Financial Strategy of the Signet Groups - Case Study Example

Part i) A review of Signet Group's performance over the last few years reveals the following: The key measures an investor looks for in a companyare earnings per share (EPS), dividend yield, price-to-earnings ratio, and the share price of the company. Earnings per share (EPS), which is profit divided by the number of outstanding shares (Cinnamon, Helweg-Larsen, 2006), for Signet Group has shown a consistent uptrend from 2002 to 2005, with a fall of 3.8% marked for the year 2006. Dividends per share (DPS) have depicted an equally consistent growth in the same time period, growing in the range of 10-20% every year, with a 10% rise in 2006. Price-to-earnings (P/E) ratio is a derivative of the EPS and depicts the market's expectations of the company's performance. P/E ratio has seen a consistent downtrend since 2002 due to declining share price. Investment in Signet's stock is considered good for investors looking for income via dividends, whereas capital gains as seen by the trend are less likely to be achieved. Part 1 - ii) The role of businesses in society these days has been emphasized particularly due to their sensitivity to social, ethical, and environmental issues. Issues like environmental damage, improper treatment of workers, or even faulty production that inconveniences or endangers customers are highlighted in the media. Reputation that can be built over a number of years can be ruined in hour through incidents that compromise social, ethical, and environmental standards. In some countries government regulation regarding environmental and social issues has increased. Even investors and investment fund managers have begun to take account of a company's Corporate Social Responsibility policy into investment decision-making, commonly known as ethical investing. The primary objective of Signet Group is to be a jewellery retailer of choice for a majority of the population in the countries where it has a footprint. Moreover, the primary financial objective of the Group is to be profitable in its operations and deliver an acceptable growth in value to shareholders, which is sustainable. In achieving its aforementioned objectives, Signet Group faces concerns regarding social, ethical and environmental matters. These matters, if not dealt with efficiently and effectively, may hinder the Group from progressing and achieving its objectives. These concerns are outlined below: Accountability to stakeholders Human rights Labour standards Health and safety; and The environment In recent years, expectations of stakeholders of public companies have increased. It is imperative that the companies manage and respond to these changing expectations so that business viability is not questioned. The success of Signet Group, for that matter any company, is dependent on the strength and effectiveness of its relationships with its various stakeholders: shareholders, customers, suppliers, and employees. Stakeholders have varying expectations from the company. For instance, shareholders or investors have an insatiable expectation of a competitive overall return from the company. They demand that the company maximize shareholder wealth. If Signet does not have a strong social, ethical and environmental (SEE) framework in place, there is a possibility that the company's reputation can be compromised which, in turn, may hurt its operations and finally, its revenue potential and profitability. Signet Group has a no-tolerance policy for unlawful discrimination. In respect of people with disabilities, full and fair consideration is given to employment. Unfair employment practices can potentially put the reputation of the organization at stake which may lead to losses. Signet Group actively participates in the Association of Jewelers of America to implement the SEE standards set by the industry across the organization. This is to ensure that SEE risks at the mining, trading and secondary processing phases of the supply chain are managed through effective cooperation within the industry. Whilst the direct environmental impact of its operations is considered fairly low, Signet Group ensures that an environmental impact review is frequently conducted so as to maintain the SEE standards. This is to reduce the environmental impact that extraction of minerals may have by ensuring careful management on part of mining companies (Signet Annual Report, 2006). Part - iii) The prime objective of shareholders of any company is to get sustainable competitive returns on their investment in the company. Preferably, shareholders seek returns in both components, namely, dividends as well as capital gains. Shareholders believe that their demands can only be met if their objectives are in congruence with the objectives of the executive management board. The prime objective of the Board at Signet Group is to achieve sustainable enhancement of business performance and shareholder value. The Board is responsible for determining all major policies, and for ensuring that effective strategies and management are in place to safeguard the organization's goals and objectives. The Board at Signet Group seeks to keep all its shareholders, potential investors, and other interested parties in the loop by presenting a balanced assessment of the company's strategy, financial position and prospects. In certain specific matters, however, the Board retains responsibility. These matters include approval of the annual report and other documents that are circulated to shareholders of the company; quarterly and annual results announcements; trading statements; distribution