Analysis of Financial and Operating Performance of Vodafone - Assignment Example

14TABLE OF CONTENTS Executive Summary…………………………………………………………… 2 Part The key ratios of Vodafone …………………………. 3 Part 2. Impact of the economic crisis to the per share of Vodafone……… 5 Part 3. Potential strategy in countering negative effects of credit crunch… 8 Part 4. Discussions and recommendations……………………………….. 10 Annexes…………………………………………………………………… 14 List of references………………………………………………………… 16 EXECUTIVE SUMMARY The report summarizes the result of operations of Vodafone for two consecutive financial periods from 2008 to 2009. The ratios obtained from the financial statements have been compared from Vodafone’s two year performances to determine growths in all aspects. Then it has been compared to the industry sector to determine its relative position. New strategies for possible income and debt financing are uncovered to assist the company in its operation considering that credit banking facilities now are tight. The weakness analysis has been derived to identify factors to be controlled, strengthened and solved. Finally, suggested recommendations to management are presented to strengthen weaknesses observed. VODAFONE CASE STUDY Analysis of financial and operating performance of Vodafone Following are the findings of the study Part 1. KEY RATIOS Key Ratios 2009 2008 Change A. Growth Sales Ratio 1. Sales growth 36% 38% (-) 0.2 2. Net income growth -0.48 -0.58 (-)10% 3. Dividend growth 27.22 31.99 (-)4.68% B. PROFIT MARGIN 1. Gross Profit margin 36% 38% (-)2% 2. Net Profit margin 10% 25% (-)15% C. FINANCIAL CONDITION Debt/equity ratio 1.0 0.63 (+) 0.37 Quick ratio 0.49 0.39 (+) 0.10 Current ratio 0.47 0.40 .(+) 0.7 D. INVESTMENT RETURN Return on Assets 0.058 0.052 (+) 0.006 Return on investments -0.929 -0.914 (-) 0.015 D. EFFICIENCY RATIO income/employee 90.799 155.755 (-)64,956 Revenue/employee 636,560 566,384 (+)70,176 Receivable turnover 5.7 N/A Inventory turnover 55 N/A Asset turnover 0 N/A Data above shows the overall picture of company performance for two years. It could be observed that there has been a negative change in the overall ratios of performance of the company. The problem of profitability of operations has started with the slow growth of sales that has affected the turn out of low net profit margin. The slow growth of sales is caused by the economic recession that started in 2008 ,the stiff competition from other mobile companies and internal operations problems. The net profit has also decreased in 2009 by 15% because the costs of selling, administrative and unexplained unusual expenses went up. The decline in the net profit will have an effect on the ability of the company to pay its short and long term obligations as well as earnings per share. Earnings per share for 2009 is $13 and industry is $15 For 2009, the gearing ratio or debt to equity is 1 meaning company has used up an equal weight of debt and equity financing, while for 2008 it is only .63%. Because of this shift to debt financing, the interest expense of the loans have increased from $1398M in 2008 to $1798M 2009. Debt financing becomes risky because of the volatility of interest rate charges. The limited net profit margin makes it difficult for the company to quickly pay its short term obligation For instance; its current and the quick ratios for the past two years showed a ratio of less than 1 that gives an idea that Vodafone is going to have difficulty in paying its maturing obligations. Investment returns remain the same for 2008 and 2009. Vodafone had significant higher capital investments in 2009 than in 2008 that included long term investments and acquisitions of property, plant and equipment. Sources of funds of these investments are debt and equity financing. The return on assets for both periods has been almost the same in spite of additional investments on assets. Consequently, the ROI provided a negative return that should alarm the company. Part 2. Impact of economic crisis to Vodafone Several factors have contributed to the decrease of share prices of Vodafone. Vodafone Share price as reported in the London stock Exchange (high) shows £1.49 for 2005, £1.55 for 2006, £1.54 for 2007, £1.98 for 2008 and a decreased share price of £1.70 in 2009. (Vodafone Annual Report) Stock price as of December 5, 2009, quoted from ADVFN is $140.2 The volatility of the market price depends on many factors, such as recession and company performance. The combined factors of unemployment, tight credit, competition and company performance are among the determinants of the increase or decrease of share prices of Vodafone. The share price of Vodafone reached a high level during the first part of 2008, and dipped down during the last quarter of 2008 to 2009 the beginning of recession period. See Chart 1 Business week carried a report saying that as stocks are turning out