Financial Ratio Analysis of Mondi PLC - Essay Example

Financial Ratio Analysis of Mondi PLC Executive Summary This is a study on the financial condition and performance of Mondi PLC, a company listed on the London Stock Exchange. Mondi PLC is a paper and packaging company which operates in markets worldwide, with strategic focus on low-cost production and exposure to high-growth emerging markets. Mondi compares favourably against James Cropper plc, another paper and packaging company listed in the LSE and which is its closest competitor among the exchange listings. While Mondi may appear to be less liquid than Cropper, it shows stronger activity turnover ratios, faster collection and cash cycle times, lower debt risk and favourable leverage, greater efficiency due to economies of scale, as well as higher profitability. More importantly, with the global economy favouring emerging market growth and the European economy arguably poised for recovery, Mondi’s heavier investment in production capacity and forest assets indicates that the company is well-positioned to take early advantage of any market expansion that may take place in the near future. 1. Company business Mondi plc is a premium listed company in the London Stock Exchange, and together with Mondi Limited comprises the Mondi Group which is an international paper and packaging manufacturer. The Group has production facilities located in 28 countries, with key operations in central Europe, Russia and South Africa, and employing 23,400 people. Mondi’s goal is to become the ‘best-performing paper and packaging group in the world’ (Mondi Annual Report 2012) and approaches this with an integrated strategy that aims at attaining standards of workplace safety, ethical business conduct, social responsibility, environmental sustainability, and economic prudence in the course of pursuing its business practices and decision-making. 2. Economic environment Mondi plc operates globally but is primarily treated here as a UK listed company, therefore analysis of the economic environment shall be focused on the UK to arrive at a concise finding. Later, the industry prospects of the paper and packaging industry shall be described with an expanded world outlook. Data supporting the economic forecasts for UK, as contained in the OECD Economic Outlook (OECD, 2012), are attached as Appendix A in this report. The OECD forecast highlighted four principal directions it sees in the UK economy. They are: (1) Real earnings are set to recover. OECD forecasts for the nominal wage shows the likelihood of an upward trend commencing 2013. The effect would be an increase in the buying power of consumers which may translate to stronger sales for consumer products like paper and industrial products like packaging. Figures shown are year-on-year percentage changes. Nominal wage refers to compensation of employees divided by hours worked (OECD 2012). (2) Private savings are high. Four-quarter moving averages. The existence of high savings is an effect of the current lack of confidence in investing and consumption. With improving economic conditions, however, savings will be a source of new investment that could fuel growth. (3) Low confidence hampers growth. The third quarter of 2012 showed an increase in real GDP to 0.99 per cent, but business confidence in the manufacturing sector registered -6 per cent quarter-on-quarter growth in domestic orders. (4) Unemployment remains stable. Unemployment was assessed at 7.9 per cent for third quarter and 8.0 per cent for the fourth quarter of 2012. As a result, productivity (computed at GDP divided by total employment) remained nearly unchanged, from 96.8 per cent at 2012Q3 to 96.6 per cent at 2012Q4. Figures are quarter-on-quarter, and productivity is calculated as real GDP divided by total employment. The foregoing tables and information were garnered from the OECD Economic Outlook 92 database and the British Chambers of Commerce, last modified on November 2012. Overall, the broad economy of the UK, which in large part is linked to the Eurozone, appears poised for stronger recovery as soon as confidence levels recover. 3. Industry environment In the Deloitte 2012 global forest, paper, and packaging sector outlook, forecasts for the industry are closely linked to the regional economic environment. There is increasing demand in emerging markets particularly in the Asia Pacific region. China is not foreseen to adequately meet this demand because of high raw material costs and producer fragmentation in their supply side, reducing their profitability. European demand is expected to remain flat while South America is seen to be slowing and North America demand will be modest. Aside from expanding into the Asia Pacific market, companies in this industry should concentrate on improving operational efficiency and cost containment, build strong cash reserves, and reduce debt exposure, according to the Global Forest, Paper and Packaging sector of Deloitte Touche Tohmatsu Limited (DTTL). 