Financial Analysis of BAE Systems Plc - Essay Example

Financial Analysis of BAE systems Plc Table of Contents Table of Contents 2 Overview of BAE Systems Plc 3 Financial performance of BAE Plc 6 Profitability ratio 6 Liquidity ratio 9 Efficiency ratio 10 Competitor analysis 11 Whether 10% of stock is acceptable 14 Recommendation 15 Reference List 16 Overview of BAE Systems Plc BAE System Plc is the world’s leading multinational defence, aerospace and security Provider Company headquartered in London, United Kingdom (UK). It is also regarded as the largest defence contractor in the world, and has achieved second rank as the highest revenue earner in 2012 in the industry. It also delivers a wide range of services and products for land, air and naval forces; additionally, the company serves advanced security, electronics, support services and information technology. It has employed around 88,200 employees, who are selected from around the world (BAE Systems, 2014a; Forbes, 2013). The principle operations of the company are electronic system, cyber & intelligence and platforms & services (UK and US and international). The electronic systems of the company includes, electronically optical sensors, commercial and digital engine and flight controls, electronic warfare systems, persistent surveillance capabilities, next-generation military communications systems and data links and hybrid electric drive systems. Cyber & intelligence includes, US based security and intelligence business and the BAE System’s Detica business. It covers the cyber, financial security and commercial activities based in the UK. Figure 1: Operational revenue (Source: BAE Systems, 2014b) Maximum sales revenue is generated in platform & services division operating in United Kingdom. The division includes maritime, air and combat vehicle activities and many other shared activities. Figure 2: Overall result of BAE Systems Plc (Source: BAE Systems, 2014b) From the above figure, it is evident that the sales of the company have decreased over the years from 2008 to 2012. The revenue has reduced by 7% reflecting lower volume of sales in Land & Armaments business and there was no contract for Typhoon aircraft delivery during 2012 under the surveillance of Salam Typhoon program (BAE Systems, 2014b). The Earning Before Interest, Tax and Amortization (EBITA) has also reduced by 6% to approximately £1,895 million (BAE Systems, 2014b). The earnings per share (EPS) went down by 2% (which excludes the benefit of UK tax settlement in 2011). The order backlog has also increased by about 8% to £42.4 billion. The order taking in non-US and UK have increased to £11.2 billion from £4.8 billion in 2011. The total dividend paid to the investors has also increased by 4% in 2012 to about 19.5 p (BAE Systems, 2014b). According to Dick Olver, Chairman of BAE Systems Plc, “BAE Systems has delivered a robust performance in a challenging environment” (BAE Systems, 2014b). The company concentrates on the way it has conducted its business over the years and also focuses on the operational and strategic progress. The mission statement of the company is to “deliver sustainable growth in shareholder value by committing Total Performance” (BAE Systems, 2014b; Reuter, 2014). Total Performance includes customer focus, financial performance, program execution and responsible behaviour. The Chief Executive Officer (CEO), Ian King, has stated that geographic extension of the company has continued to provide resilience over time even when the markets have encountered extreme economic pressures (BAE Systems, 2014b). Financial performance of BAE Plc The financial performance of BAE Systems Plc is measured with the help of ratio analysis. However, it is observed in the previous section that the sales of the company has decreased, which have affected the associated components of finance. The liquidity, profitability and solvency position of the company can be evaluated for the two years 2011 and 2012 with the help of appropriate ratios. Ratio helps in determining the operational efficiency of the company, whether it has ability to sustain in the long run. Profitability ratio The financial statement of a company helps in determining its financial health with the help of ratios. The management of BAE was concerned about the decreasing sales revenue in 2012, which has decreased to about 7% from the previous year. However, the Earning before interest tax depreciation and amortization (EBTIDA) has reduced by 6% which indicates that the profit has increased though the sales were low. The profitability ratio of BAE is examined in order to understand the exact financial condition of the company during 2011 and 2012. This information is crucial for the shareholders of BAE systems since; they depend on this financial data for taking any investment decisions (BAE Systems, 2014b). Profitability Ratios         2012   2011   Gross margin (%) Gross profit   1547 0.093080626 1449 0.081542   Net Sales   16620 17770               Operating profit (%) Operating profit   1640 0.098676294 1580 0.088914   Net Sales   16620 17770                             PBIT Profit Before Interest & Tax   1998 0.120216606 1947 