to be great again in 2009, growth of telecom was slow. The S&Ps index is up by 21%, while telecom sector was down by 1.6% this year. Report said that this is the only sector that is going to finish 2009 with a negative growth. (Steverman, Ben. 03 December 2009) It will be noted that when share prices went up in 2007 to 2008, gross profit of Vodafone remained steady while net profit was low that confirms theory that costs and operational problems of Vodafone are the source of low profitability. Economic crisis seem to have spared the business of phone companies as reports of revenues of this sector showed sales growth in 2008. According to Krause, R. of the Investors Daily (2008) wireless phones revenue has surprisingly increased by 44% from previous years. Even before the crisis period, this report said, that the forecast of wireless phone sales will grow by 10% over a decade period. Report further said that the wireless data revenue accounted for “20% of all wireless revenue for the first half of 2008, which is higher by 10% two years ago”. This only goes to show that more people use wireless phones today. Another cause of low profitability is the default of customers. Customers tend to default on line rentals because of unemployment. The unemployment rate as of November 2009 according to the Bureau of Labor Statistics is 15.4 million with an unemployment rate of 10% (Bureau of Labor Standards nod.) Almost every household in the United States have been affected by economic recession and this includes subscribers of the company that have defaulted in their line subscription payments. The trade receivables have increased from £81,990M in 2008 to £83,890M in 2009. Retained losses also went up from £81,990M in 2008 to £83,890 in 2009. A large part of cash and assets are tied up in the receivables that take longer time to collect, or in some cases be declared as bad debts. Large receivables affect the cash flows of the company. Competition is another factor affecting the company. Take for instance, Effect of the merger of T-Mobile and Orange to Vodafone. The merger of these two companies is under negotiation and is expected to be done by 2010. (Gareth Beavis) The merger of Deutsche Telecom and France Telecom will create a market leader in terms of consumer share. T-Mobile and Orange are top mobile phone carriers It is more likely that share price of Vodafone will be affected with the merger of T-Mobile and Orange T-mobile and orange hopes to capture a 37% share of the 24.8 million subscribers in UK. Vodafone comes next to China, the top largest mobile company. It has 151.8 million subscribers. T-mobile comes fourth with 60 million subscribers and Orange ranking sixth with 49 million; together will have 105 million subscribers. (Largest Mobile…n.d..)The telecom industry has 14 players, and orange and t-mobile are among the top competitors of Vodafone. (Hoovers) Vodafone, in the face of the coming competition from orange and t-mobile should not be very much worried, as in a recent mobile phone survey; (Hoovers) customers have voted Vodafone to be one of the top mobile phone carriers in the world. But they should not be complacent either as the telecom industry is driven by technological innovation. (Hoovers) Tariff and taxes have significant impact on profitability and consequently, share prices. The European Union has plans to impose a 14% increase in taxes to high end mobile phones. The plan which is under debate will “reclassify some phones as multi-functional devices. (Tarmo Vikki, 2008) A tax increase will necessarily have an effect on the price of the mobile phones services and products. When the price of the product increases, consumers tend to cut on their spending and would postpone upgrading of their mobile phones. As the controversial bill goes on, there are reports of loss of investors confidence as shares in Nokia and Erickson were reported going down. The tight credit policies of banks in lending affect sales of mobile phones and services and investments. Banks suffered losses during the crisis and have to adjust their lending policies because of this. Banks have imposed strict lending policies since the start of the economic crisis and have not changed policy directions since then. Banks also suffered from crisis and needed bailouts from governments to survive On the other hand, customers and investors at this time of crisis would rather hold to their cash than go on investing and spending. Government intervention, such as bailout, helped banks in recapitalization, but there are doubts whether this will increase employment. The study of Giannetti, M. and simonov, Andrei. (23 September 2009) showed bailouts are beneficial as it increases lending facility, but does little to improve economic growth because of possibility of resource misallocation Part 3. A Potential Strategy that could be deployed to counter the