4. Corporate performance 5.1 Horizontal and Vertical Analyses Horizontal analysis measures the growth rate of succeeding years’ accounts against those of the base year. Vertical analysis measures the relative proportion of accounts against a reference account. For the income statement, the proportion of each account is taken against total sales or revenues, and thus is called the per cent-of-sales (or revenues) approach. For the balance sheet, the proportion of each account is taken against total assets, for which it is called the common size balance sheet approach. Appendix B shows the tables containing the financial statement accounts, their growth rate from one year to the next, and the common-sized and per cent-of-sales proportions, for Mondi and competitor company James Cropper plc. Cropper was selected because out of the five companies listed under the Forestry and Paper sector in the London Stock Exchange, Cropper was closest in scope and nature of business, although Mondi is still larger and broader in the size of its assets and geographical spread of its markets. The summary of the important accounts are provided in the tables following. Table 1 shows the growth rate and proportion analyses of the two companies for the years 2010-2011 (fiscal year ending Dec 31 for Mondi and March 31 for Cropper). Revenue growth for Mondi is slow but positive at 2.3%, while that of Cropper shows a drop of 6.1%. This indicates that Mondi has an advantage in the scope of its markets, which is not surprising. Mondi operates internationally with a focus on low-cost production in high-growth emerging markets (Mondi AR 2011), while Cropper’s operations are principally contained in Europe (Cropper AR 2012). Mondi appears to leverage its geographical scope and take advantage of emerging market resilience to Europe’s economic contagion. Mondi’s 5.7% increase in gross profit is more than a hundredfold that of Cropper’s. The discrepancy lies in the more favourable cost of sales for Mondi than for Cropper. Since Mondi is exposed to economies outside of Europe, it is able to take advantage of more favourable prices for raw materials and more efficient suppliers than Cropper. Operating profit shows strong growth for Mondi at 22% while it dropped for Mondi, indicating operating cost efficiencies Mondi is able to exploit that Cropper did not. It will be noted, however, that in the previous year, Cropper’s operating costs were proportionally lower than Mondi’s, with operating and net profit margins of 15% and 12% respectively compared to Mondi’s 8% and 4.5% respectively. Table 1: Summary of horizontal and vertical analyses of income statements Income Statement Mondi Cropper Growth Pct Sales Growth Pct Sales 2011 2010 2011-12 2010-11 Revenue 2.3% 100% 100% -6.1%. 100% 100% Gross profit* 5.7% 38.9% 37.6% .047% 54.7% 51.4% Operating profit 22.9% 9.9% 8.2% -94.8% 0.9% 15.3% Net profit after tax 42.2% 6.2% 4.5% -146.8% -6.1% 12.3% *Computed as revenues less raw materials and variable costs for Mondi, and revenues less raw materials for Cropper. Table 2 presents the same analyses for the companies’ balance sheets. Mondi’s financial assets and liabilities have dropped across the board, due to the discontinued operations of the firm as a result of its demerger with Mpact (formerly Mondi Packaging South Africa). However, the cash flow from the demerger led to reduced net debt to EUR 831 million from EUR 1,364 million at yearend 2010, reflected here as strong drops in current and particularly in non-current liabilities for Mondi (Mondi AR 2011). This also resulted in a stronger capital structure for Mondi from a year ago and cross-sectionally compared to Cropper. Mondi has 46% debt to 54% equity, while Cropper has 58% debt to 42% equity. The lower debt capitalization of Mondi puts it at a lower default risk than Cropper, particularly during a period of economic weakness in Europe. Table 2: Summary of horizontal and vertical analyses of balance sheets Balance Sheet Mondi Cropper Growth Common Size Growth Common Size 2011 2010 2011-12 2010-11 Non-current assets -15.4% 70.4% 72.3% 17.8% 40.0% 36.4% Current assets -7.0% 29.7% 27.7% 1.0% 60.0% 63.6% Total assets -13.1 % 100% 100% 7.1% 100.0% 100.0% Non-current liabilities -22.1% 23.1% 25.8% 115.0% 35.4% 17.6% Current liabilities -18.1% 23.1% 24.6% -7.5% 22.1% 25.6% Total liabilities -20.2% 46.2% 50.4% 42.5% 57.5% 43.2% Total equity -5.9% 53.8% 49.7% -19.9% 42.5% 56.8% The common size figures also suggest better asset quality for Mondi than Cropper, with non-current assets – comprised of plant, property and equipment for use in production – accounting for 70% of assets compared to Mondi’s 40%. Further ratio analyses highlighting the companies’ financial performance and condition follow. 