Problems Affecting The Growth Of Company Revenues - Case Study Example

Problems Affecting The Growth Of Company Revenues Executive summary Understanding the meaning of the financial statements is the underlying reason for this study. The Board is concerned that the published corporate report of the company is not effectively communicating with external users, particularly potential shareholders. There are reasons for the Board to doubt the statement as it does not really convey to the stockholders the real situation of the company. The stockholders and users of data will not easily understand the report as there are issues not properly explained, and would seem that there are cover ups for errors and omissions. The use of ratio analysis in the study will help explain to stakeholders the underlying information of the figures in the statement and analyze the variants obtained in the information. Analysis of Arriva PLC company Case Report Part 1. Financial information Introduction Information in the financial statements is crucial for decisions of stockholder. Information may be inadvertently omitted or just not properly categorized. To help investors understand the information, a ratio analysis is done so that the strength and weaknesses of the company as well as its historical and current financial performances are determined. The ratio analysis will help to explain to investors of Arriva Plc the financial health of the company, the operating efficiency of the firm, and whether the company has used the firm’s assets correctly to increase the investor’s wealth, and whether management has ensured a fair return of investment to stockholders and if the company had used the assets optimally. It has to be compared with competition to find out company’s position in the industry. If the result shows any variance negatively, immediate actions may be brought to the attention of the management for proper corrections In compliance with the request of the Board, a ratio analysis is done to find out if the statements correctly convey information to stakeholders. The first part shows financial analysis of company performance for 2007 and 2008 Last part shows highlights of the Chairman’s statement and the business review that explains details of the operations not mentioned in the statement. The company Arriva Plc is a transport company operating in Europe. It provides a range of transport services including buses, trains, commuter coaches and water buses, in various 12 European countries, namely, Czech Republic, Denmark, Germany, Hungary, Italy, the Netherlands, Poland, Portugal, Slovakia, Spain, Sweden and the UK. The company has classified its business operations through four reportable segments, namely, as UK Trains, Mainland Europe, Central and UK Bus. It derives major part of revenues in the form of non-passenger services like government contracts. The company is headquartered at Sunderland, the UK. In 2009, Cross Country, the train operator and a part of the Arriva group, has launched m-ticket service. This service enables customers to order on-line and get tickets over mobiles. The top rivals of Arriva Plc in the transport industry are First Group Plc, National Express Group Plc, and Stagecoach Group Plc. (Hoovers) These companies, including Arriva Plc. are classified under the services sector and in the consumer services industry. Together, the group operates in the deregulated transport industry in UK and carries million passengers daily. Investors are particularly interested in the growth of revenues and their earnings in the company. They would like to find out how the company is compared with competitors. Growth performances are key issues for investment decisions. In the following tables and paragraphs, key performances are presented. Table 1. Profitability Ratios % 2008 2007 Operating margin 5.6472 6.838 Net operating margin 4.93 5.78 Sales growth 0.5205678 N/A Net income growth 0.20 0.26 The strength of the company is its high sales growth in 2008 which is a 52% increase. However, weakness is seen from the data that this growth did not match the net profit margin of sales in 2007, as same is lower. Operating margin is lower in 2008 than in 2007.while net income growth went down by 6% in 2008. What drives this operating margin to go down is a point to consider by stakeholders. Table 2. Financial Strength 2008 2007 Quick ratio 0.56 0.66 Current ratio 0.62 0.72 Debt/equity ratio 3.1487051 1.939918256 The weakness of the company, as seen from historical performance is the low liquidity ratios in 2008 than in 2007. The debt equity ratio has gone up in 2008, meaning the company used more debts as a means of financing its asset capitalization. This is quite risky in operations because company pays more interests on loans. Interest rates on