The Investment Value of Frater Ltd - Term Paper Example

Contents Contents 0 Introduction Financial ments Analysis Efficiency or activity ratio 2 Liquidity ratio 3 Investment ratio 4 Financial Gearing Ratios 5 Supplementary Information Required 6 For detailed analysis to identify the performance trend, the Frater Ltd should provide information on the financial statements for more than five years instead of just two years because these data do not accurately indicate the development of the company and its profitability. In addition, the following supplementary information should be provided, first, there should be information on the market development particularly information on the movements of the economies of the relevant country which in this case is the UK (Ranganatham & Madhumathi, 2006, pg. 106). Secondly, there should be information on the implications of the natural phenomena that might affect the company’s performance, for instance weather, natural disasters and wars. Further, there should be financial information from the specialist media sources highlighting the reputation of the company and its public image, public perception. The company wants to expand because of new technology, they should provide the technical‘s market demand data, and government policies (Ranganatham & Madhumathi, 2006, pg. 106). 6 Comparison other Companies 6 Broader Commercial Considerations 8 Share Valuations 9 Net Asset Value 9 Price/Earnings Ratio 9 Dividend Yield 10 Conclusion 10 References 13 Appendix 1 15 Appendix 2 17 Appendix 3 17 Introduction Frater Ltd. is a private, family owned company operating in the electronics industry. The customers of the company are primarily in the aerospace industry, both civil and military. They perceive a market opportunity to develop new circuit for flight control systems and have recently invested in a new robot technology. Acting as an acquisition advisor to the Global Plc., I am going to base my analysis on the financial statements provided so as to derive arrive at the investment value of the company. This report is basically based on ratio analysis for the two years provided in order to gauge the investment value and the profitability of the company. Financial Statements Analysis Profitability Ratios Profitability ratio indicates the ability of the company to generate or earn earnings in relation to its expenses and other incurred costs (Wahlen, 2010, pg. 307). Gross profit margin indicates the company ability to control its inventory costs. The calculated gross profit margin from the provided data is 23.11% in 2011 and 30.19% in 2012. This increase implies an increase in the company’s earnings as a result of effective management. The company therefore has a growth potential hence attractive to the investors. Operating profit margin is a measure of a company’s overall operating efficiency in covering all the expenses of the company’s ordinary business activities without considering the non-operating costs, the ability of the company to obtain profits through its operations. Frater Ltd. operating profit margin in 2011 was 5.87%, and operating profit margin for 2012 was 8.54 percent (Appendix). An increase in operating margin signifies an increase in company’s efficiency in its operations. Return on capital employed (ROCE) shows the company’s efficiency in generating profit from the capital employed. This ratio compares net operating profit to the capital employed (Wallace and Grandy, 2013). From the appendix, the company’s ROCE in 2011 and 2012 were 17.38% and 25.72 % respectively. This indicates an increase signaling investors that they will get more dollars from profit per dollar of their invested capital. Efficiency or activity ratio Fixed asset turnover is also known as fixed asset utilization is defined as the ratio of the enterprise annual net sales revenue to the total fixed assets (Damodaran, 2012, pg. 458). It is a reflection of how efficient and successful the company uses its assets in the revenue generation. A higher ratio indicates higher utilization and better management level of the fixed assets (Brigham & Daves, 2010, pg. 88).. According to financial statements, in 2012 the companys fixed asset turnover was 3.24 and 2011 it was 3.14. The increase in revenue in 2012 led to increase in fixed asset turnover hence increased efficiency is asset utilization. This will in turn attract more investors because they are assured of the company’s efficiency in using their investments (Damodaran, 2012, pg. 