Hornby Plc: Ratio and Horizontal Analysis - Case Study Example

Hornby Plc. SECTION A Introduction Financial analysis is mainly covered with the help of two analysis i.e. ratio analysis and horizontal analysis. This report aims at conducting the financial analysis of Hornby Plc. with the help of these two analysis techniques. First part of this report highlights the financial analysis whereas the last part focuses on corporate governance and the reflection on the company matters made by other financial reports and journalists. Financial Analysis Financial analysis of any company is carried out to analyze whether the company’s financial matters are consistent with its own prior period’s performance as well as with the industry averages. As mentioned above, the financial analysis can be conducted with the help of two approaches i.e. financial ratios analysis and horizontal analysis. Under this report, both these approaches have been comprehensively used so that a better picture of the company’s financial aspects can be sketched. Ratios Analysis Ratios analysis is that technique which unfolds various financial areas in relation to a certain benchmark. There are five broader areas in which the financial performance and position of Hornby Plc. has been evaluated i.e. 1) Liquidity, 2) Financial Stability, 3) Profitability, 4) Earnings, and 5) Dividends. The following analysis covers all these mentioned areas in detail. Liquidity Liquidity means the extent to which the current assets of the company can be liquidated. Two main ratios are computed for evaluating liquidity i.e. current ratio and quick ratio. Current ratio is computed by dividing the current assets with the current liabilities. This shows that in order to pay off the current liabilities of £1, how much current assets are available to the firm. The higher the ratio, the more positive prospect will be for the firm in terms of liquidity. If the last 5-years performance of the Hornby Plc. is taken into consideration regarding the liquidity, it is quite evident that the company has shown inconsistent performance. In the years 2010 and 2012, the company has double of the current assets available but in rest of the years, the company has struggled to improve this ratio. Besides current ratio, quick ratio has also been computed which eliminates inventories from current assets to show even liquid situation of the company. In the years 2010 and 2011, the company had a quick ratio of greater than 1 which is acceptable, however in the years 2009, 2012 and 2013, the company could not cope up and remained below the satisfactory level. Overall, the liquidity area has shown mixed results in last five years. Financial Stability Financial stability is mainly analyzed through capital structure and ability to pay the interest over its debts. For analyzing capital structure, debt ratio has been computed by dividing the total liabilities with the total assets to check how much percentage of capital is raised through debt and how much reflects the equity portion. The higher the debt ratio, the greater will be the level of borrowing; the risker will be the company in terms of financial stability. The existing debt ratio of the company in the year 2013 is 33% which has been the lowest in all the previous five years. This shows that in terms of financial stability, the company has worked to reduce a substantial level of risk. Times interest earned has been the ratio to check out whether the company has earned sufficient profits to cover its interest expense. The higher the ratio, the greater will be the financial stability of the company in paying the interest to the loan providers. Except the year 2013, the company had times interest earned ratio of greater than 3 in all four years. However, last year, the company suffered losses due to which this ratio turned into negative which in turn showing negative concerns to the loan providers of the company. Financial stability of the company has improved in terms of capital structure but some concerns have lifted up due to inability of the company to cover interest expense through net income in last year. Profitability Profitability is one of the key areas of financial analysis which covers various ratios. However, for the purpose of simplicity, only two ratios have been computed i.e. return on equity and net profit margin. Return on equity provides the investors (shareholders) an insight to check the percentage of profit the company has earned over their investment. This ratio is computed by dividing the net income with total equity. In all the previous four years, Hornby Plc. has earned above 7% return on the equity invested in the company. However, in the year 2013 the return on equity fell substantially to negative 6.87% due to a loss made by the company. The other ratio that has been computed in this regard in the net profit margin which shows the percentage of revenues that has been converted into the profits. Net profit margin for Hornby Plc. has remained more than 4% in all four years i.e. 2009-12. However, due to heavy losses in the recent year, net profit margin ratio slumped to -4.36%. Overall, the profitability position of Hornby Plc. has shown disappointing results especially in the year 2013. Earnings Earning is one of the integral areas of analysis especially for investors as they check how much income has been earned on per share basis. Earnings per share (EPS), has been the primary ratio that is computed to check the amount income earned per share. This ratio is computed by dividing the net income after tax with the weighted average number of shares outstanding. Hornby Plc. had earned the highest EPS in the year 2009 i.e. 11.17pence. However, EPS started to fall until 2011. In 2012, the company achieved better EPS of around 8.19pence. However, in