Corporate Finance of Redrow Plc and Balfour Beatty - Case Study Example

Corporate Finance of Redrow Plc and Balfour Beatty Table of Contents Table of Contents 1 Introduction 2 An Overview of the Organisations 2 Financial Analysis 3 Liquidity Ratios 3 Gearing Ratio 6 Efficiency Ratios 8 Profitability Ratios 9 Market Value Analysis 12 Conclusion & Recommendations 13 Reference 15 Appendix 16 Executive Summary Redrow Plc and Balfour Beatty Plc, both operate in the infrastructure industry. During the year 2008 and 2009, the industry experienced a serious downturn, which reduced demand to a considerable extent. However, the situation is slowly picking up, which is definitely encouraging for companies operating there. The analysis has been concluded with a note that Balfour Beatty is a more promising investment opportunity than Redrow. Balfour has more diversified operational areas than Redrow, which mainly operates in the housing development. This may be a reason behind Balfour is doing comparatively better than Redrow. As of now, the financial condition of Balfour is stronger. However, there is a lack of efficiency in the company’s receivable management system. The company must look into this matter with more concern. As of now, Balfour seems to be a better choice for the investors as this is offering a good return on the equity invested. Introduction This report aims to offer a comparative study of the financial statements of the two companies. The analysis has taken into consideration different parameters of financial analysis. To assist in understanding, the analysis has been done after taking into account the financial data of three years. In the end, a conclusion has been inferred from the entire analysis. An Overview of the Organisations Redrow Plc The company is one of the leading property development companies in the United Kingdom. The company’s operation is based on its imaginative design and quality customer service. At the time of financial downturn, the entire housing and infrastructure market was experiencing a difficult time. In such a situation, the company started dealing in mid market residential houses. As the economy is on its way to recovery, the company is required to place its strategies to make its mark in the industry. Balfour Beatty Balfour Beatty is a leading organisation in road infrastructure, electrical and mechanical engineering, support services and a number of other such disciplines. Institutionalized back in the year 1909, the organisation is now one of the prominent fixed rail infrastructures contracting company, worldwide. In the last year, the company ranked 19th in the international league of contractors. Balfour Beatty deals in infrastructure building which includes a wide range of civil and rail engineering products. In the United States, the organisation deals in asset management and capital products. The company is expected to retain its prominent position with the help of well developed strategies. Financial Analysis The financial analysis would take a number of parameters to present a comparative study of the companies. Liquidity Ratios Redrow Plc The above image displays the current and quick ratios of Redrow Plc. Starting from the year 2007 to 2009, the company’s current and quick ratios have been quite fluctuating. In these three years, both the ratios had reached their highest values in the year 2008. The current ratios of the company have been quite high throughout the period. The quick ratio values were not at all appealing for this company. In the time of financial difficulties, low quick ratios can lead organisation to a tricky situation. Redrow has a large amount of inventory in its balance sheet which can prove to be risky in the long run. In the year 2009, the company had reduced the amount of inventory and at the same time had raised debt on its accounting book. As a result, both the current and quick ratios have been low for the company. In the recession time, i.e. in the year 2008, the company had tried to enhance its liquidity position by increasing the amount of quick assets. Therefore, both the ratios have been higher in that specific year. Redrow has a low debt amount on its accounting book, so it can afford comparatively low liquidity ratios than the industry. Despite of the fact, it seems that the quick ratios of this company are quite disappointing. Redrow must maintain a minimum level of liquid assets to allow it to lay its hands on the liquid assets whenever needed. However, the low quick ratio can also be attributed to declining demand in the housing market. The reduced cash inflow had lowered the cash amount on the company’s portfolio and eventually reduced the quick ratio of the company. Whatever be the reason behind such low quick ratio, the company must develop strategies to enhance its liquidity position. The company is required to optimize its inventory and at the same time must increase the amount of quick assets on the balance sheet. In the light of declining market demand, the company must employ strategies to enhance its cash position, so that while paying off the debt amount the company does not experience any trouble. With such weak liquidity position, the company may lose on investors’ confidence, which may create adverse situation