Financial Aspects of Lonmin Public Limited Company - Example

FINANCIAL REPORT FOR LONMIN PUBLIC LIMITED COMPANY Introduction This report explores throughvarious financial aspects of the Lonmin Public Limited Company. This report presents findings on the company’s profile, stock prices, stockholders’ equity, dividend policies, credit risks, as well as other financial news. It also presents the corporate financing choices based on some theoretical framework. In addition, it establishes the company’s market value added and compares its market value with the market book value. Finally, this report presents findings on the company’s remuneration for its directors. Question 1 Lonmin Public Limited Company’s profile Being headquartered in Johannesburg, South Africa, Lonmin Public Limited Company was formed in 1909 and is a mineral resource group where it is involved in discovering, extracting, and refining and marketing platinum group metals. Its operations are in America, Asia, Europe and South Africa. Among the platinum group metals that it explores include platinum, iridium, ruthenium palladium, and rhodium. It also explores gold, chrome, nickel, and copper ores (Yahoo Finance, 2015). Share price trend Figure 1 Share price trend From figure 1 above, this report established the share price of the Lonmin Public Limited Company to have been dropping over the last five years. Its price increased steadily from $741.737 at the beginning of its 2009/2010 financial year to record the highest price over these five years to $1,033.257. The price, however, started to drop and during its eleventh month of its 2009/2010 financial period its price had dropped to $774.691 after which it started to rise to $996.759 in December 2010. Since then, the price has been dropping. The price dropped further during its 2013/2014 financial year to record the least ever price in September 2014. The reason for this decrease was due to the difficulties that Lonmin Public Limited Company faced during its operations in 2014, especially the long strikes and low metal prices. According to the Lonmin Public Limited Company (2014, p. 84), the firm’s Chairman of the remuneration committee argued that the strike reduced the company’s revenue and the idle production costs led the company to substantial losses. Lower metal prices aggravated the declining share price rate, leading to a closing share price of $185.8. Stockholders’ Equity This report sought to establish how the Stockholders’ Equity, considering both the common stock and the preferred stock has been changing over the last five financial periods. The stockholders stocks analysed by this report and presented in figure 2 below comprised of the common stock and additional paid-up capital and were $3,706M, $3,927M, $3,485M, $4,820M and $4,644M in 2010, 2011, 2012, 2013 and 2014 respectively. The retained earnings of the Lonmin Public Limited Company were $1,422M, $1,650M, $1,208M, $1,341M and $1,164M in 2010, 2011, 2012, 2013 and 2014 respectively as shown in figure 3 below. Figure 2 Graphical presentation of Stockholders’ stock Figure 3 retained earnings Total debt In analysing the total debt of the Lonmin Public Limited Company, this report considered both current and non-current liabilities. This report established that the total debt dropped in 2011 to $1,932M from $2,115M in 2010 but rose to $2,135 in 2012. It, however, dropped to $1,207M in 2013 and further to $1,132M in 2014. These results are as shown in figure 4 below. Figure 4 Total debt Total debt to equity ratio Total debt to equity ratio is one of the leverage ratios that are computed to establish an entitys capital structure, and they show the extent to which the business has borrowed to finance its assets and other resource acquisitions for it to efficiently carry out its normal operations (Tracy, 2012, p. 26 ). Table 1 Debt to total equity ratio Year 2010 Million 2011 Million 2012 Million 2013 Million 2014 Million Debt to total equity ratio = total liabilities/Equity = 2,115/2,709 = 0.78 = 1,932/2,930 = 0.66 = 2,135/2,930 = 0.73 = 1,207/2,488 = 0.49 = 1,132/3,409 = 0.33 From the analysis above, this report established that Lonmin Public Limited Company’s capital structure had high debt finances in 2010 but later improved. In 2010, for every $1 of equity capital, Lonmin Public Limited Company had $0.78 of debt, $ 0.66 debt in 2011, $0.73 debt in 2012, $0.49 debt in 2013 and $0.33 debt in 2014. Credit risk In the course of almost every entity’s operations, it enters into some dealings with counterparties of whom some may fail to honour their obligations. According to the SAS Institute Inc. (2015) and Michael (2015) state that credit risk is the probability of loss and rises as a result of obligor’s failure to meet its financial obligations. This report