
structure, which is highly dominated by debt, supports this argument. Combining a high level of
operating and financial risk a beta of 1,5 is estimated, which is supported by the ideas from FSR
(Plenborg & Gruelund, 2002, p. 59).
7.1.3 Return Demanded by Debt Investors - rD
The required rate of return for CGS’s debt investors can be estimated by (Sørensen, 2009, p. 56):
( )(1 )
Where
: Risk free rate
r : Company specific risk
: Company tax rate
D F C
F
C
r r r t
r
t
= + −
The risk free rate is estimated by a 10-year state bond, which on the 17th of Marts had an interest
rate of 3,374% (Danmarks Nationalbank, 2010). The company tax rate is estimated at a rate of 25%,
which has been estimated earlier in the paper. The company specific risk premium is estimated to
6%. The company specific risk is estimated at a high level for several reasons: Large negative net
loss for the first three quarters of 2009/10, tough competition, and a high level of financial risks.
The survival of CSG has been discussed in the media, which by itself must raise concern for
creditors (Kronenborg, 2009). From figure 14 the historical return to debt investors is calculated
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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1 (1 )
t
FCFF tt WACC
FCFFPV
r=
=+
∑
1Terminal period
1 ( )(1 )
TT
TT WACC WACC
FCFFPV
r g r
+
=
=− +
∑
from the interest-bearing debt (Cimber Sterling Group A/S, 2009g, p. 176) and actual interest paid
(Cimber Sterling Group A/S, 2009g, p. 166).
The required rate of return for CSG’s debt investors is calculated to be 7,03% (appendix 9). This
rate is somewhat higher than the historical rate this makes sense since CSG is facing a lot of risks in
the future.
7.1.4 WACC
From the estimation of CSG’s capital structure, rE, and rD it is now possible to calculate WACC
from the following formula:
* *D E
D EWACC r r
V V
= +
WACC is calculated to be 8,16% (appendix 9).
7.2 Calculation of Share Price Estimate from DCF Model
The FCFF from the forecast period (2009/10 to 2013/14) is discounted to reach the present value.
The present value amounts to DKK -342.756.487.
The FCFF from 2014/15 and forward are also discounted to reach the present value.
The present value is DKK 1.262.579.414. The enterprise value of CSG is therefore estimated at
DKK 919.822.927 where 137,30% of the value is coming from the terminal period and -37,30%
from the forecasted period. This indicates a high degree of uncertainty, since all value is created
Figure 14: Own processing
Amount in DKK 1.000
2008/09 2007/08 2006/07
Interest bearing debt 483.892DKK 497.963DKK 329.558DKK
Interests paid 29.338DKK 23.602DKK 16.859DKK
Historical return to debt investors 6,06% 4,74% 5,12%
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from 2014/15 and onwards. It also means that all variables used in the terminal period are extremely
sensitive relative to share price.
The technical share price can now be calculated as the enterprise value less net financial liabilities,
which gives a share price of DKK 9,58 at the 30th of April. The FCFF is discounted back to the 30th
April 2009, as this is the last day of the annual report; the end of the financial year. The cut off date
is the 17th March, which means that the FCFF is discounted approximately ten and a half months
too far back in time. Therefore the technical share price is discounted forward with ten and a half
months, or 321 days to be exact, to reach the value on the 17th of March. At the same time we make
a correction to the DCF model, which brings our FCFF to the middle of the financial year instead of
at the end. The technical share price is thereby DKK 11,07. As a control check of the DCF model
the residual income model is also applied. As it can be seen from appendix 13 it gives the same
result.
Comparison with Share Price Value on the 17th
of March
The closing price for CSG’s share on the 17th March was DKK 3,89. The technical share price
therefore suggests that the stock price was undervalued with DKK 7,18. This means that the actual
share price on the 17th March was 64,86% lower than the technical share price. It is important
realize that the high technical share price can be interpreted in many ways and should be seen in the
light of the assumptions made throughout the thesis. The factors that have influenced our share
price, through forecasting of value drivers, and that the market may have other expectations to, are:
General macro economic trends, CSG’s competitive situation and their strategic opportunities, the
confidence in management, and the risk assessment to mention a few. A sensitivity analysis will
reveal how small changes in value drivers, and thereby changes in the mentioned factors, will affect
the technical share price. The significance of the most important value drivers will be discussed.
7.3 Sensitivity Analysis
To get an insight into how the most important variables affect the technical share price a sensitivity
analysis is conducted. The idea is to change one variable while holding others constant and see the
effect on the share price. It should be noted that this kind of analysis will potentially produce
extreme and in some situations misleading results, since a change in one variable normally will
affect other variables, but in this analysis they are held constant. For the broader perspective of the
sensitivity the analysis still serves a good purpose.