the last year, this ratio tumbled massively and went into negative zone showing -6.9 pence. In this way, a higher streak of EPS came to its end in the last year. Dividends As far as the dividends are concerned generally, it is the amount of profit, which is distributed to the shareholders in the form of cash. Dividend distribution decision rests solely on the part of the board of directors to take given the cash position and earnings level of the company. Hornby Plc. had always paid dividends until 2013 before making significant losses. The following table shows the financial ratios in a summarized form:   2013 2012 2011 2010 2009 LIQUIDITY           Current Ratio 1.77 2.01 1.90 2.11 1.48 Quick Ratio 0.90 0.93 1.02 1.38 0.72             FINANCIAL STABILITY           Debt-to-Asset Ratio 33% 36% 42% 43% 46% Times interest earned -4.46 4.06 3.46 4.56 5.23             PROFITABILITY           Return on ordinary shareholders funds -6.87% 8.08% 7.76% 10.06% 13.35% Net Profit Margin -4.36% 4.91% 4.43% 5.72% 6.54% EARNINGS           Earnings per share -6.39 8.19 7.5 9.76 11.17             DIVIDENDS           Dividend per share 0 3.7 5 5 2.7             Horizontal Analysis Horizontal analysis takes into account the year-on-year based information. It can be observed that the overall profitability level of the company was constantly decreasing from the year 2009. In 2012, it accelerated marginally but in the last year, the profit fell down by around 179%. Sales level of the company remained steady in the last 4 years but in 2013, it went down by around 10.9%. Earnings per share also followed the same trend of decline since 2009, it increased by a 9.2% in 2012 but in very next year it recorded a decline of around 22%. If the statement of financial position of the company is analyzed, it can be noted that non-current assets of the company has constantly decreased in the past five years. Similarly, total assets of the company increased in the year 2010, after that they also suffered a consistent decline. The company always had history of paying off the dividends every year in a decent proportion as compared to the EPS, but due to sluggish financial performance of the company in 2013, it avoided paying any dividends for the first time in five years. Overall, the year-on-year based performance of Hornby Plc. could not deliver in the 2013 but the performance was a bit steady in the past four years. Sales level in the most concerned area due to which the company may have to face serious problems in the coming years if not attended properly. The following table shows the year-on-year based performance of Hornby Plc. in last four years:   2013   2012   2011   2010   2009 Net Income (2,501) -179.0% 3164 10.8% 2,855 -22.5% 3,685 -12.5% 4,212 Revenues 57,395 -10.9% 64,447 1.7% 63,372 -0.8% 63,863 3.7% 61,569 Interest Expense 561 -28.0% 779 -5.7% 826 2.1% 809 0.5% 805 Earnings per share 6.39 -22.0% 8.19 9.2% 7.5 -23.2% 9.76 -12.6% 11.17     Non-Current Assets 26,338 -5.8% 27,969 -1.9% 28,509 -1.0% 28,803 -3.7% 29,903 Current Assets 27,673 -16.5% 33,153 -5.8% 35,188 -0.8% 35,487 26.6% 28,038 Current Liabilities 15,636 -5.1% 16,480 -11.2% 18,565 10.3% 16,834 -11.0% 18,905 Total Equity 36,401 -7.1% 39,181 6.6% 36,769 0.4% 36,628 16.1% 31,554 Total Liabilities 17,610 -19.7% 21,941 -18.5% 26,928 -2.7% 27,662 4.8% 26,387 Total Assets 54,011 -11.6% 61,122 -4.0% 63,697 -0.9% 64,290 11.0% 57,941 Inventories 13,637 -23.7% 17,867 10.2% 16,213 32.1% 12,273 -14.6% 14,368 Dividend per share 0 -100.0% 3.7 -26.0% 5 0.0% 5 85.2% 2.7 SECTION B 1) Critical Reflection of Hornby Plc. in light of Journalists and other annual reports According to BFN News (2013), Hornby Plc. has perkier future despite of experiencing decline in turnover. The turnover of the company fell by the end of September yet it believes to have brighter future since it attempts to climb the initial steps in the business transformation. The report further stated that turnover of the company was reported as £22.5m declining from last year’s £23.5m. Chairman Roger Canham stated that the company’s future looks brighter as it embarks on the transformation of the progress. The chairman further stated that by doing so the financial performance and shareholders value will enhance (BFN News, 2013). Bloomberg shed light on the overall group which includes Hornby Plc. and other companies. According to Bloomberg (2010), the group is trying to emerge from a period of difficult trading despite of having a rigorous financial health. The members of the Board are satisfied with the performance of the Group that allows having renewed confidence in the company for future. The prospects for the Group have now improved significantly. The group has shown encouraging performance in the areas of product development, banking facilities, and dividend (Bloomberg, 2010). Digital look (2014) highlighted the impact of exchange rate on results of Hornby. It was reported that exchange rate loss of 0.2m would cause an overall loss of 1.2m. In a company update, Hornby stated that the plans of the group for the next financial year are well progressive and with the major obstacle of an efficient and improved supply chain, it is expected to have a steady improvement in its quality and reliability. As a result, an improved trading is expected next year. Mostly articles have highlighted the area of supply chain of the company. According to Kumar, (2011), a warning in profit is not the best way to commence the year, but it happened by Hornby. Supply shortage was one part of the cause. Interim management statement of Hornby confirmed that problems in supply chain had not re-emerged. It was expected that it will be benefited from the London 2012 fever. The company also disclosed that it was enjoying rise in year-on-year sales not only in UK but also in the