The of Granite Construction Industry Plc - Case Study Example

Strategic Financial issues -Explain how the financial ments can provide information about its; -Profitability -Gearing -Liquidity and interest coverage -Operations -Performance of the business -Locate, extract and analyse data from the published financial statements to provide a comprehensive analysis of a company's operations and performance: and -Present a clear, well structured report using appropriate style and language. CASE SCENARIO The case of Granite Construction Industry Plc. April, 2009 TABLE OF CONTENTS 1.0 Introduction 1.1 Overview of Granite Plc 1.2 Auditors Report 2.0 Analysis of Company 2.1 Table of profitability Ratios 2.2 Table of Liquidity Ratios 2.3 Table of Solvency Ratios 3.0 Analysis of Company Relative to Benchmark 3.1 Performance 3.2 Financial Standing 3.3 Investment Opportunity 4.0 Future Prospect 4.1 Advice to client's subcontractors, and suppliers on whether they should be doing business with the company. 4.2 Advice to Investor on whether they should e doing business with Granite 4.3 Advice to applicant as to whether he/she should be applying for a job in this company 5.0 Conclusion 1.0 Introduction Today, Millions of shares are traded every day on the world's stock markets (Penman, 2003). Market participants in the market such as investors are often forced to ask themselves whether they are buying or selling at the right price (Penman, 2003). In their quest for an answer, investors turn to various media including internet chat rooms, printed press, and "talking heads" on television and financial networks, who often voice opinions on what they feel the stock prices should be. (Penman, 2003). In addition, investors consult investment analysts who provide an almost endless stream of information and recommendations to sort out. There are often claims that some shares are undervalued and vice versa. (Penman, 2003). This paper focuses on Granite Construction Company. The paper is aimed at carrying out financial analyses of Granite Construction Plc with particular focus on the liquidity, profitability and solvency ratio so as to gain a reasonable basis for providing recommendations to investors and suppliers on whether to invest or continue business for the company, and finally see the various methods through which the company access the capital market. Having said this, the sections that follow will be structured as follows. Section two provides an overview of the company. Part three provide a table of the various ratios, section four compares these ratios to the industry benchmark, while the next section examine the capital structure of the company and provides recommendations to various interest groups. 1.1 Overview of Granite Plc Granite Construction Inc is a heavy civil construction contractor in the United States. The Company operates nationwide, serving both public and private sector clients (Annual report 2006). In the public sector, the company primarily focuses on infrastructure projects, including the construction of roads, highways, bridges, dams, canals, mass transit facilities and airport infrastructure (Annual report 2007). In the private sector, Granite Construction Inc performs site preparation and infrastructure services for residential development, commercial and industrial buildings, plants and other facilities (www.graniteconstruction.com). According to the (2007), the company owns and leases substantial aggregate reserves and own a number of construction materials processing plants. The Company also have a contractor-owned heavy construction equipment fleets in the United States (www.graniteconstruction.com). Bodie et al (2002), defines the macro economy as the environment in which all firms operate. According to Bodie et al (2002), based on a study on the S&P 500, stock price tends to rise with earnings per share. Although ones ability to forecast the macro economy environment can lead to speculative investment performance, it is not enough to forecast the macro economy well. (Bodie et al, 2002). It is important to forecast the environment better that competitors in order to make abnormal returns. (Bodie et al, 2002). Some of the pertinent variables that need to be taken into consideration include: Gross Domestic Product (GDP), Inflation, Employment, Interest Rates, Budget Deficit and Sentiment. However, in this study only the company financial report will be used. 1.4 Auditors Report As stated on the company website, the 2007 income and other accounts are audited and adopted statements. The company's annual report on Form 10-K and quarterly reports on Form 10-Q, as published on the company's website. In the opinion of the company's auditors and Audit Company, to the best of their knowledge, the income and other financial statement of Granite Construction Inc, is true and fair and represents the company's activities within the period (Jensen 2003, Lewis 1993). 