identified that among the financial risks that Lonmin Public Limited Company faces and manages is the credit risk. The amount of credit risk at any single time that it is exposed to is the carrying amounts of its financial assets. These assets include HDSA receivable, other non-current financial assets, trade receivables, tax recoverable, other short-term receivables, and cash and cash equivalents (Lonmin Public Limited Company, 2014, p. 151). This report established that Lonmin Public Limited Company’s credit risk for the financial periods 2010, 2011, 2012, 2013 and 2014 were $895 million, $624 million, $812 million, $713 million and $582 million respectively. This shows that its exposure to credit risk, improved in 2011, deteriorated in 2012 but from that point forward started to improve. This has been illustrated in figure 5 below. Figure 5 Credit risk exposure Dividend payment and retentions This report established that the Lonmin Public Limited Company distributes some of its earnings in the form of dividends to the stockholders. However, this was only done in the year 2010, and 2011, where dividends paid, were $30 million in each of these periods (Lonmin Plc., 2011, p. 121). After that, it has not been paying dividends since it has been making losses. In 2011, Lonmin Public Limited Company had net earnings of $281 million, which implies that its dividend payout was 10.68% leading to a retention ratio of 89.32%. In 2010, it made net earnings of $118 million and a dividend payout ratio of 25.42%, leading to a retention ratio of 74.58%. As shown in Table 2 below. Table 2 Dividend payout ratio and retention ratio Year 2010 $million 2011 $million Dividend pay-out ratio = dividend/earnings = 30/118 = 25.42% = 30/281 = 10.68% Retention ratio = 1- DPR = 1- 0.2542 = 74.58% = 1- 0.1068 = 89.32% Question 2 Lonmin Public Limited Company’s financing choices This report sought to find out how and what guides Lonmin Public Limited Company in making its sources of financing. The analysis was based on the Pecking order theory and the Trade-off theory. According to the Pecking order theory, corporations have a preferred hierarchy of financing their decisions where they first utilize the retained earnings (Lee, 2011, p. 7; Vicol & Novak, 2010, p. 13). After exhaustion of these funds, they prefer debt financing, after which, equity financing through the issuance of shares comes last as the preferred financing source. The findings of this report were that Lonmin Public Limited Company’s financial decisions are slightly enjoined in this theory since it uses its retained earnings funds and equity funds. In fact, Lonmin Public Limited Company has been raising finances by issuing extra share and its debt financing has been dropping as was earlier reported by this report under the debt item, stockholders’ equity item and retained earnings item. However, this theory is not manifested in the use of debt as the second preference for financing since the debt has been decreasing. The use of internal sources of financing is due to the financial slack. According to Lee (2011, p. 2) and the Financial Times (2015), financial slack is the excess financial resources that an entity has in excess of what is required. Through the internally generated financial slack, Lonmin Public Limited Company was able to conduct some innovative activities. Even though Lonmin Public Limited Company has not been performing well over the last five because of the sporadic being experienced in the economic arena, the investment by the use of the financial slack is dispensable to economic performance. Kraus and Litzenberger introduced the Trade-off theory in 1973. It aimed at addressing the irrelevance hypothesis by Modigliani and Miller by building in the effects of financial distress, taxes, and agency costs to acquire an optimal capital model (Vicol & Novak, 2010, p. 12). It chooses the capital structure whose combination results in the firm’s lowest capital cost in order to optimize value and consequently shareholder wealth. Once an entity establishes this optimal financing sources combination1 It is assumed that any extra dollar of financing is done in the same debt and equity financing proportions. This theory argues that an optimum leverage is achieved by striking a balance between debts corporate taxes saving advantage against the bankruptcy costs. Figure 2: Capital structure Static Trade-Off Theory From the figure above, the optimal amount of equity and debt that a firm can attain is at point D/E*. It should, however, noted that this is just a static view of the optimal capital structure as in reality it is more dynamic (Vicol & Novak, 2010, p. 12). In trade-off terms, then, the firms’ value is maximized at a lower debt to equity ratio (D/E**) as shown in the figure below. Figure 3: Capital structure dynamic Trade-Off Theory This report established that the capital structure of the Lonmin Public Limited Company has been changing over the last five years with debt decreasing while equity and retained earnings have been increasing. The witnessed change in capital structure shows that it was changing its capital structure to reflect different changes in economic conditions. According to Baker and Martin (2011, p. 18), Trade-Off Theory is dynamic with corporations tending to strike a balance in their capital structure in different optimal ratios over differing economic conditions. Financial distress and bankruptcy costs keep firms away from using debts and the fear for these conditions could have forced Lonmin Public Limited Company to avoid excessive debt use. These costs are in a form of implicit and explicit costs. Explicit financial distress costs are payments made to accountants, lawyers in filing for protection from creditors or liquidation of the firm which can represent a significant part of corporate assets (Vicol, 2010, p. 12). The indirect costs of financial distress include costs of low inventories, higher input costs from suppliers, and loss of customers. These costs restrict the firms from maintaining high levels of debt. It is through this argument that Lonmin Public Limited Company’s financial decisions are guided by a prudent assessment of the trade- off between accruing benefits from its financing decisions and the underlying risks in order to maximize its shareholder wealth. Question 3 Performance measures The calculation of the market value added is aimed at establishing the financial health of an entity. It is determined by subtracting the contributed capital by both shareholders and bondholders from the final market value of its stocks. By determining the market value added, the performance of the management and the general market is determined. The book value per share for Lonmin Public Limited Company was also computed in order to establish the value of each share-based on the reported owners equity. In calculating the market value added, this report carried out the computations contained in Table 3 below. To establish the relationship between the market capitalisation and the market to book ratio of the Lonmin Public Limited Company, this report performed the book value per share ratio and the market to book value ratio as shown in Table 4 below. Table 3 Determination of the market value added Year 2010 2011 2012 2013 2014 Market value = 197M*846.17 = 166,695M = 203M*541.062 = 109,836M = 203M*296.535 = 60,197M = 534M*319.3 = 170,506M = 570M*185.8 = 105,906M Book value = 2,709M = 2,930M = 2,488M = 3,409M = 3,233M Market value added = Market value – Stocks book value = 166,695M- 2,709M =163,986M = 109,836M- 2,930M = 106,906M = 60,197M- 2,488M = 57,709M = 170,506M - 3,409M = 167,097M = 105,906M - 3,233M = 102,673M Table 4 Computation of Market to book ratio Year 2010 2011 2012 2013 2014 Book value per share = owner’s equity/outstanding shares = 2,709/197 = 13.75 = 2,930/203 = 14.43 = 2,488/203 = 12.26 = 3,409/534 = 6.38 = 3,233/570 = 5.67 Market to book ratio = price of the share/book value per share = 846.178/13.75 = 61.54 = 541.062/14.43 = 37.50 = 296.535/12.26 = 24.19 = 319.3/6.38 =50 = 185.8/5.67 = 32.77 Figure 6 Equity’s market value against the market book value From figure 6 above, this report established that the market value of equity changed with the market to book ratio. In this respect, whenever one increased, the other increased and when one dropped, the other one also dropped. The reasons for this are that, in both cases, the market price of a stock is critical and has been used. Question 4 Lonmin Public Limited Company’s Board Remuneration This report established that the Lonmin Public Limited Company remunerates its board of directors through various forms. In developing these incentives, their impact on the various stakeholders is considered. In this respect, Lonmin Public Limited Company designs these incentives bearing in mind the possible consequences as presented by the Agency theory. According to Pava (2015), the financial agency theory emphasises on the benefits and costs as well as potential conflicts of interest that may arise from the principal-agent relationship. In the case of the Lonmin Public Limited Company, the shareholders are the principals while directors are the agents who must ensure that their principals’ value is maximised. Conflict may arise a result of the board allocating perquisites that are too high. According to the Lonmin Public Limited Company (2014, pp. 96-97)s annual reports, the company avoids getting into conflicts by the government by following the laid down laws relating to the employment of Executive Directors. It uses the English law that requires