Investment Strategies for Financial Markets and Asset Management

Faculty: Eeckels

May

2014

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Investment Strategies for Financial Markets

and Asset Management

Assignment #2-IHG.L and MLC.L Analysis

Andrew Axelrad

304628

Statement of authorship

I certify that this assignment is my own work and contains no material which has been accepted for the award of any degree or diploma in any institute, college or university. Moreover, to the best of my knowledge and belief, it contains no material previously published or written by another person, except where due reference is made in the text of the assignment.

Signed ____________Andrew Axelrad_________________________

Date _________________29/04/2014__________________________

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Table of ContentsPart A: IHG.L and MLC.L............................................................................................................................4

1. Company Profiles & Strategies..........................................................................................................4

IHG.L Strategies and Profile..................................................................................................................4

MLC.L Strategies and Profile.................................................................................................................5

2. Performance Analysis on Shares........................................................................................................7

3. Implied Returns using Dividend Discount Model..............................................................................9

IHG.L......................................................................................................................................................9

MLC.L..................................................................................................................................................10

4. Comparison of the Risk Premiums...................................................................................................11

5. Computed Betas with Comparisons..................................................................................................12

6. Computed Capital Asset Pricing Models..........................................................................................13

Conclusions to Part A...............................................................................................................................13

Part B: Minimum Variance Portfolio with IHG.L and MLC.L...............................................................14

7. Computation of Portfolio for Past Five Years..................................................................................14

8. Estimation of Portfolio’s Beta..........................................................................................................14

9. Comparison of Performance with London Stock Exchange and Lodging Industry Index...............15

Conclusions to Part B...............................................................................................................................16

Works Cited..................................................................................................................................................17

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Part A: IHG.L and MLC.L

1. Company Profiles & Strategies

IHG.L Strategies and ProfileIntercontinental Hotel Group’s main strategy focuses around “high-quality growth” which entails “consistent and sustainable growth in cash flows and profit.” They focus on customer needs and building brands in a targeted portfolio based around those respective needs. The Target Portfolio develops brands in, and is based on attractive market, their priority markets, outside their priority markets, highest opportunity segments, and guest occasions (InterConinental Hotels Group, 2014). IHG has 686,873 hotel rooms with a 1.6% growth rate from 2012. They noted a decrease in growth in order to maintain quality of their brands which is a measure of their internal performance (KPI). Furthermore, of the 4,697 hotels making up the aforementioned room total, less than 1% are owned or leased. They franchise 3,977 hotels (84.7%) and manage 711 hotels (15%). Their brands include:

IHG Brands BackgroundIntercontinental Luxury Brand, 178 hotels, 51 in pipelineHUALUXE Hotels and Resorts Luxury Brand designed for Chinese guestsCrowne Plaza “Career Focuses Business Travelers,” 391 hotels,

94 in pipelineHotel Indigo Boutique Brand, 55 hotel, 51 in pipelineEVEN Hotels Wellness Brand, 5 hotels in pipelineHoliday Inn, Express, Resort, Club Vacation (4 separate brands with similar focuses)

Middle of the road for leisure and business travelers, represent largest sector of portfolio, 3474 open hotels, 737 in pipeline

Staybridge Suites Extended Stay Brand, 196 hotels, 80 in pipelineCandlewood Suites North American Extended Stay Brand, 312 hotels,

80 in pipeline (InterConinental Hotels Group, 2014)

How does this affect their financials and ratios? The statements indicate relative stability from 2012; however, there was a notable decrease in cash and cash equivalents in the cash flow statement. The cash decrease is most likely from increases in plant, property, and equipment, the repurchasing of shares with an increase in dividends.

(CNBC, 2014)

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(Macroaxis Inc., 2014)

IHG has a high debt to equity ratio relative to the industry average indicating a reliance on debt financing despite having less debt than the industry average. IHG has a more favorable operating and profit margin relative to the industry. Through analysis, one can see IHG is taking advantage of favorable interest rates via their hotel operations. Also, one can assume that IHG’s business partnerships with franchise owners are taking advantage of favorable interest rates indicated by a massive expansion of numerous pipeline properties. However, the expansion can be assumed to not affect their book value since IHG does not own most of its assets. This assumption means that IHG is heavily reliant on the value of their brands, or market value.