rest of Europe (Kumar, 2011). The White, (2011) stated that share of Hornby has slumped 11pc after the issuance of profit warning. The company believes it would have to forego full-year expectation because of plunge in sales right before Christmas. Like other retailers, the company has also blamed snow. It seemed disappointing because the company has shown good growth in sales in UK as compared to the previous year. The main problem was to find the idea of what portions of the earnings will be missed, as it was not quantified (White, 2011). Clark, (2007) stated that Hornby reveals the results of first half. Spectators are looking for signs regarding the recovery of business after missing predictions earlier in the year 2007 because of potent pound. Since August, the decline in shares of Hornby has been seen but at the same time, minute improvement in trading is expected. Many fear that in the age of Wii and PlayStation, the interest of old-fashioned toys will be waned. Yet, the models of Hornby remain popular because of ranges such as Harry Potter and Thomas and Friends (Clark, 2007). 2) Corporate Governance The management of Hornby Plc. believes in the implementation of strong corporate governance environment across the company. The company aims at complying with the UK Corporate Governance Code. Some of the exemplary corporate governance related activities are mentioned below: Currently the company does not have any internal audit based function despite of the need for this function. The top management of the company believes that it would be a difficult task to conduct internal audit due to the size and nature of the business as well as the Hornby Plc. locations. Hornby Plc. keeps a defined distinction between the role of Chairman and Chief Executive. For this, the company has promoted the previous Chief Executive to the position of Vice Chairman. The company is continuously searching for a new Chief Executive but for the interim period, a member of the board of directors has been given the role of Chief Executive. Overall, the corporate governance compliances have been made effective and this shows the company highly believes in protecting the rights of the shareholders while taking the company to a notable position in the market. 3) Recommendation for Investment The net assets of Hornby Plc. on 31 March 2013 are reflected as 92.9p whereas the market share price of the company at the same date was around 80.75p. This difference shows that the investors are quite uncertain regarding the financial performance and position of the company even though the book values of the company are still better but due to heavy losses made in 2013, the company’s market value has been declined significantly. Even though the value of net assets per share is higher than that of the market share price, the situation is not favorable to the company at all. Such higher losses would not allow investors to show further interest in the company because net asset per share value is based upon the historical carrying value of the assets. This asset per share value does not reflect the fair value of the company. In this way, it is advised to the investors to follow a wait-and-see approach. Those investors who have the holdings of Hornby Plc. should hold this stock for a period or two to see whether any improvement comes up in the financial performance of the company. For those investors who want to build a long-term portfolio should also keep a relatively lower holding of this stock as currently the stock position as quite as certain given the poor financial performance of the company. References Berk, J. B. and DeMarzo, P. M., 2010. Corporate finance. 2nd ed. New York: Prentice Hall. BFN News, 2013. Hornby sees brighter future despite fall in turnover. [online] Available at: http://www.investegate.co.uk/News/hornby-sees-brighter-future-despite-fall-in-turnover/469781/ [Accessed 27 April 2014] Bierman, H., 2003. The capital structure decision. New York: Springer. Bloomberg, 2010. Hornby PLC HRN Final Results. [online] Available at: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aGUXVHVtborc [Accessed 27 April 2014] Brigham, E. F. and Ehrhardt, M. C., 2008. Financial management: theory and practice. 12th ed. New York: Cengage Learning. Clark, Mickey., 2007. Market report: Thursday close. This is Money. [online] 8 November. Available at: http://www.thisismoney.co.uk/money/investing/article-1615787/Market-report-Thursday-close.html [Accessed 27 April 2014] Digital Look, 2014. Exchange rate loss derails Hornby results. [online] Available at: http://www.digitallook.com/cgi-bin/dlmedia/security.cgi?csi=12265&action=news&sub_action=sharecast&story_id=21593815&rns=&username=&ac= [Accessed 27 April 2014] Eckbo, Bjørn Espen., 2008. Handbook of corporate finance: empirical corporate finance. Oxford: Elsevier. Jaffe, J. and Ross, R. W., 2004. Corporate Finance. New Delhi: Tata McGraw-Hill Education. Khan, M. Y., 2004. Financial Management: Text, Problems and Cases. 2nd ed. New Delhi: Tata McGraw-Hill Education. Kumar, Nikhil, 2011. Investment Column: Its all about health and safety at Intertek. The Independent, [online] 2 August. Available at: [Accessed 27 April 2014] Madura, J. 1999., International Financial Management, 6th ed. Stamford: International Thomson. Shaprio, A 2008., Multinational Financial Management, 8th ed. New Jersey: Wiley & Sons Sheeba, K., 2011. Financial Management. Mumbai: Pearson Education India. Shim, J. K. and Siegel, J. G., 2008. Financial Management. 3rd ed. Oxford: Barrons Educational Series. White, Gary., 2011. Questor share tip: Dont board Hornby just now. The Telegraph. [online] 25 January. Available at: http://www.telegraph.co.uk/finance/markets/questor/8280775/Questor-share-tip-Dont-board-Hornby-just-now.html [Accessed 27 April 2014] Read More