Super Cheap Auto Group Limited - Case Study Example

Table of contents Executive summary ………………………………………………….……. 2 Brief historical overview of Super Cheap Auto Group Limited ………. 2 Current business activities of Super Cheap Auto Group Limited …….... 3 Super Cheap Auto Group Limited capital structure ……………………….. 4 Super Cheap Auto Group Limited major debt and equity instruments ... 6 Super Cheap Auto Group Limited past and present dividend policy since its public listing …………………………………………………… 7 Estimating the cost of ordinary share using the Capital Asset Pricing Model (CAPM) ………………………………………………. 9 Weighted Average Cost of Capital and assumptions made ……………….. 10 References ………………………………………………………………. 12 Executive summary Super Cheap Auto Group Limited have grown and expanded steadily since inception in 1974. Successful performance for the last thirty six years is attributable to sound management, good investment decisions, quality products and customer service, adequate market as well as trade supportive policies. The company has recently developed a three year strategic plan 2009 - 2011 that will guide the company in opening more stores and acquiring more market share for its products. Super Cheap Autos performed well in 2009 and earned the company revenue of $604.2 million. Boating Camping and Fishing indicated the highest growth rate of 31% in the company as compared to Super Cheap Autos and Goldcross Bicycles. It earned the company revenue of $205.5 million. Goldcross Cycles did not perform well because it earned the company loss of $4.0 million. However, the management has taken corrective measures by tightening cost management. In addition, it has hired a promotion consultant to help develop more awareness of the bicycle sporting activities in Australia. Brief historical overview of Super Cheap Auto Group Limited Reg and Hazel founded Super Cheap Auto Group Limited in 1972 and diversified in 1978 to include Goldcross Cycles. The company grew at an impressive rate from inception to date. The company was operating seven stores in 1993 and before the end of 1994; the company had doubled its Super Cheap Auto stores to fourteen. The company acquired Marlows in 2003 and rebranded it to Super Cheap Autos. Super Cheap Auto Group Limited diversified further to Boating, Camping and Fishing in 2003. Super Cheap Company has seven stores in New Zealand. Super Cheap Auto Group Limited entered the Australian Stock Exchange in July 2004. Currently, Super Cheap Autos has over 200 stores, Goldcross Cycles has eleven stores and Boating Camping Fishing has sixty one stores. Current business activities of Super Cheap Auto Group Limited Super Cheap Auto Group Limited deals with three products. The first one is Goldcross Cycles, the second is boating, camping and fishing (BCF) and the third is Supercheap Auto products. Goldcross retails and distributes bicycles, sporting cloths and other sporting accessories in Melbourne and South East Queensland. Goldcross products include Kids bicycles, BMX, mountain, urban and road bicycles. It also provides families and individual persons with information regarding bicycles and sporting in Australia. Goldcross Cycles generated $19.1 million in 2009. The second major product of Super Cheap Auto Group Limited is Boats, Camping and Fishing (BCF). BCF deals with supply and distribution of fishing products. These products include fishing rods and reels, fishing lures and nets as well as tackle boxes. They also distribute camping tools and accessories such as tents, cooking equipments, pegs, ropes, hiking gear and clothing. Furthermore, they supply and distribute boats and boating accessories such as rod holders, fish finders and bilge pumps. The company’s sales of BCF were $205.5 million, 31% growth as compared to the sales of 2008. The company opened ten stores (10) of BCF in the year 2009. The third and final product of Super Cheap Auto Group Limited is Supercheap Auto. Supercheap Auto supply and distribute over ten thousand spare parts in Australia. It deals with motor vehicle spare parts, tools and other equipments. The products include batteries, hand and power tools, car navigation systems and stereo equipment, electrical products, oil filters and additives, seat covers, paints and other auto accessories. The total Supercheap Auto sales in 2009 were $604.2 million and recorded 8.1% growth as compared to 2008 sales. The company opened six new stores and 30 stores of Supercheap Auto were refurbished in the year 2009. The above activities earned the company $ 32.1 million in 2009. The company also invested $43 million in establishing new and refurbished all stores in the company. The company is doing