MLC.L Strategies and ProfileMillennium & Copthorne Plc. prides itself on its “high quality” branded hotels diversely located around the world. They both own and operate their properties with their operating strategy revolving around their asset management to regulate yields on revenue and costs. Their asset management strategy “compares their long-term returns on existing properties to a range of alternative investments.” Their opportunistic investing has yielded favorable returns to their shareholders while developing a quality brand portfolio including: Millennium and Grand Millennium, Copthorne and Grand Copthorne, Kingsgate, M Hotels, Biltmore, and Studio M ( Millennium Hotels & Resorts, 2014).

(CNBC, 2014)

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(Macroaxis Inc., 2014)

(YAHOO! Finance, 2014, p. MLC.L)

Millennium’s operating margin is lower than industry averages and IHG perhaps because they relatively own more properties. However, their profit margin compared to the industry is slightly better indicating they are taking advantage of opportunities effectively via their strategy. Regarding debt, they are doing a decent job at controlling it compared to the industry. Nonetheless, they are dependent on debt to finance their strategies. Their financial statements indicate a high portion of their debt to be current which could be problematic in the future if not controlled effectively. I also put Yahoo financial data below to show that different data collection companies can have different measures on how they calculate their ratios. Yahoo’s data shows the quarterly debt data which shows a heavier reliance on debt. This means that MLC can control their short term debt currently, but should be careful in developing and disposing assets in a capital efficient manner. Their book value per share indicates they are reliant on effectively utilizing and choosing their assets (properties), but they are also heavily invested in the value of the brands (market value).

*Note: When analyzing IHG.L and MLC.L financial ratios, I used industry averages. This comparison should be taken with a grain of salt because the industry is comprised of numerous hoteliers implementing a variety of strategies affecting the said ratios. Since the hotel industry is so diverse, even with the commonality of the “asset-light” approach, it is still difficult to compare properties side-by-side solely on ratio analysis.

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2. Performance Analysis on Shares

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Adjusted Close of IHG.L and MLC.L from April 2009 to April 2014

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Percentage Change of IHG.L and MLC.L from April 2009 to April 2014

IHG.L Percentage ChangeMLC.L Percentage Change

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The above charts used data taken from: (YAHOO! Finance, 2014, p. IHG.L) and (YAHOO! Finance, 2014, p. MLC.L)

Even though the average percentage change seen above is very close, the standard deviation (total risk) for MLC.L is slightly more volatile than that of IHG.L. At quick glance above on the percentage change comparison chart, you can also see more volatility with MLC.L (red line). In other words, the larger standard deviation for MLC.L means greater risk than Intercontinental Hotel Group. From a pricing angle, IHG.L will have a larger price increase/decrease since it is much more expensive than MLC.L

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despite similar average percentage changes. Finally, both IHG.L and MLC.L have positive upward trends regarding their price with IHG.L showing a greater slope in terms of price.

3. Implied Returns using Dividend Discount Model

IHG.L

(YAHOO! Finance, 2014, p. IHG.L)

Dividends were given out two times a year as indicated above and were summed up to total the dividends given out in each respective year (data on right half of spreadsheet). For both the left and right side dividends, the growth rate was calculated (i.e. £7.30 - £20.20) / £20.20)) and then averaged out for an estimated arithmetic average percentage change. The average percentage change (12.09%) was used as the growth rate for the following calculations. Note: the dividends given out in March 2014 were £28.10 and were not factored in to maintain consistency in the yearly dividend calculations on the right. If it were to be factored in, it would drop the average yearly percentage change to 2.80% distorting the actual expected future outcome.