2.0 Analysis of Company In this section, the calculation and table for the various ratios (profitability, liquidity, and solvency) for Granite Construction Inc will be presented. This will be calculated with figures drawn from the 2005, 2006 and 2007 annual report. How ever, because of the absence of some 2005 data, emphasis will be on 2006 and 2007. Part of the 2008 data cannot be accessed from the company's website, so we have laid our analysis on the 2006, and 2007 data. 2.1 Granite Construction Inc, Profitability Ratios Ratio Formula 2006 2007 Gross Profit % Gross profit ' Sales x100% 295.72 x100%=9.96% 2969.60 410.74 x100%=15% 2737.91 Net Profit % Net profit ' Sales x100% 80.51 x100%=2.71% 2969.60 112.06 x100%=4.09% 2737.91 ROCE EBIT ' (shareholders funds + debt) 88.64 x100 =9.62% 921.85 167.13 x100=17.25% 968.62 ROE Profit after Interest and tax x100 Shareholders equity 74.34 =9.51% 781.44 132.92 =18.98% 700.20 Earnings per share Net profit 'number of shares 80.51 =1.92 41.83 112.06 =2.84 39.45 Price Earning Ratio Stock price per share Earnings per share 0.81 =1.05 0.775 1.26=12 0.105 NetAssets turnover Revenue Total Assets 2969.60=1.82 1632.84 2737.91=1.53 1786.42 Fixed Assets turnover Revenue Fixed Assets 2969.60=5.4 549.64 2737.91=4.16 658.91 2.2 Granite Construction Liquidity Ratios Ratio Formula 2006 2007 Current Ratio Current assets Current Liabilities 1083.20 =1.42:1 763.44 1127.51 =1.55:1 729.95 Quick Ratio Cash and short term Current liabilities 927.39=1.22:1 763.44 935.14=1.28:1 729.95 Cash Ratio Cash,equ and short term Investment Current Liabilities 755.68=0.99:1 763.44 926.53x=1.27:1 729.95 Stock turnover stocks 'cost of sales) '365 in days 73.51x365=11.53days 2327.17 74.93X 365 =10.23days 2673.88 Debtors turnover (trade debtors 'purchases) '365 397.1 x 365 =62.28dys 2327.17 536.52 x 365 =73.24dys 2673.88 Creditors turnover (trade creditors ' annual purchases) ' 365 213.13 x 365=33.43dys 2327.17 261.38 x365=35.68dys 2673.88 Working Capital Ratio Net profit 'number of shares 310 =0.775 4000 420 =0.105 4000 NOTE: Here we have used cost of sales as proxy for purchases and cost of goods sold. 2.3 Granite construction Solvency Ratios Ratio Formula 2006 2007 Interest Cover Dividend cover Earnings per share Dividend per share 0.775 =19.38 0.04 0.105 =2.33 0.045 Dividend yield Annual dividend per share Stock price per share 0.04 =0.049 0.81 0.045 =0.0357 1.26 GEARING RATIOS Debt to equity Total Debt Total Equity 1025.53 =1.31 781.44 1086.22 =1.55 700.20 Debt to total Assets Total Debt (Currentand Long term) Total assets 1025.53 =0.57 1806.97 1086.22 =0.61 1786.42 3.0 Analysis of Company Relative to Benchmark The construction industry is a backbone of any vibrant economy. The industry with it contracts nature has unique characteristics. According to some researchers, these characteristic makes the construction business risky, difficult to manage and vulnerable to bankruptcy. In addition, the construction business turns to be very sensitive to market cycles. In most situations, the market is largely affected by government economic and political policies such as taxes, interest rate etc (King et al. 2004). Problems usually faced by the construction industry include, difficulties in raising long term capital, liquidity problems, high sensitivity to cash flow fluctuations, ease of entry and an unplanned expansion. In the next three sections, while analyzing the ratios in relation to the industry benchmark, attention will be paid to granite construction managing these factors. 3.1 Performance Gross profit percentage measures what remains from sales after the company must have paid out the cost of goods sold expressed as a percentage. An increase in sales and a fall in the cost of goods sold will obviously increase gross profit percentage all things being equal. From our analysis, though our company under case study Granite Construction made positive gross profit percentage for the two periods, the situation for 2007 when compared to 2006 is better off. That is 15% in 2007 when compared to 9.9% in 2006. The ratio tells us that, despite fall total revenue received in the period of 2007 when compared to 2006, cost of goods sold also had a decrease. Thus, management is getting more efficient and effective. Management must try to cut down ordering and other sales related cost. According to Artrill &Elliot (2005), Net profit measures the amount of revenue outstanding after all the company related expenses for the period must have been paid. In other words, Net profit percentage finds out if the average markup on goods covers the expenses, and therefore results in a profit' From the ratio, Granite Construction Inc again did better in 2007 when compared to 2006. The profit margin for 2007 is 4.09% as compared to 2.71% in 2006. How ever, the figure of 2007 falls short of the industry benchmark rating for this ratio which is 5%. It should be recalled here that 2007 was positively impacted primarily by a gain of approximately $3.5 million from the sale of gold, which is a by-product of one of the aggregate mining operations which was held for sale (www.graniteconstruction.com). The company needs to be on the lookout for downward trends in the gross profit rate. The fact that, the figure here falls short of the industry benchmark is not indication of bad performance when 2007 is compared to 2006. The year 2007 is better than 2006. This is a sign of prosperity. What the management of Granite Construction Inc should do is try and reduce the costs associated with its other activities. Cut down on General and administrative expenses. The figure for general and administrative expenses increased from $204.3 million in 2006 to $246.2 million in 2007. However, it is not signs of poor performance, because in this period, increased costs was as a result of costs incurred to support new acquisitions, growth strategy and higher variable compensation resulting from improved profitability and the number of stock damage (2007 Report). Return on capital employed measures the dollar earn by each dollar contributed by the capital of the organisation, while Return on equity measures the dollar earn by each dollar of shareholders