negative effects of the credit crisis. The credit crisis has toppled down many businesses, banks and financial institutions. As a result, capitalists, investors and businesses are now more cautious in investment decisions. Risks are always present in any investment and financial players should exercise caution and look for potential strategies in investment. One of these strategies is the use of financial derivatives, a growing market sector that offers investments using derivative instruments. Financial derivative investment instruments make it possible for an investor to invest in one or more securities available in the market. Derivatives transactions are based on the underlying value of the assets and are usually under the form of forwards, options, futures and swaps. These instruments have different rules. For example, the futures trading wherein two people who are involved in the trading agree to make a trade at a particular date in the future. In options, two, people decide to have an option to have a particular trade at some specific time in the future, but the difference, is that options do not mean that trade is required when the maturity date comes. The buyer may or may not decide to take the option at that time. (Financial Guide) One should remember that in derivatives, most parties are only agreeing to make a trade in the future, and in options, in most cases, trade is not completed at all. The option type of derivative is based on the price of the underlying asset, and it gives the buyer the right, but not the obligation to buy or sell a specific asset for a specific price for a specific time period. Stock option is the most common example of option type derivative. Financial derivatives of Vodafone. Vodafone uses derivative financial instruments to prevent the risks of fluctuation of interest rates in their financial transaction. The use of financial derivatives is guided by the approved policies of the Board of Directors that is in line with the Group’s management strategy. (Vodafone FS) Policy of Vodafone requires “that derivative financial instruments should be measured at the contract date and subsequently re-measured to fair value at each reporting date. The board designates certain derivatives as hedges of the change of the value of recognized assets and liabilities.” Hedging transaction stops when the hedging instrument expires or is sold, terminated or exercised, or not qualified for hedging. Vodafone uses interest rate swaps to convert a proportion of its fixed rate debt to floating rate to hedge the interest rate risk arising from capital market borrowings. The changes in the fair value of the hedging interests are recognized as profit or loss during the period and are called Netting. In swap transactions netting is the payment of the difference between the agreed amounts by the losers in the transaction. (Interest rate swaps n.d.) Swap transactions are usually done when there is a need for debt financing that could not ordinarily be obtained in the debt market. Swap transactions is a deal that uses interest rate swaps and currency swaps and works this way. Supposing Vodafone needs a debt financing for £10 million and company fixes his prime market rate at 7%. The contracting bank fixes its lending rate to Vodafone at 4% and both parties benefit from swap. Vodafone pays periodic payments to bank at 7% per annum; while the banks earn 3% interest from the fixed rate borrowing Vodafone in this transaction is assured of the interest-risk free financing Other financial derivatives recommended for Vodafone/ Another available financial derivatives that could be employed by Vodafone; usage of course, will depend on the policies of the board along the line, is the issuance of corporate bonds in addition to the stock market. Corporate bonds are a form of debt security and sold to investors. A corporate bond is backed up by the company’s physical assets and the money to be earned in the future operations. Corporate bonds carry a higher interest than government bonds because of higher risks. It is issued in blocks o $1,000 par value , and has the same payment coupon bond structure. Generally, it is easier to encourage investors when bond issuer has a high credit quality. Corporate bonds could be a major source of capital aside from debt and equity financing and is recommended for Vodafone. (Investopedia n.d.) Stock option trading is an example of buying and selling of financial derivative instruments where the risk protection says the maximum amount that an option buyer may lost is the option price paid and the maximum profit Vodafone can gain is the option price. The option buyer has lot of an upside gain and limited downside risk while Vodafone has limited upside potential and a lot of downside risk. The same thing goes when the contract is based on the stock price index. When the buyer feels that the