Fundamentals of Finance: Investment Report on ITV and WPP Power Line Communcation - Case Study Example

? FUNDAMENTALS OF FINANCE INVESTMENT REPORT ON ITV AND WPP School COMPANY SUMMARY ITV PLC ITV Plc, listed in London Stock Exchange (LSE) is one of the largest and oldest TV network operating in the United Kingdom (ITV PLC). It started broadcasting as ITV immediately after the 1954 Television Act was enacted to allow commercial television. Its first area of operation was London under channel 3 broadcasting licence. ITV Plc came into being in 2004 after a merger between Granada, which had six regional licences and Carlton, which controlled five licences. This led to ITV Plc to control eleven licences in total. Among other channels that ITV Plc owns include ITV2 that was formed in 1998, ITV3 that was formed in 2004, ITV4 that was formed in 2005, and CITV launched in 2006. ITV Plc has continued to grow. It acquired Friends Reunited in 2005 and 2007 saw two more acquisitions which were 12 yard, previously independent producers and Jaffe entertainment LLC, in which it took a controlling stake. Not every business for ITV Plc were acquisitions, in 2010 it sold some stake for $50 million in Screenvision and in 2011, ITV PLC acquired Channel Television and launched ITV1+1 (ITV PLC). ITV Plc has two major products ran in broadcasting and production. Broadcasting is done through a series of ITV channels that include ITV1-4, CITV, and Freeview while online service is provided by itv.com. These generate revenues through advertisement and viewer competitions. Production involves ITV studios which offer production operations, international distribution, and entertainment among others. ITV studios also generate programmes viewed through ITV channels (ITV PLC). WPP PLC Wire and Plastic Products (WPP) Plc is one of the biggest advertising companies as measured by revenue and with presence in 108 countries. It started in 1971 solely to produce wire shopping baskets. The company was renamed WPP Group upon the entry of Martin Sorrell as the Chief Executive Officer (CEO) in 1985 after purchasing some state in the company. Sorrell put structures in place that were geared towards market leadership. Subsequently WPP Plc acquired many marketing services companies not only in UK but also in US. In 1987 alone, it acquired three companies, that is, J. Walter Thompson, Hill and Knowlton that was a public relations firm, and MRB Group which was a market research company (WPP PLC). Its fast growth saw it listed on NASDAQ in 1988 and this prompted its entry into US where it persisted with its acquisition of marketing services companies. In 1992, it was named the best agency group in the world by Advertising Age, a magazine that is market and media oriented, after acquiring The Oglivy Group together with its advertisement and public relations agencies. The same year saw a launch of CommonHealth that became a specialist in healthcare communication (WPP PLC). In 1995, WPP Plc ventured further into research an established Kantar, a company that steered research interests of the group. The group’s entry into Asia was seen in 1997 when it launched Mindshare, a company that offered the media planning, research, and buying options. It was then listed in London stock exchange (LSE) in 1998 following its formation of an alliance with Japan’s third biggest advertising agency, Asatsu-DK. Its acquisitions did not end there. In 1999 it bought Lambie-Nairn which specialised in corporate identity and Prism Group, a marketing company with big interest in sports. What followed in 2000 was the largest acquisition in the group’s history. Young and Rubicam Group with all its agencies and presence in many countries became part of WPP Plc. Other acquisitions included Cordiant Communications Group, Grey Global Group in 2005, TNS in 2008 (WPP PLC). WPP Plc proud itself in the research and advertisement arena with many awards that include Cannes International Advertising Festival awards, best in employing a number of digital staff by RECMA, 41st position out of 500 by Newsweek Green rankings in 2011, most effective company of the year in 2012 by North American Effectiveness Index Rankings, GroupM , one of its subsidiary named holding company of the year in 2012 by Gunn Report for media (WPP PLC). WPP Plc’s main products include advertising services, media investment management through media planning and buying, brand and consumer insight, public relations, market research, healthcare and specialist communications, and digital expert services (WPP