The last closing price used was £1,999.00 on April 1st 2014 and the last full year dividend paid out was £42.80 in August 2013. The steps for calculation are listed below:

P0 = £1,999.00, D1 = £42.80, g = 0.1209 (12.09%)

1. P 0=[ D 0∗(1+g ) ]

( k−g )

2. P 0= D 1(k−g )

3. D 1=(P 0)∗(k−g)

4. (k−g)=( D 1p 0 )

5. k=( D 1P 0 )+g

6. So…. k = (£42.80 / £1,999.00) + 0.1209

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7. Then…. k = 14.23%

MLC.L

(YAHOO! Finance, 2014, p. MLC.L)

The same growth estimation used for IHG.L was used for MLC.L to ensure consistency. For both the left and right side dividends, the growth rate was calculated (i.e. £2.08 - £4.17) / £4.17)) and then averaged out for an estimated arithmetic average percentage change. The average percentage change (23.43%) was used as the growth rate for the following calculations. Note: the dividends given out in March 2014 were £11.51 and were not factored in to maintain consistency in the yearly dividend calculations on the right. If it were to be factored in, it would drop the average yearly percentage change to 15.68% distorting the actual expected future outcome.

Last closing priced used was £554.50 on April 1st 2014 and the last full year dividend paid out was £13.59 in August 2013. The steps for calculation are listed below:

P0 = £554.50, D1 = £13.59, g = 0.2343 (23.43%)

1. P 0=[ D 0∗(1+g ) ]

( k−g )

2. P 0= D 1(k−g )

3. D 1=(P 0)∗(k−g)

4. (k−g)=( D 1p 0 )

5. k=( D 1P 0 )+g

6. So…. k = (£13.59 / £554.50) + 0.2343

7. Then…. k = 25.88%

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4. Comparison of the Risk Premiums

The UK Bank of England Official Bank Rate (Bloomberg L.P., 2014) was used in these calculations as the risk free rate since IHG.L and MLC.L are listed on the London Stock Exchange. The 0.05% rate was divided by 12 months/year to get the above listed percentage. Even though MLC.L has both a slightly lower average return and average risk premium, it has a higher volatility or total risk. Hence, as the literature is proved correctly, the higher the risk, the higher the return. The chart below depicts this analysis.

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Risk Premium of MLC.L and IHG.L from April 2009 to April 2014

Risk Premium IHG.LRisk Premium MLC.L

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5. Computed Betas with Comparisons

The published betas above were taken from: (Thomson Reuters, 2014, p. IHG.L) and (Thomson Reuters, 2014, p. MLC.L)

1. Returns calculated for both IHG.L and MLC.L utilized:

a. [ New Adjusted ClosePrevious Adjusted Close ]−1

2. The FTSE 350 Returns were calculated with the same formula in part 1.3. Then calculated Beta by using function COVARIANCE.P and VAR.P (variance)

a. =COVARIANCE.P (all calculated returns for IHG.L in part 1, all calculated returns for FTSE 350 calculated in part 2) / VAR.P (all calculated returns for FTSE 350 calculated in part 2) = 1.013

b. =COVARIANCE.P (all calculated returns for MLC.L in part 1, all calculated returns for FTSE 350 calculated in part 2) / VAR.P (all calculated returns for FTSE 350 calculated in part 2) = 1.487

Explanations/Analysis:

The FTSE 350 Index was used for several reasons including: IHG.L and MLC.L are listed under the London Stock Exchange who in turn own and operate the FTSE indexes. Also, the FTSE 350 was used since the index value was the most comparable to the market capitalization of both companies. The beta measures the systematic risk, or non-diversifiable risk on a single asset against the average of the market. IHG.L has less systematic risk than MLC.L since IHG.L has a lower beta. Both IHG.L and MLC.L betas are comparable because betas are an additive measuring how a specific stock behaves against a benchmark (FTSE 350). In question 6 you will be able to see that the expected return is dependent on systematic risk (beta). When comparing the beta to the published respective betas above, you will notice a slight numeric difference. This difference is because different financial publishers calculate betas with different formulae and factors. Also, since beta is reliant on historical data, different returns/estimates can be used in the calculation affecting the preciseness of the calculation. However, as you can see above, the beta differences in this case are so small.

