Investment Analysis Report on Cable & Wireless Group - Research Paper Example

 Investment Analysis Report Introduction Cable & Wireless worldwide is name to reckon with in UK and in international markets in the arena of telecommunication. This write up contains a critical assessment of the performance of the company on its profitability, liquidity, solvency status, as well as on the market and other forces including an analysis of risk factors affecting the investment in stocks of the company. The objective is to suggest the investors to make an investment decision for buying its stock, or holding or selling its stocks, if already in possession. Profile of Cable & Wireless Worldwide Cable and Wireless group is a leader in telecommunication sector having an international cable network providing connectivity to 153 countries across the world. The company owns biggest fibre network in UK. Its multi service platform runs across next generation network and provide single environment for all the telecommunication requirements of a company. It is claimed by the company that it can manage the complete process of setting up of network and telecom services required for a business to succeed nationally and internationally. “The core international business changed its name to Cable & Wireless Worldwide, while its Cable and Wireless International or CWI division became a separately traded company called Cable & Wireless Communication.” (Yahoo Finance, July 26 2010)i Cable & Wireless Worldwide was demerged from Cable & Wireless Plc on 26th March 2010. The separation reflects the belief of the company that business of the company has reached a stage where a separately listed worldwide company would deliver more shareholders value by “Allowing cable & wireless communication and Cable & Wireless Worldwide to pursue their strategies independently with greater flexibility over management of resources and opportunities; Creating two separately listed companies with distinct company profiles and create market valuation; Sharpening management focus still further, helping the two businesses maximize their performance, and Providing a transparent capital structure and an efficient balance sheet for each business.” (Cable & Wireless, July 26, 2010)ii The top competitors of the group are AT&T Inc, BT Group Plc, and Deutsche Telekom AG. The company has taken a big step with demerger of Cable & Wireless Worldwide and its CEO Jim Marshiii stated in annual report for 2009-10 that “it’s not just UK where we work with large enterprise customers. Our global network has already given us market advantage in certain geographies. We believe our network is still under exploited, particularly given the rapid increase in data and the explosive demand for the bandwidth that is taking place at present.” Profitability Analysis Profitability performance plays a major role in shaping the value of a firm. The best way to analyze profitability is through the rate of growth in profits before interest & taxes, profits available to shareholders, and the returns on the capital employed. The relevant calculations for the analysis are as under: PBIT of the company shows a rising graph from 2005 till 2008 with a fluctuating rate of growth. In 2009 PBIT had a negative growth rate of -133.88%. This mainly is the result of recent recessionary forces. However, 2010 appears to be a year of recovery wherein negative growth rate of profit before interest and taxes came down from -133.88% in 2009 to -44.6% in 2010. This can be termed as huge recovery. Net profits available for shareholders also behaved in the same pattern. In 2006 growth rate was negative (-22.43%), but in 2007 the growth rate of net profits was 38.42% that slided back to -14% in 2008. However, 2009 was the year badly affected by credit crunch and the loss increased at the rate 120.2%. As stated above, 2010 is the year of recovery with a marvelous growth rate of 97.16%. The picture is similar for return on capital employed. “ROCE not only tells you how profitable a business, but also how good the management is in managing its capital. A high ROAC indicates that a larger chunk of profits can be invested back in the company for the benefit of shareholders. A high ROCE is sign of a successful growth company.”(Stock Screen, page 90)iv The good sign is that in 2010 there was growth rate of ROCE was 99/89% after meeting a great dismal performance in 2009. The year 2009 was a year wherein the value of firm came down heavily due to big losses. The only sign of relief is that these losses were caused by extraordinary items. The good news is that 2010 is a year of tremendous recovery. After going through a thud, Cable and Wireless has recovered appreciably its profitability growth rate in 2010, even though figure in aggregate is still a net loss. This recovery feature of profitability is definitely going to add to the value of the firm in coming years, and encourage the investors to make investment in Cable & Wireless Worldwide. Long Term Solvency “Long term solvency focuses on a firm’s ability to pay the interest and principal on its long term debts.” (Theodore Grossman and John Leslie Livingstone, page 24)v Ratio analysis is used to assess the long term solvency of a firm. The ratio of interest cover, also called Time Interest Earned, is used to measure the ability of the firm to pay the interest on long term debts. The ability to pay principal amount of long term debt is measured by Debt to Equity Ratio. These ratios for the last five years of Cable & Wireless Worldwide are computed hereunder for the purpose of assessing its long term solvency. The ratio of interest coverage shows that Cable & Wireless has 163.89 times capacity to pay interest on long term debts in 2009-10. This capacity was 23.86 times in 2009, 334.12 times in 2008, and 128.75 times in 2007. However in 2006 the Cable & Wireless has no capacity to pay the interest on long term debts. The company always had enough EBIT, except in the year 2006, to meet finance expenses. Interest coverage of two times is considered good for a steady and mature firm like Cable & Wireless. The company has attained not only good coverage ratio but also a great safety margin as well. Any firm invests two types of capital into its business. One is known as owned capital, i.e., investment in equity of the firm, and the other is called debt capital. Debt capital constitutes long term debts payable by the company. The debt to equity ratio “measures the proportion of total assets financed by firm’s creditors. The higher this ratio, the greater the amount of other people’s money being used to generate profits.”