for the company. Hence, the company needs to be cautious while maintaining a well balanced liquidity ratio. Balfour Beatty The above graph represents the liquidity ratios of Balfour Beatty. Although the liquidity ratios are not quite appealing for the company; one good thing is that both the ratios are on the upward direction. Apart from that, a major portion of the current assets are quick assets which is definitely a matter of appreciation. The company prefers to have a low inventory level compared to its counterparts. Despite the financial downturn, in the year 2009, the company has enhanced its liquidity position by a good amount, which demands positive reception. The company keeps a very low level of short term debt on its accounting book, which have also acted as an influenctial factor behind such strong liquidity position. Gearing Ratio Redrow Plc Financial gearing ratio measures the debt amount against the equity value in the capital structure. The capital structure of Redrow is a mixture of short and long term debt and equity. Compared to most of the players in the housing dvelopment and infrastruture industry, Redrow prefers to have low debt amount in its capital structure. In the year 2008, the company had around 45 % debt on its accounting book, which is the highest among these three years period. In that year, Redrow had increased its long term debt position by reducing its equity portion. By raising the long term debt amount, the company was able to fetch the advantage of tax shield which has enabled Redrow to reduce its tax amount. Housing and infrastructure industry is a capital intensive industry. In most of the capital intensive industries, companies prefer to reduce the probability of distress by maintaining lower debt against the equity capital. The debt holders of the organisation would be happy as it has enough equity capital to pay off its obligations. During the recession period, in the years 2008 and 2009, the company had raised its debt amount. In such a way Redrow was able to minimise the deductable tax amount to enhance the company’s net profitability. Balfour Beatty The above table shows the gearing ratio of the Balfour Beatty. It is quite apparent from the above graph, that the amount of debt amount is higher than the equity amount in its capital structure. In the year 2008, the company had reduced the amount of capital leases and at the same time almost doubled its equity portion, which led to a reduced a debt equity value. However, in the very next year, Balfour was back to its own position. Compared to Redrow, Balfour Beatty has been keeping more debt amount on its accounting book. However, that did not affect the company’s liquidity position as the company’s debt has a major portion of long term obligations. Efficiency Ratios Redrow Plc The above graph represents the ‘Debtors Turnover’ and ‘Stock Turnover’ ratios of Redrow. A high debtors turnover would mean that the company has been able to quickly turn its receivables into cash. The stock turnover has been highest in the year 2008. This reflects the efficiency of the company’s credit management. However in the year 2009, the debtors turnover has experineced a steep decline in its value. Looking at the stock turnover ratio of the company, it is quite apparent that the ratio values have been consistently low throughout this period. This reflects that the inventory management of the company is not at all appealing. In the liquidity analysis of the company, it was found that the company has been maintaining a high inventory level throughout these years. This also reflects the fact that the company has failed to manage its inventory level. As a consequence, the company would have to incur high inventory expenses. Redrow must remember that in near future keeping high inventory level can be risky for the company’s financial state. Balfour Beatty The above graph represents the efficiency ratios of Balfour Beatty. It is evident that the company’s stock turnover values have been quite high. This means that the company’s inventory managemnet demands a round of applause. The company has been able to turn its inventories into revenue with higher proficiency than Redrow. However, the debtors turnover is quite disappointing for the company. Balfour failed to manage its receivables in an effective way; as a consequence, its receivables were piling up. In the year 2008, both the ratio values have decreased. The rationale behind this had been the low sales figures in the same year. Profitability Ratios Redrow Plc The following table displays the profitability ratios of the company. After the year 2007, the company had been making losses both in ‘return on total assets’ and profit margin’ ratios. In return on total assets, the company had not experienced any further decline in the year 2009. However in 2009, the company’s profit margin had seen a further steep downturn. This is a matter of concern for the company’s prospect, that despite moving in mid housing development market; the company was still unable to save its profits in this financial downturn. Balfour Beatty The following table displays the profitability ratios of Balfour Beatty. Although the ratios are not quite high, still the company has been able to make profit in the recession