Public and Private Finance of Liberty International Plc - Case Study Example

Public and Private Finance Introduction A financial analysis has been carried out in this report for Liberty International Plc on its performance ofthree years from 2005 to 2007. The financial assessment is based on ratio analysis on information available from the companies financial statements published in respective annual reports. A comparative analysis has also been conducted of its competitor Hammerson Plc. The matter covered under analysis relate to profitability, liquidity, efficiency, gearing of capital structure, and market ratios. Contents Introduction Contents General description of business of Liberty International and its industry Profitability Liquidity Efficiency Gearing of Capital Structure Market Ratios Conclusion Appendix A Appendix B References General Description of Business of Liberty International and its industry Liberty International Plc is FTSE 100UK based listed company. January 2007 onwards the company is known as Real Estate Investment Trust (REIT). The main business of Liberty International Plc is to own, develop, and manage the shopping centers, and other commercial and retail properties. Liberty International Plc’s main income is rental income from properties owned by it. The industry to which Liberty International belongs is real estate industry which is in complete doldrums these days. The industry is facing sever economic crises due to huge decline in value of real estate properties. The effects of the crises are damaging financial structure and business of Liberty International Plc in unprecedented huge way. As per RTT News (2/26/2009)1 the company has announced its preliminary results for the year ending 31st December 2008. It has declared huge losses. “The loss for the year attributable to equity shareholders was £2.45 billion or 651.1 pence per share, compared to a loss of £105 million or 26.6 pence per share last year.” The declared losses since 2007 are basically the results of losses on valuation of assets. The company has to adopt fair market valuation on reporting dates on applicability of International Financial Reporting Standards (IFRSs). Profitability Profitability of Liberty is assessed using Gross Profit Margins, Net Profit Margins, and Return on Capital employed ratios. Gross profit margin ratio is the ‘percentage of sales left after subtracting the cost of goods sold from sales. It indicates the percentage of sales availability to operating expenses.’(Donald D Taylor and Jeanne Smalling Archer, page 171)2 As Liberty International Plc is neither a manufacturing company, nor it is a trading company, its gross margins are taken as its net rental income, i.e., rental income reduced by its rental expenses. Gross margin in 2005, 2006, and 2007 were 65.14%, 60.51%, and 69.01% respectively. The decrease in gross margins during 2006 was caused by increase in rental expenses of 28.05% of rental income in 2005 to 30.92% of rental income in 2006. However in 2007 the gross margin increased up to 65.14% mainly because of increase in rental income by 10.87% when compared with 2006. Increase in rental expenses was marginal to the tune of 0.61% of rental income. Gross margins of the competitor Hammerson Plc in 2005, 2006, and 2007 were 71.78%, 72.35%, and 75.28% respectively. The gross margins are increasing year after year; and thus considered progressive and efficient as compared to Liberty International Plc. Net profit margin is normally treated profit after interest and taxes. It ‘measures the percentage of each sales dollar remaining after al costs and expenses, including interest and taxes, and preferred stock dividends, have been deducted.’(Lawrence J Gitman, page 67)3 Bur here the net profits are considered as profits before interest and taxes (EBIT). That is operational profits are considered as net profits. The only difference between gross margins and net margins in case of Liberty International is the ‘other income’ representing gains on revaluation of investments and development property. This has made the net profit margin look like some thing extra ordinary than the net margins normally expected in a corporation. Because of huge ‘other income’ the net margins of liberty have even crossed the total revenue. The net margins for 2005, 2006, and 2007 are unbelievably 195.85%, 164.83%, and 9.05%. Such figures are the results of the application of International Financial Reporting Standards (IFRSs). According to IFRSs a corporation has to evaluate its assets at fair market value as on the reporting date. Gains of such valuations are included in other income and that resulted into unbelievable net profit margins. This rule of fair valuation of assets affected other way the net profit margins of 2007. That is why it t is not surprising when net margins decreased from 164.83% in 2006 to very poor 9.05%. It is not the performance of the company that is being reflected in the net margins, but the effect of rise and down fall of market value of real estates as at the reporting dates. This also is one of reasons of the present economic crises in the world. For the competitor Hammerson Plc, the results are similar. Its net margins in 2005, 2006, and 2007 are 315.6%, 341.2%, and then lowering down to 83.37% respectively. The effect here is also because of application of fair market value of assets at reporting dates because of adoption of IFRSs. Return on capital employed is ‘a very common measure of profitability both for external assessment of companies’ performance and for internal assessment of the efficiency of the management. It measures the return on total capital employed of the business regardless of how it is financed.’