Financial Sphere of BAE Systems - Essay Example

? BAE Systems Plc Financial Analysis Introduction “BAE Systems is a global defence and security company with approximately 100,000 employees worldwide. The Company delivers a full range of products and services for air, land and naval forces, as well as advanced electronics, security, information technology solutions and support services. In 2009 BAE Systems reported sales of ?22.4 billion (US$ 36.2 billion)”. (BAE Systems, Key Facts, 2010) Financial Performance BAE systems has performed exceptionally well over the last 5 years. The BAE group sales have crept up drastically over the previous five years clearly suggesting that the company is expanding and finding new customers for its innovative products in the aerospace, defence and security industry. The company’s sales have increased by almost 78% from the year 2005 till the year 2009. The company’s sales figures have increased 15.5% on average over the years i.e. from 2005 to 2009 (9%(2006) + 14% (2007) + 18% (2008) + 21% (2009 ? 4). This shows an increasing trend in the sales figure over all the preceding years. The Earnings before Interest, Tax and Amortization (EBITA) have been showing encouraging signs for the shareholders of the company over the five year period. BAE group’s net profit had also been following an increasing trend but the result of 2009 has been of highest worry for its stakeholders, the company reported a loss of ?45 million as compared to a profit of ?1,768 million in the year 2008, this shows a hefty reduction of ?1,813 million which equates to a reduction of approximately 102% in the reported profits of 2009 when compared with that of 2008. This loss has been made as a result of some great changes in the company’s income generating assets. The major contribution towards this loss has been attributed to the reduction in foreign exchange gains. This has been because of the weakening of the Dollar currency. BAE systems had to face an incredible strike because of the weakened US Dollar and because of it the gains diminished in the year 2009 as compared to the previous years when those gains were really higher. The second most obvious reason for this loss was because of the reduction in the Interest Income for BAE systems, the interest income within the company has been an influential factor in reducing the effect of the high interest payments and other expenditures. To further understand the financial performance of the company, the ratio analysis technique is used. There are different types of ratios available to ascertain the different operating areas of a company. The Profitability Ratios ascertain the efficient performance of a company. According to the profitability ratios, the returns for the shareholders/investors of BAE systems have reduced heavily, the company’s ROCE has reduced from 11.5% in the year 2008 to 7.3% in the year 2009 and the return for the equity shareholders has also reduced drastically. Such a reduction in the Returns for the shareholders would discourage future potential investors to invest in the company but BAE systems have not practically reduced this return offered to its shareholders in fact the company increased its dividend by 10% to 16 pence per share in the year 2009 as compared to 14.5 pence per share in 2008. The Gross Profit and the Net profit margin also reduced in the year 2009 as compared to prior years, the only strengthening feature for the company is its trend to increase its dividend over the last four to five years (the company’s dividend per share had been 10.3 pence per share in 2005). Liquidity ratios are a measure of ascertaining the day to day running of a company; it is merely a measure of ascertaining a company’s ability to pay off its obligations as they fall due. These obligations are generally the current liabilities and these current liabilities can be met by having appropriate current assets. The current ratio is a measure that analyses a company’s ability to pay off its current liabilities by negotiating its current assets. The liquidity ratios for BAE systems do not seem satisfying for its shareholders, if compared with its other industry rivals, Lockheed Martin, their Current and Quick ratio for the year 2009 were 1.165:1 and 0.96:1 respectively. (Lockheed, Annual Report, 2009) This shows that BAE system lacks behind its major competitor with respect to the liquidity ratios and with the drastic fall in the profits during the year 2009, the shareholders might feel insecure about their investment as the economic recession of recent had caused many unpredictable downfalls of many large companies. The efficiency ratios ascertain the efficient management of the creditors, debtors, cash and inventory of a company. This helps in ascertaining and capitalising on enhanced working capital management. The receivable and the payables turnover ratio have both reduced suggesting that the debts and dues would be cleared earlier. There is still a timing difference between the companies clearing off its dues earlier than collecting its debts, hence it would mean that BAE system would require additional financing in that particular period of time during which the payment is not actually received by the debtors and the creditor are to be paid a bit earlier. This would in effect increase the Interest costs for the company as the company would have to raise capital through debt financing. Inventory turnover has reduced in the year 2009 to 17 days which was 21 days in 2008, this suggests that BAE systems have a fast rate of selling off their products but this faster rate is not accompanied by a faster receivable turnover rate to further reduce the