policy; acquisitions, divestitures, material agreements and capital expenditures; risk management; annual budgets; senior appointments; corporate governance and the setting of social, ethical and environmental policies (Signet Annual Report, 2006). The Board regularly reviews matters that are pertinent in the effective running of the Board. The Chairman and the Group Chief Executive together with other executive and non-executive directors have a set of responsibilities that are fulfilled in conformity with the long-term objectives of the Group. Senior executive appointments are made based on skills and business experience considered to be appropriate for the proper and efficient functioning of the Board. On appointment, new directors are required to participate in an induction program whereby they are familiarized with the Group, its business objectives and investor perceptions. The performance of the Board, its Committees (audit, risk management) and individual members is monitored to ensure that each director's effective contribution and commitment to the role. The Board maintains rigorous internal control across the organization by way of external audit to ensure internal policies and procedures set by the Board are complied with. The Board conducts meetings with the shareholders which gives them an opportunity to monitor the company's progress and voice their concerns. The Board at Signet Group maintains a Remuneration Committee which ensures that the Group's remuneration policy is based on sound, clearly stated principles which recognize the long term interests of the Group, its shareholders, and employees. The Remuneration Committee seeks to ensure that those executive are appointed in the company which are considered to possess above industry average ability and leadership potential. As a result, such executive would be retained by providing them with above industry average total remuneration. Therefore, it is recommended by the Remuneration Committee that the executives at Signet be remunerated in a range beginning with the 51st and ending with the 75th percentiles of industry total remuneration which is based on surveys of relevant companies that fall in the same industry and sector (Signet Annual Report, 2006). Signet follows a remuneration policy that is geared towards performance. There is only one element of guaranteed remuneration and that is the base salary. The performance related portion of total remuneration rewards short-term and long-term performance with more weight extended to the latter. Short-term performance is rewarded by way of annual bonus, the targets for which are set each year after taking into account the role of the executive and current business plans. Through offering savings-related share option plans, the company provides an opportunity to the employees and directors to share in the equity of the company. To encourage senior executives to meet long-term strategic and financial objectives of the Group, Signet encourages a long-term incentive plan in addition to the provision of share options. However, the vesting of long-term incentive plan is dependent on the achievement of challenging performance conditions (Signet Annual Report, 2006). In summary, the remuneration package offered to the executives is aimed at rewarding long-term performance. The guaranteed component as aforementioned is only the base salary. The other components of remuneration discussed above are provided subject to meeting performance standards. This ensures that the equity of the company is not dipped into in situation where the company declares a loss, thereby ensuring congruence between the goals of shareholders and executive management. Part 1 - iv) The Combined Code requires that the directors review the effectiveness of the Group's system of internal controls encompassing the following areas: Financial Compliance Risk Management Operational Key procedures designed to provide effective internal controls in Signet are: Control environment - Signet has an organizational structure with clearly defined levels of responsibility and authority together with appropriate reporting procedures, especially with respect to financial, capital expenditure, investment as well as health, safety, environmental and customer service issues (Signet Annual Report, 2006). Risk Management - major business risks are identified in conjunction with operational management and steps are taken to monitor and mitigate risks. The Risk Management Committee meets regularly to discuss issues such as the Group's risk register, new regulations, and the activity of the internal audit system (Signet Annual Report, 2006). Control Procedures - each operating division maintains documented financial and operating controls as well as procedures appropriate to its own business environment and in conformity with Group guidelines. Moreover, each operating division has an internal audit system that reviews processes to check for compliance with set standards (Signet Annual Report, 2006). Financial Reporting - Signet has a comprehensive financial reporting system approved by the Board. There is regular reporting to the Board on business development, competitive environment and any material breaches of procedure. The Group has strengthened its resources to meet the increasing demands of corporate governance, to comply with the Sarbanes-Oxley Act, and to address evolving accounting standards. Furthermore, the Group has strengthened its finance function to reflect the increased demands of IFRS accounting and US GAAP requirements (Signet Annual Report, 2006) The Principles of Good Governance of the Combined Code require that: Every listed company