well currently. Sales have been increasing steadily and the shareholders earn sustained dividends. Super Cheap Auto Group Limited capital structure According to the Super Cheap Auto Group Limited balance sheet, the company has two main types of capital. The first one is equity financing and the second is debt financing. Equity financing grew steadily from $104,600 in 2005 to $156,300 in 2009. Total growth in equity financing in the five years was $51,700. Increase came from retained profits that were ploughed back to the business and increase in the number of ordinary shares. Debt financing also increased steadily in the five years from $75,200 in 2005 to $114,700 in 2009. Total growth in debt financing in the five years was $39,700. Increase came from additional commercial bills that were borrowed to finance business expansion. Figure 1: shows the Debt, Equity and Total capital and their corresponding proportion Super Cheap Auto Group Limited capital for the period between 2005 and 2009. 2005 2006 2007 2008 2009 Net Debt in Australian $ “000” 75.2 80.9 95.1 118.9 114.7 Total equity in Australian $ “000” 104.6 112.9 124.5 135.7 156.3 Net Debt % proportion 41.82 41.74 43.31 46.68 42.32 Total equity % proportion 58.18 58.26 56.69 53.28 57.68 Source: Super Cheap Auto Group Limited (2005- 2009) Figure 2: Shows a graph indicating the trends of capital structure of Super Cheap Auto Group Limited for the 2005-2009 periods. Figure 3: Shows a graph indicating the trends of dividend pay out ratio of Super Cheap Auto Group Limited for the 2006-2009 periods. Source: Super Cheap Auto Group Limited (2005- 2009) The figure 2: shows high proportions of equity financing for the five year period as compared to debt financing. Equity ratios declined steadily from 2005 to 2008 and start improving in 2009. Debt ratios grew steadily from 2005 to 2008 and declined in 2009. The period between 2005 and 2008 showed declining equity ratios and increasing debt ratios because the Super Cheap Auto Group Limited increased debt financing as compared to equity financing. However, towards 2009, the company increased more equity financing as compared to debt financing. The period between 2008 and 2009 was hard for the company and more funds had to be borrowed from the commercial banks. After 2008, the Australian economy improved and was recovering from the global credit crunch and business operations were more efficient and effective. Consequently, the company’s performance increased. The company borrowed loans and ploughed back the profits it earned into the business. Figure 3: shows that dividend pay out ratio has been fluctuating for the four years. Super Cheap Auto Group Limited major debt and equity instruments The Company major equity instruments were ordinary shares and the major debt was commercial bills. Amount of ordinary shares increased from $135700 in 2008 to 156300 in 2009. Commercial bill and other financing reduced from $131500 in 2008 to $127700 in 2009. Increase in ordinary shares was brought about by increase in company’s profits ploughed back. This has also caused the commercial bills to reduce because the company is becoming financially stable each year and continues to use own resources to finance company’s projects. Figure 4: shows major debt and equity instruments for 2008 and 2009. 2008 2009 Ordinary shares in Australian $ “000” 135.7 156.3 Commercial bill and other financing in Australian $ “000” 131.5 127.7 Source: Super Cheap Auto Group Limited (2005- 2009) Super Cheap Auto Group Limited past and present dividend policy since its public listing. The dividend policy of Super Cheap Auto Group Limited can be explained by investigating the dividend pay out ration, earning per share and dividend yield. Dividend pay out ratio is proportion of net income paid out as dividends to shareholders as compared to the total profit earned. The company’s dividend policy has been commendable and favorable to shareholders. This is because shareholders of the company benefit from steady growth of dividends accruing to them. However, dividend pay out ratio has suffered from significant fluctuation between 2006 and 2009 financial period. The fluctuations were caused by company’s decisions to finance its projects through retained earnings. However, cost of equity is generally more as compared to cost of debt. Therefore the company should consider balancing the debt and equity financing. Figure 5: the table showing dividends, profits and dividend pay out ratios for the period between 2006 and 2009 2006 2007 2008 2009 Profits 16,510 22,332 25,800 32,135 Basic earning per share ($ cents) 15.5 21.0 24.2 30.2 Dividend pay out ratio 48.35 42.89 49.55 46.45 