Financial Analysis of Orange Telecom - Case Study Example

INTRODUCTION Orange Telecom comes under the umbrella of France Telecom, which happens to be one of the most successful telecommunication operators ofthe world with a market share of 46%. France Telecom had sales worth 45.503 billion euros at the end of 2010 and 33,848 billion euros as on September 30, 2011. Also the customer base for France Telecom was 221 million customers (of which 162 million are mobile customers and 14.2 million are broadband internet (ADSL) customers all over the world) at 30 September 2011. Orange Telecom is concentrated in Europe where it provides mobile and broadband internet services. Its brand Orange Business Services caters to the telecommunication needs of multinational companies and is very successful at that (Orange Telecom, n.d.). Orange grew tremendously over a short spell in the United Kingdom and the rest of the world. It started off as a mobile phone brand and moved on to become one of the leading providers of broadband, content and other related services worldwide. Orange competed with brands like Intel and L’Oreal for the title of World’s most powerful brands by Millward Brown Optimor in 2010 and reached the 50th rank after climbing 14 spots from 2007. Markets like those in Luxemburg and Tunisia have acceded to the kingdom of Orange and this accounts for the huge increase in the customer base of Orange. Orange Telecom’s presence in Africa and Middle East is quite noticeable and includes 19 countries with 60 million customers and 16,700 employees (Orange Telecom, n.d.). Orange France had 80,000 employees at the end of 2010. Orange has a strategic plan called Conquests 2015 under which it will develop a new organizational model in order to improve even more in areas involving well being of employees, economic performance and satisfaction of customers. The prime reason behind this plan is to position Orange as the number one telecom operator in France in terms of customer care (European Network for Women in Leadership, 2011) RATIO ANALYSIS Profitability Ratios: The gross profit margin for Orange Telecom is showing a rather fluctuating trend from 2006 to 2010. The profitability decreased as it was 59.49% in 2009 and fell to 58.68% in 2010. This fall can be attributed to the fall in revenue as well as the increase in cost of sales in 2010. As seen in the horizontal analysis (appendix), revenue percentage growth is negative in 2009 and 2010 as a result of which gross profit decreased in both the years and so did the gross profit margin. The overall trend for the operating profit margin has been falling over the five years, after it increased to 20.39% in 2007. The operating profit margin in 2010 is 16.62%, which means it decreased from 2009. However in the economic crunch of 2009, telecom companies were less hit and Orange Telecom managed to get the Best Telecom Carrier and the Best Managed Service Provider awards. This explains why Orange did not face sharp declines in revenues or profits over the five years (Clark, 2009). This is majorly because depreciation and amortization expense, impairment in goodwill and impairment of fixed assets all increased in 2010, leading to a fall in operating income. Since the revenue decreased and expenses increased, so the operating profit margin decreased in 2010. The capital turnover decreased in 2010 as total capital increased in while the revenue fell in 2010. Capital turnover has been decreasing after 2008 because of falling revenue and increasing total capital in 2009 and 2010. The return on capital employed showed a downward trend after 2008 because total capital and operating profit move in opposite directions, the former increased while the latter decreased. The return on shareholder’s funds kept falling after 2007 after it rose in 2010. The total equity and total profit for the year both increased in 2010. One major reason for the increased profit in 2010 is the reduced income tax of 1755 million euros. This tax is considerably lower in 2010 than in the preceding years. Liquidity Ratios: The current ratio showed an overall