0.109567   Net Sales   16620 17770                             PBT Net Profit Before Tax   1369 0.082370638 1466 0.082499   Net Sales   16620 17770                             PAT Net Profit After Tax   1079 0.064921781 1256 0.070681   Net Sales   16620 17770                             ROCE Profit Before Interest & Tax   1998 0.296395194 1947 0.2789   Capital employed   6741 6981                             ROE Profit After Tax   1079 0.285903551 1256 0.292161   Equity   3774 4299                             Capital turnover Sales   16620 2.465509568 17770 2.545481   Capital Employed in debt and equity   6741 6981 The following deductions are crucial for understanding the profitability position of BAE. Gross Margin highlights the gross profit of BAE, which is calculated by deducting costs of sales from sales revenue. It is observed that, the gross margin in 2012 has increased with respect to 2011, which implies that, BAE has decreased its cost, though sales revenue is lower than previous year. However, the CEO of BAE has expected change in the financial data due to the defence budget in the US, which have remained constrained in response to the reducing expenses of overseas operation. Both the operating profit and profit before interest and tax in 2012 has increased compared to 2011. This trend highlights that the operational and financial cost has decreased. Profit before Tax of BAE in 2012 has increased compared to 2011, this indicates that the interest payments have lowered over the years. PBT gauges the profit of BAE that is calculated after deducting net financing cost of the business. The pre-tax earnings capability of BAE has improved over the years in 2012. However, the PAT of BAE has decreased in 2012, which indicates that tax payments have increased over the years from 2011. This ratio generally indicates the profit that is available for distribution to the shareholders through dividends or future re- investment. It can be deduced that BAE has failed to concentrate on the expenses and tax payments, as a result the PAT has decreased to a considerable level. Thus, the shareholders will not receive adequate dividend at the end of the period of their investment. ROCE of BAE is higher in 2011 than 2012 signifying that there is decrease in variance of non-current liabilities during both the accounting periods. Return on Equity gauges the return to the shareholders of the investment in BAE during a period. In 2011, the ratio was 29.21% but in 2012 the ratio dipped to 28.59%. It can be stated that, as the company focused on expanding its business and diversifying its products, which has increased the costs associated to the business. The rise in cost has affected the profit and simultaneously the ROE has decreased. The capital turnover ratio indicates the frequency of utilizing the capital during a certain period of time. The capital turnover ratio of BAE is observed to have decreased in 2012 compared to 2011. Thus, it can be highlighted that the company has reduced its frequency of utilizing the capital in expansion and investment activities. This is due to the fact that, the company has encountered trouble and disagreement regarding the contract with Saudi Arabia, over the price; hence, they were reluctant to go for any expansion during the year and utilize their capital resources (BBC, 2013). The overall outlook of the company’s operation is observed to be conservative during 2011-2012. The company had remained cautious regarding its modest growth, which underlined the earnings per share and constrained the operation in UK and US market. Despite of the decreasing revenue, it cheered its shareholders by increasing the final dividend in 2012 to 19.5p. Another main setback that affected the profitability condition of the company, relates to the 40% decrease in revenue as the contract with Saudi Arabia encountered huge difficulty. Along with that, the defence budget in the US was also cut down by an amount of $487 billion for the next few decades (BBC, 2013). Apart from the above difficulties, there were other issues too, which created big obstacle for the biggest aerospace and defence provider, BAE. In October 2012, it encountered collapse because of the cancellation of the merger worth $45-billion with EADS, the European aerospace giant. However, there was an unexpected string opposition from Germany that also created a lot of issues for the company (Yahoo! Inc., 2013). Liquidity ratio The liquidity ratio is calculated to understand the liquidity position of BAE, whether it has the ability to pay back its short term obligations out of the accumulated assets. It also gauges whether the company can maintain a healthy working capital for its daily operation (BAE Systems, 2014b). Liquidity Ratios         2012   2011   Current ratio Current asset   11316 4.247747748 9504 1.966073645   Current liability   2664 4834               Acid test ratio Current asset - Inventories   11200 4.204204204 9369 1.938146463   Current liability   2664 4834 In order to understand the liquidity position of BAE, the following deductions are necessary. The current ratio indicates whether the company has the ability to pay back its current