VIU Course and Section Number: Managerial decision (503)

Section-71

Date: 09th March 2016

Academic Integrity Statement: We have read the Student Academic Code of Conduct and this
assignment complies with the Code.

Academic Integrity Statement: I/We have read the Student Academic Code of Conduct and this assignment complies
with the Code.
EXECUTIVE SUMMARY

A grant of one million dollars would be provided to us for investment in publicly traded
companies. This report is contains the financial analysis of Air Canada and Lufthansa group to
determine which of the companies is most suitable for investment.
We have considered qualitative factors such as SWOT of both companies and their dividend
policies. In analyzing quantitative information contained in the Annual Report we computed and
compared key investment ratios for both companies.
Based on the interpretation of the results and analysis of information obtained, Lufthansa is a
better company for the long-term investment.

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Table of Contents
EXECUTIVE SUMMARY ...............................................................................................................2
TABLE OF CONTENTS ..................................................................................................................3
1. INTRODUCTION .....................................................................................................................4
1.1 ABOUT THE COMPANIES ........................................................................................................... 4
A) AIR CANADA ..........................................................................................................................4
B) LUFTHANSA ...........................................................................................................................5
2) SWOT ANALYSIS ....................................................................................................................6
A) AIR CANADA .................................................................................................................................. 6
B) LUFTHANSA ....................................................................................................................................... 6
A) LIQUIDITY RATIO .............................................................................................................................. 7
B) SOLVENCY RATIO.............................................................................................................................. 8
C) PROFITABILITY RATIO ....................................................................................................................... 9
D) EFFICIENCY RATIO ............................................................................................................................ 9
E) MARKET RELATED RATIO ............................................................................................................... 10
F) ANALYSIS OF DIVIDEND YIELD AND DIVIDEND PAYOUT RATIO .................................................... 10
G) ANALYSIS OF EARNING PER SHARE RATIO .................................................................................... 11
H) ANALYSIS OF PRICE EARNINGS RATIO ........................................................................................... 12

4) CONCLUSION & RECOMMENDATION ........................................................................................ 13

5) APPENDIX-1 ............................................................................................................................. 15
ANNUAL FINANCIAL STATEMENT ........................................................................................................... 15
AIR CANADA ........................................................................................................................................... 15
6) APPENDIX-2 .................................................................................................................................. 16
7) APPENDIX-3 ............................................................................................................................. 17
ANNUAL FINANCIAL STATEMENT ........................................................................................................... 17
LUFTHANSA............................................................................................................................................. 17
8) APPENDIX-4 ............................................................................................................................. 19
STATEMENT OF COMPREHENSIVE INCOME.............................................................................................. 19
9) BIBLOGRAPHY .......................................................................................................................... 20

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 1. INTRODUCTION

A million dollars grant would be made available to us by March 9, 2016 for investment purposes.
We have decided to invest the money into a profitable company with long term prospects to be
guaranteed of a good return on the investment over time. Two companies have been selected as a
possible investment choice. The two companies which are Lufthansa and Air Canada are both
companies in the Aviation Industry. Air Canada is a publicly trade firm in Toronto Stock
Exchange. Lufthansa also is a publicly trade firm, trading on the German Stock Exchange. In this
term paper we would analyze these two companies separately considering both quantitative and
qualitative factors. The 2014 Audited Annual Financial Statement would be a key source of
information that would be used in our quantitative analysis. While other information obtained
from reliable sources be it journals, articles and books would be used for our qualitative analysis
in other to arrive at an investment decision that would meet or exceed our expectations as
investors.

