The Financial Analysis of Balfour Beatty Plc and AMEC Plc - Assignment Example

Introduction UK’s economy is slow moving in the face of current financial meltdown wherein larger industrial activity is depressing owing to lack ofdemand. The current financial crisis had largest impact on the construction sector of the economy which shrunk to its lowest level in last 12 years during 2009.(Monaghan,2009). Such depressing scenario therefore may not be suitable for the firms to perform to their optimum level. It is pertinent to note that one of the leading causes of the financial crisis emerged due to imprudent lending decisions of financial institutions in subprime mortgage market and as such the firms that were engaged into construction and other related activities suffered a lot due to this. Balfour Beatty Plc (Firm) is one of the leading firms in UK offering constructing and other civil engineering services. Based in London, it is 15th largest construction firm in the world with revenue of more than £8 Billion per year. AMEC Plc is one of the competitors of the firm offering civil engineering services in more than 30 countries with approximately 23000 employees. Both the firms are working in the same economy and are competing with each other in civil engineering activity. This report will therefore attempt to perform the financial analysis of both these firms to make a performance comparison. The intended aim of this report is therefore to offer an insight into how both the firms performed during 2007-2008 while identifying the aims and objectives of the firms, the governing mechanism of both the firms as well as discussing the role of both the executive as well as non-executive directors of the firms. Civil Engineering Industry in UK Before discussing the performance of both the firms, it is important that a general and comprehensive view of the industry must be undertaken so as to put financial analysis in its right context. During 2009, the commercial construction activity has declined as compared to other sub-sectors of the industry such as housing construction. However, years prior to 2009 were considered as good for the civil engineering industry as profitability and revenue of two major firms under study continued to increase. It is also important to note that the civil engineering industry is mainly divided into three broad sub-sectors i.e. housing, commercial as well as civil engineering work of large magnitude. Mostly the firms which are engaged into large scale civil engineering services often tend to perform better as compared to the firms that are specifically concentrated into just one sector. This happens mainly due to diversification of not only the activities performed by the firms but diversification into the new markets also. Diversification and market expansion therefore seems to be two of the most important strategic tools that are being used by the firms to achieve their desired profitability level. Further, firms in housing construction are mostly dependent on the external financing offered to the consumers for buying their homes and as such the reduction in the consumer finance during the current financial meltdown affected the profitability of such firms. General Overview of Performance In his Statement, Chairman of Balfour Beatty plc indicated the firm’s business model has been resilient and was able to produce consistent results due to its strong and stable base. The obvious reason was that the firm has been working on projects which are initiated with public private partnership therefore its overall customer base remained stable and non-volatile in nature. This fact however also indicate that the firm has probably restricted itself from taking the calculated risks and failed expand into new markets. Chief Executive’s Review also indicate that the firm earned most of its revenue from the regulated customers however the firm focused more on its strategy of acquisition. Most of the growth in 2008 was achieved through a combination of working with the regulated customers as well as by acquiring different businesses across the globe. This growth may be attributed to the firm’s strategy of achieving the sustainable long term growth for the shareholders and it is because of this reason that the firm deliberately adapted the strategy of working with the government agencies to generate its revenue. This however, may also limit the ability of the firm to generate more revenues because working with few buyers increases the risk specially in troubled times. It is also important to note that the firm has been able to start a new initiative for the safety and environment management. Through its zero harm initiative it has put in place the effective safety management system which attempt to minimize the safety concern in an industry where ratio of accidents is relatively high. Operating review of the firm indicate that business is essentially focused on four areas include housing, civil and specialist services, rail and engineering as well as the investment services. Most of the revenue of the firm is generated through its programme and facility management services which contribute 60% of the revenue of the firm. However, the firm’s markets are only restricted up to UK and US whereas currently firm made an entry into the German market also. The above discussion therefore indicates the firm’s strategy is focused and mainly concentrated on the development of business in few segments and customers. Most of the growth has been generated through its existing base of customers i.e. government customers in UK and US. The Chairman Statement of AMEC Plc however, indicates that the firm has been able to achieve more discipline in its performance. It has been able to divest itself from its non-core activities and focus has been further narrowed down to the management of the core activities of the firm. From management perspective, focus on the core activities of the firm often allows firms to become more discipline and commit its resources in more efficient manner. Though AMEC is more diversified as compared to the firm however, from 2006, it has completely shifted its focus and concentrated on its core activities. It is also important to mention that AMEC has been able to modify its business model and is now focused more on the service based model thus further disciplining its risk profile also. Chairman considers this move as one of the essential moves to achieve the sustainable development. Chief Executive’s Review however focuses on the nature of customers with which the AMEC is working currently. As compared to Balfour Beatty plc which is focused more on working with select base of government customers, AMEC has been able to work with firm’s like BP which are more capital intensive in nature and achieve their growth through their own unique business models. It is however, critical to note that such approach of focusing on customers like BP make the demand for AMEC’s services as derived demand. Derived demand however, can increase the risk profile because firm’s revenue depends upon how well its customers are performing. Finally, CEO’s review also discusses some implications for the safety management of its employees. AMEC’s growth is therefore driven by its cost cutting efforts as well as working in an expanded and diversified market. Performance Comparison This report will be assessing the performance of Balfour Beatty plc, and AMEC Plc for 2007 and 2008. Profitability The profitability figures indicate that the profitability of AMEC Plc is higher than the profitability of Balfour. Both the gross margin as well as net margin is higher for both the years indicating the improved performance of the competitor. It is important to note that the AMEC Plc (Competitor) is more diversified business as compared to the firm hence the