The Prospects of Investing in George Wimpey Plc - Case Study Example

I. EXECUTIVE SUMMARY Rationale - This paper is intended to analyze the prospects of investing in George Wimpey plc based on the following: A. Company's resilience as seen in its 125 years in the industry that has been marked by highs and lows in the market; B. How the company fared in previous years based on a financial analysis of its 2005 & 2006 financial statement; C. How it sees itself in the next 3-4 years based on industry trends and the Company's business model, i.e., KPIs. 2. Methodoloy - The proponent used key financial ratios to determine the performance of the company and residual earnings method to valuate the company's share. 3. Financial Statement Findings - Based on the financial statement, George Wimpey is financially sound and is likely to survive the adversities of the market. This finding however is hinged on the condition that the company will endeavor to intensify measures to control cost of sales, which is actually one of the pillars of the company's business model. 4. Valuation of Shares - II. ANALYSIS OF THE INDUSTRY 1. Scope - The industry addresses the demand for housing in U.K. and the U.S. The homebuilding business process entails land banking, site development and sales, which are mostly attained thru financing. 2. Market - The 19 billion homebuilding industry is now experiencing "the worst slump in more than a decade" (Bloomberg, Baseley). A. Cause - According to Home Builders Federation chairman, i.e., Stewart Baseley, the slump is "unique" since it is due to the lower number of approved mortgage applications, attributable to global tightening in the credit market, rather than high unemployment or inflated borrowing interest rates. In fact, in March 2008, the volume of approved mortgage applications marked the lowest since 1997 (Bloomberg). B. Effect - With the contraction of demand, house prices fell year on year in April 2008, homebuilders are compelled to cut down on overhead. As of July 2008, Bloomberg reports that about 60,000 employed in the industry are likely to lose their jobs in the process. C. Outlook - While the industry has seen steady growths since 2002, estimates have it that it would slowdown settling at a CAGR of 3.3% from 2007 to 2011 (Datamonitor 7). III. THE BUSINESS MODEL - George Wimpey plc's business model encompasses activities like acquisition of land, home and community design, urban regeneration and the development of supporting infrastructures (TaylorWimpey plc). Specifically, George Wimpey plc is engaged in the construction of apartments, 2-3 bedroom houses and 4-5 bedroom houses among others and is anchored to the business' four pillars (Wimpey Annual 2006) namely: 1. Land - Reduction of the real cost of land is essential and this can be achieved thru various strategies like the addition of medium and long term value added plots and close monitoring of land prices in the U.S. to resume timely and market driven land acquisition activities . 2. Costs - To become competitive in this industry, all projects must be cost driven and this can be done by establishing a framework that will measure and challenge every cost in the area. 3. Sales - Efficiency and effectiveness of the company's sales process are the key objectives reinforced by an excellent customer service. This plays a very vital role in realizing the company's revenue targets and desired profit margin. 4. People - Being a key element in the success, periodic and timely updating of the company's employee compensation package is vital in staying competitive in terms of retaining and procuring the best human resource in the industry. It also goes without saying that manpower training is a crucial in order to develop the future leaders of the organization that will bring the company into the future. IV. HISTORY OF THE COMPANY (Finding Universe) 1. Humble Beginnings - The original owners were Walter Tomes and George Wimpey who initially worked as contractors for residential projects that required structural and decorative masonry. In 1893, Walter Tomes sold his share of the company leaving George Wimpey sole owner of the company. The 1890's was the company's launch pad to fame and recognition, winning contracts like the local town hall and laying down the foundation for London's first "Electric Tramway". At the turn of the century, having gained prestige, they would be commissioned to build the 140-acre White City complex that housed the 1908 Olympic Games. 2. Gaining Ground - After the death of George Wimpey in 1913, his heir sold the company to Godfrey Way Mitchell who opted to retain the original name of the company in recognition of the achievements of the company. From that time on, he would transform the company into the construction juggernaut that it is known today. His vision for the company brought them to places outside of the U.K. winning a wide array of projects that ranges from building an entire community to the development of oil fields, refineries, pipelines and support systems in Kuwait, Borneo, Iraq, Syria and New Guinea. The company's expansion effort abroad was awarded with the Queen's Award for Export Achievement in 1977. 3. Paradigm Shift - The 1990's marked a revolutionary change in the company's management, organizational and ownership structure. New blood was infused into top executive posts. They were not only significantly young but some even came from outside the company's ranks. Market research was institutionalized to guide all the activities of the various departments. These moves would eventually strengthen their financial position, opening a spectrum of options they never had in their 50 years of operation like the acquisition of McLean Homes from Tarmac in 1996. 