458). Net Asset Turnover is found by dividing sales by net assets. This ratio basically measures how a business is asset intensive and how these employed assets are efficiency. According to statements obtained in 2012 the companys net assets turnover was 3.207 and 2011 was 3.211. An increase in net assets turnover indicates that the company’s cash flow has increased. This therefore means that the company has a potential to grow in the future thereby attracting more investors because they are assured that they will get more returns in the future from their investments. Debtor collection period represents the approximate number of days, amount of time, which it takes for the company to collect trade payables or the average amount of time taken to receive payments from the receivables owed by clients and customers (Damodaran, 2012, pg. 460). The calculation as per the provided financial statements indicates an increase from 12days in 2011 to 14 days in 2012. However, the increase was insignificant implying that the efficiency in trade debts collection is still high. This means that the company is efficient and timely in collecting its customer debts indicating that it has high efficiency in managing its cash flows. Creditor’s payment period represents the average amount of time a company takes to make payments to its creditors; it shows the average period taken to settle the company’s debts owed to trade suppliers. The rise of creditor payment period is therefore good news to the company. The period increased from 29 days in 2011 to 33 days in 2012. The higher the number the better because all companies would want to conserve cash in order to maximize their cash flows (Mayes & Shank, 2012, pg. 234). From the debtor’s collection period and creditor’s payment period, it is evident that the debtor days are shorter than the creditor days hence high efficiency of the company in managing its cash flows. Liquidity ratio This kind of ratios determines the ability of the company to meet its short term debt obligations. A higher value of these ratios indicates a higher margin of safety possessed by the company to cover the short term debts (Brigham & Daves, 2010, pg. 87). Current ratio The current ratio is the ratio of enterprises current assets to current liabilities. The current ratio is an indicator of liquidity and hence reflects the companys short-term solvency (Brigham & Daves, 2010, pg. 87). The Company’s current ratio in 2011 was 1.27, which is good because it is above 1. Meaning that the company has this amount £1.27, for every dollar in its current liabilities. The ratio increased in 2012 to 1.30 meaning increased solvency and net working capital hence increasing its ability to generate cash. Acid test ratio is far more strenuous simply because it includes less liquid assets, inventories. The acid test ratio increased from 0.47 in 2011 to 0.49 in 2012. This shows that for every dollar of the Company’s current liabilities, it only has £0.47 or £0.49 of the very liquid assets to meet its most immediate obligations. This implies that the company is not able to meet its current obligations from its liquid assets however; the ability increased signifying increase in solvency (Brigham & Daves, 2010, pg. 88). Investment ratio The Investment Ratio sets forth the fundamental split between stocks and bonds that you should consider at different stages of your financial life cycle (Needles, 2010, pg. 634). Earnings per Share represent profit after tax and total equity ratio. This ratio reflects the creation of after-tax profits per share, the higher the ratio, the more the profit created. The Earnings per Share was ￡0.27 in 2011 and ￡0.32 in 2012. The increase shows that the company has created more profits from its operations. The dividend cover ratio was £3.21 in 2011 and ￡4.57 in 2012. Frater Ltd EPS and dividend cover both indicate an improvement in their values hence indicating that the company has great potential. This will in turn attract more investors (Needles, 2010, pg. 634). Financial Gearing Ratios The gearing ratio is a financial ratio that shows the capital structure of a company. The financial gearing ratio shows how much debt is used by the company compared to the funds that is provided the shareholders (Leach, 2010, pg. 126).  