differences in the profitability therefore can be attributed to relatively diversified and expanded business. It is also critical to note that the differences in profitability can also can be attributed to the manner in which firm adapts its accounting policies. Different accounting estimates such as depreciation can really affect the overall bottom line of a firm regardless of the fact that the firm has earned profit from its core activities or not. According to the notes to the financial statements of AMEC Plc, it depreciates its assets on straight line basis however the time period to depreciate land and building is 50 years whereas plant and equipments are depreciated within 3 to 5 years. Since the firm is in the business of providing civil engineering and other services therefore such high useful life of the assets will definitely add up to the profitability of the firm for the current year. Liquidity Management Liquidity management is one of the critical aspects of managing the solvency of the firm and ensuring that the firm fulfills its short term obligations. Since short term solvency provides critical insight into the ability of the firm to pay off its current liabilities therefore there are two important financial ratios that need to be discussed. Current and Acid Test Ratio The ratios indicate that the competitor is in better position to pay off its current liabilities from its own sources. Ideally a current ratio of 1:1 is considered as best to pay off £1 of current liabilities from £1 of current assets. However, the firm’s current ratio is less than in both the years indicating the overall liquidity management may not be as good as compared to the competitor. It is also critical to note that the competitor’s current liabilities are relatively low as compared to the current liabilities of the firm. A low level of current liabilities also indicate that the cash management is relatively and the competitor is able to finance its day to day operations mostly through its own internally generate cash rather than relying on the external finance. It is also because of this reason that the firm’s interest expense is almost negligible thus indicating that the competitor rely less on external financing. Management Efficiency Management efficiency is often ascertained with the help of few ratios that can indicate the manner with which management has been able to manage the assets of the firm. Asset management of the firm includes the management of the current as well as fixed assets in generating the revenue for the firm. Inventory holding period for the firm is 4 days in 2007 and 5 days in 2008 whereas for the competitor, it is 1 day in both the years. Though both the firms are mostly service oriented in nature therefore this ratio may matter most in this case whereas the ratios like receivable as well as payable turnovers are important indicators with which working capital is managed. Receivable turnover for the firm is 68 and 69 for year 2007 and 2008 whereas for the competitor, it is 77 and 94 in respective years. Clearly, the ratios of the competitors are far better than the firm as the competitor is able to manage its receivable in better manner as compared to the firm. higher inventory turnover also reflects that the firm is able to receive its funds generated through sales more rapidly therefore it also indicate the relative efficiency with which the firm is able to manage its resources. Similarly, the payable in days for the firm is 129 days for both the years whereas for competitors it is 75 and 116 days. It is critical to mention that high payable in days also indicate the firm’s ability to use the spontaneous financing therefore higher payable in days reflects the manner in which firm often is able to utilize the indirect funding provided by its suppliers. The above discussion indicates therefore that the competitor’s working capital management and overall asset management is better as compared to the firm. Debt Management Debt management is another important aspect of measuring the performance of any firm as this analysis clearly indicates as to how the firm has been able to finance its assets. Higher debt ratios though may provide leverage impact on the price to earnings of a firm however, at the same time; it also increases the overall risk profile of a firm. It is therefore always considered more prudent that a balanced debt to equity ratio is maintained so that the firm is able to keep its risk profile within a manageable range. Firm’s gearing is 61% and 51% respectively in both the years however, competitor’s gearing ratio is 0 reflecting that all the assets of the firm are managed through internal cash generation. There is a widespread difference between the gearing of two firms and clearly the competitor has been able to manage its debt in more appropriate manner. High gearing ratio in difficult times may become more problematic for the firms as financial institutions toughen their lending criteria and access to credit becomes more difficult. in current economic scenario when revenues are decreasing for almost every firm high gearing ratio means more cash outflow for debt management therefore the free cash flows to the firm becomes less which invariably impact the performance of the firm. Internally generated funds therefore create significantly favorable impact for the firm in such times as firm’s own funds are utilized for future capital expenditure incurred to increase the capacity of the firm. Market Ratios Market ratios indicate about the firm’s acceptability by the market and how external investors tend to view and show their trust in the firm. There are different market ratios that can be considered in this regard including P/E, EPS, ROE as well as dividend cover. Firm’s P/E ratio is 14.12 and 7.63 in respective years whereas competitor’s ratio is 2.20 and 1.27 per share. Similarly, earnings per share are 0.35 and 0.43 for 2007 and 2008 whereas for competitor it is 0.36 and 0.62. Market ratios however, can be easily distorted due to some manipulation with the accounting methods and policies. The Earnings per share can easily be distorted if different methods for depreciation accounting are adopted whereas P/E ratio can also be misleading in the face of high gearing ratio. Firm has high gearing ratio whereas the competitor’s gearing is zero thus the differences between the P/E can be attributed to this fact because high leverage ratio provides interest benefit to the firm and resultantly for a firm having high gearing, P/E tend to be on higher side as compared to the firm with a low gearing. Conclusion The above discussion indicate that the firm’s performance as compared to its closest competitor i.e. AMEC Plc may not be considered as satisfactory in nature. Most of the performance indicators are lagging behind the competitor’s and as such it becomes obvious that the firm must attempt to diversify itself. The slow and sustained growth of the firm can also be attributed to its deliberate strategy of working with only the regulated customers. Thus working with a small base of customers restricts the ability of the firm to expand itself and achieve more market space. In order to grow at relatively extensive pace, it is therefore critical that the firm must diversify its activities and expand into new markets. Expansion into new markets will therefore allow the firm to develop a new niche of business to work with the non-governmental customers. This will further strengthen the firm and its ability to generate revenue will improve. References 1. Monaghan, A (2009) UK construction activity shrinks to lowest level in 12 years Telegraph, Available: http://www.telegraph.co.uk/finance/financetopics/recession/4931729/UK-construction-activity-shrinks-to-lowest-level-in-12-years.html Last accessed 2nd March, 2010 Read More