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Change in variable -20% -10% -5% 0% 5% 10% 20%
Analysis of growth drivers
Revenue growth in terminal period 3,20% 3,60% 3,80% 4% 4,20% 4,40% 4,80%
Price per share 8,68 9,77 10,39 11,07 11,81 12,64 14,59
Profit ratio from sales (before tax) 5,60% 6,30% 6,65% 7% 7,35% 7,70% 8,40%
Price per share 0,95 6,01 8,54 11,07 13,6 16,12 21,18
Turnover rate of assets 1,6 1,8 1,9 2 2,1 2,2 2,4
Price per share -109,33 -42,44 -14,28 11,07 34 54,85 91,33
Analysis of financing drivers
WACC 6,53% 7,34% 7,75% 8,16% 8,57% 8,98% 9,79%
Price per share 34,83 15,23 15,12 11,07 7,72 4,93 0,53
Beta 1,12 1,26 1,33 1,4 1,47 1,54 1,68
Price per share 15,51 13,17 12,09 11,07 10,1 9,18 7,47
Company specific risk premium 4,80% 5,40% 5,70% 6% 6,30% 6,60% 7,20%
Price per share 17,68 14,11 12,53 11,07 9,71 8,45 6,17
Figure 15 from appendix 14
Sensitivity calculations are made on the variables that are believed to have the largest impact on the
share price and/or the variables that are estimated with substantial uncertainty in the forecasting
section.
Revenue growth rate, profit ratio from sales (before tax), turnover rate of assets, WACC, beta, and
company specific risk premium are evaluated to be the most important value drivers.
7.3.1 Growth Drivers
From figure 15 it can be seen that the most important value drivers are profit ratio from sales
(before tax), turnover rate of assets, and WACC. These will be discussed in the following. Our
share price estimate is extremely sensitive towards changes in turnover rate of assets. A 5% increase
will increase the share price to DKK 34, and a 20% increase will increase the share price to DKK
91,33. The investment needed to obtain the forecasted revenue growth and other factors that affect
the turnover rate of assets are thereby enormously sensitive.
It can also be seen that our share price estimate is very sensitive towards the profit ratio from sale
(before tax). A 5% increase will increase the share price to DKK 13,60. A 20% decrease gives a
share price of DKK 0,95. The profit ratio from sale (before tax) is dependent on relation between
revenue growth and costs held for sale. The forecast of costs held for sale was among other things
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based on a successful implementation of the cost minimizing initiative Thor. A forecasted
implementation failure of Thor would have affected our price estimate substantially.
The least significant growth rate driver is the revenue growth. A 20% decrease in revenue growth
will only make the price drop to DKK 8,68.
7.3.2 Financing Drivers
Our share price estimate is also very sensitive towards WACC. A 10% increase gives a share price
of DKK 4,93. The two important risk measures, beta and company specific risk premium, are used
when estimating WACC, and they are both applied in the sensitivity analysis to understand their
individual impact on share price. The sensitivity of beta and the company specific risk premium - in
relation to our share price estimate - is approximate the same. A 20% increase of beta gives a share
price of DKK 7,47, where a 20% increase of the company specific risk premium gives a share price
of DKK 6,19. As already mentioned WACC is affected by a lot of factors, which are continually
adjusted according to the financial and operating risks of CSG. The static WACC used in our
fundamental analysis is therefore vulnerable and a major uncertainty factor.
8. Peer Group Analysis
The relative value of CSG is calculated by using price multiples also called the method of
comparables. In our peer group analysis the price multiples price/sale (P/S) and price/book value
(P/B) is use to calculate the market value of CSG. P/E and other price multiples using some format
of earnings, is not used since it makes no sense when earnings are negative. Since CSG and two of
our peer group companies have reported losses in their latest annual report P/E is not used. The
different price multiples are calculated for each company with their market capitalization on the 17th
of March 2010, their sales and book value of equity are taken from their latest annual report. This
gives us a problem with the data being from different dates, but as we cannot get the sales and book
value of equity at any specific date we will ignore this error. Simple averages of the multiples are
then calculated and used to estimate a share price of CSG that can be compared and discussed in
relation the technical share price at DKK 11,07.
Four different averages are used to calculate a share price for CSG. First an average of CSG’s three
closest competitors is used. This provides a share price of DKK 20,10 which well above the share
price on the cut-off date and our technical share price. The second average removes Ryanair. They
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are excluded for several reasons: They are the largest international airline in the world and they
have been making profit for a long time, they do not operate domestic routes in Denmark, and their
strategy is based on extreme cost minimization, which does not reflect CSG business strategy. The
second share price is thereby only with Norwegian and SAS. Both SAS and Norwegian operate
domestic routes in Denmark. SAS is a NC and Norwegian is a LCC. The idea is that the mix
between the price multiples from a NC and a LCC will reflect a hybrid carrier like CSG. From
appendix 15 the calculations of the market value by using price multiples can be seen. The book
values of equity and revenue (sales) from SAS and Norwegian are taken from their most recent
annual report available before the 17th March. The market values are calculated from the number of
shares and the closing share price on the 17th March 2010. The P/S and P/B give two different share
price estimates, DKK 12,76 and DKK 10,27 respectively. These are averaged to end at a share price
of DKK 11,51, which is close to our fundamental share price.