fund. Return on capital employed (ROCE) is the rate of return a business is making on the total capital employed in the business (Penman 2003, Berlin, W.J., & Lexa 2005). Capital will include all sources of funding. The company has again fallen short of the industry benchmark figures for both ROCE and ROE. However, the fact that 2007 is better when compared to 2006 shows sign of improving trends. The industry benchmark for ROCE is 18% while that of ROE is 22%. My client, Granite Construction Inc ROCE is 17.25% while ROE is 18.9%. Here it can be deduced that, Granite Construction Inc can be a market follower. The company is however improving as the figures for 2007 is better than 2006. According to the (2007) the company has made huge investment, which will provide the infrastructure and oversight necessary to maximize the profitability of the future work and execute the long-term growth strategy of the company. According to Penman (2003), net assets turnover measures the amount of sales generated for every dollar worth of assets. It is normally calculated by dividing sales or revenue in dollars by total assets. It shows the pricing strategy, and the efficiency of management. Here however, Granite construction falls short of the industry standard as ratios for asset turnover and fixed asset turnover are less. Management needs to negotiate and bid for good contract terms for the company, reduce other expenses, and watch out for wastage. Emphasis should be laid on total quality management. In all, the profitability ratios show that the company is doing well and there have been improvements from 2006 in almost all the ratios. 3.2 Financial Standing According to the company (2007) financial report, the company has a $200.0 million private placement of 6.11% Senior Notes due December 12, 2019. In addition, the Company purchased and retired 2,470,430 shares of its common stock during the fourth quarter at a total cost of approximately $92.7 million, representing an average cost of $37.54 per share (www.graniteconstruction.com). The current ratios have also witnessed improvements from 2006 when compared with 2007. The current ratio and Acid test ratio and cash ratio show that Granite construction has enough current assets to cover its short-term liabilities without facing business risk that is the risk that it might not meet its short-term commitments. The cash ratio for example shows that Granite construction Inc could only cover 99% of its short-term liabilities in 2006 using cash ratio while in 2007 the company was able to cover and 127%.Here, Granite Construction is doing better than the industry benchmark and consequently the competitors. The industry benchmark for current ratio is 1.2 and for acid test ratio it is 0.9. Granite construction has 1.27 and .99 respectively. At the level of stock turnover, the company the company is also doing better than the industry benchmark and consequently the competitors. This is so because the company uses less days to turn off its stocks than the industry competitors. The company stock turn-over day is 10.23 as supposed to the industry benchmark of 14.2days. Granite construction Inc as seen from the Debtors turnover has better credit policies to the customers when compared to the industry benchmark, the number of days offered to debtors to pay their debt is questionable. That is 73.24 days as compared to the industry benchmark of 22.0 days. How ever, this is due to a new product launch and a favourable credit terms given to client to encourage purchase. The company again has favorable terms of trade with the suppliers when compared to the competitors and market benchmark. Here, the company takes just 18.1days to pay its creditors while competitors take 35.68days. This is again good indication of good financial standing. However, what I will recommend here is for the company should try and tie the debtor's collection period and creditor's payment period to fall within the same payment band. Management needs to negotiate good sales terms for the company. The company frequently uses warrant and securities, as the capital structure lay more emphasis on debt. According to Artrill and Elliot (2005), gearing is a general term'describing'a financial'ratio that compares some form of owner's equity (or capital) to borrowed funds. Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds. From the perspective of Penman (2003), the higher a company's'degree of leverage, the more the'company is considered risky. An acceptable level'is determined by its comparison'to ratios of'companies in the same industry.'The best known examples of gearing ratios include the debt-to-equity ratio (total debt / total equity), times interest earned (EBIT / total interest), equity ratio (equity / assets), and debt ratio (total debt / total assets). The gearing ratio is higher when compared to the industry benchmark. This is a good indication of the company use of warrants and convertibles. 