PLC). COMPANY STRENGTHS AND WEAKNESSES Financial strengths and weaknesses of a company are best determined through analysing its financial performance (Brealey, Myers & Marcus, 2012). Ratio analysis becomes hand in this situation. Ratios are divided into five major categories, that is, profitability, investment, gearing/leverage, activity, and liquidity. Each type of ratio has significance and communicates a lot of information. Ratio analysis is therefore fundamental since it covers all aspects of financial performance and position. All stakeholders or interested parties focus on ratio analysis in order to understand how their company is fairing (Kadous, Koonce & Thayer, 2012). It is of paramount importance that the ratios be analysed and interpreted since not all stakeholders understand what they communicate. According to Brigham & Houston (2004) there are three forms of ratio analysis and interpretation, these are: Trend analysis/time series analysis- this seeks to compare performance and position of a given company over a period of time. Cross sectional analysis-this compares performance and position of one company with another within the same period of time. Industrial analysis-this compares the performance and position of a company with the industry averages. This report shall comparatively analyse key financial ratios as follows: 1. Current ratio This is a liquidity ratio that measures the strength of a company in meeting its short term financial obligation with recommended ratio being 1: 2 (Brealey et al., 2012). Here current assets are compared with current liabilities. ITV Plc has a current ratio of 1: 1.97 for 2011 which showed a slight improvement from 2010 that had 1: 1.95 (Bloomberg). This is an impressive ratio since it is almost the same as the recommended ratio. It shows that ITV does not have any threat in settling its short term payments. WPP has a current ratio of 1: 0.96 for 2011 which is a slight improvement from 1: 0.93 for 2010 (Bloomberg). The ratio is far below the recommended ratio and it shows that the company may face difficulties in settling their short term financial obligations if the trend continues (Doina & Mircea, 2008). ITV Plc performed better in this ratio than WPP. 2. Gearing ratio This ratio compares funds borrowed to the owner’s equity (Atrill & McLaney, 2011). . It shows the extent to which a company’s activities have been financed through borrowing. Gearing ratio is usually long term oriented hence compares long term debt with shareholder’s funds (Atrill & McLaney, 2011). ITV’s gearing ratio was 112.73% for 2011 down from 184.46% in 2010. This gearing ratio is too high but showing a downward trend. This implies that ITV borrowed more than its net assets and this signifies that it is a high risky company. This equally reduces the net income through finance cost. WPP’s gearing ratio was 56.47% in 2011 compared to 54.13% in 2010. There was a slight increase over the two years; however, the level of debt in WPP is much lower than that of ITV. The end result is that ITV is riskier than WPP. 3. Profitability ratios These ratios indicate how efficient and effective a firm is in controlling its costs. They also show efficiency in pricing strategy (Glen et al., 2003). Operating profit margin ITV shows a steady increase in this ratio from the previous years. The ratio is 18.83% for 2011 compared to 16.72% for 2010 (Bloomberg). This improvement is desirable and implies that ITV has the potential to control its direct cost (Glen et al., 2003). WPP on the other shows a slight improvement from 10.48% for 2010 to 11.91% in 2011 (Bloomberg). The improvement is good but ITV has done better in this result. Net income profit ITV shows a decline in this ratio from 13.03% in 2010 to 11.54% which is a reverse of operating margin (Bloomberg). This may mean that ITV did not manage other costs other than direct costs well (Brealey et al., 2012). Others may have been beyond control for example, finance cost that increased. WPP on the other hand showed an increase from 6.28% in 2010 to 8.38% in 2011. This result is implies that WPP controlled its other costs better than ITV hence it is better than ITV in this result. Return ratios These ratios are important since they show the efficiency in use of assets and equity (Aguerrevere, 2009). According to Bloomberg all return ratios for ITV are showing a decrease from the previous year. Return on equity declined massively from 53.48% in 2010 to 33.67% in 2011 and return on assets declined slightly from 8.73% in 2010 to 8.19% in 2011. These ratios have reduced as a result of a decline in net profit margin over the two years. All return ratios for WPP have shown an upward trend. Return on equity improved from 9.5% in 2010 to 12.82% in 2011 and return on assets improved from 2.51% in 2010 to 3.43% in 2011 (Bloomberg). This result is good but in all instances ITV’s return figures are high, however, an improvement is desirable for long investment rather than high figures so WPP is the company to watch in returns. 