The difficulties of finding relevant comparable firms motivated us to use the comparable method in
a more general manner. For the third multiples Airline industry standards of P/S and P/B are used to
estimate a share price. Reuters.com provides the “airline industry standard”, which consist of the 17
airlines from mainly US, but also with international airlines represented (Reuters, 2010). Despite
this bias it is found to provide valuable information about the airline industry as a whole, since it is
important to look at industry numbers when using multiples (Penman, 2007, p. 78). The industry
standard yielded two different P/S and P/B share price estimates of DKK 4,56 and DKK 6,35
respectively. The average share price estimate is thus DKK 5,46. This estimate is rather close to the
original share price of CSG on the 17th of March.
It is extremely difficult to find airlines that closely resemble CSG and as a peer group that is similar
to the company under investigation is the basis of the method of comparables the share price
estimated relative to SAS, Norwegian, and the “airline industry standard” is combined and a simple
average is taken to end up with an estimate of DKK 8,49. We use this average as it comprises the
largest group companies for our analysis and it is found to be most likely that an external investor
would use this when comparing the price of CSG with their competitors. This estimate sits in
between our technical price and the actual price on the cut-off date.
From the calculation process in excel it became obvious that the method of comparables is
extremely sensitive to changes to the peer group and price multiples that are used. Depending on the
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peer group one ends up with very different share price estimates. This shows one of the deficiencies
in the method of comparables.
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9. Conclusion
The airline industry has had some turbulent years after the deregulation and the emergence of
LCC’s. NC’s are facing challenges regarding their entire business model and in that also their cost
structure. LCC’s are increasing their market share and a lot of NC’s have already started their own
LCC brand or are introducing LCC product features to minimize costs. CSG has seen an
opportunity to expand into the market of LCC and with the purchase of assets from the bankrupted
Sterling A/S they started this expansion. The airline industry has seen a fierce competition for
customers and with the only differentiating parameter being price; profits have been hard to
maintain. CSG has focused on its cost structure but has still been facing problems in relation to its
profits. They have therefore initiated the Odin and Thor projects to increase revenue and decrease
costs. We have not seen the effect of these initiatives yet, but according to CSG the effect of an
improvement in EBIT of TDKK 100.000 will be seen in 2010/11. The strategy has been evaluated
and like other airlines they face significant challenges in the future with regard to customers, and
especially competitors. CSG is facing considerable challenges in relation to the macro environment
as the growth in the airline industry is closely related to the development in the world economy and
with the recent recession and the estimated low growth the next couple of years there will be an
increased focus on costs and profitability. Political decisions can change the market situation
completely and the proposed tax on pollution would have a substantial effect on the competitive
situation for CSG. Another factor that might increase the competitive situation for CSG is a
potential expansion of the rail network in Europe.
The process of the IPO was turbulent and ended with a share price that was half of the minimum
that was initially asked. The share price dropped immediately and together with allegations of an
illegal downgrade shortly after the introduction to the stock exchange CSG ended up with a
considerable amount of angry investors. Nevertheless CSG raised approximately TDKK 251.000 in
the IPO but the recent losses have taken its toll on liquidity.
ROE decreased significantly over the historical period investigated mainly due to a large increase in
net borrowing rate but also a decrease in ROIC. The net borrowing rate was mainly influenced by
large foreign exchange losses, some of which would presumably be hedged in the future. The
reason for the decrease in ROIC was mainly a decrease in the profit ratio from sales (before tax),
which should be increased with the focus on the two initiatives Odin (sales promotion) and Thor
(costs minimizing) in the future. Assuming that CSG has enough liquidity to hedge some of its
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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foreign exchange obligations and minimize costs in the future, it should be possible to increase
profitability and thereby ROE.
CSG has considerably lower load factor than its closest competitors and together with the decrease
in yield over the past year it is evident that CSG is under a lot of pressure from competitors, which
it seems can only be overcome by increasing its sales activities to increase the load factor, as CSG
has limited flexibility to change the price of tickets. CSG has launched the Odin initiative to try to
increase their sales and assuming this succeeds CSG should be able to increase its load factor.
CSG is facing a lot of risks in the coming years. Almost all of their loans are floating rate loans. At
present the interest rate is low and in the short run the floating rate loans could be an advantage but
as interest historically have fluctuated quite a bit the loans could turn out to be a disadvantage. CSG
faces risks associated with both fuel prices and spare parts, which are both, settled in USD. The fact
that approximately half of CSG’s fleet is leased on an operational lease reduced the risk associated
with overcapacity, as these lease contracts have to be renegotiated ever so often. The reduced risk
from the operational leases and the future hedging of the exchange rate and fuel prices is not
enough to outweigh the other risks associated with CSG. The low level of cash resources, TDKK
100.000, is extremely risky, since CSG cannot survive another year with the same loss as they had
in the first three quarters of 2009/10, without a new capital injection.
This paper has made a thorough evaluation of the strategy of CSG and analysis of the financial
situation of CSG. The future of CSG is very uncertain and the technical share price is characterised
by this uncertainty. The heavy expansion and the focus on low costs is a risky move when looking
at the competition within this segment, but on the other hand a lot of the NCs have been faced with
dramatic losses over the past couple of years, whereas LCC have been able to present sizeable
profits. The forecast is based on our analysis of CSG with regard to their strategy and past financial
performance and the overall development in the industry and in the economy. Most of the emphasis
was put on the developments within the strategy, the industry, and the European economy. The
historical financial performance was used less in the forecasting, since CSG’s has changed so much
in the recent year.