1.1 ABOUT THE COMPANIES

a) Air Canada

Air Canada's predecessor, Trans-Canada Air Lines (TCA) inaugurated its first flight on
September 1, 1937. The 50-minute flight aboard a Lockheed L-10A carried two passengers and
mail between Vancouver and Seattle. By 1964, TCA had grown to become Canada's national
airline; it changed its name to Air Canada. Air Canada is Canada's largest full-service airline and
the largest provider of scheduled passenger services in the Canadian market, the Canada-U.S.
trans border market and in the international market to and from Canada. Together with its Air
Canada Express regional partners and leisure carrier, Air Canada rouge, Air Canada serves over
38 million passengers annually and provides direct passenger service to more than 190
destinations on five continents. Air Canada has major hubs in four Canadian cities (Toronto,
Montreal, Vancouver and Calgary).
Its extensive global network provides scheduled passenger service directly to 63 Canadian
destinations, 55 destinations in the United States and 86 in Europe, Africa, the Middle East, Asia,
Australia, the Caribbean, Mexico, Central America and South America.

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 Air Canada is a founding member of Star Alliance™, the world's most comprehensive air
transportation network. The airline became fully privatized in 1989. Air Canada shares are traded
on the Toronto Stock Exchange (TSX:AC). Air Canada is among the 20 largest airlines in the
world and employs 28,000 people. Its corporate headquarters are located in Montreal. Mission of
Air Canada is to connect Canada and the world with their flights. Air Canada’s goal is to fully
develop as a leading global airline, to be among those with the highest levels of customer
experience, employee engagement and value creation for shareholders and other stakeholders.
(Aircanada.com, 2016)

b) LUFTHANSA

Lufthansa is one of the leading airlines in the world and the biggest airline in Germany. The
history of Lufthansa can be traced back to 1926 when it started business in Berlin as 'Deutsche
Luft Hansa Aktiengesellschet'. Its services were stopped during the Second World War and
resumed operations in 1955. The Lufthansa Group is a global aviation group with a total of
around 540 subsidiaries and equity investments, which in the financial year 2014 were organized
into five operating segments: Passenger Airline Group, Logistics, MRO, Catering and, up to the
end of 2014, IT Services. All the segments occupy a leading position in their respective markets.
In 1997, it announced the founding of "Star Alliance" with United Airlines, Air Canada, SAS
and Thai Airways International. Benefit from the world fly network offered by "Star Alliance", it
provides passengers with flexible traveling choice on the basis of convenient flying services.
Also, it signed an agreement on co-operation with many international airlines including United
Airlines, Thai Airways, North-Euro Airline, Varig Brazilian Airlines and South African
Airways. (Lufthansagroup.com,2016), (Travelchinaguide.com, 2016);

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 2) SWOT ANALYSIS

a) AIR CANADA

Strengths:
- There different route network provides Air Canada with access to key markets
- Average of 1519 daily schedule flights to 186 destinations on five continents
- 61 domestic flights and 74 international flights
- Average 38.5 million passengers cared by air Canada by 2014
- Strong fleet operations with 209 active aircrafts
- Strong market position

Weakness:
- High maintenance cost on old air crafts
- Compromise with the tariffs due to high competition in the industry
- Fostering customer understanding of different product segments

Opportunities:
- Growing global airline industry
- Air Canada is a founding member of the Star Alliance® network


Threats:

- Volatile fuel cost likely to put pressure on margins

- Increasing competition from international airlines

(Centreforaviation.com, 2016)

b) LUFTHANSA

Strengths:

- Focus on high quality

- Strong Brand
- Complementary global network
- There balance sheet is strong
- Ample hubs in the Europe
- JV with other lines make the airline strong ( USA Airlines )

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Weakness:

- It has high cost base within the airline

- Its Industrial relations are strained with their pilots
- Lufthansa's preoccupation with selective protectionism perpetuates a negative culture

Opportunities:

- There new offers and lowest cost platforms provide options for the growth
- There integration would provide greater efficiencies

Threats:
- LCC Competition is remains
- Competition in long haul markets from the Big Three Gulf carriers
(Emirates, Qatar Airways and Etihad)

(Centreforaviation.com, 2016)

3) COMPARATIVE ANALYSIS – QUANTITATIVE AND

QUALITATIVE FACTORS

As part of our analysis, we would be considering quantitative and qualitative factors of the
company to determine its financial health and how best it would meet our expectation as
investors. Find below analysis of various classes of ratios used, ratio numbers and the
interpretation of the results from our computation.

a) Liquidity Ratio

Liquidity ratios are a class of financial metrics used to determine a company's ability to pay
off its short-terms debts obligations. Generally, the higher the value of the ratio, the larger the
margin of safety that the company possesses to cover short-term debts. A company's ability
to meet its short-term debt obligation is a key determinant to whether a company would be

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able to continue as a going concern. Inability to meet short term liability may is an indicator
that a company is at a higher risk of bankruptcy.