The companys gearing ratio in 2011 was 7.87%, 2012 dropped to 6.12 %. A reduction in gearing ratio means a reduction in interest to be paid on annual basis and low risk of bankruptcy case suit filed by creditors especially when the company is not able to repay the debts. The lower the ratio, the higher the level of protection of the interests of the creditors. This increased safety will attract more investors (Leach, 2010, pg. 126). Supplementary Information Required For detailed analysis to identify the performance trend, the Frater Ltd should provide information on the financial statements for more than five years instead of just two years because these data do not accurately indicate the development of the company and its profitability. In addition, the following supplementary information should be provided, first, there should be information on the market development particularly information on the movements of the economies of the relevant country which in this case is the UK (Ranganatham & Madhumathi, 2006, pg. 106). Secondly, there should be information on the implications of the natural phenomena that might affect the company’s performance, for instance weather, natural disasters and wars. Further, there should be financial information from the specialist media sources highlighting the reputation of the company and its public image, public perception. The company wants to expand because of new technology, they should provide the technical‘s market demand data, and government policies (Ranganatham & Madhumathi, 2006, pg. 106). Comparison other Companies E2V TECHNOLOGIES PLC engages in the design and supply of specialist components and sub-systems for the medical and science, aerospace and defense, and commercial and industrial markets. The company offers a range radio frequency power solutions，provides high performance imaging solutions and hi-rel semiconductor solutions. Mainly used for aerospace, defense and high reliability’s industry projects, it is similar with Frater. The income statements showed that the high level of Frater’s cost of sales resulted in the lowest operating profit margin. Return on capital employed (ROCE) to measure the capital utilization efficiency of enterprises. E2V Ltd.’s ROCE had a ROCE of 34.16% in 2012 and Frater Ltd had 25.72%, the reason for lower ROCE of the Frater Ltd is the large amount of operating expenses. The company has shorter turnover days as compared to its competitors, indicating better efficiency in the use of its funds implying that Frater Ltd performed well in the year 2012 (Brigham & Daves, 2010, pg. 88). The current ratio and acid test ratio are indicators of the companys short-term solvency. The current ratio generally should be more than 2:1; acid test ratio should be 1:1 or more. E2V Ltd.’s current ratio was 2.21:1 in 2012 and Frater Ltd was 1.31:1, this shows that E2V Ltd was closer to the standard level, while Frater Ltd needs to be strengthened in this regard. EPS ratio reflects the creation of after-tax profits per share, the higher ratio shows that the creation of the more profits, Frater Ltd.’s EPS was 0.27 in 2011 and 0.32 in 2012, showing a rising trend, although there are obvious gaps with E2V 0.45, but still it is promising. When contrasted to E2V Ltd, Frater Ltd did not perform that well in 2012. For example, the debtor collection period and EPS ratios are all in proper levels. Except that profitability requires more attention and some improvements in the cost of sales and current assets should be made (Brigham & Daves, 2010, pg. 88). Generally, the performance of Frater Ltd is at par to the industry in the UK particularly in terms of its liquidity, profitability, leverage and gearing and efficiency ratios. Broader Commercial Considerations With the global economy will recover, the economic outlook will continue to improve thus the European debt crisis will pass. In a period of last six years fuel costs have declined. From May 2012 to date there has been almost 25 percent decline in the international oil prices most importantly, in the air transport industry which still plays an important role in the field of personnel and cargo transportation. As more and more people have the ability to travel by plane, aviation industry customer base continues to expand. The International Air Transport Association expects the global airline passenger numbers to increase from 2.835 billion passengers to 2.966 billion passengers in this year. These figures are enough to show that the global aviation industry prospects remain optimistic about the industry, despite the current global difficulties it faces. The current situation of the aerospace industry means Frater’s main business has an outstanding