Source: Super Cheap Auto Group Limited (Annual reports 2007 (36); Annual reports 32 2009) Figure 6: Shows a graph indicating the trends of profits of Super Cheap Auto Group Limited for the 2006-2009 periods. Figure 7: Shows a graph indicating the trends of earning per share of Super Cheap Auto Group Limited for the 2006-2009 periods. Source: Super Cheap Auto Group Limited (2005- 2009) Figure 6: Shows steady growth of profits of Super Cheap Auto Group Limited for the 2006-2009 periods. This was brought about by company’s rapid growth and expansion due to improving business environment and efficient marketing approaches used by the company. The company has also improved its distribution system that has led to reduction of distribution expenses. Figure 7: Indicates sustained growth of earning per share of Super Cheap Auto Group Limited for 2006-2009 periods. Steady increase in company’s earning per share resulted from improved and increased profitability of Super Cheap Auto Group Limited. This is a good for the shareholders because they earn more in terms of dividends. Estimating the cost of ordinary share using the Capital Asset Pricing Model (CAPM) Besley (27) define cost of capital as long term average returns that shareholders and lenders earn for giving out their monetary resource to businesses. It is expressed as a percentage of the price of stock and reflects the opportunity cost of investments. It varies from one company to another because different companies have different risks and gearing levels. The cost of equity of Super Cheap Auto Group Limited can be computed as follows. The following information was identified. Rm = 10.02% (market rates for 2009 according to CIA February 4, 2010), Rf= 5.47% (financial times March 6, 2010) interest free and beta is assumed to be 2.5. Other assumptions include the following. The aim of the company is to maximize its economic value. Super Cheap Auto Group Limited aims at maximizing the value of the company. In addition, the environment in which the company operates is highly competitive. Highly competitive business environment is the one that they are many buyers and seller of products the company is dealing in, they is free entry and exit of competitors and the company cannot influence the market. The company is rational and risk averse. Therefore, cost of equity is computed using the formula below. Cost of equity = risk free rate of interest + (beta) (Market interest rate -risk free rate of interest-) Re= Cost of equity, Rm= Market interest rate, Rf= risk free rate of interest, ß= beta Re= Rf+ ß (Rm- Re) Re= 5.47%+2.5(10.02%-5.47%) =5.47%+ 11.375% = 16.845% The company’s cost of Equity is therefore 16.8%. Weighted Average Cost of Capital and assumptions made Weighted average Cost of Capital (WACC) is the minimum return on capital that accrues to the owners of capital or securities. WACC is used by the company to evaluate company projects or investments. Equity, bonds and debt are used to compute WACC and are assigned to respective rate of returns. Each type of capital is awarded a weight depending on its proportion to the total capital of the company. Figure 8: The table showing yearly equity and debt for 2009 Source: Super Cheap Auto Group Limited (2005 - 2009). WACC of Super Cheap Auto Group Limited can be calculated using the following formula. According to Agar (460), WACC= (Proportion of debt*rate of interest) + (Proportion of debt*cost of equity). Therefore, information from figure 8 is used to compute the company’s WACC. = (0.4232*10.02%) + (0.5768*16.84%) = 0.139595 WACC of Super Cheap Auto Group Limited is 13.96%. The company will only invest in projects that bring at least 13.96%. References Agar, Christopher. Capital investment & financing: a practical guide to financial evaluation. London: Butterworth-Heinemann, 2005. Besley, Scott and Eugene, Brigham. Essentials of Managerial Finance. 14th ed. USA: Cengage Learning, 2008. Besley, Scott. Essentials of Managerial Finance. USA: Cengage Learning, 2008. Central Intelligence Agency. The World Fact Book: Australia [USA]. 4 Feb.2010. https://www.cia.gov/library/publications/the-world-factbook/geos/as.html Financial Times. Markets data Bonds & Rates Overview Australia. 6 March 2010 http://markets.ft.com/markets/bonds.asp Peirson, G., Brown R., Easton, S., Howard, P., Pinder, S. Business Finance. 10th ed. New York: McGraw-Hill, 2009. Supper Cheap Auto Group Limited. Annual Report 2006. Australia, 2006. Supper Cheap Auto Group Limited. Annual Report 2007. Australia, 2007. Supper Cheap Auto Group Limited. Annual Report 2008. Australia, 2008. Supper Cheap Auto Group Limited. Annual Report 2009. Australia, 2009. Read More