increasing trend from 2006 onwards. This is because the increase in total assets over the five years is more than the increase in total liabilities over the five years. An improving quick ratio is indicative of the fact that Orange Telecom has spent cash on assets and there was an increase in cash outflow. It is better to have a lower quick ratio in order to avoid liquidity problems. The quick ratio has also been increasing from 2006 onwards because though the inventory fluctuated it was not significant enough to decrease the overall quick ratio. The inventory level dropped sharply in 2009 but increased little in 2010. A high level of inventory is not good for a company as cash is tied in inventory and there are also high warehousing costs attached to it. But a low level of inventory can lead to problems in meeting the increasing demand. So Orange telecom should maintain an appropriate level of inventory at all times. Working Capital Ratios: The fluctuating trend of inventory has more pronounced effects on the inventory days as they are directly proportional to the inventory level. Inventory days increased 2008 onwards which is not a good indication as the more the inventory days the more time is there before inventory in converted into sales and then later cash. The receivable days decreased in 2008 but recovered in 2009 and 2010 because of the falling trade receivables. This is also slightly disturbing as the company will have to wait for more days before its receivables are recovered. Additionally, there are costs attached to recovering receivables so Orange Telecom will incur these costs along with more time consumption. The higher the payable days the more cash float a company has as its payments are deferred. The payable days increased significantly in 2010 which means the company has more time to pay back its dues. There will be more cash available for operations as a result. Capital Structuring/ financing ratios: Interest cover shows how many times interest can be paid with the given amount of operating profits. The increase in interest cover is due to the falling finance costs and not because of operating profits (which also fell slightly 2007 onwards). It would be better if Orange Telecom’s interest cover increases as a result of rising operating profits as it will enable Orange to pay its finance costs on time. The gearing ratio had slight changes over the five years because of minor fluctuations in non-current liabilities and total capital over the years. The higher the gearing ratio for a company, the more it is exposed to risk, so prospective investors shy away from companies that have a high gearing ratio. The gearing ratio for 2010 is 55.37% which is considerably high and it means that Orange Telecom is more vulnerable to downturns in the business cycle and it will have to repay its debt even in times of falling sales. Downturns in the business cycle can include recessions or economic crunch. But it has been experienced that telecoms are less vulnerable to economic downturns than other companies as the demand for their services is very inelastic and even in recessionary times customers cannot do without these services. PROFORMA INCOME STATEMENT AND BALANCE SHEET An underlying assumption for this is the 3% growth in the sales revenue. The gross profit is 58.67% of sales and an increase in sales will lead to a proportionate increase in gross profit which is a positive sign for the company. The cost of sales if 42.57% of sales and it will increase with sales but this increase will be offset by the increase in gross profit. Total assets are 207% of sales while total equity is 69.33% of sales. An increase in sales will lead to an increase in total assets and total which there will be more cash outflow. The British Orange has huge investment plans as Everything Everywhere (which owns British Orange) has decided to invest $ 2.4 billion in a three year network evolution program (Hibberd, 2011). This will be a huge cash outflow for the company and if it is financed through debt, then finance costs will rise sharply. Total liabilities are roughly 