(Michael Broadbent and John Cullen, page 57)4 Liberty has return on capital employed in 2005, 2006, and 2007 of 11.67%, 10.60%, and 0.57% respectively. The lower return on capital employed in 2007 is because of lower net margins in 2007 as discussed above. However, Liberty International Plc has not exploited its total assets as effectively as its competitor Hammerson has. Hammerson Plc’s return on capital employed for 2005, 2006, and 2007 are 12.88%, 13.45%, and 3.40%; and these performances are better than Liberty International Plc. Liquidity Liquidity reflects the working capital management efficiency of the company. In fact it is a test of the short term solvency of the company. A solvent company is able to meet its short term obligations as and when those become due. Liquidity of firm is tested through the firm’s current and quick ratios. ‘Current ratio, one of the most commonly cited financial ratios, measures firm’s ability to meet its short term obligations. Generally the higher the current ratio, the more liquid the firm is considered to be.’(Lawrence J Gitman, page 58)5 Generally the standard current ratio of 2:1 is considered best for a firm, but this standard changes from industry to industry. Liberty has current ratio of 0.69, 1.30, and 0.77 respectively in 2005, 2006, and 2007. These ratios reflect the poor status of liquidity in all the three years. Though there were slight improvements in 2006, but those were again dashed away in 2007. The current ratios of Hammerson for 2005, 2006, and 2007 are respectively 0.20, 0.35, and 0.67. The Hammerson is badly trapped in liquidity crisis than even the Liberty International Plc. “The quick (acid test) ratio is similar to current ratio except that it excludes inventory, which is generally the least liquid current asset. A quick ratio of 1:1 is recommended or greater is occasionally recommended, but as with the current ratio, what value is acceptable depends largely on the industry.” (Lawrence J Gitman, page 59)6. Quick ratio does not consider those assets that are not quickly convertible into cash for its calculations. Inventory is considered to be such asset. That is the only difference between quick ratio and current ratio. Quick ratio of 1:1 is considered business worthy. Liberty has mixed quick ratios of 0.68, 1.18, and 0.36 in 2005, 2006, and 2007 respectively. Liberty has an improved ratio of 1.18 in 2006; but the company again is in liquidity crunch in 2007. The company would have certainly faced problems in meeting its short term obligations. The situation of Hammerson is worst. Its quick ratios for 2005, 2006, and 2007 is similar as current ratio, as current assets of Hammerson do not include inventory or other such assets that are not quickly convertible into cash. Both companies are facing serious liquidity problems. These companies will have to find ways to improve their short term solvency status, if they have to stay in the business. Clearly both companies are not managing their working capital as effectively as required. Efficiency Efficiency in general management of the company can be evaluated through the use of Stock Turnover ratio, Assets Turnover ratio, Trade receivable turnover, Creditors turnover, and interest cover ratio. Out of these ratios stock turnover ratio and creditors’ turnover ratio are not applicable in a real estate business. Taking into account the calculations of other above mentioned ratios in the appendix, the efficiency of Liberty International Plc is analyzed as under: Trade Receivable turnover expresses ‘the speed with which a company can obtain the payment from customers for outstanding receivable balances.’(Steven M Bragg, page 69)7 Delay in collection from customers is considered inefficiency. Liberty has not been efficient in this regard as its collection period has increased from 66 days in 2005 to 74 days in 2006, and then to 99 days in 2007. Hammerson has improved upon its delayed period of 212 days in 2005 to 195 days in 2006, and 179 days in 2007. Assets Turnover ratio is ‘the test of how well a business is using its assets overall.’(John A Tracy, page 59)8 Liberty’s total asset turnover ratio in 2005, 2006, and 2007 is 0.15 times, 0.12 time, and 0.12 times. The decrease in asset turnover ratio in 2006 as compared to 2005 can be termed as inefficiency of the company. But the company managed the same asset turnover ratio in 2007 despite start of economic down fall all around; and this is commendable achievement for the company. The competitor Hammerson is poorly placed when compared to Liberty with its assets turnover at 0.041 times, 0.04 times, and 0.04 times for 2005, 2006, and 2007 respectively. Interest Cover Ratio measures the ability of the firm to meet its fixed interest liabilities; and profits before interest and taxes are considered to evaluate this ability or capacity of the firm. Liberty International had this capacity of 4.95 times the interest in 2005, 4.88 times in 2006, and in 2007 Liberty had no capacity to meet its interest liabilities. On the other hand Hammerson has maintained this capacity quite effectively at 7.70 times in 2005 and 8.04 times in 2006. In a bad period of 2007 Hammerson has also maintained a capacity of 2 times the interest, whereas Liberty did not possessed any capacity to meet interest liabilities. Gearing of Capital Structure Gearing or financial leverage indicates the use of debt capital in financing the total assets of the company. Debt ratio is used to measure the gearing in capital structure of a firm. In 2005, 2006, and in 2007, liberty had 59.76%, 45.92%, and 48.22% of total assets financed through debt capital. In 2005, the company has highly geared structure and in 2006 and 2007 the structure is low geared as debt ratio is less than 50% in 2006 and 2007.Whereas its competitor Hammerson had high geared capital structure in 2005 with debt ratio at 52.44%, and that came down to 40.17% and 40.95% in 2006 and 2007 respectively. During 2006 and 2007 Hammerson was low geared company. It may be noted that in highly geared capital structure equity holders have the advantage of trading in equity. Market Ratios: These ratios are connected with the interests of investors into the firm. The ratios considered are Earning per share, Price/ Earning ratio, Dividend Yield, and Dividend cover. Earning per share (EPS) is “the amount of reported income, on per share basis, that a firm has available to pay dividends to common shareholders or to reinvest in itself.”