Index Price of S&P 500 or FSTE will rise within the next few days, he will purchase an index stock option in the derivatives market and wait for the outcome on call or put expiry dates. In such a case, stock options transactions have more risks to Vodafone and are not recommended, but advisable to investors. Another derivative instrument is the futures contract that is a “standardized, transferable, exchange traded contract that requires delivery of a commodity, bond, currency or stock index at a specified price, on a specified future date. As differentiated from options, futures trading there is physical delivery of the underlying asset. It is a forward contract, meaning “they pledge to make a certain transaction at a future date” Futures contract is regulated by a clearing house, and transactions are monitored to see that agreements are done. This is commonly used in commodities to lock up the price of future deliveries. Some of these are Futures prices for crude oil, natural gas, heating oil, gold, silver, and agricultural futures including corn, wheat, coffee, soybeans and cattle. (Futures contract definition) Part 4. Discussions and recommendations The factors that push demand for mobile phones are technological innovations and the increase of consumer spending. Technological factors could be responded by Vodafone thru its research and developments and continuing efforts to upgrade its products. Consumer spending could be countered by adding value programs that could bring, for example, more mobile data services to consumers. The profitability of the company has been low as compared to competitors. This problem could be improved by Vodafone thru efficient operations and good marketing strategy. Vodafone has a competitive advantage of economies of scale as a large company. It has the ability to provide a highly automated service to large number of customers. Let us look at the weaknesses of its operations and marketing. Based on the analysis done in Vodafone’s financial performances for the last two years, following weaknesses are established: a. The over all financial status of the company is weak. There is a need to look on the costs of production and other expenses as these pushes down the net profit of the company. b. Competitors are financially stronger than Vodafone as all their ratios are much higher. Competitors have raised cost of mobile data services while there is no report that Vodafone has followed. c. The shares of stock fell in the last quarter of 2008 and is slowly gaining in 2009 It is surprising to find that the shares of stock increased in first part of 2008 at the start of recession. Discussions. After several years of losses, Vodafone is slowly gaining its position in the market and recovering. Although growing at a slow pace, a lot of factors have to be done by the company to be competitive and to gain investors confidence. The effect of economic crisis is not felt very much by the telecom industry as the wireless phone has become a useful means of communications. Opportunities seen in the present operations of the company are that Mobile data service is becoming popular that could be a reliable source of sales income Recent problems of the industry, first, are the protectionist’s policy of governments and the impending increase of taxes to the mobile unit providers. An increase of tax is untimely during recession, as this will raise the cost of services and cost of the unit. Any tax increase for that matter will cause demand for mobile phones and services to go down. The impact to Vodafone is reduced revenue that would result to unemployment and loss of confidence of shareholders. The next pressing problem is the tight credit and default payments of customers. Banks have imposed tight credit and lending policies that limits availability of money while rate of unemployment does not stop from going up. Recommendations to management 1. Efficient cost control. An internal audit program to monitor costs and operating expenses must be established by the management. An inefficient cost control eats up expenses of the company thereby lowering the profit margin of the company.An internal control monitors areas where costs could be limited in the operation. For example, an area where company could make a lot of savings is on cost cutting, including trimming down of jobs. Present number of employees is 64,405 and has an average cost of $39.83 per hour in terms of salaries and wages (BLS) A 10 percent reduction in the number of workforce would mean a sizeable amount of savings on cost. 2. Marketing strategy. Management must keep up with strategies of competitors and come up with innovative strategies to attract mobile phone users. Data mobile services for example could be improved. Advertisements and promotional gimmicks are but two ways to attract customers. For instance, free ring tones, example – Christmas ring tones, love song ring tones. Pricing strategy. Other companies have increased their rate of data mobile services. Vodafone should follow the industry pattern but must not exceed it. 3. Lobbying to law makers in Congress must be done by Vodafone, along with other companies to be affected by the tax increase. A lobbying effort will make law makers realize the adverse effect of additional taxes to the industry. 