Our technical share price is considerably different from the share price at the cut-off date. The DCF
model yielded a fair price of DKK 11,07 and the price of the cut of date was DKK 3,89. This
difference might stem from several factors. It might mean that the share price of CSG is
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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undervalued, but as our sensitivity analysis showed even the slightest change in either of the most
important value drivers will have a large effect on the share price. This means that the difference
might originate from different expectations in the development of one or more of the value drivers.
It might also mean that investors do not believe that CSG will survive in the fierce competition in
the long run. Because of the risks associated with CSG and the uncertainty of the future of CSG and
other airlines and the fact more than 137% of the value of CSG lies in the terminal period it cannot
be concluded whether the share price at the cut-off date is fair.
A peer group analysis was also used to evaluate the share price but this analysis revealed flaws of
the method more than it gave us a better estimate of whether the share price was fair. It became
apparent that it is extremely sensitive towards the choice of peer group and in an industry like the
airline industry where it is difficult to find publicly traded peers it has limited value. The method of
comparables yielded a result of DKK 8,49, which would suggest that CSG’s share is undervalued
but it might also just be due to a poor choice of peer group. Again it cannot be concluded whether
the share price at the cut-off date is fair.
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Income statement 1st May - 30th April
Amount in DKK 1.000
2008/09 2007/08 2006/07
Revenue 1.297.757DKK 1.148.192DKK 970.791DKK
Production costs -673.504DKK -549.151DKK -471.021DKK
Other external costs -72.103DKK -59.781DKK -47.865DKK
Staff costs -401.771DKK -356.472DKK -288.790DKK
Other operating income -DKK 44.854DKK -DKK
Operating profit before rental and leasing expenses,
depreciation, amortisation, impairment, etc. (EBITDAR)150.379DKK 227.642DKK 163.115DKK
Rental and leasing expenses -58.257DKK -69.908DKK -63.930DKK
Depreciation, amortisation and impairment -93.841DKK -84.191DKK -45.591DKK
Operating profit/loss (EBIT) -1.719DKK 73.543DKK 53.594DKK
Financial income 1.472DKK 32.585DKK 6.231DKK
Financial expenses -78.888DKK -36.840DKK -24.042DKK
Profit/loss before tax (EBT) -79.135DKK 69.288DKK 35.783DKK
Income taxes 20.210DKK -13.281DKK -9.938DKK
Profit/loss for the year -58.925DKK 56.007DKK 25.845DKK
Attributable to:
Shareholders of Cimber Sterling Group A/S -58.925DKK 56.007DKK 25.845DKK
Appendices
Appendix 1: Official Income Statement of CSG
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Reformulatet income statement 1st May - 30th April
Amount in DKK 1.000
2008/09 2007/08 2006/07
Revenue 1.297.757DKK 1.148.192DKK 970.791DKK
- Operating costs held for sale -1.147.378DKK -965.404DKK -807.676DKK
Rental and leasing expenses -58.257DKK -69.908DKK -63.930DKK
Operating profit from sale (before tax) 92.122DKK 112.880DKK 99.185DKK
Reportet tax -20.210DKK 13.281DKK 9.938DKK
Taxshield on net financial costs 5.835DKK 5.901DKK 4.215DKK
Tax allocatet to other operating profit -DKK -11.214DKK -DKK
Tax of operating profit from sale -14.376DKK 7.968DKK 14.153DKK
Operating profit from sale (after tax) 106.498DKK 104.912DKK 85.032DKK
Other operating profit (before tax accounts)
Other operating profit -DKK 44.854DKK -DKK
Tax effect of other operating profit 11.214DKK
Other operating profit (after tax accounts)
Value adjustments of hedging instruments* 20.870DKK -13.464DKK 1.052DKK
Depreciation, amortisation and impairment -93.841DKK -84.191DKK -45.591DKK
Net operating profit less adjusted tax (NOPLAT) 33.527DKK 40.898DKK 40.493DKK
Financial income 1.472DKK 32.585DKK 6.231DKK
Financial expenses -78.888DKK -36.840DKK -24.042DKK
Tax effect 5.835DKK 5.901DKK 4.215DKK
Net financial expenses (after tax) -71.582DKK 1.646DKK -13.596DKK
Comprehensive income for the year -38.055DKK 42.543DKK 26.897DKK