5.2 Liquidity Table 3 following present the liquidity position of Mondi and Cropper. Liquidity represents the ability of the firm to meet its short-term obligations, thus implying the risk of default the company faces. Mondi’s current ratio is only half that of Cropper for two years running, indicating that it may have fewer current assets to pay for short-term and maturing debt. The same trend holds true for the acid-test and cash ratios. Cropper’s current liabilities were 26% and 22% of total assets in 2010 and 2011 respectively, while Mondi’s were 25% and 23% of total assets for the same years, so both companies carry roughly the same proportion of current liabilities. Cash and near cash for Mondi were 1.3% and 3% while those of Cropper were 9% and 11% of total assets for 2010 and 2011 respectively. It appears therefore that Mondi does have a greater risk of default than Cropper. It should be noted, however, that accounts receivable for Cropper was 30% and 26% of total assets for 2010 and 2011 respectively, while that of Mondi was approximately 15% of total assets two years running (see Appendix B). This goes to an assessment of the quality of current liabilities, depending on the efficiency and success rate of Cropper on collecting on receivables. Table 3: Liquidity ratios of Mondi and Cropper Ratio Formula Mondi Cropper 2011 2010 2011-12 2010-11 Liquidity           Current ratio current assets/current liabilities 1.282 1.129 2.715 2.487 Quick (acid-test) ratio (Cash + MS + AR) / Current liab 0.782 0.674 1.631 1.519 Cash ratio (Cash + MS) / Current liab 0.147 0.052 0.476 0.347 Sales to assets Sales / Total Assets 1.017 0.864 1.513 1.725 5.3 Activity Table 4 shows the activity ratios for Mondi and Cropper. Mondi was able to turn its inventory nearly twice as fast as Cropper in 2011, although Cropper slowed down the speed at which it turns over its stock in 2011 over 2010 (this is confirmed by the days in inventory, where Mondi’s is half that of Cropper). Table 4: Activity ratios for Mondi and Cropper Ratio Formula Mondi Cropper 2011 2010 2011-12 2010-11 Activity           Inventory turnover cost of goods sold / inventory 5.509 4.986 2.867 3.387 Average collection period in days accts receivable / average sales per day 52.724 64.542 61.584 63.480 Fixed asset turnover sales / net fixed assets 1.445 1.195 3.781 4.741 Total asset turnover sales / total assets 1.017 0.864 1.513 1.725 Accounts payable days Accts payable / (COGS/365) 92.680 107.831 96.089 91.453 Days in inventory Inventory / (COGS/365) 66.260 73.209 127.332 107.768 The average collection period of Mondi was also much faster than Cropper in 2011 (although they were about the same in 2010), indicating that Mondi was more efficient in converting receivables to cash, and therefore does not need to maintain a high level of cash in the bank. Extra cash may therefore be placed in marketable securities for extra income. Both the faster turnover of inventory and faster collection speeds up the cash cycle of Mondi, which is a more productive and efficient use of its working capital. Fixed asset turnover and total asset turnover is faster for Cropper than Mondi, which seems to place Mondi at a disadvantage. Taking a closer look at Mondi’s sizeable non-current assets, it is evident that most are in the form of property, plant and equipment (60% of total assets), forestry assets (5% of TA) and intangible assets (4% of TA, see Appendix B), the latter of which is comprised mainly of goodwill (Note 13, Mondi 2012 AR). This works to the enhancement of Mondi’s productive capacity. Given the present slow economy, when the recovery decisively takes off then Mondi is poised to respond to the surge in demand because it already has the capacity to do so. 5.4 Leverage Table 5 presents the leverage ratios for the companies. Financial leverage indicates the degree to which the firm is able to make use of borrowed funds, which has a lower cost of financing, to amplify earnings to equity. Leverage ratios should reflect moderate debt; debt ratios which are too low mean that the firm is poorly leveraged, while ratios that are too high indicate that the firm may be taking on too much debt risk that may lead to default. Table 5: Leverage ratios for Mondi and Cropper Ratio Formula Mondi Cropper 2011 2010 2011-12 2010-11 Leverage           Debt Ratio LTD / (LTD + equity) 0.301 0.342 0.455 0.237 Times interest earned ratio; Interest coverage earnings before interest & taxes/interest 1.128 0.410 1.810 18.96* Debt-equity ratio LTD / equity 0.430 0.519 0.834 0.311 *Net of exceptional pension credit For 2011, the debt and debt-equity ratios for Mondi are better situated than that of Cropper. It is generally more favourable for equity to have a higher proportion to total assets than debt, since in the likelihood of liquidation, equity must be sufficient to pay off creditors. It will be recalled that Mondi benefitted from a stronger cash position as a result of its demerger with Mpact, and it used this cash to draw down its leverage by paying off a substantial portion of long-term debt (Note 9, Mondi AR 2011). The reduced level of borrowings is seen as a reduction in the debt ratio and the debt to equity ratio from 2010 to 2011. 