loans are subject to changes that drive down the profit of the company. Long term loans have been obtained to support the franchise cost of railway system. The current ratio and quick ratios are measures to gauge profitability of the company. The higher the ratio provided in the operation, the better for the company and a ratio of 1 or higher means company has no liquidity problem. Both current and quick ratio of Arrive plc are less than 1 meaning company is facing problem in paying short term debts. Table 3. Management effectiveness (%) 2008 2007 Sector Return on equity 3.14% 1.93% 0.46 Return on assets 3.73% 4.17% 0.23 Return on investment 15.48% 12.26 0.28 Return on capital employed 20% 15.70% N/A The company has increased the wealth of investors by a higher margin of returns in 2008 than in 2007. Relative to competition, the positive variance arrived from ROE, ROA and ROE, company has obtained a comfortable margin, meaning the company had used company resources efficiently and optimally and has shown its strength in this area of operations The ROE is a measure of the net income that a firm is able to earn as a percent of stockholders' investment and is considered as the best measure of performance by a firm’s management. (Financial Dictionary Arriva performed better when compared with industry and sector when investment returns are considered. This also goes to show that the industry is capital intensive and small players cannot compete unless it is done in a specialized way. Table 4. Management efficiency Arriva Industry Sector S&P Receivables turnover 7.79 0.10 1.69 7.42 Inventory turnover 0.23 2.86 5.79 Asset turnover 1.16 0.00 0.25 0.49 Revenue/Employee (TTM) 78,481 1,703 39,410,944 512,200 Net Income/Employee (TTM) 2,598 112 2,105,872 34,461 The present number of employees of Arriva Plc is 40,487, and the ratio explains that the employees are more efficient in generating revenues to the company than its competitors It also collects its receivables faster than the industry and sector. The industry is labor-intensive: average annual revenue per worker ranges from $30,000 to $60,000, depending on the sector 14% from which they operate Ariva Share Chart December 2008 to December 2009 http://www.advfn.com/lse/SharePrice.asp?shareprice=AV. The price per share of Arriva Plc is 384.00p which is second highest among the sector. The volatility of share price movement is driven by stockholders’ confidence, economy and company performances. It has a high and low performance that dipped in March this year, and has reached a peak in November. This demonstrates the continuing confidence of stockholders to the company. Table 6. Comparison of share prices, EPS, P/E and Dividend Yield Transport company Share Price EPS P/E Div. yield First Group Plc 405.00 30.20 51.30 0.19 Arriva PLC 384.00 61.50 9.68 24.06 National Express Group 186.90 94.30 10.73 0.05 Stagecoach PLc 166.00 16.70 8.76 3.789 Share price is the amount paid by the stockholder for a number of saleable stock of the company. The share price of First Group is highest among the transport group. ... Earnings per share give the investor a quick look on the company’s profitability. It is calculated as the net income divided by the total number of outstanding shares. Price earning ratio is a measure of how much you are paying for every $1 of company’s earning and expresses how expensive a stock is The share price of First Group Pls is shown to be the highest in the sector, and yet it gives out a small yield as compared to Arriva Plc. Investors anticipates a higher yield because they paid a high price for the share. From the table above, we see how the P/E is related to the stock price. As a rule, “the higher the P/E, the more earnings growth investors are expecting and the higher premium they are willing to pay for that anticipated growth. (Investopedia). However, if we relate this P/E to their earnings for instance, First Group, share price is seen to be overvalued. This is so because First Group’s growth prospects do not justify its current price since it has negative revenues. (Investorwords, n.d.) An overvalued share price has the possibility of an expected change that may cause financial loss of the company. Arrive Plc also gave out the highest yield to investors in 2008. In 2009, reports gathered from company’s websites showed negative growth revenues for these companies. First Group Plc. had a negative -6.30% growth; National Express Group had negative -23.20% growth and Stagecoach Group Plc at 11.40% EPS, share price and price earning ratio for the four groups of transport companies are shown in chart at left and tables below. Source: From financial statements of each transport company. Available at their websites Dividend Information The dividend yield is what attracts investors to