Intercontinental Hotels Group: Financial Analysis - Essay Example

? Intercontinental Hotels Group – Financial Analysis Intercontinental Hotels Group – Financial Analysis Introduction This report presents a comprehensive analysis of the financial performance and position of the InterContinental Hotels Group as per the financial information available for the last two financial years (i.e. 2011 and 2010). The report comprises of a detailed financial performance analysis based on ratio analysis. In addition to this, the treatment of intangible assets by the Group has also been discussed along with the extent to which compliance is made with the relevant accounting standards. Background Information Intercontinental Hotel Group Plc. owns one of the leading brand and chain of hotels and resorts across continents. The group’s registered corporate office is located in Denham, United Kingdom and the group has a history of almost 60 years of delivering the highest level of quality of customer service which has permitted the group to achieve phenomenal growth over the last few decades. The group operates not only by owing hotels and resorts completely and also by entering into franchise agreements with other companies to operate hotels and resources The group has more than 4,500 hotels which are operating in different countries. The group operates hotels brands including Crown Plaza Hotel, Holiday Inn Express, Staybridge Suites, Candlewood Suites and others. These brands are arranged in a way that they reflect both luxury and budget hoteling facilities for guests. The group offers a hotel loyalty program through which it has achieved 63 million members who received updates and discounts on bookings and other privileges (Yahoo Finance, 2012). Financial Ratios Analysis For the purpose of analyzing Group’s financial performance in the last two years, following ratios have been determined and a discussion for them is presented while considering additional supporting information available in the Group’s annual report. It is pertinent to mention here that there are material exceptional items in the financial statements of IHG (InterContinental Hotels Group, 2011). These exceptional items are not considered for the purpose of calculating ratios. However, the impact of these exceptional items has been evaluated at the end of financial analysis. Profitability of IHG Keeping in view the profitability ratios as calculated below for the Group, it is noted that the Group has improved its performance in terms of returns. Apart from the continuing effects of recent global financial distress, the Group has managed to report growth in its profits. As evidenced by the gross and operating margins presented below, the Group has been able to report considerable growth in its gross and operating profits. One of the main reasons for this growth has been increase in total revenues of the Group. On the other hand, it is worth mentioning here that IHG’s cost of sales declined in 2011 whereas revenues climbed up, thus signifying the level of operational efficiency reached by the Group. Following this improvement in cost of sales figure in 2011 and gross profits, the trend translated into operating profits also, due to which the Group has been able to report higher operating margin for the year ended 2011 (Peterson & Fabozzi, 2012; Warren et al., 2011; InterContinental Hotels Group, 2011). Profitability Ratios Ratio 2011 2010 Return on Capital Employed 17.35 % 12.29 % Return on Equity 67.93 % 97.59 % Operating Profit Margin 21.32 % 17.44 % Gross Profit Margin 56.39 % 53.75 % Source: (InterContinental Hotels Group, 2011) In addition to this, the returns on capital employed and on total equity of the Group have also shown favorable changes. With the increase in profits attributable to shareholders of the Group, the return on equity and capital employed also increased, and this increase in net profits for the Group has been such that it overcame the impact of increase in capital employed and equity (InterContinental Hotels Group, 2011; Arnold & Kumar, 2008). Operational Efficiency of IHG The Group’s operational efficiency, as discussed in the previous section, has been the key to its overall improved performance. The operating cycle period and sales revenues earned by the Group per employee have all increased favorably for the Group. In addition to this, the average inventory turnover period has increased owing to the increase in sales revenue of the Group. Similarly, another indicator of operational efficiency of the Group has been average settlement period for trade receivables. The Group has managed to report improvements in the time period required to collect amounts receivable from its customers (Horngren & Harrison, 2009; InterContinental Hotels Group, 2011). Efficiency Ratios Ratio 2011 2010 Operating Cycle 504 days 441 days Sales Revenue per Employee 0.22 0.21 Average Inventory Turnover Period 193 days 188 days Average Settlement Period for Trade Receivables 76 days 83 days Source: (InterContinental Hotels Group, 2011) Since the