92% of sales and an increase in total liabilities would mean cash inflow but this inflow is not large enough to meet the outflow due to equity and total assets. Total liabilities will increase further if the above mentioned investment is financed through debt. In the long term Orange will have to pay back the loan as well as the interest accrued on it. This will become difficult if the declining trend of revenues continues. CONCLUSION The profitability ratios overall are falling for Orange Telecom which should be a cause of concern for the management. The liquidity ratios increased which means there were more outflows for the company. If this trend continues then liquidity problems can occur in the future. The working capital and the capital structuring ratios both are alarming for Orange Telecom as there will be delayed recovery of receivables and more exposure to business cycle fluctuations. Recently France Telecom decided to withdraw from some European markets and its Austrian, Portuguese and Swiss assets are on sale. European markets have shown slow growth and France Telecom’s CEO has decided to pull out of countries where France Telecom (FT) is one of the top two operators is not. FT tried to merge Sunrise with Orange Switzerland in order to compete aggressively with Swisscom. However the watchdog authorities averted this merger for the fear that the merged company would exercise monopolistic behavior (TeleGeography, 2011). On the other hand, Orange is the leading operator in Poland with 14.6 million subs. Orange has big plans for its operations in Poland and has signed an agreement with T-mobile to share radio access networks. The implementation of this project will complete till 2014 and will prove to be very lucrative for Orange Telecom (Middleton, 2011). The declining revenues for Orange are rather a disturbing fact and investors might shy away from investing in Orange Telecom. APPENDIX HORIZONTAL ANALYSIS Title 2006 2007 2008 2009 2010 Revenue (in millions of euros) 51,702 52,959 53,488 45,944 45,503 Growth from Base Year Base year 2.43% 3.45% -11.14% -11.99% Gross Profit (in millions of euros) 29,366 30,243 30,216 27,334 26,701 Growth from Base Year Base Year 2.99% 2.89% -6.92% -9.08% Net Income (in millions of euros) 4768 6819 4492 3465 4877 Growth from Base Year Base Year 43.02% -5.79% -27.33% 2.29% Total assets (in millions of euros) 103,171 101,183 93,652 90,910 94,276 Growth from Base Year Base Year -1.92% -9.22% -11.88% -8.62% Total Liabilities 71,533 66,660 63,109 58,153 62,727 Growth from Base Year Base Year -6.81% -11.77% -18.70 -12.31 RATIOS ANALYSIS OF FINANCIAL STATEMENTS FORMULAE 2010 2009 2008 2007 2006 PROFITABILITY Gross Profit Margin (Gross Profit) /Revenue 58.68% 59.49% 56.49% 57.11% 56.80% Operating Profit Margin (Operating Profit)/ Revenue 16.62% 17.11% 19.20% 20.39% 13.52% Capital Turnover (Revenue)/Total Capital 0.64 times 0.71 times 0.78 times 0.73 times 0.68 times Return on Capital Employed (Operating Profit)/ Total Capital 10.70% 12.07% 15.01% 14.81% 9.23% Return on Shareholder’s Fund (Profit for the year)/Equity 15.46% 12.05% 14.40% 19.87% 15.07% LIQUIDITY Current Ratio (Current Assets)/Current Liabilities 0.64 0.58 0.58 0.53 0.54 Quick Ratio (Current Assets-Inventory)/Current Liabilities 0.61 0.55 0.55 0.50 0.51 WORKING CAPITAL Inventory Days (Inventory*365)/Cost of Sales 13 12 15 17 14 Receivable Days (Trade Receivables*365)/ Revenue 45 44 42 45 48 Payable Days (Trade Payables*365) /Cost of Sales 156 148 147 151 144 CAPITAL STRUCTURE/FINANCING Interest Cover (Operating Profits)/ Finance Costs 4 times 3 times 3 times 4 times 2 times Gearing (Non-current Liabilities) / Total Capital 55.37% 55.85% 54.42% 52.92% 58.20% PROFORMA INCOME STATEMENT Account Title 2010 (in millions of euros) %age of Sales Proforma (in millions of euros) Revenue 45,503 100% 46,868* Cost of sales (19,375) 42.57% (19,956) Other Operating income 573 1.25% (590) Gross Profit 26,701 58.67% 27,502 Other Operating Expenses (2532) 5.56% (2,608) Labor Expenses (9214) 20.24% (9490) Gains (losses) on disposal of assets 62 0.136% 63.86 Restructuring