* Dirty surplus account that is reportet in the statement of equity
Attributable to:
Shareholders of Cimber Sterling Group A/S -58.925DKK 56.007DKK 25.845DKK
Earnings per share
Basic/diluted earnings per share -19.642DKK 18.669DKK 8.615DKK
Calculation of taxes
Reportet taxes from income statement 20.210DKK -13.281DKK -9.938DKK
Interest based on Note 9 page 166 in prospectus 23.338DKK 23.602DKK 16.859DKK
Tax shield (interest * 25%) 5.835DKK 5.901DKK 4.215DKK
Appendix 2: Reformulated Income Statement of CSG
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Balance sheet
Assets
Amount in DKK 1.000
2008/09 2007/08 2006/07
Non-current assets
Intangible assets
Trademarks 5.081DKK -DKK -DKK
Rights 4.627DKK -DKK -DKK
Development projects 1.451DKK 1.793DKK 1.729DKK
11.159DKK 1.793DKK 1.729DKK
Property, plant and equipment
Land and buildings 15.609DKK 16.871DKK 16.707DKK
Aircraft and aircraft components 731.969DKK 759.470DKK 569.567DKK
Other plant and equipment 19.091DKK 16.468DKK 8.494DKK
Property, plant and equipment under construction 9.080DKK 2.476DKK 1.435DKK
775.749DKK 795.285DKK 596.203DKK
Other non-current assets
Deposits and other receivables 20.462DKK 8.615DKK 16.956DKK
Total non-current assets 807.370DKK 805.693DKK 614.888DKK
Current assets
Inventories, consumer goods and goods for resale 82.145DKK 60.834DKK 45.652DKK
Trade receivables 123.184DKK 137.956DKK 138.845DKK
Derivative financial instruments -DKK -DKK 1DKK
Corporation tax receivable 5DKK 93DKK 183DKK
Other receivables 50.113DKK 33.437DKK 16.103DKK
Prepaid expenses 22.985DKK 4.752DKK 6.264DKK
Securities 128DKK 1.066DKK 26.228DKK
Cash at bank and in hand 4.282DKK 1.814DKK 25.565DKK
Total current assets 282.842DKK 239.952DKK 259.892DKK
TOTAL ASSETS 1.090.212DKK 1.045.645DKK 874.780DKK
Appendix 3: Official Balance Sheet of CSG
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EQUITY AND LIABILITIES
Share capital 600DKK 600DKK 600DKK
Share premium 30.652DKK 30.652DKK 30.652DKK
Value adjustments of hedging instruments 8.458DKK -12.412DKK 1.052DKK
Retained earnings 122.668DKK 181.593DKK 170.666DKK
Total equity 162.378DKK 200.433DKK 202.970DKK
Liabilities
Non-current liabilities
Deferred tax 51.762DKK 65.012DKK 55.897DKK
Provisions 750DKK -DKK 51.947DKK
Mortgage debt 20.210DKK 7.378DKK 6.914DKK
Banks 350.837DKK 354.762DKK 217.681DKK
Lease obligations 31.462DKK 38.762DKK 45.520DKK
Total non-current liabilities 455.021DKK 465.914DKK 377.959DKK
Current liabilities
Mortgage debt 1.596DKK 1.012DKK 1.253DKK
Banks 59.523DKK 55.857DKK 28.966DKK
Bank overdrafts 12.964DKK 33.434DKK 22.968DKK
Lease obligations 7.300DKK 6.758DKK 6.256DKK
Derivative financial instruments -DKK 16.546DKK -DKK
Prepayments from customers and accrued income 177.527DKK 90.221DKK 34.736DKK
Trade payables 102.117DKK 83.673DKK 78.496DKK
Other payables 106.914DKK 91.797DKK 121.176DKK
Provisions 4.872DKK -DKK -DKK
Total current liabilities 472.813DKK 379.298DKK 293.851DKK
Total liabilities 927.834DKK 845.212DKK 671.810DKK
TOTAL EQUITY AND LIABILITIES 1.090.212DKK 1.045.645DKK 874.780DKK
Appendix 3: Official Balance Sheet CSG - Continued
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Reformulated Balance Sheet
Assets
Amount in DKK 1.000
2008/09 2007/08 2006/07
Operating assets
Trademarks 5.081DKK -DKK -DKK
Rights 4.627DKK -DKK -DKK
Development projects 1.451DKK 1.793DKK 1.729DKK
Land and buildings 15.609DKK 16.871DKK 16.707DKK
Aircraft and aircraft components 731.969DKK 759.470DKK 569.567DKK
Other plant and equipment 19.091DKK 16.468DKK 8.494DKK
Property, plant and equipment under construction 9.080DKK 2.476DKK 1.435DKK
Deposits and other receivables 20.462DKK 8.615DKK 16.956DKK
Inventories, consumer goods and goods for resale 82.145DKK 60.834DKK 45.652DKK
Trade receivables 123.184DKK 137.956DKK 138.845DKK
Derivative financial instruments -DKK -DKK 1.052DKK
Corporation tax receivable 5DKK 93DKK 183DKK
Other receivables 50.113DKK 33.437DKK 16.103DKK
Prepaid expenses 22.985DKK 4.752DKK 6.264DKK
Operating liquidity 4.282DKK 1.814DKK 4.854DKK
= Core Operating assets 1.090.084DKK 1.044.579DKK 827.841DKK
Operating liabilities
Deferred tax 51.762DKK 65.012DKK 55.897DKK