future (Schniederjans, 2010, pg. 234). Robotics is a highly integrated of industrial automation technology, the world recognizes that the robot is the important force to promote the future developments. For instance, various types of robot research and development projects are underway in various countries. Industrial robots have been widely used in automobiles and auto parts manufacturing, machining industry, electrical and electronic industry, rubber and plastics industry, food industry, logistics and many other fields. Frater Ltd.’s investment will have an outstanding potential (Schniederjans, 2010, pg. 234). Share Valuations In order to calculate the companys share price, we use the Net Asset Value，Price/Earnings Ratio and Dividend Yield. Share prices are ￡3.75, ￡2.37 and ￡0.59. There answers are different because the three methods have shortcomings. Net Asset Value Net assets per share are the value of a single unit, or the value of the Funds shares. This figure refers to mutual funds buy and sells shares in the price (Correia, 2007, pg. 17-17). This method uses the historical cost accounting principle, and this tends to underestimate the value of certain assets, and the market forces of supply and demand generally push stock prices higher than book value per share valuation (Morrell, 2007, pg. 67). Valuable support behind each share, the stock price is much higher than the net asset value per share is frothy. So from this formula the calculated per share price is higher than the calculated price with other formulas (Droms & Wright, 2010, pg. 39). Price/Earnings Ratio A valuation ratio of a companys current share price compared to its per-share earnings (Damodaran, 2012, pg. 468). Denominator (earnings) which is based on accounting earnings measure is usually susceptible to manipulation of form, making the quality of the P / E good or bad for basic earnings figures. In an efficient market, stock prices should reflect the potential of the future value creation (Baker & Powell, 2005, pg. 151). Dividend Yield Dividend yield is the ratio of dividends and stock price. This measure is not the best because it is based on the amount of dividend paid by the company (GIBSON, 2009, pg. 341). Dividend paid does not indicate the performance of the company because it depends on the board of directors’ decision. For instance, they may decide to retain the profit even if the company is performing well. This means that calculated stock price using this method may be low and greatly varies because the stock prices are affected by the company’s performance and perception in the market over rally (WARREN et al, 2009, pg. 678). Further, of the total return, dividend is only one component and hence does not indicate all the information which is related to the expected return thus suboptimal (PINTO, 2010, pg. 318). Conclusion The companys financial statements reflect the financial position of the basic operating results. Through two years of Flathead financial ratio analysis, stock valuation and comparison with other listed companies in the same industry, the company can invest. The company has earnings capacity, good debt management, new products and old products also have development prospects. According to the analysis of the financial statements provided by the two year period, the acquisition should be undertaken because of the following ratios. In terms of profitability, the company’s overall performance and efficiency is increasing hence providing the basis for the company’s development and survival. There is increasing attention and concern about the corporate profitability by the investors, creditors or business executives so as to gauge the potential and future performance of the company and an increase in it provides a good basis for the acquisition to take place. In addition, the analysis outlines that the company is very efficient in its operation, for instance, it has an increasing fixed asset turnover, net asset turnover, and increase in credit payment period which indicates efficiency cash flow management. This is because it is reflection of how efficient and successful the company uses its assets in the revenue generation. A higher fixed asset turnover ratio signifies higher sales revenue generated by the assets to the company hence higher returns to the investors. Further, it implies that the company’s effectiveness in employing this investment in fixed assets in revenue generation has increased hence increase in overall efficiency and