obligations from the current assets. The current ratio of BAE identifies that it has acquired a strong liquidity position in the industry by maintaining higher value of current ratio. It signifies that, BAE has adequate asset base to pay its suppliers and make urgent payments related to the business. The acid test ratio signifies whether the company has maintained adequate short term assets for paying off its urgent liabilities without affecting the inventory. In case of BAE, there is no direct inventory as products are manufactured based on the contracts. Thus, the value of inventory is taken into account while calculating the acid test ratio, which is due for the next year. The acid test ratio of BAE is high and it indicates that the company has achieved a strong liquidity position in the industry. Efficiency ratio The efficient ratio indicates the ability of the company to convert business transactions into cash in order to run the business effectively (BAE Systems, 2014b). Efficiency ratio     2012   2011   Debtors day Trade receivables *365   3070380 184.7400722 2968180 167.033202   Net sales   16620 17770               Creditors day Trade payables *365   5053790 304.0788207 4190200 235.8019133 Cost of sales   16620 17770                             Asset Turnover Net sales   16620 1.468716861 16620 1.748369451   Total assets   11316 9506 The following deductions are crucial for understanding the efficiency of BAE during the period. Debtors day of BAE have increased in 2012 as compared to 2011, which highlights that the debtors are reluctant to make the payment on time and decrease the period. Arguably, it can be stated that the company has lost the interest on the amount that are kept with the debtors. The creditors days of BAE has also increased over the years from 2011 to 2012, it denotes that the suppliers have increased the credit period for making the payments. The overall ratio analysis of BAE states that, the company has gone through a tough situation during this period of time, due to a series of issues during the operation of their business. The company’s officials have informed that the defence market in the UK have stabilized the changes that have taken place due to the shift in priorities; these were outlined in 2010 through Strategic Defence and Security Review by the UK government (Yahoo! Inc., 2013). Thus, the company has decided to continue its business in a constrained manner. Competitor analysis The aerospace and defence industry have also become competitive with the emergence of strong companies, which have the ability to serve economy effectively and protect the population from external threat (Lockheed Martin Corporation, 2014b; Lockheed Martin Corporation, 2014c). A strongest competitor of BAE Systems is Lockheed Martin, which is an American company. It specializes in providing defence and aerospace security along with advanced technology to the clients that are present worldwide. It employs around 113,000 employees who are selected from around the world (Lockheed Martin Corporation, 2014c). They are mainly engaged in design, research, development, integration, development and sustainment of the advanced technological systems. Lockheed Martin is regarded as one of the largest defence contractors in the world, where the majority of the revenue is generated from military sales. It operates in five major segments: Information Systems & Global Solutions, Aeronautics, Missile and Fire Control, Space Systems and Mission Systems and Training. During 2009, the company topped in the list of contractors in US Federal Government (Lockheed Martin Corporation, 2014a). On November, 2000, Lockheed Martin sold Aerospace Electronic Systems to BAE systems for an amount of $ 1.67 million, a deal which was during July 2000. Additionally, the company sold one of its unit, Lockheed Martin Control Systems to BAE Systems during May, 2001 (R. Petrescu and F. Petrescu, 2013; Lockheed Martin Corporation, 2014d). The financial analysis of Lockheed Martin is executed in order to understand the financial condition of the same during 2012 and 2011 and compare it with that of BAE Systems. Ratio analysis of Lockheed Martin is depicted below (Lockheed Martin Corporation, 2014d; Squeo, 2000). Profitability Ratios         2012   2011   Gross margin (%) Gross profit   4196 0.08893222 3744 0.080517861   Net Sales   47182 46499               Operating profit (%) Operating profit   4434 0.093976516 4020 0.086453472   Net Sales   47182 46499                             PBT Net Profit Before Tax   4072 0.086304099 3631 0.078087701   Net Sales   47182 46499                             PAT Net Profit After Tax   2745 0.058178967 2655 0.057098002   Net Sales   47182 46499 Liquidity Ratios         2012   2011   Current ratio Current asset   13855 1.13986014 14094 1.161912613   Current liability   12155 12130               Acid test ratio Current asset - Inventories   12586 1.035458659 12755 1.051525144   Current liability   12155 12130 Efficiency ratio     2012   2011   Debtors day Trade receivables *365   2395495 50.77137468 2213360 47.60016344   Net sales   47182 46499               Creditors day Trade payables *365   743870 44.75752106 