4. Today and the Future - George Wimpey plc is probably one of the oldest and largest construction consortiums in the world. It has been in the homebuilding business since 1880, starting as a stone working business in Hammersmith, and to date the company has been able to build 850,000 homes across the U.K. and U.S.. Throughout the late 1990's and early 200's, Wimpey was able to achieve record breaking growths in terms of revenues and net profit before tax. It has been a leader in the homebuilding industry and will likely stand its ground for years to come. V. FINANCIAL STATEMENT ANALYSIS - This analysis is based on the 2005 and 2006 financial statements of the company, which were actually the last 2 years of the company's operation prior to the merger in mid-2007 with Taylor Woodrow plc. The proponent opted to gauge the company's performance using four financial measures, which are as follows: 1. Profitability and Cost Management - While George Wimpey plc was able to post annual revenues of 3,147.4 million for 2006, which is a 4.8% increase year on year, the effect of their stellar performance (i.e., above the European Homebuilding Industry growth of 4% over last year and the 3.5% Compounded Annual Growth Rate (CAGR) spanning from 2002 to 2006 (Datamonitor 9)) was however tapered by the 6.9% increase in cost of sales. The spike in cost of sales reduced their profit margin to 8% from 10% last year. This is further reflected in the ROCE, which dropped from 18.18% to 13.42%. The company therefore needs to re-evaluate how they managed the costs attributable to sales in 2006, after which institutionalize measures to control, if not cut down, cost for them to improve on profitability and maintain competitiveness. 2. Liquidity - The financial strength of the company plunged from 4.02 to 3.58. Nonetheless, it is still a re-assuring figure since it is way above industry accepted Current Ratio of 1.69 (Industry Overview: Homebuilding, Reuters). In general, the company's liabilities increased due to the increase in trade and other payables by 27.5%, which are mainly a function of the increase in the prices of operating supplies. 3. Asset Management - The Company was more efficient in 2006 in the use of its assets to generate much needed revenues. This was manifested in the improvement in the Asset Turnover (i.e., ATO) from 1.44 in 2005 to 1.5 in 2006 despite the fact that the net operating asset increased slightly in 2006. 4. Growth - Notwithstanding the fact that sales grew by an impressive 4.8% over the previous year, i.e., higher than industry growth in Europe pegged at 4% (Datamonitor), 2006 was marred by a slowdown in the expansion of the business en banc based on several growth indicators that registered modest figures as compared to 2004-2005. These are as follows: A. Growth in Net Operating Asset - The operating assets of the company grew only by 6.9%, paling in contrast to its robust growth rate of 12.5% in 2005 over 2004. This was further dampened by the 18.8% increase in operating liabilities resulting to a measly 0.5% growth in net operating asset. In essence, the company was not able to achieve one of its key performance indicators, which is to acquire additional land specifically in the U.S. market. Increase in operating liabilities on the other hand, is due to the 27.5% increase in trade and other payables, which subsequently, are a function of the spike in acquisition cost. B. Growth in Ordinary Shareholder's Equity - While the OSE increased by 10.5% over the previous year, it was not as impressive as the 16% surge the company had in 2005 versus 2004. Similar to the growth on NOA, the company needs to resume land acquisition where it can (i.e., in this case, in their U.S. market) to improve their performance in the aspect of land banking. C. Growth Rate in Operating Income - For the past two years, George Wimpey PLC's operating income has been on a downswing, declining by 9.48% from their 2004 performance in 2005 and further plummeting by a stunning 18.22%. The major reason here is the drastic increase in the cost of sales since revenue grew over the 2004-2006 spread while other expenses generally went on a plateau-like pattern so to speak. Based on the aforementioned financial ratios, George Wimpey plc is still strong and reliable (i.e., a revenue growth of 4.8%). This above industry performance is mostly due to the company's years in the business, which has actually withstood the test of various market adversities that it faced in the course of their 125 years in the business. If the company wants to improve their growth however, they need to focus more on the management of their cost specifically in costs incurred for every sale they make. This is very crucial to the company's growth and to ensure that they are able to bring themselves further into the future. The analysis also shows clearly that the company has not been very aggressive in increasing their operating assets as compared to their performance in this area in the previous year. With this in mind, it is imperative for the company to endeavor to resume strategic land banking. While the proponent believes that the major reason for the slowdown in property acquisition is the uncertainties in the U.S. market, land banking is however rudiment in the company's business model in achieving a sustainable growth therefore, all efforts must be undertaken to regain momentum in their property acquisition activities. As mentioned in the Chairman's message, short term goals include increasing the volume of their land inventory. The proponent believes that this gap should be provided in the U.S. sector. They can do this by closely monitoring land prices to ensure that they are able to seize any opportunity to buy properties in the U.S. Note further that these findings and recommendations are aligned with the company's key performance indicators (KPI) and the pillars on which the George Wimpey plc's are pegged, i.e., land, cost, sales and people. VI. VALUATION OF COMPANY SHARES - The analysis of this section, using the residual earnings method, aims to determine the prospects of investing in the company. Indexes were based on the 2006 financial statement of the George Wimpey plc. 1. Assumptions - In order to determine the present value of the company's shares, the proponent had to project the business until 2009 using several factors to arrive at the values of key parameters. These are as follows: A. Revenue Forecasting - Using George Wimpey plc's 4.8% revenue growth in 2006 as index, the proponent projected the company's revenue based on market projections found on Datamonitor's "Homebuilding in Europe" for 2007 to 2011. The projection factors accounted for a slowdown in the industry's Compounded Annual Growth Rate (CAGR) from 3.5% to 3.3%. B. Expense Forecasting - To maintain conservatism, the proponent opted to maintain a straight line to project expenses like cost of sales, administrative expenses, financial expenses and tax rates. C. Inventory and Other NOA Turnover - The proponent opted to follow a plateau-like pattern to project the following parameters. 