investing in the company In 2008 Arrive plc. has provided a much higher yield than its competitors in the industry, sector and S &Ps. Comparison is needed in order to know the variation of yields received by investors from different competitors. Arrive has shown its strength in this providing yield to stockholders. Part 2. Non-financial information Chairman’s Statement The report of the Chairman highlighted the growth of revenues of the company for 2008 is a continuation of its achieved success in 2007.There is an admission that the company is not insulated in upheaval in world economy but was not severely affected because of its strategic poison. The operations of the company are cash generative due to structural stability and diversity of UK Bus, UK trains and mainland Europe. The company has low exposure to fluctuations in passenger revenue. Passengers’ demand cannot be predicted but highlights that commuters benefit as well as Arriva because of market diversity and geographical location. Future revenues depend on long term viability of an order book and consumer demands. The company has strong and dependable cash flows that can support challenges of the macro economic environment. Cross Country franchise transformed UK trains division. Bus and rail franchises performed well during 2008 with satisfactory growth in passenger revenues. Demand continues to be healthy, UK bus division has grown through increased passenger numbers, increased contract mileage in London and acquisitions. The Chairman reported the company’s extensive presence in mainland Europe through acquisitions in Hungarian and Slovakian markets. Significantly developed position in greater Madrid area, reinforced positions in Italy, Germany and Portugal and have re won significant contracts and won number of smaller new ones. Looking beyond, the Chairman promised continued investment for future growth thru capital investments in the fleet to make it attractive to customers and for contracts. Company will continue to invest in training and development of employees, provide network access for the group to learn from each other. It will continue to have long term relationship building with stakeholders. Find new ways to create value for shareholders and for customers. Chairman mentioned the problem of urban congestion and sustainability of travel due economic uncertainty The report promises to address environmental issues to make best possible use of fuels and other resources, continue to innovate with alternative fuels, experimental trials and increase passenger service. Business review This part analyses the internal problem that affected the growth of revenues of the company. Some of the problems seen in the operation are those pertaining to state laws, fuel costs hike, transport price and, other factors. 1. For instance, what has been the effect of the Cross Country Franchise to the profitability of the company. Cross Country Franchise is expected to realize L600 million in revenue on its first year of operation, that is, 2008. However, losses in this deal were not confirmed as there are only about L300 million realized revenue from fares. It was seen that subsidy from the government, regulated fares are not enough to cover franchise cost of Cross Country. CC franchise was entered into in 2007 and will expire in 2017. ((Regulatory News 2007) ) This means Arriva Plc will shoulder part of its costs. 2. The cost of fares is another problem of the company as in many areas of their operations, they experienced lack of sensible pricing that do not rightly compensate for their costs of operation. Fuel and maintenance costs keep on going up but the hands of the Arriva management are tied up and could not change prices. In several instance, price fares have been problems in operations and considered not sensible by the company, meaning price fares does not measure to the cost of operations. The company cannot easily increase their fares as it is governed by service contracts. 3. Transport demand. According to studies about price elasticity of demand, Price elasticity. The elasticity of demand for buses has been found in a study to be low, as this is the means of transportation for low income commuters. [Transport economics –elasticity and transport. n.d.] This means changes in the market structure, e.g. increase in fare of the transport will not affect their demand for the rides in buses. On the other hand, rails and air fares system have been found to have high elasticity that shows when price increases, demand for air transport and rails go down because of the increase in price. Elasticity is a quantitative tool used to assess the effect of price for example, to the quantity of demand. The firms can use the price elasticity of demand estimates theory to predict effect of a change in fares to quantity demanded. Demand for transport services. The elasticity of demand study concluded that “economic growth is resulting in a proportionately greater increase in the use of these modes of transport” It is therefore fair to conclude that the growing market can support the additional investments in the transport sector. (Tutor2u) 4. Population growth. The requirements of the transport services will depend on the demographics and growth of the population. As of 2008, estimates of UK population have grown to 61.4 million. (National Statistics on line) This is a fairly a large share of market to be served by the transport group. 