(Lawrence J. Gitman, Page 64)vi The Cable & Wireless had 28.63% of total capital employed in 2010 was taken as long term loans; and this debt capital was 76.97% of total capital employed in 2009, 27.73% in 2008, 35.47% in 2007, and 37.8% in 2006. Usually long term debts are secured by lien on properties. That is why long term debts are considered highly secured in comparison to equity capital. In fact equity capital is not at all secured and its security, if any, is always left to the performances of the firm over a period of time. Long term debts are such a liability that has to be paid back irrespective of the status of earnings of the company. A debt to equity ratio is computed relatively as per the nature of the business of the firm. Considering this, the Cable & Wireless is safely placed in 2010 to pay back the long term debts, as the ratio is just 28.63% of total capital employed. This ratio is considered safe so long it is less than 50% of total capital employed. Cable & Wireless has all along been taken less than 50% except in the year 2009, when it earned maximum losses. Capital Gearing or leverage of capital structure “The Debts to assets ratio indicates the percentage of assets funded by creditors, and is used to evaluate financial leverage of a company.” (Kurt Heisinger, page 642)vii Debt to assets ratio of Cable & Wireless for different years is calculated as under: When more than 50% of total assets are financed through debt capital, the company is said to be highly geared. “A highly geared company is one which has high proportion of fixed interest capital compared with equity capital. A low geared company has little fixed capital compared with ordinary shares, including reserves that form shareholders’ interest “(Allan Ashworth, page 95)viii. Equity investors must note that highly geared capital structure has the advantage of trading in equity. The interest liability on debt capital is fixed. After meeting the fixed liability of debt capital during the periods of high income, equity holders will get the advantage of higher share of earnings. The situation will get reversed during period of low earnings. This happened during 2009 in the case of Cable & Wireless. There were losses and it was period of highest capital leverage in the last five years. Even otherwise, the company always had highly geared capital structure, as the debt to asset ratio always remained more than 50%. From the point of view long term solvency, though Cable & Wireless has highly geared capital structure but the company is in a position to meet its fixed interest liabilities on long term debts and also able make the repayments of principle amounts of long term debts. Under such a scenario the company will always have a pressure on its liquidity funds as discussed herein after. Short Term Finances (short term solvency) Liquidity ratios are used to analyze a firm’s capacity to meet its short term obligations. From such ratios information can be obtained to judge the short term solvency of the firm. In fact a comparison is made between short term obligations with the short term resources to judge the liquidity to meet short term obligations. The required ratios in case of Cable & Wireless World (CWW) are calculated hereunder in order to analyze its short term solvency: Current ratio indicates the firm’s capacity to meet the current obligations. The higher the ratio, the greater is the capacity of the firm to pay its bills. Generally ratio of 2:1 is considered the best in any industry but this standard differs from industry to industry as well. CWW has a poor ratio throughout if considered from the point of view of this standard. Right from 2006 to 2010 ratio is less than 2, and in 2009 and 2010 it is even less than 1. In short, CWW has been facing liquidity crunch right from 2006 and the situation was worst in 2009 and 2010. Current ratio is considered a crude measure of liquidity because it does not consider the individual components of current assets. Quick ratio is somewhat accurate guide of liquidity. This ratio is same as current ratio except that it excludes inventories from current assets, as the inventories are the least liquid asset among current assets. The required standard for this ratio is 1:1. CWW has maintained this ratio well up to the standard from 2006 to 2008. Thereafter the ratio went down to poor 0.69 in 2009 and 0.84 in 2010 indicating that CWW could not stand well during the credit crunch period that persisted world over. Stock days or inventory turnover ratio is an indicator of the liquidity of inventory. The higher the stock turnover ratio, the more efficient is the management of stock. Sometimes a relatively high turnover is the result of low level of inventory and frequent stock outs, and that exactly is the case here with CWW. This situation is more costlier to the firm than carrying a larger investment in inventory and having a lower turnover ratio. The situation of CWW with regard to stock days is not at all satisfactory, as it is the result of too many small orders for inventory replacement. Debtors days (or average collection period) and Creditors days (or average payment period) are the indicators of the movement of liquidity. The faster collection of debtors and slow payment to creditors increase the available credit period of working capital. In CWW case the average collection period is rising. In 2006 the debtors’ days or average collection period was 105 days and that has increased to 157 days in 2009. This is not a good sign. The company is not efficient in its collections from debtors. At