Provisions (non-current) 750DKK -DKK 51.947DKK
Derivative financial instruments -DKK 16.546DKK -DKK
Prepayments from customers and accrued income 177.527DKK 90.221DKK 34.736DKK
Trade payables 102.117DKK 83.673DKK 78.496DKK
Other payables 106.914DKK 91.797DKK 121.176DKK
Provisions (current) 4.872DKK -DKK -DKK
= Total operating liabilities 443.942DKK 347.249DKK 342.252DKK
Core net operating assets 646.142DKK 697.330DKK 485.589DKK
Non Core operating assets -DKK -DKK -DKK
Net operating assets 646.142DKK 697.330DKK 485.589DKK
Appendix 4: Reformulated Balance Sheet CSG
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Financial liabilities
Mortgage debt (current) 1.596DKK 1.012DKK 1.253DKK
Banks (current) 59.523DKK 55.857DKK 28.966DKK
Bank overdrafts (current) 12.964DKK 33.434DKK 22.968DKK
Lease obligations (current) 7.300DKK 6.758DKK 6.256DKK
Mortgage debt (non-current) 20.210DKK 7.378DKK 6.914DKK
Banks (non-current) 350.837DKK 354.762DKK 217.681DKK
Lease obligations (non-current) 31.462DKK 38.762DKK 45.520DKK
= Total financial liabilities 483.892DKK 497.963DKK 329.558DKK
Financial assets
Financial liquidity -DKK -DKK 20.711DKK
Securities 128DKK 1.066DKK 26.228DKK
Total financial assets 128DKK 1.066DKK 26.228DKK
= Net Financial liabilities 483.764DKK 496.897DKK 303.330DKK
Total Equity (Equity = asset - liabilities) 162.378DKK 200.433DKK 182.259DKK
Equity
Share capital 600DKK 600DKK 600DKK
Share premium 30.652DKK 30.652DKK 30.652DKK
Value adjustments of hedging instruments 8.458DKK -12.412DKK 1.052DKK
Retained earnings 122.668DKK 181.593DKK 170.666DKK
Total equity 162.378DKK 200.433DKK 202.970DKK
Appendix 4: Reformulated Balance Sheet – Continued
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Statement of changes in equity
DKK’000 Share capital Share premium Value adjustments
of hedging
instruments
Retained
earnings
Total
Equity at 1 May 2006 600DKK 30.652DKK -DKK 130.330DKK 161.582DKK
Changes in accounting policies -DKK -DKK -DKK 14.491DKK 14.491DKK
Equity at 1 May 2006 after changes 600DKK 30.652DKK -DKK 144.821DKK 176.073DKK
Comprehensive income for the year -DKK -DKK 1.052DKK 25.845DKK 26.897DKK
Equity at 30 April 2007 600DKK 30.652DKK 1.052DKK 170.666DKK 202.970DKK
Comprehensive income for the year -DKK -DKK -13.464DKK 56.007DKK 42.543DKK
Extraordinary dividend -DKK -DKK -DKK -45.000DKK -45.000DKK
Costs related to interim dividend -DKK -DKK -DKK -80DKK -80DKK
Equity at 30 April 2008 600DKK 30.652DKK -12.412DKK 181.593DKK 200.433DKK
Comprehensive income for the year -DKK -DKK 20.870DKK -58.925DKK -38.055DKK
Equity at 30 April 2009 600DKK 30.652DKK 8.458DKK 122.668DKK 162.378DKK
Appendix 5: Official Statement of Changes in Equity
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Reformulated Statement of changes in equity
Amount in DKK 1.000
2008/09 2007/08 2006/07
Equity at the beginning of the year 200.433DKK 202.970DKK 176.073DKK
Transactions with owners
Extraordinary dividend -45.080DKK
Comprehensive income for the year
Retained earnings (net income) -58.925DKK 56.007DKK 25.845DKK
Value adjustments of hedging instruments 20.870DKK -13.464DKK 1.052DKK
Comprehensive income for the year -38.055DKK 42.543DKK 26.897DKK
Equity at the end of the year 162.378DKK 200.433DKK 202.970DKK
Appendix 6: Reformulated Statement of Changes in Equity
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Key ratios
2008/09 2007/08 2006/07 Formula
Key ratios from statement of equity
Net income
average equity
Operating profit after tax (NOPLAT)
Net operating assets
Net income + interest*
average total assets
Change in equity
Equity at the beginning og the year
* Interest payment from note 9 in the Prospectus
ROIC 8,34%5,86%5,19%
-18,99% -1,25% 15,28%Equity growth rate
13,64%-32,48% 27,77%ROE
4,91%8,29%-2,77%ROA
Appendix 7: Key Ratios
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Benchmarking of Airline Specific Ratios
2008/09 2007/08 2006/07
Load Factor( RPK divided by ASK. Describes the utilisation of the of available seats.)
CSG 56,60% 61,90% 59,40%
Norwegian 79,00% 80,00% 79,00%
Ryanair 81,00% 82,00% 83,00%
SAS 71,60% 71,90% 74,10%
ASK (Available seat kilometres. Number of available seats multiplied by the distance flown.)