In order to determine the liquidity position of the two company under analysis for investment
purposes we have decided to compute the Current Asset ratio as it is deemed the most
appropriate mainly because the company is in the service industry and do not have inventory
which would have been used in computing the quick acid test ratio.

Name of Ratio Air Canada Lufthansa

2014 2013 2014 2013
Current Asset
Ratio 0.98 1.03 0.75 0.88

From the ratio numbers above computed above we can see that the current asset ratio of Air
Canada is higher than that of Lufthansa in both years. However the current asset ratio of Air
Canada reduced by 4.85 percent in 2014, while that of Lufthansa reduced by 14.77 percent in
2014.
From the analysis above, Air Canada has a better current asset ratio compared to Lufthansa.
This means it’s in a better position to meet it current liabilities using its current assets. Its
liquidity position also did not drop so much as compared with Lufthansa.

b) Solvency Ratio

This ratio will help us assess how well each company can settle its long-term financial
obligations and develop future assets. A company weighed down with debt is probably a less
favorable investment than one with a minimal amount of debt on its books, this is because a
highly leveraged company would spend more of its earnings on servicing its debt than
reinvesting it into the business for future growth or paying investors as dividend. Also as
investors it gives us an insight into how likely a company will be to continue meeting its debt
obligations. Hence as investors we would prefer a company with a lower leverage which
translates to lower risk. We have decided to use the Debt Equity Ratio to determine the
financial leverage of the both companies.
Name of Ratio Air Canada Lufthansa
2014 2013 2014 2013
Debt to Equity
-10.40 -7.78 6.56 3.77
Ratio

While we prefer a low debt to equity ratio as investors, a negative ratio is not acceptable. A
negative debt to asset ratio means Air Canada has more debt than assets to cover its debts in
2013 and 2014. Most time this is an indicator the company is not profitable and the company

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must turn around if it wants to survive. A negative debt-to-equity ratio also means the
company's net worth is negative.
Very few bankers will extend loans to a company with a negative net worth unless there are
extenuating circumstances, and there are assets that the company can pledge. A negative net
worth means that the company probably is in trouble because it has been losing money for a
long time. Lufthansa’s debt to equity ratio increased by 74.01 percent in 2014. However, it
still has a better Debt to Equity ratio compared to Air Canada whose Debt to Equity Ratio is
negative in 2013 and 2014. The fact that the Debt to Equity Ratio of Air Canada increased
by 33.68 percent in 2014 is an indicator that they are not doing well in trying to reverse the
negative ratio. Lufthansa in this case is more solvent compared to Air Canada.

c) Profitability Ratio

Profitability ratios are used to give us an idea of how likely it is that a company will turn a
profit, as well as how that profit relates to other important information about the company
and because high revenues alone don't necessarily translate into dividends for us as investors
nor does it guarantee increased stock prices, we want to be sure the company chosen for
investment is one which is able to clear all of its expenses and costs. Profitability ratios used
would give us an idea of how likely it is that a company will turn a profit, as well as how that
profit relates to other important information about the company. A company that has a higher
ratio and increase in trend over the years would be a better company for investment.
Name of Ratio Air Canada Lufthansa
2014 2013 2014 2013
Return on
-0.09 -0.01 -0.47 0.21
Equity

Air Canada recorded a negative Return on Equity ratio in 2013 and 2014. With the negative
ratio increasing by 800 percent in 2014. While that of Lufthansa reduced from 0.21 to -0.47
which is about 323.81 percent. The negative ratios recorded by the two firms means the
companies are both having negative returns on equity however while Air Canada has
recorded negative returns in both years, Lufthansa recorded negative return on equity only in
2014. Although the Return of Lufthansa in 2014 is worse than that of Air Canada, because of
the trend over the years over review, we still believe Lufthansa is still a better option as
profitability is concerned.

d) Efficiency Ratio

For companies to run its day-to-day operations it must invest in assets to perform its
operations. Efficiency ratios measure how effectively the company utilizes these assets, as
well as how well it manages its liabilities. This ratio is particularly important because it
informs us as investors about a company's ability to use what it has to generate the most
profit possible for owners and shareholders. As investors we would be looking to invest in a
company, which is able to generate more profit for its investors in relation to how much

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 asset it, possess. For this analysis a company with a higher ratio trend would be the preferred
company for investment.