amount of purchases made on credit by the company is not available in the financial statements of the company, therefore average settlement period for trade payables has not been determined. However, as noted in Note 19 accompanying the financial statements of the company, payments to creditors are made within 45 days period, which means that it takes one and a half month for creditors of IHG to receive their payments (InterContinental Hotels Group, 2011). Liquidity Position of IHG Keeping in view the trends shown in current assets and liabilities of the Group and considering the ratios determined in the table presented below, it can be stated that the company has improved its liquidity position only slightly in 2011 as compared to 2010. There is no significant improvement observed in IHG’s liquidity position because the company still has a significant amount owed in lieu of trade and other payables ($ 707 million: 2011, $ 722 million: 2010) (InterContinental Hotels Group, 2011; Albrecht et al., 2008). Liquidity Ratios Ratio 2011 2010 Current Ratio 0.67 0.51 Acid Test Ratio 0.67 0.50 Source: (InterContinental Hotels Group, 2011) Both current and quick ratios have shown improvement in almost equal proportions because of significant increase in cash holdings by the company which form part of both these ratios ($ 182 million: 2011, $ 78 million: 2010) (InterContinental Hotels Group, 2011). Solvency Position of IHG The solvency position of the Group has shown considerable improvement at the end of financial year 2011 as compared to 2010. The improvement in the gearing ratio of the Group has been due to the significant increase in total equity of the Group. The Group recorded a considerable increase in its retained earnings and also there has been an increase in the ordinary share capital of the Group (InterContinental Hotels Group, 2011). Solvency Ratios Ratio 2011 2010 Gearing Ratio 1.21 2.67 Interest Cover Ratio 8.73 times 6.93 times Cash Flow to Debt Ratio 0.93 0.75 Source: (InterContinental Hotels Group, 2011) Apart from this, the ability of the Group to cover its financing costs has raised sharply from 6.93 times to 8.73 times in 2011. This means that the Group is now able to pay its finance costs more than 8 times through its operating profits. In addition to this, owing to the increase in net cash flows resulting from operating activities of the Group, there has also been improvement stated in the cash flow to debt ratio for the Group (InterContinental Hotels Group, 2011; Horngren & Harrison, 2009). Ratios for Investors As has been observed in other performance measurement analysis for the Group, the dividend cover ratio is attractive and has improved for the Group in 2011. This increase in dividend cover ratio shows that the earnings of the Group support the payment of dividends to its shareholders significantly (Peterson & Fabozzi, 2012; InterContinental Hotels Group, 2011). Investment Ratios Ratio 2011 2010 Dividend Cover Ratio 2.55 2.35 Price Earnings to Growth Ratio 0.43 (4.90) Dividend Yield 8.23 6.13 Source: (InterContinental Hotels Group, 2011) The lower value for price earnings to growth ratio shows that the stock for IHG is undervalued. On the other hand, the dividend yield on Group’s shares has shown positive signs for investors. With the increase in dividend payments made to the Group’s shareholders relative to the market prices of their stocks. This increase is also an attraction for investors to invest in the Group’s stocks (InterContinental Hotels Group, 2011; Warren et al., 2011). Impact of Exceptional Items Although there has been a considerable improvement shown by the company in the year ended 2011, but this improvement may be attributed to significant inflows from gains and other incomes, which are reported as exceptional items by the Group in its income statement. These exceptional items include income and expenses recorded under administrative expenses, other operating income and expenses, gains or losses resulting from impairments and gains or losses incurred on disposal of assets. In the year 2010, the amount stated for exceptional items was $ 9 million, which increased to $ 83 million in 2011. When the impact of these exceptional items is excluded from the overall profits of the Group, the difference between net profits for the Group remain significantly higher in 2011 as compared to 2010 ($ 377 million: 2011, $ 293 million: 2010) (InterContinental Hotels Group, 2011). IHG’s Treatment of Intangible Assets and Compliance with Accounting Standards The intangible assets of IHG form significant part of the total non-current assets. The breakup of Group’s total intangible assets is provided as follows: Assets 2011 2010 Amount ($ millions) Amount ($ millions) Software 114 120 Management Contracts 115 106 Other Intangibles 79 51 Total Intangible Assets 308 277 Total Non-Current Assets 2173 2310 Percentage of Intangible Assets to Total Non-Current Assets 14% 12% Source: (InterContinental Hotels Group, 2011) In 2011, the Group purchased $ 48 million worth of intangible assets, which