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6. Computed Capital Asset Pricing Models

The capital asset pricing model uses the risk free rate, the market return, and the calculated betas. The risk free rate is the same listed in question #4 taken from (Bloomberg L.P., 2014) (UK Bank of England Official Rate). The market return (r (m)) was taken from a PDF report published by the FTSE (FTSEGroup, 2014) at 11.9%. Hence, the equation goes as follows:

1. Expected Return=risk free+β × [ market risk−risk free ]2. Or…. r (e )=r ( f )+ β (e )× [r (m )−r ( f )]

CAPM and DDM both estimate returns of an individual stock or its value, but have different focuses. DDM relies that the company has given dividends and on calculating the average growth from dividends given in a period of time. DDM also assumed that a stock’s dividends grow at a constant rate! On the other hand, CAPM emphasizes the use of benchmarking by using a stock’s beta comparing an individual stock’s performance to that of the market. CAPM utilizes risks to estimate an expected return for all stocks even if they do not give out dividends unlike DDM (requires dividends). Regarding the differences in DDM and CAPM, for both IHG.L and MLC.L we can infer that the stocks are over-priced, because the average actual returns are less than the expected returns calculated above.

Conclusions to Part AMLC.L has both a greater standard deviation or volatility (0.07962) and beta or systematic risk (1.487) than IHG.L who has both comparatively lower volatility (0.06497) and systematic risk (1.013) respectively. However, that being said, IHG.L has a slightly higher average return (2.073%) and average risk premium (2.069%) than MLC.L who has 2.023% and 2.019% respectively. When it comes to an expected return, MLC.L is back on top in parallel to the greater risk with around 17.6% compared to IHG.L who has an expected return of around 12%. Reasons for this are that the expected return accounts for the systematic risk and the greater the risk, the greater the expected return. Finally, since the market

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premiums are high due to an extremely small risk free rate, the expected returns are affected systematically.

Part B: Minimum Variance Portfolio with IHG.L and MLC.L

7. Computation of Portfolio for Past Five Years

X a=(σb

2−σ a σb ρa ,b )(σ a

2σ b2−2 σa σb ρa , b )

X b=1−Xa

Expected Portfolio Return=Avg . ReturnIHG. L ×Weight IHG. L+ Avg . ReturnMLC . L ×Weight MLC . L

8. Estimation of Portfolio’s Beta

Estimated Portfolio Beta = IHG.L (0.73552) + MLC.L (0.40754) = Portfolio Beta (1.14306)

The portfolio’s Beta indicates systematic risk to be less than MLC.L but greater than IHG.L. The expected returns of an asset are only dependent on systematic risk that cannot be eliminated. Of course, similar to the calculating beta in Part A, there are many limitations including frequency used in computation, sample size, how you benchmark it, etc.

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9. Comparison of Performance with London Stock Exchange and Lodging Industry Index

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Portfolio and FTSE 350 Travel & Leisure Performances from April 2009 to April 2014

Portfolio Performance FTSE 350 Travel & Leisure Performance

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FTSE 350 Performance Portfolio Performance

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Index information was taken from: (YAHOO! Finance, 2014, p. FTSE 350) and (Fusion Media Limited, 2014, p. FTSE 350 Travel & Leisure)

The performance of the portfolio indicated by both charts and table above yields greater risk and returns than the FTSE 350 and the FTSE 350 Travel and Leisure Indices. The portfolio can be said to have greater systematic risk and unsystematic risks. This is because systematic risks cannot be eliminated and the expected return and risk premium of the portfolio is dependent on these types of risks. Also, since there are only two assets in this portfolio, there is greater unsystematic risk compared to the indices that have larger arrays of diversified assets. Finally, the FTSE 350 Travel & Leisure was chosen for comparative lodging performance since both IHG.L and MLC.L are part of the index.

Conclusions to Part BThe portfolio beta (1.14) indicates risk is well balanced since the average portfolio return is between the individual average returns of IHG.L and MLC.L and the individual betas of the respective assets. However, the risk is balanced in relativity to the size of the portfolio and in comparison to the two chosen indices. In other words, the portfolio has the highest amount of volatility/risk compared to the indices that has a greater amount of diversification of assets. That being said, both indices have less volatility and relative returns. The aforementioned can also be seen when comparing the FTSE 350 and FTSE 350 Travel & Leisure volatility and average returns. Ideally, the theme of this paper indicates the truth about risk theory, the greater the risk, the greater the return!

