Finances and Management of Marstons Plc and Whitbread Plc - Research Paper Example

 Financial Analysis and Management Introduction This report is divided into three parts. First part deals with an understanding about Price/ Earning ratios and its multiples. It determines that P/E ratio reflects the behavior of earnings over the price of shares of the firm. In the second part a comparative review is undertaken of the financial performances of Marston’s Plc and Whitbread Plc for the years 2007 and 2008.The review is carried through ratio analysis of the performances under the categories of profitability, liquidity, and activities. In third part the behavior of share prices of both companies is studied with reference to conclusions of the performances and behavior P/E ratio in first two parts of the report. Contents Introduction Price Earning Multiples Comparative Financial Performance Review Behavior of Market Prices of Shares Appendix Containing Ratio Calculations References a) Price Earning Multiples Price – Earning (P/E) Ratio is the most popular statistics in any stock market discussion. It is a sort of owners’ appraisal of share value. ‘P/E ratio measures the amount that investors are willing to pay each dollar of a firm’s earnings. The level of this ratio indicates the degree of confidence that investors have in the firm’s future performance. The higher the P/E ratio, the greater is the investor confidence.’(Lawrence J. Gitman, page 70)i Price Earning Multiple is a summary measure which primary reflects growth prospectus, risk characteristics, shareholder orientation, corporate image, and degree of liquidity. P/E multiple is a technique to measure the value of a firm. This value is obtained by multiplying the expected earning per share with average P/E ratio for the industry. The basic factors that affect the computation of P/E ratio are earning per share and the market price of the shares of the company. P/E ratio is very suitable in measuring the value of firms that are not listed or publicly traded. This is because in case of publicly traded companies their value can be easily measured through quoted prices of their shares. P/E ratio is considered to be a superior method of measuring the value of firm as compared to book value or liquidation valuation mainly because the P/E multiple considers the expected earning of the firm. P/E ratio of Marston Plc and Whitbread Plc are calculated as under. The sources for information used are annual reports of Marston Plc (2008)ii and Whitbread Plc (2008)iii and Yahoo.com. It is not that everything is positive about P/E ratio. The limitation of ratio analysis is that ratios are not fully representative of the performances of the firms. Ratios are only indicators of the performances. P/E ratio calculated on basis of historical results and estimated results provide an altogether different picture. That is why there is a difference between earning per share before and after the results of exceptional items, that are historical results. In fact exceptional profits do not represent actual performance of the firm and therefore any ratio calculated on the basis of profitability after exceptional items would be misleading. P/E on basis of operational profits for 2008 for Whitbread is only 4.42 and that is almost same as that of Marston’s 4.59. That means both firms have performed competitively well and no adverse remark can be drawn against any of the firm. Market prices resulting from these normal results would not be affected by P/E calculated on basis of exceptional results. This is one of the reasons that P/E is always calculated on basis of estimated earning per share. Lower estimated earning per share on basis of analysts’ results (taken from Yahoo.com) provide EPS of £16.61 in case of Marston’s Plc for the fiscal period to be ended in 2009 and that of Whitbread at £87.2 for 2009. Based on these estimated EPS, the P/E ratio comes to £8.01 and £15.05. It may be noted that there is no impact of exceptional items in these results. Accordingly these are determining factors like estimated EPS that play a role in establishing the P/E ratios of the firms. So are as FTSE index is concerned, this series is ‘designed to represent the performance of UK companies, providing investors with a comprehensive and complementary set of indices that measure the performance of all capital and industry segments of the UK equity market.’