5. 5. 5. Unconnected challenges. The unconnected challenges had held back the operating profit 5.1These are the strikes in Germany, the unsatisfactory result of rail contracts and the high cost of fuel. There were lower contracts closed as compared to previous years and price was maintained in 2007 levels. Meaning the company was not allowed to increase its service cost. 5.2 Arriva Plc has a competitive advantage in scale as it has the ability to buy fuel in big quantities and has the capability to maintain its fleet. For instance, the company can use the futures market to hedge their fuel consumption for one year. Fuel is a vital element of transport operation and cost of oil supply is subject to rise in cost. Big companies have the means to ensure their fuel requirements against risks. Small companies can compete and be profitable by providing specialized services such as rental, leasing services and cargo handling not usually covered by big transport company. A specialized strategy of service will fill the gap of the need of customers for 5.3 Layout of Financial report In terms of layout and presentation, competitors presented a well laid out and easy to understand reports. First Group Plc is prepared with graphics and easy to follow diagrams and explanations. Website is encouraging. Stagecoach is simple but elaborates the operational and financial review that could be traced in the accounts. Directions in the website of National Express Plc are hard to follow and do not encourage visitors in the site. Arriva Plc’s website is dull and no appeal. Users of data will find information difficult to follow and understand. It has very limited use of graphical presentations for immediate recall and retention of information. For comparison of information, it is easier to find consolidated data from website analysts like Yahoo Finance and Reuters than going to each individual websites. However, there is difficulty in cross references because of currency translations of $ dollar to £. 6.Analysts recommendation. Reuters have made a “hold buying” recommendation for Arriva as of December 2009. An analyst recommendation is based on their analysis of company performances; analysts give recommendation on buy/hold positions in the stock market.. (Reuters. 21 Dec. 2009) Conclusion The strength and weaknesses have been seen in the financial performance analysis. First it showed strength in the following areas profitability – sales growth it pays higher dividends to stakeholders Competitive advantage in economies of scale that results to management efficiency and effectiveness. The weaknesses are shown in: - Low net profit margin - Liquidity in meeting short term obligations. Current ratio and quick ratio are both low. High debt/equity. - High costs of operations. i.e. fuel, maintenance and labor - Passengers’ fare and contract price ate not parallel to operating cost. - Revenues from franchise are not enough to cover the franchise - Stock market analysts recommendation to HOLD buying transactions with Arrive Plc. The 2008 data is a useless piece of information when expressed in isolation. However, when compared with something else, we can gather an excellent picture of the company’s situation and the trends that are developing. For example a ratio that has been increasing is a sign that management is implementing effective business policies and strategies and same is observed when it is on the negative. In this context, we see signs of problems brewing in Arriva, Plc.. The strength and weaknesses of the company show different signals. It has been observed that a trend establishing the weaknesses of the company is revealed by the ratios, particularly in the liquidity of the company. The company has obtained more debt obligations in 2008, and result of operations shows it has difficulty in paying short and long term obligations. The reasons for these variants are operational problems that management must control. Annex. Calculatons KEY RATIOS 2008 2007 Industry Sector 1. Sales growth 0.5205678 -3.96 -17.06 2. Net income growth 0.204625 0.264655452 5 yr. dividend growth 5.98 7.85 7.85 13.42 3. Dividend yield 24.06p 