interest costs for the company and improve its working capital in the future. The asset turnover ratio for BAE systems suggests that the company is growing with proportion to its increase in revenue. This ratio determines the amount of sales generated from each pound of assets. The basic EPS for the BAE group in the year 2009 was negative 1.9 pence per share and 49.6 pence per share in 2008. The negative effect on the EPS has been brought upon by the foreign exchange translation issues, amortisation issues and other non cash financial movements. If these negative non cash movements were ignored, BAE group plc has performed well during the financial year 2009 (a year considered as one of the difficult economies year for many companies). If the company’s underlying earnings post tax are considered, BAE plc shows a 10% increase in the EPS as compared to 2008. Economic and Industry analysis Although the aircraft sector is a very profitable sector, organizations can only compete successfully if they innovate on a regular basis. The aircraft industry has always been on a rise; however it is not a stagnant industry The industry analysis suggests that the global aerospace and the defence industry is a highly competitive industry with lots and lots of rival for BAE plc, the top most rivals for BAE plc around the globe include Lockheed Martin and Boeing but BAE plc performed immensely and surpassed both these companies to take the top spot in 2008. BAE systems plc was the top most company amongst the top 20 arms producing companies with respect to the revenue it generated (Sipri, 2008). BAE systems plc increased their revenue figure by 21% as compared to its sales revenue figure in 2008. Lockheed Martin on the other hand was only able to raise its sales revenue by only 6%, this clearly shows the difference between the performance of the two companies and it suggests that BAE systems plc has had an upper hand over its global competitor in the global market. Besides the global market, BAE systems plc has a major demand within Europe and especially within UK i.e. in its home country. BAE plc enjoys a monopoly within Britain and it is the only company within Britain to produce warplanes. BAE plc satisfies the demands of Britain’s aerospace, defence and security needs alone. Not only are Britain’s aerospace industry’s requirement fulfilled by BAE plc, the land and the naval demands are also met by the company. BAE plc produces a wide variety of tanks and armoured cars and supplies it to its domestic consumers i.e. the Britain’s army. Besides the army, Britain’s naval necessities are also met up by BAE plc. The company provides high-tech nuclear submarines to the UK army and acts as a backbone to the Navy (Leigh et al, 2007). Key Personnel Analysis The higher management within BAE plc has kept the company running effectively and efficiently. The highly skilled leadership of both the Chairman and the CEO has led the company to achieve this increasing trend in revenue over the past five years or so. The Chairman has kept such a strategy that helps the company to focus towards the fulfilment of the shareholders interest. Proper leadership under both the Chairman and the CEO has led to the appointment of highly skilled non-executive directors that suit the environment within the company. The higher management within the company has focused upon motivating the middle and the lower level employees as well; this motivation was done through the introduction of highly successful scheme for the employees of the company. Under this scheme, all probable employees that come up with an innovative idea are awarded with a “Chairman’s Award for innovation”, such an incentive keeps in maintaining an innovative environment within the workforce of the company. Besides such ideas, the management has also focused upon reducing the costs consistently; this reduction would help the company in enhancing their profits in the future. The board has also focused on the shareholders perspective as well by offering a dividend per share of 16 pence per share. The annual dividend in 2009 was covered 2.5 times by the underlying earnings of the company, in 2008, this figure of 2.6 times of the earnings underlying. Share Price Evaluation There are many methods that can be used to ascertain the share price of any company, the price earnings ratio method being one of the most successful one. This method for share price evaluation requires a suitable company that is in the same industry sector as of BAE plc; hence Lockheed Martin seems to be the most appropriate company whose price earnings ratio can be used to ascertain the share price of BAE plc. According to the P/E ration method of evaluation, the share price for BAE plc should be around ?4.238/share, hence it can be clearly said that, the share price is clearly undervalued and that BAE plc is a great investment opportunity for many investors as they would gain very much buy buying the share at a reduced price and there is a high probability that the share price of BAE plc would rise in future. Although this methods has its own weaknesses but it is still a handy technique to use. Conclusion The loss arising in the year 2009 seems to be a discouraging factor for potential investors and the existing shareholders of BAE plc group, this loss leads to the idea that the company may not perform well in the future but such an idea is easily overtaken by analyzing the performance of the company over the past 5 years. According to all the calculation and research, it seems that BAE plc is a great venture to invest in; there are many reasons that constitute such a conclusion. The main reasons that supplement such a decision