828185 46.60579629 Cost of sales   16620 17770                             Asset Turnover Net sales   47182 1.22052927 46499 1.226627625   Total assets   38657 37908 The following conclusions are reached after comparing the ratios of both the companies. Profitability ratio: The gross and operating margin of Lockheed Martin and BAE Systems is almost the same over the years and the changes are negligible; this is indicative of the fact that there is not scope of them to earn higher profit during the period due to the economic pressure. The profit after tax or net earnings of BAE Systems is observed to be higher than Lockheed Martin, as a result it can be stated that the shareholders of the former will be benefitted from the difference if they have to decide between the two companies. Though the profitability position of BAE system is stronger than Lockheed martin, but the latter is a tough competitor as it has shown growth over the years and extended its operation worldwide to acquire adequate market share. Liquidity ratio: The liquidity ratio of BAE Systems is stronger than that of Lockheed Martin, as the value of the ratio is high. The current and acid test ratio of Lockheed Martin is lower than 2, which states that its liquidity position is weak in the industry. This is indicative of the fact that the company encounters difficulty in paying off its current obligations. Efficiency ratio: The creditors and debtors days of Lockheed Martin are comparatively lower than that of its competitor. However, it denotes that the former does not get enough credit terms from its suppliers. The performance of efficiency ratio of Lockheed Martin is stronger than BAE systems. Whether 10% of stock is acceptable Lockheed Martin has achieved considerable profit over the years and this is good indicator that BAE Systems can decide to invest in 10% of stake of the company. In order to evaluate whether Lockheed Martin is appropriate for investing, the share price movement of the same is observed for the last four years. Figure 3: Share price movement of Lockheed Martin (Source: Author’s creation) From the above figure it is evident that the share price of Lockheed martin has increased over the years showing a sharp upward movement. This increase indicates that, the company is prosperous enough in investing 10% stake of the company. Recommendation From the above graph it can be recommended that, the stake of Lockheed Martin is acceptable for BAE Systems as the company has shown considerable growth in revenue and profit for the last few years along with the earnings per share. The dividend paid out by the company is competitive in the defence industry. Moreover, the company has succeeded in achieving national and international contracts, which have added to their goodwill and revenue. Reference List BAE Systems, 2014a. BAE Systems At A Glance. [online] Available at: < http://bae-systems-investor-relations-v2.production.investis.com/bae-systems-at-glance.aspx > [Accessed 26 October 2014]. BAE Systems, 2014b. Annual Reports 2013. [online] Available at: < http://bae-systems-investor-relations-v2.production.investis.com/ > [Accessed 26 October 2014]. BBC, 2013. BAE Systems Profits Drop As Defense Budgets Fall. [online] Available at: < http://www.bbc.com/news/business-21528977 > [Accessed 26 October 2014]. Forbes, 2013. BAE Systems Growing Steadily In Defence Services By Beating Incumbents. [online] Available at: < http://www.forbes.com/sites/lorenthompson/2013/08/12/bae-systems-growing-steadily-in-defense-services-by-beating-incumbents/ > [Accessed 26 October 2014]. Lockheed Martin Corporation, 2014a. Our Businesses. [online] Available at: < http://www.lockheedmartin.com/us/who-we-are/organization.html > [Accessed 26 October 2014]. Lockheed Martin Corporation, 2014b. Annual Report 2001. [online] Available at: < http://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=7&cad=rja&uact=8&ved=0CD0QFjAG&url=http%3A%2F%2Fwww.lockheedmartin.com%2Fcontent%2Fdam%2Flockheed%2Fdata%2Fcorporate%2Fdocuments%2F2001-Annual-Report.pdf&ei=xP1NVISTLsjr8AX00oI4&usg=AFQjCNEbw0773xA7OLSARkTXEedpXvo_AQ&bvm=bv.77880786,d.dGc > [Accessed 26 October 2014]. Lockheed Martin Corporation, 2014c. Who are We. [online] Available at: < http://www.lockheedmartin.com/us/who-we-are.html > [Accessed 26 October 2014]. Lockheed Martin Corporation, 2014d. Annual Reports. [online] Available at: < http://www.lockheedmartin.com/us/news/annual-reports.html > [Accessed 26 October 2014]. Petrescu, R. and Petrescu, F., 2013. Lockheed Martin. Norderstedt: Books on Demand. Reuter, 2014. BAE Systems Battles Lockheed For $10 Billion F-16 Upgrade Work. [online] Available at: < http://www.reuters.com/article/2014/07/14/us-airshow-britain-fighter-upgrades-idUSKBN0FJ20J20140714 > [Accessed 26 October 2014]. Squeo, A., 2000. Lockheed Martin Agrees to Sell Sanders Unit to BAE Systems. [online] Available at: < http://online.wsj.com/articles/SB963520490931725161 > [Accessed 26 October 2014]. Yahoo! Inc., 2013. BAE Systems Profits Drop On Defense Cuts. [online] Available at: < https://au.finance.yahoo.com/news/bae-systems-profits-drop-defense-011137359.html > [Accessed 26 October 2014]. Read More