the same time creditors days are also rising. In 2006 creditors days were 154 and increased to 245 day in 2009. The increase in creditors’ days is more than increase in debtors’ days. This may indicate that overall credit period is rising, but at the same time it shows the inability of the firm to meet its current obligation indicating sever liquidity problems, particularly in 2009 and thereafter. Overall, the liquidity situation of CWW is not satisfactory. The current ratio is limping and creditors’ days are rising. Low stock days are not playing a major role as it seems CWW does not require higher stocks for its operations. CWW is not meeting it current liabilities timely and investors can realize its impact on the normal business. Perhaps some of long term debt capital will be required to be diverted to meet shortages of working capital in order to diffuse liquidity problems temporarily. Investors’ Ratios The above chart indicates that share price has nose dived from £ 139.6 in March 2009 to £ 55.35 in March 2010. The share price was maintaining a rising trend till 2007 and thereafter the downward trend is continuing till date, though the price at the timing of writing this analysis was £68.75. This slide in shares prices has shaken the faith of investors, which is reflected from P/E ratio calculated in the above chart. “The P/E ratio measures the amount that investors are willing to pay for each dollar of a firm’s earnings. The level of this ratio indicates the degree of confidence in the firm’s future performance.”(Lawrence J. Gitman, Page 70)ix Higher P/E ratio indicates increasing value of share being ascribed to future earnings as opposed to present earnings. That is to say likely future growth is what is being valued through P/E ratio. Despite the recessionary conditions in 2009, investors showed a great faith when the P/E ratio rose to 199.43 against a very poor EPS of 0.007P. The P/E ratio has come down to 10.25 as on 31.03.2010. The basic reason for this is demerger of Cable & Wireless World from Cable & Wireless Communications. Now two companies are separately listed on various stock exchanges and it will take some time to regain the confidence of the investors. The dividend yield for a stock relates the annual dividend to share price. Typically companies with good growth potential retain a high proportion of earnings and have a low dividend yield, whereas companies in more mature industries pay out a high portion of their earnings and high yield. The Cable and Wireless was placed in the latter category till 2009. The effects of recession forced the company to reschedule its strategy. The CWW was demerged and two companies came into existence. All this affected the dividend yield and the investors shied away temporarily from the company. Risk Analysis Decision of investment in shares of a company is connected with various risks that are associated with the performance of company. “In most basic sense, risk is the chance of financial loss. More formally, the term risk is used interchangeably with uncertainty to refer to the variability of returns associated with a given asset.”(Lawrence J. Gitman, Page 226)x From the point of investors in shares of Cable & Wireless, risk of investment is related to interest rates, liquidity risk, and market risks. The investment in such shares will be adversely affected with interest rates changes. Increase in interest rates will devalue the investment and decrease in interest rates will increase the value of investment in shares. Given the circumstances, it is not easy to liquidate the investment in shares of Cable & Wireless, as buyers will also be looking the investment from safety point of view. This is called liquidity risk of an investor. Then there are market risks that the value of investment in shares will decline because of forces that are not connected with financial market like political, social, and other economic factors. Risks of making investment can be assessed through sensitive analysis of possible return on investments on shares of Cables & Wireless. The dividend yield provides a direct platform for such sensitivity assessment. The company maintained an increasing dividend graph till 2009, and if the unusual circumstances of recession are discounted there are chances that investors will like to buy the shares of the company. Probability distribution of market prices of shares of Cables & Wireless provides another tool to assess the risk of such investment. If the probability is more than say 80% then the chances of that event are more to occur. The results with zero probability will never happen. So probability distribution of market prices of company’s shares will provide various alternatives to take a decision to buy the shares, sell the shares, or to hold the shares till price rise is favorable. Conclusion and Recommendation The track record of Cable and Wireless is a mixed bag of successes and failures. Profitability performance of the company was satisfactory till 2009 when the company came the cloud of recessionary forces. Though company has made strides in 2009-10 relatively, but in the aggregates terms the results still show losses. The company has a highly geared capital structure, but it is in a position to meet its long term liabilities. Liquidity wise the company’s position is very delicate. There is always a danger of company not meeting short term obligations. Market is not reacting specially with Cable and Wireless Group. The revision of its strategy to demerge the Cable and Wireless World has not started showing results. Risk factors are there as in any other investments. The recommendation is that fresh investment in the equity of the company should be a cautious decision. The funds should be invested over a period of time judging the performance alongside, and not in one go. Those who have already invested in to the equity of the company should undertake the policy of ‘wait and watch’. Hold the investment and sell only when it is absolute necessary. Overall the company has great potential to make a turn around. Word Count: 3220 References Read More