The Capital Structure of the Hong Kong and China Gas Company - Report Example

The Hong Kong and China Gas Company or Towngas was founded in 1862 as the first Hong Kong’s public utility. As per 2004 its pipeline network was about 3,000 kilometers as well as covered around 85% of the economy. Its main business involves the distribution and gas production, marketing of the same product and the provision of after-sales services that are comprehensive. The company’s operations have diversified to usage of landfill gas and LPG stations of filling. It also has joint ventures establishments in 30 cities. (towngas.com, 2004) The employee fraternity comprised of 1922 workers in 2008. Besides its major utility business, it also indulges in property business like the branch of Grand Waterfront known as Ma Tau Kok and other activities such as investment, securities, financing, investment holding and property holding. (Wrightreports, 2008) This study is set out to analyse the capital structure of the Hong Kong and China Gas Company. To this there will be a vivid answering of the question, “How is the capital structure of the Hong Kong and China Gas Company?” There will also be a comprehensive analysis of the merits and demerits associated with the capital components utilised. Internal funds used may involve only the capital reserves. According to the pecking order’s theory, the firm is in the right track since it follows the order, with debt being its first preference and then common stock. The theory of the pecking order justifies this approach with regards to the order of external funds since it betows financial managers with the morale to remain with the control over the firm, to avoid the reactions of the market that are negative as it reacts to the new share issue and also do away with agency outlays of equity. (Thomas, 2001) Based on the consolidated balance sheet (unaudited) as at June 2008 presented by the company the long-term capital used to run the business mainly comes from share capital and debt alongside capital Reserves. Debt comprises of the borrowings and loans obtained from minority interests. (EPS (earnings per share) 30th April 2008 was 31.8 Hong Kong cents and for April 30th 2007 was 67.8) (towngas.com, 2008) Borrowings of the group aggregated bank loans and overdraft in entirety and which are unsecured. Borrowings had a maturity profile of 28% in a year, 3% in 1-2 years and 69% in 2-5 years as per 2007. As at 30th June 2008 the balance sheet had reserves being 24,297.5 HK$ million, borrowings 4,773.6, loan from minority interest 23.3, and share capital 1,666.4. As at 31st December 2007 Reserves were 22,098.5, borrowings 4,273.4, loan from minority interest 9.6 and share capital 1,514.9. As per the 2007’s unaudited balance sheet Reserves were 19,160.4, borrowings 5,610.9, loan from minority interest 53.2 and share capital 1,514.9 as at 30th June 2007. As at 31st December 2006 Reserves were 14,141.7, borrowings 5609.2, loan from minority interest 49.8 and share capital 1,377.2- All the amounts being in Hong Kong Million dollars. (EPS for 30th June 2007 was 90.3 HK cents and for 2006 30th June was 41.4) (hkcg.com, 2008) The results for the audited balance sheets as at December 2004 and December 2005 were as follows: In 2005; Reserves were 9,863.9, borrowings 5,857.2, loan from minority interests 74.2, share capital 1,377.2. On the other hand, as at December 2004; Reserves 8,001.0, borrowings nil, loan from minority interests 54.2, share capital 1,403.7. These figures are also in Hong Kong Dollars in millions. (EPS for 2005 31st December was 94.9 and for 2004 31st December was 58.3 HK cents) (Towngas.com, 2005) Just to mention, capital reserve is a resource which emanates from surplus capital of a company like an upward revaluation of assets to make sure that they are reflected in the prevailing market value subsequent to their appreciation. The allocation of these sums to the capital reserve is a sign that they are invested in a permanent way and will therefore be not paid to shareholders in the form of dividends. (Businessdictionary.com, 2009) Reuters’ website presents the debt/ equity ratio of Town gas as 36.64. (reuters.com, 2009) Debt/ equity ratio is computed by dividing long-term debt by ordinary shareholders’ equity. Thus, if equity of shareholders is € 20,000 and long-term € 4,000 the debt/ equity ratio is 4,000/ 20,000= 0.2. (investorwords.com, 2009) Therefore, Town gas utilises more long-term debt to carry out its business and just a substantial amount of shareholders’ equity to do the same. The company almost entirely concentrates on the usage of debt to finance its business when one interprets the 36.64 debt/ equity ratio. To shareholders debt capital kind of financing is advantageous to the company since with the high corporate debt its interest is an allowable expense against taxation. The company is in a position to raise its capital at a relatively lower cost than the market rate. Debt capital is termed cheap due to the relief of tax. (Lumby and Jones, 2003 p 477) Also the control on the business to the shareholders existing is not in any way diluted by the debt securities’ issuance. Disadvantages to shareholders may be the fact that interest on the debt securities has to be paid regardless of the income made in any given period of operation. Yet still, a very huge ratio of debt/ equity in a business reduces a great deal the ability of the company to get short-term loans as well as increasing the chances of insolvency. (Schneeman, 2002 p 303, 304) The debt holders’ issuing a debt is a merit since interest charges on the debt have to be catered for regardless of the earnings made by the company. Secondly, at maturity the debt has to be repaid. Disadvantages