should be headed by an effective board which should lead and control the company. Signet has a Board that consists of directors who are in charge of effectively controlling the company. Signet, in compliance with the requirements of the Combined Code, has appointed a Chairman and a CEO who have a clear division of responsibilities to ensure a balance of power and authority and prevent the one-man show situation. The Board, as required by the Combined Code, has a balance of both executive and non-executive directors so that the Board's decision-making is not dominated by any one or small group of individuals. Appointments to the Board are subject to a formal and transparent recruitment procedure. Remuneration is maintained at levels sufficient to attract and retain the directors needed to successfully run the company. In conformity with the Combined Code, the structure of remuneration is such that there are both fixed as well as performance-linked payouts. The company's annual report states both the remuneration policy as well as remuneration details of each director. The Board of Directors at Signet considers that it has complied with the requirements as stipulated in the Combined Code. Part 2 - a) Dividend Policy Signet has a dividend policy that takes into account earnings, cash flow, gearing, and the needs of the business. The first priority of the company is to maintain sufficient distributable reserves and liquidity to ensure that operational needs and/or business growth are not limited by the unavailability of funds and that cushion is available to cover all known contingencies. Thereafter, the company intends to operate a distribution policy that considers a split between the interim and final dividend payments. Given the earnings pattern of the Signet Group, final dividend payments are given more weightage as compared to interim dividends. For the year 2006, Signet Group announced a dividend of 3.3p, a 10% surge over the prior year (Signet Annual Report, 2006). Financing Policy Signet Group is dependent upon the availability of equity and debt financing to fund its operations and growth. It, therefore, prepares annual budgets and medium term plans which help to identify future capital requirements so that appropriate facilities can be arranged in a timely manner (Signet Annual Report, 2006). The current capital structure of Signet Group as extracted from its 2006 annual report is 12% debt versus 88% equity. Such a low figure for debt depicts that Signet Group is more inclined toward equity financing than debt financing. Part 2 - b) Because different companies are in different types of business and have different capital structures, the cost of capital applied to one company may differ radically from the cost of capital of another company (Azzopardi, 2004). A technique referred to as the weighted average cost of capital has been developed as a remedial measure. Weighted average cost of capital (WACC) is the discount rate used to convert expected future cash flow into present value for all investors. Generally, all investments producing a return above WACC are considered positive net present value (NPV) investments and should be accepted. Contrariwise, all investments producing a return below WACC are negative NPV investments and must be rejected. However, investments cannot be simply judged on the basis of NPV. The formula for WACC calculation also encompasses solvency ratio. The solvency ratio usually changes according to business cycles and other factors. Therefore, WACC may not suitably appraise an investment. There are various ways of measuring a firm's performance. One way is to use accounting measures such as return on equity, return on assets, etc. Another way is to use market measures and determine the firm's performance by looking at the stock's value. These measures, however, do not provide an effective evaluation of firm performance. One such measure that determines the true value-creating performance of a firm is Economic Vale Added (EVA) analysis. This analysis attempts to determine the net contribution to value by a company's investment decisions which other measures fail to provide (Meigs, et al., 1999). This means the after-tax returns of the company should exceed the cost of capital invested. EVA is calculated as follows: EVA = (ROIC - WACC) x Invested Capital Formula for Return on Invested Capital (ROIC): ROIC = Net Income / Liabilities + Shareholders Equity EVA is dependent on return on invested capital as well as the cost of capital. Higher ROIC and a lower cost of capital can increase EVA significantly. For example, let's consider that EVA for Signet Group is 1,000,000. This means that it is the net contribution to value added by the company's investment decisions. Higher EVA can alter the capital structure by increasing the proportion of equity to debt. However, every company has a target in terms of maintaining an optimal capital structure that minimizes cost of capital and maximizes shareholder wealth. A higher equity and lower debt in the capital structure substantiates the financial strength of the company. REFERENCES Azzopardi, F. (2004). A Holistic View on Investment Appraisal. University of Leicester. Retrieved on May 10, 2007 from http://mgimalta.com/publications/academic-articles/A-holistic-view-of-investment-appraisal.pdf Cinnamon, R., Helweg-Larsen, B. (2006). How to Understand Business Finance. New Delhi: Kogan Page. Meigs, R.F., Williams, J.R., Bettner, M.S., & Haka, S.F (1999). Accounting: The Basis for Business Decisions.11th Ed. New York: Irwin-McGraw Hill. Signet Annual Report, 2006. Retrieved on May 10, 2007 from www.signet.com Read More