CSG DKK 857.994 DKK 621.281 DKK 485.372
CSG 38,10% 28,00% N/A
Norwegian DKK 11.530.000 DKK 7.561.000 DKK 5.371.000
Norwegian 52,49% 40,77% 55,05%
Ryanair 13,90% N/A N/A
SAS -16,30% 5,20% -0,30%
RPK (Revenue passenger kilometres. Number of occupied seats multiplied by the distance flown.)
CSG DKK 498.060 DKK 390.101 DKK 283.960
CSG 27,67% 37,38% N/A
Norwegian DKK 9.074.000 DKK 6.059.000 DKK 4.223.000
Norwegian 49,76% 43,48% 56,23%
Ryanair 13,80% N/A N/A
SAS -16,70% 2,10% -0,70%
Yield (profit per RPK. Calculated by the average revenue per RPK minus the average cost per RPK.)
CSG 1,43
Appendix 8: Airline Specific Key Ratios
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Calculation of WACC
Risk free rate 3,374%
rC 6,00%
Tax rate 25,00%
rD after tax 7,03%
Beta 1,40
E(rM) - rF 5,30%
rE 10,79%
Estimated long term D/V 70%
Estimated long term E/V 30%
WACC 8,16%
Appendix 9: Calculation of WACC
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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Forecast of Value Drivers
Income statement 2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
Revenue 18,27% 13,03% 23,00% 16,00% 8,00% 7,00% 5,00% 4,00%
- Operating costs held for sale -84,08% -88,41% -100,50% -95,00% -91,00% -87,00% -87,00% -86,00%
Rental and leasing expenses -6,09% -4,49% -7,26% -7,00% -7,00% -7,00% -7,00% -7,00%
Profit ratio from sale (before tax) 9,83% 7,10% -7,76% -2,00% 2,00% 6,00% 6,00% 7,00%
Effective tax rate 19,17% -25,54% -25,00% -25,00% 25,00% 25,00% 25,00% 25,00%
Operating profit from sale (after tax) 9,14% 8,21% -5,82% -1,50% 1,50% 4,50% 4,50% 5,25%
Other operating profit 3,91% 0,00% 0,00% 0,00% 0,00% 0,00% 0,00% 0,00%
Other operating profit (after tax accounts)
Value adjustments of hedging instruments* -1,17% 1,61% 0,00% 0,00% 0,00% 0,00% 0,00% 0,00%
Net operating profit less adjusted tax (NOPLAT) 3,56% 2,58%
Balance
Net working capital/revenue -0,03776 -0,08377 -0,0500 -0,0500 -0,0500 -0,0500 -0,0500 -0,0500
Non-current net operating assets/revenue 0,64508 0,58166 0,5500 0,5500 0,5500 0,5500 0,5500 0,5500
Inverse value of Turnover rate of assets 0,60733 0,49789 0,5000 0,5000 0,5000 0,5000 0,5000 0,5000
Turnover rate of assets 1,65 2,01 2 2 2 2 2 2
Appendix 10: Forecast of Value Drivers
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
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Budget Forecast
Income statement 2007/08A 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
Amount in DKK 1.000
Revenue 1.148.192DKK 1.297.757DKK 1.596.241DKK 1.851.640DKK 1.999.771DKK 2.139.755DKK 2.246.743DKK 2.336.612DKK
- Operating costs held for sale -965.404DKK -1.147.378DKK -1.604.222DKK -1.759.058DKK -1.819.791DKK -1.861.587DKK -1.954.666DKK -2.009.487DKK
Rental and leasing expenses -69.908DKK -58.257DKK -115.887DKK -129.615DKK -139.984DKK -149.783DKK -157.272DKK -163.563DKK
Operating profit from sale (before tax) 112.880DKK 92.122DKK -123.868DKK -37.033DKK 39.995DKK 128.385DKK 134.805DKK 163.563DKK
Operating profit from sale (after tax) 104.912DKK 106.498DKK -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK
Other operating profit (before tax accounts)
Other operating profit 44.854DKK -DKK -DKK -DKK -DKK -DKK -DKK -DKK
Tax effect of other operating profit 11.214DKK -DKK -DKK -DKK -DKK -DKK -DKK -DKK
Other operating profit (after tax accounts)
Value adjustments of hedging instruments* -13.464DKK 20.870DKK -DKK -DKK -DKK -DKK -DKK -DKK
NOPLAT -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK
Balance
Net working capital -43.351DKK -108.716DKK -79.812DKK -92.582DKK -99.989DKK -106.988DKK -112.337DKK -116.831DKK
Non-current net operating assets 740.681DKK 754.858DKK 877.933DKK 1.018.402DKK 1.099.874DKK 1.176.865DKK 1.235.708DKK 1.285.137DKK
Net operating assets 697.330DKK 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK
Appendix 11: Budget Forecast
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
Page 89 of 93
Firm Value Using Discounted Cash Flow Model
Amount in DKK 1.000