to debt holders chip in where they (debt holders) are not eligible to participate in the sharing of superior profits by the firm. Also during inflation, the debt returns may become lower especially when debt is repaid during this period. Thus inflation times are a bad occurrence to debt holders because they cannot enjoy full returns. (Shim and Siegel, 2007 p 360) Debt financing is advantageous to managers due to the fact that since interest on debt is a tax allowable expense, it minimises the cash outflow from the business for the purposes of the tax payment. Disadvantages are also evident where the loans issued bring with themselves strings attached by way of covenants and therefore restricting the ventures to be undertaken by the company. (Harper, 2006 p 277) Shareholders merit the issuance of shares since this represents an ownership of the business. One secures ownership of the business by purchasing shares and thus, can take part in the decision making process of the business. And still shareholders share profits of the business through the dividends’ issue. The company does not have to repay the amount obtained through the share issue while compared to the issue of debts. (insolvencyhelpline.co.uk, 2005) The shareholders, after a share issue, may have to lose some control on management of the company and eventually the business may be taken over. They have to share ownership with the new shareholders. (businesslink.gov.uk, 2009) Shares issuance reduces the challenges to the management since it is not an obligation to pay dividends. This form of capital also aids the company in case of future long-term financing that calls for the company’s creditworthiness. Demerits of share capital may include the fact that shares’ floating needs a lot of cost outlays due to the brokerage, underwriting and expenses on issue. (Khan, et al, 2005) To the business, use of high debt component like Town gas exposes it to high vulnerability to bankruptcy since the more the debt the greater the bankruptcy risk. It requires collateral as well which places the business in a risky position as regards the loss of assets. (Peavler Rosemary, 2009) Thus, while concluding it is good to note this especially when it applies to Town Gas Company which uses to a big extent the debt type of capital. The movement in EPS can serve as a good indicator of the impact of the types of capital applied in the business operations since it shows the net earnings divided by the outstanding shares. The data of EPS used includes the basic and diluted shares. This is while answering the question, “How is the capital structure of the Hong Kong and China Gas Company? Reference List: Businessdictionary.com. (2009). Capital Reserve: Definition. Retrieved June 9, 2009 http://www.businessdictionary.com/definition/capital-reserve.html Businesslink.gov.uk. (2009). Floating On a Stock Market: Your Options. Retrieved June 9, 2009 http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=107440 1437 Harper, Stephen C. (2006). Extraordinary Entrepreneurship: The Professionals Guide to Starting an Exceptional Enterprise. John Wiley and Sons. Edition: illustrated. p 277. Hkcg.com. (2007). Preliminary Announcement of 2007 Interim Results: Half Yearly Results. Retrieved June 8, 2009 http://209.85.129.132/search?q=cache:O9GSZ_KuHkkJ:https://www.hkcg.com/files/new s/eng/20070913_Towngas_2007_Interim_Results_Eng.pdf+The+Hong+Kong+and+Chin a+Gas+Company+BALANCE+SHEET&cd=7&hl=en&ct=clnk&gl=ke Insolvencyhelpline.co.uk. (2005). Shares and Shareholders. Retrieved June 9, 2009 http://www.insolvencyhelpline.co.uk/business_advice/finance_grants/raising_finance/sha res.php Investorwords.com. (2009). Debt/Equity Ratio: Definition. Retrieved June 9, 2009 http://www.investorwords.com/1316/debt_equity_ratio.html Khan. et al. (2005). Basic Financial Management. Tata McGraw-Hill. Edition: 2. Lumby, Stephen and Jones, Chris. (2007). Corporate finance: theory & practice. Cengage Learning EMEA. Edition: 7, illustrated. p 477. Peavler, Rosemary. (2009). Debt and Equity Financing: The Advantages and Disadvantages of Debt and Equity Financing. Retrieved June 9, 2009 http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm Reuters.com. (2009).Quote For Towngas China Company Limited. Retrieved June 9, 2009 http://in.reuters.com/money/quotes/quote?symbol=1083.HK Schneeman, Angela. (2002). The Law of Corporations and Other Business Organizations. Cengage Learning. Edition: 3, illustrated. pp 303,304. Shim, Jae K and Siegel, Joel G. (2007). Schaums Outline of Financial Management. McGraw-Hill Professional. Edition: 3, illustrated. p 360. Thomas J. Liesz. (2001). Why Pecking Order Theory Should Be Included In Introductory Finance Courses. Retrieved June 17, 2009 http://www.mountainplains.org/articles/2001/pedagogy/PECKING%20ORDER%20THE ORY.htm Towngas.com. (2004). Company Profile. Retrieved June 7, 2009 http://www.towngas.com/tgweb/eng/ab_towngas/company_profile.asp?position=left Towngas.com. (2008). Preliminary Announcement of 2008 Interim Results: Half Yearly Results. Retrieved June 8, 2009 http://209.85.129.132/search?q=cache:7ouEPk0SoXoJ:https://www.towngas.com/files/ne ws/eng/003engin.pdf+The+Hong+Kong+and+China+Gas+Company+BALANCE+SHEE T&cd=13&hl=en&ct=clnk&gl=ke Towngas.com. (2005). Towngas’ 2005 Annual Profit HK$5,281.4 Million. Retrieved June 20, 2009 http://209.85.129.132/search?q=cache:3RpFOGPTxesJ:https://www.towngas.com/files/n ews/eng/Press_Release_2005_Annual_English.pdf+Hong+Kong+and+China+Gas+Com pany+Limited+2004+balance+sheet&cd=2&hl=en&ct=clnk&gl=ke Wrightreports (2008). Hong Kong and China Gas Company Limited (The) - Company Profile Snapshot. Retrieved June 7, 2009 http://wrightreports.ecnext.com/coms2/reportdesc_COMPANY_438550303 Read More