(David Logan Scott, page 121)9 Liberty has declared EPS of 29.0p, 462.1p, and 114.8p in 2007, 2006, and 2005 respectively. In 2005 and 2006 the EPS was huge only because of gains on valuation of assets were considered while calculating income available to shareholders. The case of Hammerson is similar to Liberty as is clear from its declared EPS of 34.9p, 357.5p, and 198.0p in 2007, 2006, and 2005 respectively. Price/ Earning (P/E) ratio is an indication of how much investors are willing to pay for per pound earning of the firm. The calculations of P/E are made by dividing market price per share by earning per share. The market price of shares of Liberty and Hammerson are not available on any of the concerned websites on internet. Accordingly it is not possible to compute P/E and make comments on that. Dividend yield is also calculated with reference to market price of shares. Accordingly it is not possible to compute it and make comment in this respect as well. Dividend cover reflects the availability of profits to meet the dividend payments to shareholders. For Liberty International there was no such cover in 2007. In 2006 the cover was 16.05 times and in 2005 the cover was 4.24 times. Comparatively Hammerson had cover of 1.49 times in 2007. In 2006 and 2005 it has dividend cover of 17.08 times and 10.71 times respectively. It is important to point out that huge available dividend covers in 2006 and 2005 are because of consideration of gains on valuation of assets while calculating earnings available to shareholders. This is because IFRS are applicable to both the firm causing assets valuation gains or losses on reporting date at fair market value. Conclusion Liberty International Plc and its competitor Hammerson Plc are sailing in the same boat. Profitability with related effects of both companies was unbelievably larger than revenue for 2005 and 2006 due to effects fair market valuation of assets on application of IFRSs. The results reversed in 2007. The companies are suffering from liquidity crunch so severely that short term solvency is at stake. Liberty did not have profits to cover dividends and even fixed interest liabilities in 2007. The situation is worsening and some hard remedial measures are required to save the company. Appendix A Ratio calculations of Liberty International Plc for the years 2005, 2006, and 2007 Appendix B Ratio calculations of Hammerson Plc for the years 2005, 2006, and 2007 Current Ratio Current Assets/ Current Liabilities 2007 2006 2005 0.20 0.35 0.67 Current ratio measures the short solvency position of entity. The current ratio of 2:1 is considered optimum for all industries. Quick Ratio (current Assets- inventory) / current liabilities 2007 2006 2005 0.20 0.35 0.67 Also called acid test ratio, it is fairly stringent measure of liquidity. It is calculated similar to current ratio except that current assets do not include inventories. Gross Profit Margin Gross Margin / Sales % 2007 2006 2005 75.28% 72.35% 71.78% Gross profit margin is that portion of revenue that is left over after meeting cost of sales to meet the other operating expenses. As the company is not a manufacturing unit, its net rental income is considered as gross profit. Net Profit Margin % Net Profit before interest and taxes /Sales 2007 2006 2005 83.37% 341.2% 315.6% Net profits considered here are EBIT and includes valuation gains as well. Return on Capital Employed EBIT/ Capital Employed % 2007 2006 2005 3.40% 13.45% 12.88% It is return on investment measuring overall effectiveness of management. Stock Turnover 365/ (Cost of Goods sold / stock) Not Applicable Stock turnover measures the activity of the inventory. This ratio is not applicable in business of real estates. Trade Receivable Turnover Trade Receivable/ (sales/365) 2007 2006 2005 179 195 212 days It is average collection period useful for evaluating credit policies Creditors turnover Trade Payable/ (Purchases/ 365) 2007 : Not suitable It is an average payment period and helpful in assessing the performance of credit period. Earning Per share Profit attributable to equity shareholders/ Average no. of shares in issue 2007 2006 2005 34.9p 357.5p 198.0p Earning per share represents the amount earned on behalf of each outstanding equity share. Price earning ratio (P/E) Market Price per share/ Earning per share This ratio cannot be calculated because of non- availability of market prices of shares of the company It evaluates the amount an investor is willing to pay for each dollar of earning. Dividend Yield Dividend per share/ Market price per share This ratio cannot be calculated because of non- availability of market prices of shares of the company It measures the amount of cash dividends per share during the most recent 12 months divided by current market price of the share. Dividend Cover Net profit attributable to equity holders/ Dividend paid to equity holders 2007 2006 2005 1.49 17.08 10.71 times It reflects the firm’s ability to meet its dividend payments from its profits Gearing Debt/ (debt + equity) % 2007 2006 2005 41.95% 40.17% 52.44% It measures how assets of the firm have been financed in proportion of debt and equity capital Assets Turnover Sales/Net Assets 2007 2006 2005 0.04 0.04 0.041 It measures the efficiency of utilization of assets to produce sales. Interest Cover ratio EBIT/ Interest Payable 2007 2006 2005 2.0 8.04 7.70 times It reflects the number of times profit before interest and taxes able to meet the interest liability References Read More