directors to be employed on contracts, and it is these contracts that define the obligation that the company will have over them including the remuneration issues. According to Lonmin Public Limited Company (2014, p. 86), the board is entitled to both short term and long term incentives. The short-term incentives include bonus. This report supports this incentive since it is based on the operational delivery. It, therefore, encourages the board to work hard in order to earn the bonus leading to increased value of shareholders. In designing its long-term incentives, this report found that the Lonmin Public Limited Company is ready to implement the agreed recommendations by the shareholders, which will also be based on some performance metrics. The board also thinks like shareholders and appreciates the need to make a change in the companys shares in order to increase the value of personal holding and which is also motivational (Lonmin Public Limited Company, 2014, p. 86). The long-term incentive plan is aimed at creating an alignment of executive and shareholders interests (Lonmin Public Limited Company, 2014, p. 92). Through this plan, the executive owns some shares, and their performance is measured through return on investment or capital. Further results on the remuneration established that the board has reviewed remuneration downwards, a move that shareholders have well received. In order to ensure that the Lonmin Public Limited Company attracts and retains employees of the highest calibre to take it to the next level, it is determined to offering a base salary that is competitive (Lonmin Public Limited Company, 2014, p. 87). There are also benefits in kind that are offered to its executive directors and include car allowance, life insurance, income protection insurance, private medical insurance and annual medicals among others. This report supports such benefits since they are forms of rewards that are necessary to keep the board and the management motivated and dedicated to better the performance of Lonmin Public Limited Company. Other rewards are in the form of relocation or expatriate assistance offered to executive directors who work away from their home location. This report also found that the Lonmin Public Limited Company has an annual share award plan to its executives which has been aligned with shareholders’ interest to incentivise them to the delivery of long-term strategic objectives (Lonmin Public Limited Company, 2014, p. 91). Further results indicated that Lonmin Public Limited Company pays its Executive Directors for the loss of office, but the concerned Director must give a notice of six moths. This policy is pursued by the company with a view to protecting the interests of shareholders (Lonmin Public Limited Company, 2014, p. 97). References Baker, H.K. & Martin, G.S., 2011. Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. Illustrated ed. Hoboken, New Jersey: John Wiley & Sons. Financial Times, 2015. Financial Slack. [Online] Available at: HYPERLINK "http://lexicon.ft.com/Term?term=slack" http://lexicon.ft.com/Term?term=slack [Accessed 18 April 2015]. Lee, S., 2011. How Financial Slack Affects Firm Performance: Evidence from US Industrial Firms. Journal of Economic Research, 16, pp. 1-27. Lonmin Plc., 2011. Annual Report and Accounts for the year ended 30 September 2011. Financial report. Johannesburg: Lonmin Plc Lonmin Plc. Lonmin Public Limited Company, 2014. Annual Report and Accounts for the year ended 30 September 2014. Financial report. Johannesburg: Lonmin Public Limited Company Lonmin Public Limited Company. Michael, 2015. 2015. [Online] Available at: HYPERLINK "http://riskencyclopedia.com/articles/credit_risk/" http://riskencyclopedia.com/articles/credit_risk/ [Accessed 18 April 2015]. Pava, M.L., 2015. Financial agency theory. [Online] Available at: HYPERLINK "http://www.britannica.com/EBchecked/topic/1468723/financial-agency-theory" http://www.britannica.com/EBchecked/topic/1468723/financial-agency-theory [Accessed 18 April 2015]. SAS Institute Inc., 2015. Credit Risk Management. [Online] Available at: HYPERLINK "http://www.sas.com/en_us/insights/risk-fraud/credit-risk-management.html" http://www.sas.com/en_us/insights/risk-fraud/credit-risk-management.html [Accessed 18 April 2015]. Tracy, A., 2012. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. Sydney: RatioAnalysis.net. Vicol, M. & Novak, J., 2010. Capital Structure: Testing Pecking Order Theory and Static Trade-Off Theory in the Current Crisis. Master Thesis. Prague, Czech Republic: Charles University in Prague Charles University in Prague. Yahoo Finance, 2015. Business Summary. [Online] Available at: HYPERLINK "http://finance.yahoo.com/q/pr?s=LMI.L+Profile" http://finance.yahoo.com/q/pr?s=LMI.L+Profile [Accessed 18 April 2015]. Read More