are almost double then the purchases made in 2010 ($ 29 million) (InterContinental Hotels Group, 2011). It is pertinent to mention here that the Group follows the International Financial Reporting Standards as its framework for preparing the financial statements. With regard to classification and treatment of intangible assets, the applicable financial reporting standard under IFRS is “IAS 38 Intangible Assets”. According to the requirements laid down under this standard, a company shall recognize its intangible assets, whether created or developed inside or purchased from outside, if it is possible to measure the cost of assets with reliability and it is expected that the benefits earned through such assets in future will be assumed by the company. In case where such recognition conditions are not met due to the nature of assets or other factors, it is allowable to recognize such item as an expense (Deloitte, 2012; Needles & Powers, 2010; Arnold & Kumar, 2008). As mentioned in the table earlier, there are three main types of intangible assets held and recognized by the Group. The first of these three types of assets is software, which included both licensed and in-house developed software. As per the information presented in the notes to financial statements by the Group, these assets are capitalized on the basis of their costs. Moreover, the Group follows a straight line method for amortizing these software over their useful period of their life. In addition to this, the Group also recognizes its management contracts as intangible assets. The management contracts as noted in the accompany information to the financial statements of the Group are the contracts entered into by the purchaser of an asset(s) sold with the Group. These contracts are capitalized by the Group on the basis of gain or loss incurred on disposal of such assets. These values are regarded by the company as the fair market values for such management contracts and are then amortized over the useful period of life of such contracts. Normally, the useful period of life for management contracts range between 6 to 50 years for the Group (InterContinental Hotels Group, 2011). The third type of intangible assets includes payments made to the owners of hotels for securing the management contracts as discussed above. The payments made to these owners are recognized as capital expenditures and following a straight line method, they are amortized over a period of ten years (InterContinental Hotels Group, 2011). These treatments of intangible assets are in accordance with the guidelines issued by IASB under IAS 39 (Deloitte, 2012). Reference List Albrecht, W.S., Stice, E.K. & Stice, J.D., 2008. Financial Accounting: Cocnepts and Applications. Mason: CENGAGE Learning. Arnold, G. & Kumar, M., 2008. Corporate Financial Management. New Delhi: Pearson Education India. Deloitte, 2012. IAS 38. [Online] Available at: http://www.iasplus.com/en/standards/standard37 [Accessed 4 December 2012]. Helfert, E.A., 2001. Financial Analysis Tools and Techniques: A Guide for Managers. New York: McGraw-Hill. Horngren, C.T. & Harrison, W.T., 2009. Accounting. Upper Saddle River, NJ: Prentice Hall. InterContinental Hotels Group, 2011. Annual Report. Financial Statements. London: IHG. Needles, B.E. & Powers, M., 2010. Financial Accounting. Mason: Cengage Learning. Peterson, P.P. & Fabozzi, F.J., 2012. Analysis of Financial Statements. John Wiley & Sons, Inc.: New York. Warren, C.S., Reeve, J.M. & Duchac, J., 2011. Financial and Managerial Accounting. Mason: South-Western Cengage Learning. Yahoo Finance, 2012. Intercontinental Hotels Group plc (IHG). [Online] Available at: http://finance.yahoo.com/q/pr?s=IHG+Profile [Accessed 3 December 2012]. Appendix Ratios Calculation InterContinental Hotels Group Ratio 2011 2010 Current Ratio 0.67 0.51 Acid Test Ratio 0.67 0.50 Return on Capital Employed 0.17 0.12 Return on Equity 0.68 0.98 Cash Flow to Debt Ratio 0.93 0.75 Operating Cycle 504.18 441.10 Sales Revenue per Employee 0.22 0.21 Price Earnings to Growth Ratio 0.43 (4.90) Dividend Yield 8.23 6.13 Operating Profit Margin 0.21 0.17 Gross Profit Margin 0.56 0.54 Average Inventory Turnover Period 192.75 188.25 Average Settlement Period for Trade Receivables 76.18 83.18 Gearing Ratio 1.21 2.67 Interest Cover Ratio 8.73 6.94 Dividend Payout Ratio 1.13 1.23 Dividend Cover Ratio 2.55 2.35 Financial Information for the Group   2011 2010 Current Assets 578 466 Current Liabilities 860 921 Inventory 4 4 Net Income 377 284 Capital Employed 2173 2,310 Equity 555 291.00 Operating Cash Flow 623 583 Long term Debt 670 776 Total Debt 2413 2,485.00 Days Inventory Outstanding 1.89 1.94 Days Sales Outstanding 836.99 789.14 Days Payable Outstanding 334.70 349.97 Number of Employees 7956 7,858.00 Sales 1,768 1,628 P/E Ratio 0.14 0.20 EPS Growth Rate 32% -4% Annual Dividend per Share 148 121.00 Cost of Sales 771 753 Payables 707 722 Receivables 369 371 EPS 2011,2010,2009 130.40 98.6, 102.8 (2009) Market Price 17.99 19.73 EPS growth 32% -4% EBIT 559 444 Interest Expense 64 64 Read More