Name of Ratio Air Canada Lufthansa

2014 2013 2014 2013
Total Asset
Turnover Ratio 1.25 1.31 0.98 1.03

From the ratio computation above the ratio is Air Canada in the years under review is higher than
that of Lufthansa these mean Air Canada is more efficient at using all its assets to generate the
most profit for its owners.

e) Market Related Ratio

Because we are not investing directly in either Air Canada or Lufthansa (i.e we are not promoters
of the company), rather we are going to be investing through the purchase of shares in the stock
market, this means that when we buy shares at a certain value, we would make a profit only
when the price of the shares go up or when we get regular dividends from their investments or a
combination of both. This is the key reason why we are using Market related ratios to assess the
preferred company for investment. Market related ratios compare the current stock price of the
company, which is being quoted on the stock exchange to various balance sheet, income
statement and cash flow items. Find below the details of market ratios used for our analysis and
the interpretation of their results.

Name of Ratio Air Canada Lufthansa

2014 2013 2014 2013
Dividend Yield - - - 2.90
Earnings Per
0.35 0.02 0.12 0.68
share
Price to
32.57 374.50 115.25 22.68
earnings ratio
Dividend
- 66.29
Payout - -

f) Analysis of Dividend Yield and Dividend Payout Ratio

Air Canada had a nil dividend yield and dividend payout ratio in 2013 and 2014. Further analysis
of their financial statement led to the discovery of this clause on page 108.

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"Air Canada is subject to series of covenants and undertakings, including a prohibition on
dividends and share repurchases as well as certain limitations on executive compensation
arrangements"
Based on the foregoing it means if we invest in Air Canada we would not be able to get any cash
return from the firm in form of dividend or share repurchase. The clause did not say for how long
this prohibition is expected to last, so it could be for as little as the next couple of years or as
much as 100 years.

Asides that, it also means Air Canada is hugely restrained as to what it uses its profit for, such
restrictions are placed by creditors to ensure payment of their debt is guaranteed to some extent.
This would mean only funds available after settling their debts would be reinvested into the
company as retained earnings, thus growth is significantly reduced.
Lufthansa’s dividend yield and payout ratio in 2014 was nil. Further analysis of the financial
statement revealed the following clause on page 4
"…we have modernized our dividend policy. It allows for consistently high dividend amounts.
To avoid paying out dividends from the substance of the company, however, we will continue to
propose a dividend only if it is covered by a sufficient net result for the year...Unfortunately, this
was not the case in the 2014 financial year...as a result, and in line with our dividend policy, no
dividend will be paid for the 2014 financial year".
From this extract we can deduce that dividend was not paid in 2014 because the performance of
Lufthansa in 2014 was not good enough to be able to float dividend payment. And thus we
believe the decision not to pay dividend from the substance of the company is reasonable. If as
investors from other indicators analyzed we believe Lufthansa would recover in subsequent
years, we could expect dividend payments in line with profits made.

g) Analysis of Earning Per Share Ratio

Air Canada’s EPS increased in 2014. Its EPS of 0.35 in 2014 is also higher than that of
Lufthansa, which is 0.12. While a higher EPS is always preferred as this means the company is
more profitable and the company has more profits to distribute to its shareholders. However,
because many things can manipulate this ratio, as investors it’s good we take a look at it but we
would not let it influence their decisions drastically.