management of the company. In terms of liquidity, the company is able to meet its short term obligations as they come due. This is evidenced by an increase in the current ratio from 1.27 in 2011 to 1.30 in 2012 meaning increased solvency and net working capital hence increasing its ability to generate cash. In addition, there is an increase in the acid test ratio as well hence increase in solvency. The company also has a successful investment programs which is evidenced by an increase in EPS and dividend cover ratio. The increase in EPS shows that the company has created more profits from its operations. This type of ratios is usually used by many investment analysts in utilizing the trend in EPS so as to help assess the investment potential of a business. Frater Ltd EPS and dividend cover both indicate an improvement in their values hence indicating that the company has great potential hence a good basis for the acquisition. Finally, the company has a good capital structure hence has no risk of bankruptcy. The company has a reduction in the gearing ratio meaning a reduction in the interest to be paid on annual basis and low risk of bankruptcy case suit filed by creditors especially when the company is not able to repay the debts. This lower ratio promises higher level of protection of the interests of the creditors which the increases the safety to the investors hence a good basis for the acquisition. References PINTO, J. E. (2010). Equity asset valuation. Hoboken, N.J., Wiley. WARREN, C. S., REEVE, J. M., & DUCHAC, J. E. (2009). Accounting. Mason, OH, South-Western Cengage Learning. GIBSON, C. H. (2009). Financial reporting & analysis: using financial accounting information. Mason, OH, South-Western Cengage Learning. DAMODARAN, A. (2012). Investment valuation: tools and techniques for determining the value of any asset. Hoboken, N.J., Wiley. BAKER, H. K., & POWELL, G. E. (2005). Understanding Financial Management a Practical Guide. Oxford, Blackwell Pub. BRIGHAM, E. F., & HOUSTON, J. F. (2009). Fundamentals of financial management. Mason, OH, South-Western Cengage Learning. CORREIA, C. (2007). Financial management. Cape Town, Juta. DROMS, W. G., & WRIGHT, J. O. (2010). Finance and Accounting for Nonfinancial Managers All the Basics You Need to Know. New York, Perseus Books Group MORRELL, P. S. (2007). Airline finance. Aldershot, UK, Ashgate. MAYO, H. B. (2013). Investments an introduction. Mason, OH, South-Western, Cengage Learning. KHAN, M. Y., & JAIN, P. K. (2007). Financial management. New Delhi, Tata McGraw-Hill. BRIGHAM, E. F., & DAVES, P. R. (2010). Intermediate financial management. Cincinnati, Ohio, South-Western, Cengage Learning. PETERSON DRAKE, P., & FABOZZI, F. J. (2012). Analysis of financial statements. WAHLEN, J. M., BRADSHAW, M., BAGINSKI, S. P., & STICKNEY, C. P. (2010). Financial reporting, financial statement analysis, and valuation. Mason, Ohio, South-Western. GIBSON, C. H. (2009). Financial reporting & analysis: using financial accounting information. Mason, OH, South-Western Cengage Learning. KAPIL, S. (2011). Financial management. Noida, India, Pearson. LEACH, R. (2010). Ratios made simple a beginners guide to the key financial ratios. Petersfield, Hampshire, Harriman House. MAYES, T. R., & SHANK, T. M. (2012). Financial analysis with Microsoft Excel. Australia, South-Western, c2012. NEEDLES, B. E., POWERS, M., & CROSSON, S. V. (2010). Financial and managerial accounting. Mason, OH, South-Western Cengage Learning. RANGANATHAM, M., & MADHUMATHI, R. (2006). Investment analysis and portfolio management. Delhi, India, Pearson Education/Dorling Kindersley (India). SCHNIEDERJANS, M. J., HAMAKER, J. L., & SCHNIEDERJANS, A. M. (2010). Information technology investment: decision-making methodology. Singapore, World Scientific. Appendix 1 1. Gross profit margin= (Gross profit)/Turnover×100% 2011：（5941-4568）/5941×100%=23.11% 2012： （8756-6113/8756×100%=30.19% 2. Operating profit margin= PBIT/Turnover×100% 2011: 349/5941×100%=5.874% 2012: 349/5941×100%=5.87% 3. ROCE= PBIT/(Capital Employed)×100% 2011: 349/2008×100%=17.38% 2012: 748/2908×100%=25.72% 4. Debtor collection period= Debtors/Sales×365 2011: 191/5941×365=12 2012: 330/8756×365=14 5. Creditor payment period= Creditors/COGS×365 2011: 352/4568×365=29 2012: 550/6113×365=33 6. Net assets turnover= Turnover/(Net assets) 2011: 5941/1850=3.211 2012: 8756/2730=3.207 7. Fixed assets turnover= Turnover/( Fixed assets) 2011: 5941/1893=3.14 2012: 8756/2702=3.24 8. Current ratio= (Current