2. Methodology - In determining the valuation of the price company's shares, the proponent used residual earnings method. This section evaluates the strengths and weaknesses of this method. A. Strength - The method is very applicable to George Wimpey plc since it has a very sound balance sheet. This method capitalizes on the company's financial strength brought about by years in the business and of course, being the leader in the homebuilding industry. Note that the company has a beta coefficient of less than 1, i.e., 0.865 (Datastream), which means that the company is less volatile to certain market fluctuations, an attribute not very attractive for short term gains. B. Weakness - The residual earnings method in this case is not a reflection of the present situation of the company since the method, which uses data from its previous organizational structure, i.e., pre-merger, did not account for the effects of the merger between George Wimpey plc and Taylor Woodrow plc. Note that there is now an internal problem brewing within the company after investors were not willing to give it the 500m it needs to shore up its balance sheet (Harrison, Writedowns). In fact, if things do not go well, it might collapse when covenants will be tested in February 2009. V. RECOMMENDATION - Based on the findings of this research, the proponent provides two recommendations, which are as follows: 1. Fundamental Analysis - Based on the method and data used, it is highly recommended that prospective investors buy shares of the company at 4.80 per share since the actual valuation of the shares based on the projections made is pegged at 5.49 or a 14.4% over value. This is however good for capital investors, i.e., long term, since investors who intend to profit in the short term are not likely to gain attractive gains from it. The recommendation to invest for the long haul rather than to gain short term profits is further reinforced by the beta coefficient of the company, i.e., 0.865%, which is less than 1. Simply put, George Wimpey plc is less volatile than the market trend making it not an attractive investment option for short term investors. 2. Technical Analysis - Based on post-merger and current market trends, i.e., company state, investing in George Wimpey plc or in the homebuilding industry in general, is not a very good idea. As a matter of fact, the proponent suggests selling of company shares with the imminent threat of financial collapse in February 2009 after news that the company has not been able to raise the 500m. As mentioned in the industry analysis, the homebuilding industry is experiencing one of the worst market slump in decades add to that the rippling effect of company downsizing and laying off of thousands of employees to cut down on their overhead expense, which will subsequently cause unemployment, a key factor that will affect the housing slump further. Note also that in projecting for expenses, the proponent assumed a steady increase however, with exponential increases in operating expenses (e.g., fuel), these assumptions may not hold true eventually. These qualitative analyses are further reinforced by the industry projections made by Datamonitor in their research on the homebuilding industry. The prcis therefore of the above mentioned recommendation is that George Wimpey plc is a good option for investors looking for a long term business as attested by their financial statement for 2005 and 2006. However, based on current industry wide trends and company updates per se, any plans to bet on the company or the homebuilding industry for that matter has to be deferred until the following are addressed accordingly: A. The 500m dilemma - Deciding to invest in George Wimpey plc might have to wait until after February 2009 when the company's covenants will be tested. Note that unless they raise the 500m additional capitalization to augment their balance sheet, there might no longer be a company to invest on. B. Low Mortgage Application Approval Rate - The housing slump is said to be a function of the low approval rate in mortgage application due to the global tightening of the credit market and not because of the normal factor of unemployment. Unless this is addressed immediately, this unique reason might eventually convert to unemployment with the impending laying off of hundreds of thousands of workers brought about by the slowdown in demand. VI. FIGURES AND COMPUTATIONS WORKS CITED "Annual Reports and Accounts 2006". hemscott.com George Wimpey, 2007. Web. 21 July 2008. < http://www.hemscott.com/ir/wmpy/ar2006/ar.jsppage=home>. Barwell, Tim. "U.K. Homebuilders to Cut Tens of Thousands of Jobs (Update 3)." Bloomberg.com Bloomberg Press, 21 May 2008. Web. 20 July 2008. . "Company Histories, George Wimpey plc". findinguniverse.com Finding Universe, n.d.. Web. 23 July 2008. < http://www.fundinguniverse.com/company-histories/George-Wimpey-plc-Company-History.html>. Harrison, Edward. "Taylor Wimpey faces bankruptcy." creditwritedowns.com Credit Writedowns, 03 July 2008. Web. 24 July 2008. . "Homebuilding in Europe, Industry Profile (Reference Code 0201-2074)", Datamonitor.com Datamonitor, July 2007. Web. 23 July 2008. . "Industry Overview: Homebuilding". reuters.com Reuters, n.d.. Web. 23 July 2008. . "Our Business (Overview)". taylorwimpey.com TaylorWimpey plc, n.d.. Web. 23 July 2008. < http://www.taylorwimpey.com/Home/AboutUs/OurBusinessOverview>. Read More