4. Investment ratios These are the set of ratios that investors concentrate on. They give an indication of the monetary returns that investors should expect (Franco et.al 2011). a) Dividend payout ratio (DPR) Franco et.al (2011) argues that this ratio shows the portion of net income distributed as dividends. In most cases companies have policies relating to this ratio. Others prefer it to be a flat figure throughout the years while others want it to be dependent on the net income realized (Papadopoulos & Charalambidis, 2007). Companies may prefer this ratio to be as low as possible so that they have enough funds to invest on other profitable opportunities. According to Papadopoulos & Charalambidis (2007) short term investors would want this ratio to be high while long term investors would want the ratio to be low so that internally generated funds can be used for other investment to maximize on shareholder wealth. ITV did not pay any dividend in 2010 hence its DPR is 0%. This improved to 25.19% in 2010. WPP had DPR of 38.38% in 2010 which decline to 37.08% (Bloomberg). WPP would have decreased the DPR so that they can invest on expansion. Even if there was a decline in DPR for WPP, still the figures are higher than ITV. P/E ratio This ratio is normally influenced by the market demands and therefore a company has no control over the ratio. It indicates the investor willingness to invest in the company (Constand et al. 19991). P/E ratio for ITV is 14.42 while that of WPP is 12.10. The P/E for ITV indicates that the willingness of investors is to pay ?14.42 for every ?1 of earnings and the P/E for WPP indicates that the willingness of investors is to pay ?12.10 for every ?1 of earnings. Security Market Line (SML) The SML represents capital asset pricing model (CAPM) and deals with efficient securities under systematic risk (Brealey et al., 2012). Aggressive securities normally have beta more than one and are sensitive to systematic risk than the market securities. Defensive securities normally have beta which is less than one and therefore less risky compared to the market securities while risk free securities have a beta equal to zero (Brealey et al., 2012). It is represented by the equation Rs=Rf+(ERm-Rf)*? SML for ITV ?=1.143, Rf = 1.773%, ERm= 11.062% (Bloomberg). Rs=1.773 + (11.062-1.773)*1.143=12.39%. SML for CPP Plc ?=1.059, Rf = 1.773%, ERm= 11.062% Rs=1.773 + (11.062-1.773)*1.059=11.61%. From the above it appears that securities for both WPP and ITV are aggressive and therefore more sensitive to systematic risk than the market securities. However, ITV securities are more sensitive to systematic risk than WPP. SUMMARY, COCLUSION AND RECOMMENDATIONS Based on ratios calculated above, WPP Plc has done well in net profitability, in returns, and is less risky since it has less debt in its capital structure. WPP has also consistently paid out dividends with higher payout ratios. From the P/E ratio, WPP has cheaper securities than ITV which are less risky from the SMLs drawn. The only point that ITV outdid WPP was in the current ratio, which WPP can able to control. WPP therefore appears the best company to invest in. Since Mr. Timothee is a conservative investor who prefers to keep some cash with himself then WPP is the best company to invest since it has promised a higher payout ratio to the investors and is less risky in all respects. Dividends paid will be able to fulfil his preference for cash. Bibliography Aguerrevere, FL. (2009). ‘Real Options, Product Market Competition, and Asset Returns’, Journal of Finance. 64(2), 957-983 Atrill, P. & McLaney, EJ. (2011) Accounting and finance for non-specialists 7th ed. New York: Prentice Hall Financial Times. Bloomberg (n.d.). Financial and market ratios, Brealey, RA., Myers SC., & Marcus AJ. (2012) Fundamentals of Corporate Finance, McGraw-Hill International Edition. Brigham, Houston, 2004, Fundamentals of Financial Management, 10th edition, New York: John Wiley & Sons. Constand, RL., Freitas, LP., Sullivan, MJ. 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