Income statement 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
NOPLAT -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK
Net operating assets 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK
FCFF = NOPLAT - Change in NOA -244.880DKK -155.474DKK -44.069DKK 26.297DKK 47.610DKK 77.737DKK
Discount factor (1+WACC)^t 1,08 1,17 1,27 1,37 1,48
PV FCFF -226.406DKK -132.901DKK -34.829DKK 19.215DKK 32.164DKK
PV FCFF to and with 2013/14 -342.756DKK 1.868.887DKK
Terminal value
PV terminal value 1.262.579DKK
PV of operating activities / firm value 919.823DKK
- Net financial liabilities 483.764DKK
On 30.04.2009 On 17.03.2010
Equity value 436.059DKK 503.555DKK
value per share 9,58DKK 11,07DKK
Discount rate (WACC) 8,16%
Appendix 12: Discounted Cash Flow Model
Valuation of Cimber Sterling Jeppe Fredslund and Anders Blokager Olsen
Page 90 of 93
Firm Value Using Residual Income Model
Amount in DKK 1.000
Income statement 2008/09A 2009/10E 2010/11E 2011/12E 2012/13E 2013/14 Terminal period
NOPLAT -92.901DKK -27.775DKK 29.997DKK 96.289DKK 101.103DKK 122.672DKK
Net operating assets 646.142DKK 798.121DKK 925.820DKK 999.885DKK 1.069.877DKK 1.123.371DKK 1.168.306DKK
ROIC -14,38% -3,48% 3,24% 9,63% 9,45% 10,92%
Residual income (WACC) -145.624DKK -92.898DKK -45.546DKK 14.703DKK 13.806DKK 31.010DKK
Discount factor (1+WACC)^t 1,08 1,17 1,27 1,37 1,48
PV residual income -134.638DKK -79.410DKK -35.996DKK 10.743DKK 9.327DKK
PV residual income to and with 2013/14 -229.973DKK 745.516DKK
Terminal value
PV terminal value 503.654DKK
PV of operating activities / firm value 919.823DKK
- Net financial liabilities 483.764DKK
On 30.04.2009 On 17.03.2010
Equity value 436.059DKK 503.555DKK
value per share 9,58DKK 11,07DKK
Discount rate - WACC 8,16%
Appendix 13: Residual Income Model
Page 91 of 93
Sensitivity Analysis
Change in variable -20% -10% -5% 0% 5% 10% 20%
Analysis of growth drivers
Revenue growth in terminal period 3,20% 3,60% 3,80% 4% 4,20% 4,40% 4,80%
Price per share 8,68 9,77 10,39 11,07 11,81 12,64 14,59
Profit ratio from sales (before tax) 5,60% 6,30% 6,65% 7% 7,35% 7,70% 8,40%
Price per share 0,95 6,01 8,54 11,07 13,6 16,12 21,18
Turnover rate of assets 1,6 1,8 1,9 2 2,1 2,2 2,4
Price per share -109,33 -42,44 -14,28 11,07 34 54,85 91,33
Analysis of financing drivers
WACC 6,53% 7,34% 7,75% 8,16% 8,57% 8,98% 9,79%
Price per share 34,83 15,23 15,12 11,07 7,72 4,93 0,53
Beta 1,12 1,26 1,33 1,4 1,47 1,54 1,68
Price per share 15,51 13,17 12,09 11,07 10,1 9,18 7,47
Company specific risk premium 4,80% 5,40% 5,70% 6% 6,30% 6,60% 7,20%
Price per share 17,68 14,11 12,53 11,07 9,71 8,45 6,17
Appendix 14: Sensitivity Analysis
Valuation of Cimber Sterling
Jeppe Fredslund and Anders Blokager Olsen
Page 92 of 93
Peer Group Analysis
Market Value calculated relative to Norwegian and SAS
DKK 1.000 Sales Book value Market value P/S P/B
CSG DKK 1.297.757 162.378 ? ? ?
Norwegian NOK 6.226.413 897.368 4.627.480 0,743 5,157
SAS SEK 44.918.000 11.389.000 6.810.300 0,152 0,598
Ryanair EUR 2.343.868 2.425.061 5.466.000 2,332 2,254
Average of Multiples: 1,076 2,670
With Norwegian, SAS, and Ryanair Market Value Share Price
Sales P/S 1.395.894DKK 30,68DKK
Book Value P/B 433.477DKK 9,53DKK
Average 914.685DKK 20,10DKK
Without Ryanair Market Value Share Price
Sales P/S 580.628DKK 12,76DKK
Book Value P/B 467.218DKK 10,27DKK
Average 523.923DKK 11,51DKK
Market Value calculated relative to the "airline industry"
P/S P/B
Industry standards 0,16 1,78
Market Value Share Price
Sales P/S 207.641DKK 4,56DKK
Book Value P/B 289.033DKK 6,35DKK
Average 248.337DKK 5,46DKK
Market Value calculated relative to SAS, Norwegian, Ryanair, and the "airline industry"
8,49DKK
Appendix 15: Peer Group Analysis
Valuation of Cimber Sterling
Jeppe Fredslund and Anders Blokager Olsen
Page 93 of 93
Appendix 16: Air Traffic Growth and GDP Growth
GDP growth in EU 27 countries {{52 Eurostat 2010}}
Figure from IATA.org {{80 IATA 2010}}
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