4. Company should design an easy repayment plan for defaulters in order to recover default payments of customers. This plan will reduce company losses on bad debts and hasten collection of accounts receivables. For instance, Vodafone may introduce a zero rate interest of repayment on default, and an extended term limit to encourage customers to pay. 5. Turning inventory into cash. A lot of cash is tied up in the inventory of the company that limits its cash flow. An inventory sale can be offered on discounted prices, discounted programs and promotions that will attract budget conscious consumers. 6. Customer relations program. A customer relations training program for sales and first line employees should be given. These employees are the first people of the company that meets the customer and they create the image of the company. They are also the first people who communicate to customers and will be reliable source of information on the impression to the company and monitor movements of the competitors. Creating an impression to customers generates word of mouth advertisements that will build or destroy sales of the company 7. Issuance of corporate bonds as an alternative from getting loans from banks. Bonds carry a fixed rate of interest during the life period of the bond. Recommendation to investors. There are four recommendations to investors for possible investments in Vodafone. First is the corporate bond investment when introduced by Vodafone. Second is the debt financing to the company under the swap transaction as it has a fixed rate of interest during the entire transactions, and has fewer risks. Third, Investors can also add stock options in their investment portfolio as this is more favorable to them. Fourth, is the stock market investment. Dividend yield have increased and this could encourage investors to invest in the shares of Vodafone. Annex 1. Selected ratios for Vodefone Financial Data 2009 2008 2007 Revenue 41,017.00 35,478.00 31,104.00 Cost of Revenue, Total 25,842.00 21,890.00 18,725.00 Gross Profit 15,175.00 13,588.00 12,379.00 Net Income 3,078.00 6,660.00 -5,351.00 Current Assets 13,029.00 8,724.00 12,813.00 Total Inventory 412 417 288 Current Liabilities 27,947.00 21,973.00 18,946.00 2009 2008 2007 I. Growth sales rate Gross profit divided by revenue Gross profit 15,175.00 13,588.00 12,379.00 Revenue 41,017 35,478.00 31,104.00 Sales growth 0.36996855 0.382997914 0.397987397 . c Retained earnings divided by total assets Retained earnings -73,719.00 -71,926.00 -72,815.00 Total assets 152,699 127,270.00 109,617.00 Net income growth -0.482773299 -0.565160682 -0.664267404 Dividend growth 27.32 31.29 12 PRICE RATIO Market price per share divided by earnings per share Company Industry Sp 500 Earnings per share 13 15.9 27.6 SOURCE DATA MSN money central PROFIT MARGIN Gross Margin Gross profit divided by total revenue Gross profit 15,175.00 13,588.00 12,379.00 Total revenue 41,017.00 35,478.00 31,104.00 Profit margin 0.36996855 0.382997914 0.397987397 Net profit margin Net income after taxes divided revenue Net income after taxes 4,189.00 9,001.00 -2,383.00 Revenue 41,017.00 35,478.00 -14,853.00 0.102128386 0.253706522 0.160438969 FINANCIAL CONDITION Debt/equity ratio Divide total debt by total equity Total debt 66,537.00 49,277.00 42,550.00 Total equity 86,162.00 78,043.00 67,067 1.005667906 0.631408326 0.634440187 Quick ratio Current assets minus inventory divided by current liabilities Current assets 13,029.00 8,724.00 12,813.00 Inventory 412 417 288 13024.88 8719.83 12525 Current Liabilities 27,947.00 21,973.00 18,946.00 Quick ratio 0.4490 0.396842944 0.739112475 Current ratio Current asset 13,029.00 8,724.00 12,813.00 Current liabilities 27,947.00 21,973.00 18,946.00 Current ratio 0.471 0.40:1 0.68:1 INVESTMENT RETURN Return on assets Net income divided by total assets Net income 3,078.00 6,680.00 -5,351.00 Total assets 52,699.00 127,270.00 109,617.00 ROA 0.05840718 0.052486839 -0.076183439 Return on equity Net Profit ÷ Average Shareholder Equity for Period = Return on Equity Company Industry S&P ROE 7 16.7 14.7 Return on capital 4.8 12.5 7.9 MANAGEMENT EFFICIENCY Company Industry S&P income/employee 119,277 95,640 43,361 Revenue/employee 896,273 732,930 780,513 No. of employees 64.405 Receivable turnover 5.7 23.1 13.7 Inventory turnover 55 26.8 8.8 Asset turnover 0 0.60 0.8 Source of data: Money Central List of reference Advfn. 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