Core Activities of Associated British Foods Plc - Case Study Example

Analysis of Associated British Foods plc Core Activities and Operations Associated British Foods plc (ABF) is a diversified international company that grows and sells food and ingredients and manages retail outlets selling food and fashion items. ABF has 85,000 employees in 43 countries. Global sales reached 6.8 billion in 2006. Its business mission is to achieve strong, sustainable leadership positions in markets that offer potential for profitable growth through increasing the size of existing businesses, acquisition of complementary new businesses, and by improving operating efficiency. The company has three strategic business segments: Sugar and Agriculture, Retail, and Grocery and Ingredients. It grows sugar from beets in the UK and Poland, and owns and operates cane plantations in Zambia and Swaziland in Africa and in Guanxi Province in China. The company also produces bioethanol from wheat and cane production waste, and sells animal feeds and feeds microingredients to farmers in over 40 countries. As part of its retail business segment, ABF also operates Primark in the UK, Ireland, and Spain, where it sells fashion items to men, women, and children under the age of 35. The Grocery and Ingredients segment of ABF is the biggest in the group, which owns well-known brands that are market best-sellers. ABF's revenues increased 13% to 6.8 billion in line with operating profit, which increased by 11% to 622 million in 2007. These accomplishments reflect the company's presence in high-growth markets such as China, India, Latin America, and Africa. Despite the strength of the sterling having an adverse effect on financial figures, the increases reflect good management and operating performance. The company is active in the search for alternative bio-fuels at a time of rising petrol prices, allowing ABF to benefit from and take advantage of the increasing demand for environment-friendly energy sources. The company is therefore properly positioned to take advantage of future market conditions. Profitability Ratios Using data from the 2007 Annual Report (ABF, 2007) as summarised in the enclosed Appendices give the profitability ratios as of September 2007: Profit Margin = 9.01% The value of the profit margin was calculated from the adjusted profit before tax amounting to 613 million whilst total sales amounted to 6,800 million. The profit margin for the year is slightly lower than the previous year's figure of 9.36% from profits of 561 million on sales of 5,996 million. The profit margin went down slightly because of losses from currency transactions when translating non-sterling revenues to sterling revenues. Since the sterling is stronger than other currencies, most especially the U.S. dollar in which some of the company's revenues are recorded, the amount of sterling that could be earned for each dollar would be slightly lower than if the dollar were strong. Non-UK sales (3,547 million) were over half the total sales. According to the financial statements, operating costs were much higher this year than last year. This was explained in several places of the report as due to the number of acquisitions spent this year, resulting in higher employee expenses for example. The total number of employees in Europe, Middle East, and Africa went up from 4,917 in 2006 to 37,084 in 2007 because of acquisitions in these regions. Asset Turnover = 1.97 times The asset turnover was calculated using the sales figure of 6,800 million and the total capital employed of 3,460 million. This means that every 1 invested in the company's assets returned sales of 1.97 or almost twice the invested capital. This figure gives an indication of how well the company utilised its assets. In the absence of comparative figures with other companies, this figure does not signify much. However, the asset turnover in 2006 was much higher at 2.1 because the company had higher margins and lower assets (valued at 4,579 million) before the company went on an acquisition spree that increased the total capital employed from 2,906 million in 2006. With the increase in assets and flattening sales caused by currency changes, the asset turnover was lower in 2007. This signifies that the company management was less efficient at generating sales from the increased amount of assets that it employed. Return on Total Capital Employed = 17.7% The company used the average capital employed for the year of 3,261 million to come up with the figure of 18.8%, which is 1.1% higher than what could be computed based on the financial statements (2007, p. 49) where calculations showed that the total capital employed amounted to 3,460 million whilst the adjusted profit before tax is 613 million. The ROCE measures the relationship between the profit generated and the total worth of the business, which is the difference between the sum of the fixed and current assets amounting to 6,980 million and the current liabilities of 1,443 million. This measure is purely academic and proceeds from the amounts already calculated. The lower ROCE in 2007 can be explained by the lower margins and lower asset turnover. What this means is that the company was not able to generate higher margins from the resources that it had during the current year. The annual report also calculated its ROCE based on average capital employed. This may be more realistic to use, because the company is also in the business of buying and selling other companies, which changes the asset composition in the balance sheet and affect the calculations for profitability ratios. ABF was therefore slightly less efficient and profitable in 2007 than in 2006, showing some difficulty in digesting acquisitions. Qualitative Analysis of Financial Statements The latest annual report of the company, with over 100 pages, is rather dense and loaded with information. Much of the report (a total of 36 pages) was dedicated to the Notes to the Financial Statements, followed by the operating review (16 pages) and to how the company practices corporate citizenship and governance (12 pages). The collective effect on the reader is that of increasing confidence in the reliability and openness of management that allows a better knowledge of the company. In terms of graphic quality, the colourful photographs that are used certainly helped in the marketing efforts. There are appetising photographs of sprawling sugar plantations, sizzling prawns, freshly baked bread, a beautiful fashion model wearing an elegant dress, and the faces of the executives are certainly brimming with confidence and cheer. They look like a bunch of competent managers whose job is to take care of the capital invested in the company. At least, they do not look like fat slobs with doubtful faces who are about to run away with high salaries and stock options for themselves. The report does not feature too many photographs, although the few that are included give a good impression of the sprawling and diversified nature of the company. Diversification is a good