period, despite steep competition from its competitors. Looking at their net profit margin, it will not be wrong to say that the company has maintained its profit margin throughout the year. Although the profit margin has been quite low in these years, still in the wake of financial downturn the performance is worth an appreciation. As this report is intended for the prospective invetors, they must know what they are going to gain if they invest in any of these two organisations. The following table displays a comparative study of the return on equity values for both the companies. From the above table, it is very much apparent that Balfour Beatty is doing pretty well as compared to Redrow. In the year 2008 and 2009, the return on equity values have been negative for Redrow, while Balfour has been offering a high return on equity to its investors. Although, the company’s return on equity values have declined in these years, but the line from 2008 to 2009 shows that it is trying hard to get back to its leading position. Even in the year 2007, Balfour had a higher return on equity values as compared to Redrow. Market Value Analysis Redrow Plc (Source: MSN Money, 2010) The above image represents the market performance of Redrow Plc in comparison to NASDAQ and S&P 500 index. The company’s stock has outperformed both the indices in the year 2008. However, from April 2008, the company stocks experienced a downward spiral. As of now, the company is doing pretty badly in comparison to both the indices. The market is reviving, but the company has failed to do. This is apparent from its downward graph which started in August, 2009. Balfour Beatty The following image displays the market performance of Balfour Beatty in comparison to NASDAQ and S&P 500 index. (Source: MSN Money, 2010) The company has a history of outperforming both the indices in the previous years. However, as of now, the company had failed to do so as the market is reviving at a faster speed than the company itself. The black graph is far below the red and yellow ones. However, from August 2010, the graph has seen an upward direction which is definitely a good sign for the company. Conclusion & Recommendations Both the companies, Redrow and Balfour Beatty have been operating in the infrastructure industry. As the industry is quite capital intensive, most of the companies prefer to keep more equity capital rather than having debt on their accounting book. This reduces the probability of distress for the companies. In comparison it has been noticed that Balfour maintains a higher debt equity ratio than Redrow. However, the liquidity position of the former is better than the latter one. Balfour has been keeping more long term debt and very less amount of short term obligations in its capital structure, which enhances its liquidity position despite having comparative more debt. On the other hand, Redrow has been relying more on short term debt which troubled its liquidity position. Apart from this, the company’s inventory level is also quite alarming as it reduces its quick asset ratios. The gearing ratios have been higher for Balfour as it has taken more long term obligations. Talking about the efficiency ratios, Balfour has been doing pretty well in its inventory management. Undoubtedly, the company’s inventory management system is more efficient than that of Redrow. Both the inventory and receivable management system of the company have failed to perform, which has led to weak inventory and debtor turnover ratios. The company must look into this matter to optimize its inventory level, so that the company has to bear lesser inventory cost in the near future. The debtor turnover ratios have been high for the company throughout the analysis period. However, in the year 2009, debtor turnover ratio has seen a downward movement, which can be a matter of alarm. Redrow must retain the efficiency in its receivables management system and try to turn its receivables with a greater speed. Although Balfour has been doing well in the inventory management system, the company has failed to show its performance in the debtor management section. Throughout these three years, Balfour’s debtor turnover ratios have been quite low. The company needs to have more stringent receivable cycle to enhance its position in this regard. Redrow has been incurring losses for the last two years and on the other side, despite troubled times, Balfour has been making profit. Even the company has been offering a return on equity to its investors, which is much higher than Redrow. Even in the market values, Balfour is seen as more valuable by the investors. From the overall analysis, it seems that investing in Balfour Beatty would fetch more profits than investing in Redrow. However, as the recession period is just over, it is recommended to watch out for more companies before zeroing down on one company. Reference MSN Money. 2010. Redrow PLC(GB:RDW). [Online]. Available at: http://moneycentral.msn.com/investor/charts/chartdl.aspx?Symbol=GB:RDW [Accessed on November 09, 2010]. MSN Money. 2010. Balfour Beatty Plc(GB:BBY). [Online]. Available at: http://moneycentral.msn.com/investor/charts/chartdl.aspx?Symbol=GB:BBY [Accessed on November 09, 2010]. Appendix Redrow Plc Balfour Beatty Read More