costs and similar items (680) 1.49% (700) Depreciation and Amortization (6,461) 14.19% (6655) Remeasurement resulting from business combination 336 0.738% 346 Impairment of goodwill (509) 1.11% (524) Impairment of fixed assets (127) 0.279% (130) Share of profits (losses) of associates (14) 0.03% (14.4) Operating Income 7562 16.61% 7789 Cost of gross financial debt (2117) 4.65% (2181) Income and expense on net debt assets 120 0.263% 124 Foreign exchange gains (losses) 56 0.123% 58 Other financial income and expense (59) 0.129% (61) Finance costs(net) (2000) 4.39% (2060) Income tax (1755) 3.85% (1808) Consolidated net income after tax of continuing operations 3807 8.36% 3921 Consolidated net income after tax of discontinued operations 1070 2.35% 1102 Consolidated net income after tax 4877 10.71% 5023 *assuming a 3% increase in sales revenue PROFORMA BALANCE SHEET Account title 2010 %age of Sales Proforma Assets: goodwill 29,033 63.8% 29,904 Other intangible assets 11,302 24.84% 11,641 Property, plant and equipment 24,756 54.41% 25,499 Interests in associates 8176 17.96% 8,421 Assets available for sale 119 0.26% 123 Non-current loans and receivables 891 1.96% 918 Non-current financial assets at fair value through profit or loss 96 0.21% 99 Non-current hedging derivatives assets 328 0.72% 338 Other non-current assets 21 0.046% 22 Deferred tax assets 4424 9.72% 4,557 Total non-current assets 79,146 173.9% 81,520 Inventories 708 1.56% 729 Trade receivables 5,596 12.29% 5,764 Current loans and other receivables 775 1.7% 798 Current financial assets at fair value through profit or loss excluding cash equivalents 758 1.67% 781 Current hedging derivatives assets 72 0.158% 74 Other current assets 2,346 5.16% 2,416 Current tax assets 124 0.272% 128 Prepaid expenses 323 0.71% 349 Cash equivalents 3,201 7.03% 3297 Cash 1,227 2.69% 1,264 Total current assets 15,130 33.25% 15584 Total assets 94,276 207% 97,104 Equity and Liabilities: share capital 10,595 23.28% 10,913 Additional paid-in capital 15,731 34.5% 16,203 Retained earnings 2,775 6.09% 2,858 Equity attributable to the owners of the parent 29,101 63.95% 29,974 Non-controlling interests 2,448 5.38% 2,521 Total equity 31,549 69.33% 32,495 Non-current trade payables 466 1.024% 480 Non-current financial liabilities at amortized cost, excluding trade payables 31,617 69.48% 32,566 Non-current financial liabilities at fair value through profit or loss 2,175 4.78% 2,240 Non-current hedging derivatives liabilities 250 0.549% 258 Non-current employee benefits 1,826 4.01% 1881 Non-current provisions 1,009 2.21% 1039 Other non-current liabilities 528 1.16% 544 Deferred tax liabilities 1,265 2.78% 1303 Total non-current liabilities 39,136 86% 40,310 Current trade payables 8,274 18.18% 8,522 Current financial liabilities at amortized cost, excluding trade payables 4,525 9.94% 4,661 Current financial liabilities at fair value through profit or loss 366 0.80% 377 Current hedging derivative liabilities 18 0.039% 19 Current employee benefits 1,816 3.99% 1,870 Current provisions 1,546 3.39% 1,592 Other current liabilities 2,105 4.62% 2,168 Current tax payables 2,353 5.17% 2,424 Deferred income 2,588 5.68% 2,666 Total current liabilities 23,591 5.17% 24,299 Total equity and liabilities 94,276 207.18% 97,104 Bibliography Clark, R. (2009) Making the best of tough times, Telecom Asia, May. European Network for Women in Leadership (2011) DELPHINE ERNOTTE APPOINTED EXECUTIVE VICE-PRESIDENT OF ORANGE FRANCE, European Network for Women in Leadership, 1 March. Hibberd, M. (2011) Everything Everywhere announces £1.5bn network investment, Mobile communications international, 8 December, Available: http://www.telecoms.com/37632/everything-everywhere-announces-1-5bn-network-investment/. Middleton, J. (2011) Orange, T-Mobile to share Polish network, telecoms.com, 22 july. Orange Telecom Group, [Online], Available: http://www.orange.com/en_EN/group/. Orange Telecom Our Brand, [Online], Available: http://www.orange.com/en_EN/group/brand/. TeleGeography (2011) France Telecom to withdraw from several European markets, TeleGeography, 29 July. Read More