assets)/(Current liabilities) 2011: 537/422:1=1.27:1 2012: 886/680:1=1.30:1 9. Acid test ratio= (Current assets-inventory)/(Current liability) 2011: 199/422:1=0.47:1 2012: 886/680:1=1.30:1 10. EPS= (Profit before ordinary dividends)/(Number of ordinary shares) 2011: 268/1000=￡0.27 2012: 484/1500=￡0.32 11. Dividend Cover= EPS/(Dividend per share) 2011: 0.27/0.08=3.21 2012: 0.32/0.07=4.57 12. Gearing= (Long term liabilities)/(Share capital + reserves + long term liabilities) 2011: 158/2008×100%=7.87% 2012: 178/2908×100%=6.12% Appendix 2 1. Net Asset Value P(0)=(Total assets-external debt)/(Number of ordinary shares) (2900+2700+886-680-178)/1,500 =￡3.75 2. Price/Earnings Ratio P(0)=EPS×appropriate PER 0.27× (8.33+8.5+9.5)/3 =￡2.37 3. Dividend Yield P(0)=(Dividend per ordinary share)/(Comparable DY) (104÷1500)/((12%+10.3%+12.7%)÷3) =￡0.59 Appendix 3 E2V TECHNOLOGIES PLC ORD 5P Income Statement  (£ m) 31-Mar-13 31-Mar-12 31-Mar-11 31-Mar-10 31-Mar-09 Continuing Operations Revenue  200.36 234.62 228.58 201.25 233.19 Operating Profit/(Loss)  35.63 35.21 30.49 -6.04 -19.54 Net Interest  1.00 1.49 2.71 4.84 7.32 Profit Before Tax  34.20 32.04 25.83 -9.72 -28.41 Profit After Tax  26.73 23.54 19.49 -2.27 -21.30 Discontinued Operations Profit After Tax  0.00 0.00 0.00 0.00 0.00 PROFIT FOR THE PERIOD  26.73 23.54 19.49 -2.27 -21.30 Attributable to: Minority Interests  0.00 0.00 0.00 0.00 0.00 Equity Holders of Parent Company  26.73 23.54 19.49 -2.27 -21.30   Continuing EPS Earnings per Share - Basic  12.53p 11.12p 9.14p -1.66p -34.42p Earnings per Share - Diluted  12.38p 10.86p 9.05p -1.66p -34.42p Earnings per Share - Adjusted  11.07p 13.37p 11.26p 6.67p 30.20p Continuing and Discontinued EPS Earnings per Share - Basic  12.53p 11.12p 9.14p -1.66p -34.42p Earnings per Share - Diluted  12.38p 10.86p 9.05p -1.66p -34.42p Earnings per Share - Adjusted  11.07p 13.37p 11.26p 6.67p 30.20p   Dividend per Share  4.10p 4.90p 0.00p 0.00p 7.95p Balance Sheet  (£ m) 31-Mar-13 31-Mar-12 31-Mar-11 31-Mar-10 31-Mar-09 Assets Non-Current Assets Property, Plant & Equipment  36.61 32.05 30.29 31.34 39.38 Intangible Assets  81.64 80.38 93.80 104.06 119.20 Investment Properties  0.00 0.00 0.00 0.00 0.00 Investments  0.00 0.00 0.00 0.00 0.00 Other Financial Assets  0.00 0.00 0.00 0.00 0.00 Other Non-Current Assets  9.14 12.69 12.10 13.36 6.73   127.39 125.11 136.19 148.75 165.31 Current Assets Inventories  43.95 43.58 47.45 35.48 42.43 Trade & Other Receivables  46.65 47.24 50.35 53.22 63.61 Cash at Bank & in Hand  11.29 8.63 12.89 27.81 6.37 Current Asset Investments  0.04 0.19 0.53 0.00 0.00 Other Current Assets  0.00 15.05 0.00 0.00 0.00   101.94 114.69 111.21 116.51 112.41   Total Assets  229.33 239.81 247.40 265.27 277.72   Liabilities Current Liabilities Borrowings  0.00 0.00 0.00 0.00 -9.75 Other Current Liabilities  -47.77 -61.26 -74.86 -74.67 -63.47   -47.77 -61.26 -74.86 -74.67 -73.22   Net Current Assets  54.17 53.44 36.35 41.84 39.19   Non-Current Liabilities Borrowings  -20.76 -38.30 -39.58 -69.47 -132.82 Provisions  -4.48 -5.34 -8.77 -14.53 -13.73 Other Non-Current Liabilities  -4.37 -3.47 -2.94 -2.97 -4.27   -29.61 -47.11 -51.29 -86.97 -150.82   Other Liabilities  n/a n/a n/a n/a n/a Total Liabilities  -77.38 -108.37 -126.15 -161.64 -224.04   Net Assets  151.95 131.44 121.25 103.63 53.68   Capital & Reserves Share Capital  10.93 10.75 10.74 10.74 3.13 Share Premium Account  42.91 41.81 41.78 41.78 41.78 Other Reserves  44.40 43.95 47.58 50.07 5.68 Retained Earnings  53.72 34.93 21.15 1.04 3.09 Shareholders Funds  151.95 131.44 121.25 103.63 53.68   Minority Interests/Other Equity  0.00 0.00 0.00 0.00 0.00 Total Equity  151.95 131.44 121.25 103.63 53.68 Ratios - based on IFRS 31-Mar-13 31-Mar-12 31-Mar-11 31-Mar-10 31-Mar-09 Continuing Operations PE Ratio - Adjusted  10.84 9.14 10.26 5.92 1.37 PEG - Adjusted  -0.63 0.49 0.15 -0.08 3.43 Earnings per Share Growth - Adjusted  -17.20% 18.74% 68.82% -77.91% 0.40% Dividend Cover  2.70 2.73 n/a n/a 3.80 Revenue Per Share  93.96p 110.82p 107.23p 147.22p 376.90p Pre-Tax Profit per Share  16.04p 15.14p 12.12p -7.11p -45.91p Operating Margin  17.56% 14.29% 12.47% -2.51% -9.33% Return on Capital Employed  35.24% 34.16% 36.25% -5.65% -22.40%   Continuing & Discontinued Operations Dividend Yield  3.42% 4.01% 0.00% 0.00% 19.27% Dividend per Share Growth  -16.33% n/a n/a -100.00% 10.42% Net Asset Value per Share (exc. Intangibles)  32.18p 24.02p 12.92p -0.20p -104.71p Net Gearing  6.23% 22.58% 22.02% 40.20% 253.73% Read More