22.65p 5.98 0.03 4. Earnings per share 52.6p 43.5p -14.65 -31.81 5. Gross profit margin 0.12 9.16 6. Net profit margin 4.93 5.78 7. Debt/equity ratio 3.1487051 1.939918256 8. Quick ratio 0.5699196 0.663795499 0.35 1.42 9. Current ratio 0.6206028 0.720894693 0.51 1.76 10. Return on assets 3.73% 4.17% 0.01 0.23 11. Return on equity 16% 12% 0.05 0.46 12. Return on capital employed 20% 15.70% 13. Return on investment 15.48% 12.26 0.02 0.28 Long term debt/equity ratio 186.88 274.16 91.2 185.5 Financial Data 2008 2007 Change Competitors in m £ in m. £ Revenue 3,042.20 2,000.70 Net operating expenses 2,870.40 1,872.70 Group operating profit 171.8 128 Profit for the year 111.2 90 Dividends per ordinary share 24.06p 22.65p Basic earnings per share 52.6p 43.5p Computations 1. Sales Growth Revenue 3,042.20 2,000.70 Sales growth 0.5205678 subtract last year's sale from this year then divide the answerby last years sale Net income growth Retained earnings/total assets Retained earnings 609.7 571.1 Total assets 2,979.60 2,157.90 Net income growth 0.204625 0.264655452 3. Dividend growth Dividends per ordinary share 24.06p 22.65p 4. Price ratio Earnings per share 52.6p 43.5p 5. Gross Profit margin Gross profit divided by total revenue Gross profit 171.8 128 0.068376 Total revenue 3,042.20 1,872.70 5.6472 6.838 Net profit margin Net income after taxes divided revenue Net income after taxes 150 115.8 Revenue 3,042.20 2,000.70 Net profit margin 0.0493064 0.057879742 4.93 5.78 FINANCIAL CONDITION Debt/equity ratio Divide total debt by total equity Total debt 2,261.40 1,423.90 Total equitiy 718.2 734 3.1487051 1.939918256 Quick ratio Current aasets minus inventory divided by current liabilites Current assets 640.4 518.9 inventory 52.3 41.1 588.1 477.8 Current liabilities 1,031.90 719.8 Quick ratio 0.5699196 0.663795499 Current ratio Current asset 640.4 518.9 current liabilities 1,031.90 719.8 Current ratio 0.6206028 0.720894693 Investment Returns Return on assets Net income divided by total assets Net income 111.2 90 Total assets 2,979.60 2,157.90 0.0373204 0.041707215 3.73% 4.17% Return on equity Net Profit ÷ Average Shareholder Equity for Period = Return on Equity Net profit 111.2 90 Ave. shareholder equity 682.5 710.2 16% 12% Return on capital EBIT divided by total assets minus liabilities EBIt 150 115.8 Total assets 2,979.60 2,157.90 Total Liabilities 2,261.40 1,423.90 718.2 734 ROCE 0.2088555 0.157765668 ROI Net profit - Cost of investment divided by cost of investment Simply divide investment into the net profit. Net profit ($775)/Investment ($1,525) =.508 X 100 = 51% Investment 718.2 734 Net profit 111.2 90 0.1548315 0.122615804 ROI 15.48% 12.26 P/E = (Stock Price) / EPS Stock price 465.10p EPS 61.5p 46 7.5609756 List of References Advfn.com. Arrive Plc. Share Price. [On line] Available at http://www.advfn.com/lse/SharePrice.asp?shareprice=AV.[Accesse 18 December 2009] Arriva Co. Uk. Company Profile [On line] Available at http://www.arriva.co.uk/arriva/en/about_arriva/company_profile/overview/ [Accessed 17 December 2009] Arriva Co. Uk. Annual Report [On line}Available at http://annualreport2008.arriva.co.uk/en/management-review/chairmans-message.aspx [Accessed 18 December 2009] …… Arriva PLC: Franchise Win. Regulatory News 2007. [On line} Available at http://www.arriva.co.uk/arriva/en/investor_relations/regulatory_news/rnsitem?id=1184047280nPrrAC7E0a&t=popup [accessed 18 December 2009] Financial Dictionary. Return on equity definition. [On line} Aailable from http://financial-dictionary.thefreedictionary.com/return+on+equity [Accessed 21 December 2009] First Group Co. Earnings per share [On line} Available at http://www.firstgroup.co [Accessed 18 December 2009] Hoovers. Arriva plc. competitors. [On line} Available at http://www.hoovers.com/company/Arriva_plc/hkktif-1.html [Accessed 18 December, 2009] Investopedia. Price Earning Ratio definition [On line] Available from http://www.investopedia.com/terms/p/price-earningsratio.asp[Accessed 18 December 2009. National Express Group. Share Price. [On line} Available at http://www.nationalexpressgroup.com/nx1/investor/share_price/[Accessed 18 Decembe 2009] National Statistics on line. UK population grows to 61.4 million Population Estimates [On line} Available at http://www.statistics.gov.uk/cci/nugget.asp?ID=6[Accessed 18 December 2009] Reuters. 21 December 2009. Vodafone Analysts Recommendation [On line} Available at [http://in.reuters.com/money/quotes/recommendations?symb [Accessed 21 December 2009] Stagecoach Group Plc. Share Price. [On Line] available at http://www.stagecoachgroup [Accessed 18 December 2009. Tutor 2u.net. Transport economics –elasticity and transport[On line] Available at http://tutor2u.net/economics/content/topics/transport/transport_elasticity.htm [Accessed 18 December 2009] Read More