are; Sales have been amplifying at an increasing rate over the past 5 years. The dividend offered to the shareholders of the company has also increased over the past 5 years (even when the company was making a loss in the year 2009). The loss figure has arisen because of some non financial and other accounting treatments otherwise the company has performed excellent in its area of operation and it took over Boeing and Lockheed Martin to become the number 1 arms-producing company in 2008. The shares valued by the market can be considered under-valued. This reduction in value may be as a result of the economic crisis or the reported loss of the company in the year 2009. Executive Summary This paper aims to carry out a thorough research of BAE group plc to assess the investment potential within the company. This research has been carried out by applying different financial appraisal techniques. The paper starts with the introduction about the company, it basically gives and overview about the company’s area of operation and the products that it offers. This basic overview is followed by a vast financial appraisal of the company. The financial appraisal is performed thorough the help of different techniques, most prominently, the ratio analysis technique. The ratio analysis technique is used to analyze the prior two year performance and besides that, other important financial review is done using the Five year summary provided within the Annual Report of the company. BAE plc’s Industry is also analysed putting special emphasis on its main global competitors. The Industry Analysis is followed by the assessment of the company’s performance by the Chairman and the Chief Executive Officer of the company. The assessment focuses on the areas which both the CEO and the Chairman had deemed to be of great importance for the company. Finally the Company’s share price is ascertained to evaluate whether it is under or over-valued within the market and after this calculation a final verdict is given which shows that the investment is potentially viable for any upcoming investors/shareholders. APPENDIX Profitability Ratios Ratios Formulae Calculation 2009 (?’ million) Calculation 2008 (?’ million) 2009 2008 ROCE Operating Profit b/f Interest and Tax/Total Assets – Current Liabilities 982/(25407-11993) 1718/(25675-10790) 7.3% 11.5% ROE Net Income/Shareholder’s equity -45/4727 1768/7289 -1% 24.3% Gross Profit Margin Gross Profit ? Sales * 100 982/22415 * 100 1718/18543 * 100 4.4% 9.3% Net Profit Margin Net Profit ? Sales * 100 -45/22415 * 100 1768/18543 * 100 -0.2% 9.5% Liquidity Ratios Ratios Formulae Calculation 2009 (?‘million) Calculation 2008 (?‘million) 2009 2008 Current Ratio Current Assets ? Current Liabilities 8788/11993 8069/10790 0.73 : 1 0.75 : 1 Acid Test Ratio (Current Assets – Inventory) ? Current Liabilities (8788 – 887)/11993 (8069 – 926)/10790 0.66 : 1 0.66 : 1 Efficiency Ratios Ratios Formulae Calculation 2009 (?‘million) Calculation 2008 (?‘million) 2009 2008 Receivable Turnover Ratio Trade Receivables/Credit Sales * 365 3764/22415 * 365 3831/18543 * 365 61 days 75 days Inventory turnover period Inventory/Cost of Goods Sold * 365 926/20060 * 365 887/15386 * 365 17 days 21 days Asset Turnover Revenue/Total Assets 22415/25407 18543/25675 0.88 0.72 Trade Payable Turnover Ratio Trade Payable/ Credit Purchases * 365 1063/9330 * 365 1004/7809 * 365 42 days 47 days Credit purchases are deemed to be the raw material and other bought in costs Trade Payable figure is taken from Note 20 (Notes to the group accounts) Trade receivable is the total figure as on the face of the balance sheet Valuation Ratios Ratios Formulae Calculation 2009 (?) Calculation 2008 (?) 2009 2008 EPS Profit/(loss) attributable to ordinary shareholders ? Weighted Average Number of Ordinary shares -67/3532 1745/3519 (1.9) pence 49.6 pence Price/Earnings Ratio Market Value of share/EPS 3.57/(0.019) 3.82/0.496 -188 times 8 times Dividend Cover EPS/Dividend per share -0.019/0.16 0.496/0.145 -0.11 times 3 times Dividend Yield Dividend per share/Market share price * 100 0.16/3.57 *100 0.145/3.82 * 100 4.5% 3.8% Market Value of Share is calculated as per the ESOP Trust market holding value in the BAE systems. 2009 (?) 2008 (?) Market value of holding 3,644,598 shares 13,000,000 8,000,000 Market Value per share (31 Dec 09/2008) 3.57 3.82 Gearing Ratios Ratios Formulae Calculation 2009 (?) Calculation 2008 (?) 2009 2008 Debt/Equity Ratio Total Debts/Total Equity * 100 3815/4727 * 100 3482/7289 * 100 81% 48% Interest Cover EBIT/Interest Expense (Net finance costs) 982/700 n/a ( because net finance income) 1.4 times 2009 2008 Total Debts ? (‘million) ? (‘million) Non-Current Liabilities Loans 2840 2608 Trade and Other Payables 522 701 Current Liabilities Loans and overdrafts 453 173 Total Debts 3815 3482 Lockheed Martin P/E Ratio Market Value of Share/ EPS 82.3/7.86 = 10.4 times BAE plc Share price Evaluation Value of a Share = Underlying earnings per share * Suitable P/E ratio = 0.407 * 10.4 = ?4.238/ share References Annual Report 2009, BAE Systems http://bae-systems-annual-report-2009.production.investis.com/~/media/Files/B/Bae-Systems-Annual-Report-2009/Attachments/pdf/BAE_Annual_Report_2009.pdf Annual Report 2009, Lockheed Martin http://www.lockheedmartin.com/data/assets/corporate/documents/ir/2010/2009-Annual-report.pdf BAE Systems, Key Facts, 2010 http://www.baesystems.com/AboutUs/FactSheet/index.htm Leigh D. & Evans R.(June 7, 2007) “BAE SYSTEMS” Guardian.co.uk http://www.guardian.co.uk/world/2007/jun/07/bae.baesystemsbusiness Sipri, The SIPRI Top 100 arms-producing companies, 2008 http://www.sipri.org/research/armaments/production/Top100 Read More