way for a company to take advantage of the different business cycles in different parts of the world (Sharpe, 1964). Therefore, according to the diversification theory, a company like ABF can continue growing and becoming profitable because it is not too dependent on one industry segment (e.g., fashions or food) and can perform better if a recession hits one industry (fashion) but allows the company to earn higher profits in another industry (agricultural products). There are also several points in the annual report where the management is forthcoming with the problems that were met during the past year that affected over-all financial performance, such as the currency fluctuations, weak business segments that failed to perform according to expectations, and the way the different business segments performed. The financial report by the Chief Financial Officer indicates asset disposals of losing subsidiaries, write-offs, and cash inflows. This better explains how the cash was generated. A segmental analysis showing the breakdown of revenues and expenses starts the Notes to the Financial Statements, giving a clear view of how each business segment performed during the past year. This allows a comparison of the company's yearly performance. There is also a section (7 pages) specifying the remuneration policies of the company and the duties of the executives and directors. This also helps the reader and potential shareholder to assess whether the management is adequately compensated. One detail dampened the confidence of the reader, which is the below-FTSE performance of the share price, a trend that has gone on since 2005. Why this is so given the diversified nature of the company can be explained by the fact that its profitability ratios were slightly lower this year than in the previous year. One reason is the weaker dollar that led to lower sterling revenue figures. Another explanation is that the company performed not as well in 2007 whilst managing its diversified portfolio due to weak markets in Europe and the US, which affected the over-all performance of ABF despite its strong performance in growth markets like China and India. Although comparisons of the company's performance from 2006 to 2007 are clearly stated and easy to understand, it would be better to have a comparison with similar companies that are diversified by operating business segments in the same industries where ABF competes. This would be more accurate in giving a future shareholder the information that would help decide whether to buy shares in the company than in another. This, of course, is not as simple as it looks because it may be difficult to find a company with the same portfolio of businesses as ABF, but indicating how it fares in competition with other agricultural products companies, grocery and ingredient producers and retailers, fashion houses that are in the same league as Primark, etc. would be a big help. Otherwise, a potential shareholder would have to depend on investment brokers or financial analysts and their recommendations. One other perfect detail in the report is a listing of the subsidiaries and joint ventures (ABF, 2007, pp. 91-92). This listing informs the reader the involvement of ABF in other countries and gives the impression that the management is good at managing across cultures and is able to have a better feel of what global markets want. Over-all, the report successfully gets the message across that ABF is a well-managed company that continues to grow because it meets the needs of its customers worldwide. Usefulness of Information in Financial Statements The latest annual report of ABF is comprehensive, covers the important information that shareholders need, colourful and informative. It is easy to understand as far as the over-all strategic and operational performance summaries are concerned. The outline and layout of the report are such that various information are presented at a level of detail that may range from those who do not know much about finance, marketing, or operations to those who are interested in the detailed financial information. The report mixes photographs and summaries from the CEO and COO in a balanced manner. The CFO's report, on the other hand, is straightforward and does not have photographs because none is needed. There are substantial notes to the financial statements that also show the company as sensitive to personnel and human resources issues (its notes on the pension plan are six pages long). Together with the other notes, the report is helpful by giving a balanced view of business performance. Listing the companies that it bought and sold over the years is also a good way of showing how the company is changing over time, whether it is focusing on a specific set of industries so it could manage itself better, or whether the company is going into other industries and trying to learn how to be profitable. The image, at least, is one of daring and risk-taking which, as basic finance theory teaches, is a way to earn higher returns. ABF also shows that it is complying with IFRS accounting standards. The report contains a progress report of how earnings of the past five years are being restated according to the new accounting regulations (McDonnell, 2003). Aside from the absence of information on comparable diversified companies, in view of the inaccuracy of comparing ABF with the FTSE 100's index performance, the report is complete. Buying a share in a company such as ABF that gives generous dividends and a growing share price is attractive, but one has to know if this would be a better investment compared to another (Fama, 1998). Lastly, a diversified corporation can grow organically by increasing sales and profits. It could also grow through acquisitions, buying profitable companies with higher sales and margins (Brigham & Davies, 2004). Or it could grow by becoming more efficient, cutting costs, selling more in different industries, and growing profits it invests for future growth or distribute as dividends. What the report shows is that ABF is doing all three, and this is a good way to manage a business. Reference List ABF/Associated British Foods plc (2007) Annual report and accounts 2007. London: ABF plc. Brigham, E. F. & Davies, P.R. (2004) Intermediate Financial Management, 8th Ed. London: Thompson. Fama, E. (1998) Market efficiency, long-term returns, and behavioural finance. Journal of Financial Economics, 49, pp. 283-306. McDonnell, J. (2003) International financial reporting standards and revenue recognition. New York: PricewaterhouseCoopers. Sharpe, W. (1964) Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19, pp. 425-442. Appendix A.1: Consolidated Income Statements of ABF as of 15 September 2007 [Source: ABF, 2007, p. 48] Appendix A.2.1: Segmental Analysis 2007 [Source: ABF, 2007, p. 59] Appendix A.2.2: Segmental Analysis 2006 [Source: ABF, 2007, p. 60] Appendix B: Balance Sheet of ABF plc [Source: ABF, 2007, p. 49] Appendix C: Progress Report of IFRS Compliance of ABF plc [Source: ABF, 2007, p. 100] Read More