3.3 Investment Opportunity From above, it can be observed that the company uses more debt than equity in financing its activities. This is evidenced by the debt to equity ratio of 1.4. There is therefore some minimal effects of financial risk. That is, the risk that the firm might not meet its long-term debt obligations. Investment opportunities in the construction industry abound, but my advice to the company will be to first of all consolidate its present position. With enough cash reserves, any prominent investment should be appraised before any investment decision made. Ways in which the company uses Debts, derivatives, stocks. Warrants, options and other Convertibles Items 2007 2006 2005 Notes Payable 212.26 189.33 140.57 Debt Capital Lease 28.70 28.66 26.89 Long term Debt 268.42 78.58 124.42 Capital Lease Obli Other Debts 46.44 53.52 46.56 Common Stock 0.42 0.42 0.42 The company uses long term debt to finance lease equipments. The company uses common stock and preferred stock to raise additional capitals and to lure employees into partners. The company has steadily increased its long term debts within the past three years. This is minimize effect of the principal agent problem. ). A company that has a negative net working capital therefore faces higher risks than a company that has a positive net working capital irrespective of the profitability of the company. This is so because, the company with higher current liabilities may have high levels of debts that may be uncollectible, but which must have been included in the sales figure used in calculating profit. Debtors may default on the payment of debt and inventories may go obsolete. (Elliot and Elliot, 2005). Consequently, current assets that are made up of too much inventory and accounts receivables may not adequately cover current liabilities given that the company may end up not converting the receivables and inventories into cash. (Elliot and Elliot, 2005). The company is frequently accessing the capital markets, throough individual investors, leasing organizations, developmental institutions and banks. The Company Cost of Capital The company cost of capital is defined as the expected return on a portfolio of all the company's securities. The cost of capital is the discount rate that is used in discounting he cash flows on projects that have similar risk to that of the firm as a whole. Companies often undertake a series of projects with different risks. Consequently, the cost of capital for the company can only be used to discount cash flows if the projects in question have similar risks to that of the firm as a whole. (Myers and Brealey, 2002). The company cost of capital is expressed as WACC is calculated by multiplying the cost of each capital component by its proportional weight and then summing: Where: Re = cost of equity, Rd = cost of debt E = market value of the firm's equity, D ='market value of the firm's debt V = E + D , E/V = percentage of financing that is equity D/V = percentage of financing that is debt , Tc ='corporate tax rate Items/years 2007 2006 2005 Debts (D) 1086.22 938.29 850.67 Equity (E) 700.20 694.54 621.56 Firms Value (V) 1786.42 1632.84 1472.23 Re 18.98 9.51 - RD 13.8 13.00 (1-TC) 0.64 0.64 2007 WACC=0.392(0.19)+ 0.61(.14) (0.64) =10.23% 2006 WACC =0.42536 (0.095) +0.57464(0.13) X (0.64)=7.4% The company cost of capital increased between the two periods as a result to rising debt proportion 4.0 Advices My advice for investors is for them to hold or buy shares in Granite construction Inc, as the company's shares represents a good value for their money. By investing in the company, investors will merely be putting their money where their mouth is. This is because, profits are constantly increasing and with significant investment already made, the company will soon be making super normal profit. No wonder, management bought back a significant proportion of shares outstanding that's another indication of management confidence. 5.0 Conclusion This study carried out an analysis of Granite Construction Inc a key player of the construction industry in the US. In the course of the study, the company was found to be doing quite well in some ratios when compared to the industry competitors and the benchmark. Granite Construction Inc analysis also shows that, to minimize the risk often associated with the construction company, the company has its own production unit of gravel and other stuff. Thus money from the sale of this stuff can be used to compliment it other major activities. The advice given to investors here is that, they should put their money where their mouth is for, Granite Construction Inc, represents a good value for their investment. To suppliers, the quick payment system operated by the company is unique to the industry as such; suppliers should strife at strengthening their relationship. For applicants, the company is a going concern; applicant should not hesitate to seek a career with the company. The valuation analysis also proves that Granite construction Inc shares will rise subsequently, I recommend that people currently holding these stocks should HOLD or BUY them. References Atrill, P. & Elliot J., (2005). Financial Accounting for non specialists. 3th Edition. Prentice Hall: London Berlin, W.J., & Lexa, J. F., (2005).Financial modeling in medicine: Cash flow, basic metrics, the time value of money, discount rates, and internal rate of return. Journal of American college of Radiology. Vol.2 Issue3, Pp. 225-231 Myers S. C. Brealey R. 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Financial Accountability & Management, 10(2): 143-160 Lewis; J.R (1993) Activity-Based Costing for Marketing and Manufacturing. Quorum Books. Machovec, M.F. (1995). Perfect Competition and the Transformation of Economics. Routledge. Bodie Z. Kane A., Marcus A. J. (2002). Investments. 5th Edition. McGraw-Hill Jensen Michael C., (2003): Theory of the Firm Residual claims, and organisational forms. Cambridge, Massachusetts London, England Penman S. H. (2003). Financial Statement Analysis and Securities Valuation. Second International Edition. McGraw-Hill www.graniteconstruction.com Read More