(FTSE Index Company)iv Whitbread Plc is on the list FTSE UK 100 and as per this index P/E ratio of Whitbread Plc is 31.238 as per Bloomberg.com (24.03.2009).v This figure is almost double of what actual calculations shows as above and accordingly it will certainly create confusion as has been apprehended by the director of Marston’s Plc. Dividend payouts have no relation with the earnings of the company. Sometime companies declare dividend out of their retained profits. Accordingly it is not necessary that dividend payouts affect the market prices of the shares of the company. The reason is that value of shares is the result of P/E multiples; and for P/E ratio what matters is the earning per share and not the dividend pay outs. b) Comparative financial performance review The comparative financial performance review of Marston’s Plc and Whitbread Plc has been undertaken on the basis of performances of two companies for the year 2008 and 2007. The review is based on ratio analysis. These ratios have been calculated in the attached appendix. The review has been undertaken under the categories of profitability, liquidity, and activity performances of the concerned firms. Profitability Operating profit ‘measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividend are deducted. It represents the pure profits earned on each sales dollar. Operational profits are pure because they measure only the profits earned on operations ignoring interest, taxes, and preferred stock dividends.’ (Lawrence J. Gitman, page 67)vi The operational profit performance of Marston’s has dropped from 24.62% in 2007 to 23.56% in 2008 even though total revenue has increased from $652.8m in 2007 to $666.1m in 2008. The reason appears to be the increase in cost of goods sold. Similarly the operational performance of Whitbread has also deteriorated in 2008. In 2007 its operational profits were 15.25% and that dropped down to 14.38%. Interestingly even when the cost of goods sold has gone down and total revenue increased, the operational profits have gone down. ‘The net profit margin is a relative measure of operating efficiency, after taking account of all expenses and income taxes.’(James C Van Home and John MartinWachowicz, page 187)vii Marston’s has earned net profit of 12.61% during 2007 and that has gone down to 9.28% in 2008. This reduction in net margin is because of finance costs that increased from £68.8m to £80.7m. On the other hand Whitbread’s net margins have shown an increase from 23.99% in 2007 to 44.78% in 2008. This tremendous increase is not the result of any extraordinary efficiency in the operations of the firm but because of net profits of £440.8m from the sale of discontinued operations. Accordingly this increased performance should not be read as anything achieved by Whitbread on account of efficient management of finance and tax matters. The net margin before discontinued operations was £83.3m and that is hardly 6.84% of the revenue. Accordingly the performance of Whitbread on account of net margins is worse than that of Marston’s. Return on total assets ‘provides a measure of the return on capital invested in operations.’(William O Cleverly, page 220)viii The situation is the same as in case of net profit margins. For Marston’s the ratio declined from 3.48% in 2007 to 2.51% in 2008; whereas Whitbread has shown an increase from a mere 9.87% in 2007 to 22.32% in 2008. All this has happened due to profits on sale of discontinued business in case of Whitbread. Otherwise the performance on return on total assets is less efficient than Marston’s. The story is the same so far as return on equity is concerned. Return on equity ‘tells how efficiently a company used its investment of stockholders’ equity to produce profits.’(Ellie Williams and Ellie William Clinton, page 228)ix The return on equity has comedown in the case of Marston’s from 11% in 2007 to 8.74% in 2008; whereas Whitbread has shown a rise from 23.99% in 2007 to 43.17% in 2008 due to profits from sale of discontinued business. Overall there is decline in profitability performance in case of both companies. But on record the profitability of Whitbread has increased tremendously but that in fact is not operational efficiency. The rise in profitability is due to profits on sale of discontinued business; otherwise comparative performance of Whitbread is not better than that of Marston’s Plc. Liquidity Liquidity of a firm can be tested through its current and quick ratios. ‘Current ratio indicates the ability of the company to pay its current liabilities from its current assets and, thus shows the strength of the company’s working capital position.’(Hermanson, Edward, and Meher, page 669)x Current ratio of 2:1 is considered optimum for any type of industry. As per this parameter the current ratio of Marston’s is very poor. It was 0.58 in 2007 and that improved to 0.9 in 2008. Still the ratio is delicate and the firm may not be able to meet its current obligations as those become due. The position of Whitbread Plc is also very delicate so far as liquidity is concerned. Its current ratio has come down from poor 0.44 in 2007 to 0.28 in 2008. Whitbread Plc is also facing serious liquidity problems. Quick ratio is almost similar to current ratio except that only those current assets are considered for its calculations that can be quickly converted into cash. That is why inventory is not considered to compute quick ratio. Quick ratio of 1:1 is considered best for any firm. Marston’s quick ratio was 0.51 in 2007 and that improved slightly to 0.81 in 2008. Whitbread is sailing in the same boat. Its quick ratio was 0.4 in 2007 and further deteriorated to 0.26 in 2008. Both companies are facing liquidity crunch and may find very difficult to meet their current obligations. In fact short term solvency of the both firms is in danger because of their dwindling liquidity position. Activity Activity of Marston Plc is tested through inventory turnover ratio, asset turnover ratio, and average collection period. Inventory turnover ratio measures how many times in an accounting period the inventory balance sells out.’