*Note: For any of the evaluations, comparisons, and analysis used, I credit Dr. Eeckels’ Investment class, as well as the text (Jordan, Bradford D; Miller Jr, Thomas W; Dolvin, Steven D, 2012).

Works Cited

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Millennium Hotels & Resorts. (2014). Our Business. Retrieved from millenniumhotels.com: http://www.millenniumhotels.com/corporate/our-business.html

Bloomberg L.P. (2014, April 10). UK Bank of England Official Bank Rate . Retrieved from bloomberg.com: http://www.bloomberg.com/quote/UKBRBASE:IND/chart

CNBC. (2014). IHG.L : London Stock Exchange. Retrieved from apps.cnbc.com: http://apps.cnbc.com/view.asp?country=US&uid=stocks/summary&symbol=IHG.L#

CNBC. (2014). MLC.L : London Stock Exchange. Retrieved from http://apps.cnbc.com/: http://apps.cnbc.com/view.asp?country=US&uid=stocks/summary&symbol=MLC.L

FTSE Group. (2014, March 31). FTSE UK Dividend+ Index. London: FTSE International Limited.

Fusion Media Limited. (2014, April 1). FTSE 350 - Travel & Leisure Historical Data. Retrieved from investing.com: http://www.investing.com/indices/travel---leisure-historical-data

InterConinental Hotels Group. (2014). Our Strategy. Retrieved from ihgplc.com: http://www.ihgplc.com/index.asp?pageid=43

Jordan, Bradford D; Miller Jr, Thomas W; Dolvin, Steven D. (2012). Fundamentals of Investments Valuation and Management (6 ed.). New York: McGraw-Hill Irwin.

Macroaxis Inc. (2014). IHG Fundamentals. Retrieved from http://cdn.macroaxis.netdna-cdn.com/: http://cdn.macroaxis.netdna-cdn.com/invest/market/IHG.L--fundamentals--Intercontinental-Hotels-Group-plc

Macroaxis Inc. (2014). Millenium Findamentals. Retrieved from macroaxis.com: http://www.macroaxis.com/invest/market/MLC.L--fundamentals--Millennium-Copthorne-Hotels-plc

Thomson Reuters. (2014, April 1). InterContinental Hotels Group PLC (IHG.L). Retrieved from reuters.com: http://www.reuters.com/finance/stocks/overview?symbol=IHG.L

Thomson Reuters. (2014, April 1). Millennium & Copthorne Hotels PLC (MLC.L). Retrieved from reuters.com: http://www.reuters.com/finance/stocks/overview?symbol=MLC.L

YAHOO! Finance. (2014, April 1). FTSE 350 (^FTLC) -FTSE. Retrieved from uk.finance.yahoo.com: https://uk.finance.yahoo.com/q/hp?s=%5EFTLC&b=1&a=03&c=2009&e=1&d=03&f=2014&g=m

YAHOO! Finance. (2014, April 1). Intercontinental Hotels Group plc (IHG.L) -LSE. Retrieved from finance.yahoo.com: http://finance.yahoo.com/q/hp?s=IHG.L&a=00&b=1&c=2009&d=03&e=1&f=2014&g=v

YAHOO! Finance. (2014, April 1). Intercontinental Hotels Group plc (IHG.L) -LSE . Retrieved from finance.yahoo.com: http://finance.yahoo.com/q/hp?s=IHG.L&a=00&b=1&c=2009&d=03&e=1&f=2014&g=m

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YAHOO! Finance. (2014, April 1). Millennium & Copthorne Hotels plc (MLC.L) -LSE . Retrieved from finance.yahoo.com: http://finance.yahoo.com/q/hp?s=MLC.L&a=00&b=1&c=2009&d=03&e=1&f=2014&g=v

YAHOO! Finance. (2014, April 1). Millennium & Copthorne Hotels plc (MLC.L) -LSE . Retrieved from finance.yahoo.com: http://finance.yahoo.com/q/hp?s=MLC.L&a=00&b=1&c=2009&d=03&e=1&f=2014&g=m

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