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 h) Analysis of Price Earnings Ratio

As investors this ratio will help us determine how much we should pay for a stock based on its
current earnings. In other words we would use this ratio to decide what multiple of earnings a
share is worth. A lower ratio is better for the investor because it means he pays less to get a
certain multiple of earnings.
The P/E of Lufthansa in 2014 is 115.25 it exceeds that of Air Canada which is 32.57. Also the
Price Earnings Ratio of Lufthansa increased by 408.16percent in 2014. Based on the analysis of
this ratio Air Canada has a lower risk compared to Lufthansa, because more is at stake for every
investment in Lufthansa held when compared to Air Canada.

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4) CONCLUSION & RECOMMENDATION

From the financial analysis of Air Canada and Lufthansa in 2013 and 2014 above, we have
decided to invest in Lufthansa Group of Companies based on the following the reasons:

Qualitative information obtained from the financial statement reveled that Air Canada is
subject to series of covenants and undertakings that has prohibited it from dividend payment and
share repurchases. As young investors we will prefer to get returns on our investment in form of
dividend and share repurchases. Amount received yearly would be an additional income for us.
The fact that we are uncertain about when Air Canada will change its dividend policy to allow
payment to shareholders is a major concern to us. In comparison Lufthansa’s dividend policy
allows for dividend payment so long as it is made out of the yearly profit. Also Lufthansa has a
stronger brand compared to Air Canada, this enhances the public perception of its shares worth.
This will enable us get a fair return for our shares if we decide to sell it in the future.

Quantitative analysis of key investment ratios in both companies revealed that Air
Canada has solvency problems. Its negative Debt to Equity ratios in the two years analyzed is an
indicator that the company is highly leveraged and has a negative net income. This means the
company will spend more of its earnings offsetting its current debt and will have limited funds to
reinvest to the business. This reduces the potential for growth of the company and we will not
want invest in a company experiencing stunted or slow growth rate. From our analysis above,
Lufthansa is considered a more profitable investment option this is because it only has a negative
Return to Equity ratio in 2014, while Air Canada had a negative Return to Equity Ratio in both
years. Hence Lufthansa shows a better likelihood of turning shareholders investment into profit.
Also the price to earnings ratio, which reveals that investors are willing to pay more to purchase
Lufthansa’s shares. This is generally so because they project better performance and growth for
Lufthansa compared to Air Canada.

Based on our research and analysis we believe Lufthansa Group of Companies is a better
investment choice in the long run and better suits our investment needs.

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5) APPENDIX-1

Annual Financial Statement

Air Canada

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6) APPENDIX-2

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7) APPENDIX-3

Annual Financial Statement

Lufthansa

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8) APPENDIX-4
Statement of comprehensive Income

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9) BIBLOGRAPHY

Aircanada.com,. (2016). aircanada.com - About Air Canada. Retrieved 28 February 2016, from
http://www.aircanada.com/en/about/index.html

Centreforaviation.com,. (2016). Air Canada SWOT: Working towards sustainability, but familiar
foes await - along with some new ones | CAPA - Centre for Aviation. Retrieved 29
February 2016, from http://centreforaviation.com/analysis/air-canada-swot-working-
towards-sustainability-but-familiar-foes-await---along-with-some-new-ones-203548

Centreforaviation.com,. (2016). Lufthansa SWOT: new low cost platforms are smarter strategy
than resorting to protectionism | CAPA - Centre for Aviation. Retrieved 29 February
2016, from http://centreforaviation.com/analysis/lufthansa-swot-new-low-cost-platforms-
are-smarter-strategy-than-resorting-to-protectionism-217932

Kaur, H., Kaur, H., & profile, V. (2014). Air Canada Airline: Swot Analysis Of Airline.
Flyingplanes1229.blogspot.ca. Retrieved 29 February 2016, from
http://flyingplanes1229.blogspot.ca/2014/06/swot-analysis-of-airline.html

Travelchinaguide.com,. (2016). Lufthansa - the Biggest Airline in Germany. Retrieved 28

February 2016, from http://www.travelchinaguide.com/china-
flights/airlines/lufthansa.htm

(2016). Retrieved 28 February 2016, from

https://www.lufthansagroup.com/en/company/history.htmsl

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