(Stephen L Nelson, page 355)xi Marston’s inventory turnover was 12 days in 2007 and inefficiency crept in and this period increased to 14 days in 2008. The performance of Whitbread Plc was inefficient when compared with the performance of Marston’s. The inventory turnover was 25 days in 2007 and 26 days in 2008. Assets turnover ratio measures ‘how efficiently a firm utilizes its assets. A company with high assets turnover suggests that its assets help promote sales revenue.’(Gallaghar and Andrew, page 97)xii Marston’s asset turnover is very poor. It’s 0.28 times in 2007 and 0.27 times in 2008. The ratio of Whitbread Plc is little better than Marston’s Plc. It is 0.41 times in 2007 and 0.5 times in 2008. Both companies are not effectively utilizing its assets to bring in more revenue. “The key to successful financial management is to conserve the resources of your business and make these resources work hard for you.’ (Ronald C Spurga, page 31)xiii Average collection period reflects the average time taken to make recoveries from accounts receivable. Marston’s average collection period is 39 days in 2007. This period was further delayed to 41 days in 2008. This inefficiency is being reflected in the working capital of the company. That is why the company is facing acute liquidity problems. Average collection period of Whitbread Plc is 21 days in 2007 and 19 days in 2008. Its performance has deteriorated as compared to 2007, but the performance is still better when compared with Marston’s Plc. Overall both companies have not performed well on profitability front. Even though Whitbread has shown good profits only because of profits on sale of discontinued business, but its profitability performance is as inefficient as that of Marston’s Plc. Liquidity is another problem that both companies are suffering from and this difficult liquidity position needs an improvement instantly. Inventory turnover, assets turnover, and average collection period are also inefficient in case of both companies. In fact companies are not utilizing resources at their disposals. c) Behavior of Market Prices of shares The historical performances of share prices of both companies over the period of two years are as under. The source of these prices is Yahoo.com. The prices of the shares of Marston’s Plc are available from January 2007 and that of Whitbread Plc from June 2006 Marston’s Plc Whitbread Plc Amount in £ per share June 2006 1166 January 2007 415 Ending of fiscal period 2007 344 (October 2007) 1646 (Feb 2007) Ending of fiscal period 2008 133 (October 2008) 1312 (Feb 2008) The market prices of both companies behaved in similar fashion. The market price of shares of Marston’s Plc fell down from £415 per share in January 2007 to £344 per share in October 2007, and then steeply fell down to £133 per share in October 2008. If we compare these prices with the profitability performance of Marston’s Plc, it will be seen that the company’s net profits came down from 12.61% in 2007 to 9.28% in 2008. The result was that diluted earning per share (before exceptional items) dwindled from 27.6p in 2007 to 22.5p in 2008. This impacted the P/E ratio of the company and thus the prices of shares. It will be observed that though deteriorating financial performances affected the market prices over two years period but fall in market price in 2008 was steeper than the fall in 2007. Initially factors affecting the P/E ratio directly brought down the prices but later in 2008 other factors also impacted the fall of market prices. Prior to February 2008 the market prices behaved in accordance with fall in financial performance that affected P/E ratios, but after February 2008 P/E ratio factors coupled with psychological factors impacted the general market crash. Though in case of Whitbread Plc total profitability went up in 2008 due to profits from sale of discontinued business, yet the market prices fallen and behaved in accordance with the other trends of the market. That shows share prices behaved as per falling financial performances till 2007; but thereafter lowering financial performances coupled with other factors brought the market prices steeply down. It may be noted that profitability due to exceptional items did not mattered at all so far as market price is concerned. Market prices reacted with actual performances and not with exceptional performances of the company. This provides an answer to the query of Jenny Hilton that market prices may not behave in accordance with dividend payouts but with actual normal performance of the companies. This is the earning per share that matters for P/E ratio and the P/E ratio determines the prices of the shares. Even exceptional results including dividend payouts may not affect the market prices. Appendix- ratio calculations References Read More