5.5 Profitability Table 6 below shows the ratios that indicate the level of profitability of Mondi’s and Cropper’s operations for the two years. Cropper has a higher gross profit margin than Mondi for the two years, although this may be due differences in the calculation of gross profit between the two. Mondi specified its gross profit figure while Cropper did not, necessitating an approximation from its deductions from revenues. There may have been elements attributable to cost of goods sold which were not included in the tally for the Cropper gross profit margin, which were included in the Mondi gross profit margin (i.e., variable selling expenses and energy cost of production). The operating profit margin shows the level of profitability of regularly recurring business (note that a non-recurring extraordinary item was excluded from Cropper for 2010). Mondi operated more profitably than Cropper for both years, and by as much as a factor of ten in 2011. The net profit margin indicates that Mondi was also more profitable than Cropper for the year 2011, although in 2010 Cropper outperformed Mondi in this aspect, mainly because of the inclusion of the exceptional pension credit, a non-recurring item, in the calculation of the net profit for the year. Return on investment and return on equity likewise show that Mondi realized greater earnings on its assets and higher gains for its shareholders than did Cropper for the year 2011, although these figures were lower than Cropper for the same reason as net profit margin. Table 6: Profitability ratios for Mondi and Cropper Ratio Formula Mondi Cropper 2011 2010 2011-12 2010-11 Profitability           Gross profit margin gross profit / sales 0.389a 0.376a 0.547b 0.514b Operating profit margin operating profit / sales 0.099 0.082 0.009 0.031c Net profit margin net profit after taxes / sales 0.070 0.051 0.011 0.102 Return on investment (ROI) net profit after taxes / total assets 0.071 0.044 0.016 0.176 Return on equity (ROE) net profit after taxes / stockholders' equity 0.132 0.088 0.038 0.310 aGross profit is provided in the annual report as revenues net of materials, energy and consummables, as well as variable selling expenses b Gross profit calculated by the author from the annual report as revenues net of materials and consummables, without provision for energy and other variable costs which may be directly attributed to cost of goods sold. Energy costs in the income statement are assumed to be the aggregate for the company including administrative and other units, in light of the lack of a breakdown in usage. COperating profit net of exceptional pension credit which is a non-recurring item. 5. Conclusion: Assessment of future company performance This study examined the performance of Mondi plc and assessed its prospects in the light of developing economic and industrial forecasts. Mondi’s exposure to emerging markets has been instrumental in maintaining the company’s positive growth while its competitor, which is limited to the European market, experiences revenues slowdown. Because of the size of its operations, Mondi has the advantage of economies of scale reflected in efficient operations and high turnover ratios, the timely divestment of its South African operations resulting in cash enhancement and debt reduction, global capability to explore fast growing emerging markets, and investment in productive capacity which could propel ahead of its competitors in a recovery. References Bank of International Settlements (BIS) BIS Economics Paper No. 17: UK trade performance across market sectors. BIS Department for Business Innovation and Skills, London. Feb 2012. Bank of International Settlements (BIS) BIS Economics Paper No. 18: Industrial Strategy: UK Sector Analysis. BIS Department for Business Innovation and Skills, London. Sept. 2012 Brigham, E.F. & Daves, P.R. Intermediate Financial Management. Mason, OH: South-Western Cengage Learning, 2012 Deloitte 2012 Global forest, paper, and packaging sector outlook. 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PR Newswire UK Disclose 02 Nov. 2012: Regional Business News. Web. 11 Feb. 2013. PR, Newswire. "MONDI PLC - Mondi launches €500 million Eurobond." PR Newswire UK Disclose 21 Sept. 2012: Regional Business News. Web. 11 Feb. 2013. Appendix A OECD Forecast of UK Economic Indicators OECD Database, last updated 23 November 2012 OECD Database, last updated 23 November 2012 OECD Database, last updated 23 November 2012 OECD Database, last updated 23 November 2012 Appendix B Horizontal and Vertical Analysis Worksheets Tables prepared by author from annual report data Note: Cropper’s fiscal year ends March 2012, thus 2012 figures report activities covering last three quarters 2011 and first quarter 2012. Read More