Accounting and Finance of British American Tobacco - Case Study Example

School: Topic: FINANCIAL OF BAT 2009 to Lecturer: Contents Introduction 3 Financial accounting 4 Corporate governance 4 Stakeholders and key performance indicators 4 Key stakeholders 4 Key performance indicators 5 Ratio analysis 9 Financial management 11 Share price performance 11 Company rating 13 Strategic management 14 Conclusion and recommendation 17 References 18 Introduction When doing business in a competitive global market, the need to get proactive and strategic to gain competitive advantage is not an option of choice. Rather, it is very necessary that corporations and global firms understand the external environment in which they do business if they can succeed (Samuelson, Fischer & Dornbusch, 2007). In order to strategically plan for the future, corporations need to have a fair idea of their financial state not just for the present but for the past also (European Commission, 2012). This way, the corporation is able to identify its shortfalls and strengths and build on these in the right ways for growth (Pavitt, Dosi & Soete, 2008). Based on the background given, this report is prepared to critically appraise and evaluate the financial state of British American Tobacco (BAT) over a 5 year period from 2009 to 2013. As part of the appraisal and evaluation, critical financial outcomes and variables including financial accounting will be reviewed. Under financial accounting, the corporation’s approach to corporate governance, stakeholders, and key performance indicators will all be reviewed. There shall be an analysis of the corporation’s financial management, which shall entire share price performance and company rating. Financially, the strategic management approach used by the corporation within the period given shall be assessed. All these financial assessments will make it possible to draw conclusion on the corporation’s current market position and make recommendations for the future on how it could be more competitive. Financial accounting Corporate governance At BAT, corporate governance is used as a set of principles, mechanisms and processes necessary for controlling and directing affairs (Choo, 2013). As reported by the Group’s chairman, the company has over the years ensured a comprehensive corporate governance practice, backed by the UK Corporate Governance Code (Burrows, 2011). What is more significant and worth discussing is the company’s attitude towards corporate governance reporting, where it publishes its governance report on its website and also into the Global Reporting Initiative (GRI). As part of this effort, the company was in 2011 recognised with a first place award “in the People Reporting and Executive Remuneration Reporting categories for the FTSE 100 in the PricewaterhouseCoopers Building Public Trust Awards” (Burrows, 2011). This is indeed a good sign of strong commitment towards corporate governance, backed by the key principles of ensuring board independence and fair representation, information disclosure, and effective stakeholder involvement (Tsai, 2000). Stakeholders and key performance indicators Key stakeholders As far as key stakeholders are concerned, BAT follows the stakeholder theory more than the agency theory. That is, the firm recognises that its internal actions and programmes are influenced by a collective group of stakeholders beyond its shareholder, who can be classified as internal and external stakeholder (Samantha, 2012). Internally, employees, corporate management, and owners are all recognised as stakeholders. External stakeholders on the other hand include suppliers, society, government, creditors, shareholders, and customers. As a major commitment to meeting the collective needs of all these stakeholders, the company has a holistic approach to governance which reports to almost all these stakeholders through audit and accountability reports, corporate social responsibility report, remuneration report, and management board report (BAT, 2011). Key performance indicators As noted by Parmenter (2010), key performance indicators (KPI) are necessary in helping stockholders, potential investors and customers make useful assessment of the performance and viability of the firm’s business model. In the light of this, BAT has within the five year period focused on reporting six (6) major KPIs which are group share of key subsidiary markets, global drive brand (GDB) volumes, adjusted diluted earnings per share (EPS), total shareholder return, adjusted profit from operations, and cash generated from operations (BAT Annual Report, 2013). The tables and figures below summarise the outcome of the KPIs reported in the five year period. Table 1: % change in Group share of key subsidiary markets from 2009 to 2013 Indicator Year Value (%) group share of key subsidiary markets 2009 +27.9 2010 +25.3 2011 +0.4 2012 +0.1 2013 +0.2 Source: BAT Annual Report 2009 to 2013 From table 1, it is seen that from 2009, the company’s increase in percentage share measured by group share of key subsidiary markets have been declining sharply, which is a major source of worry. Table 2: % change in GDB Volumes from 2009 to 2013 Indicator Year Value (%) global drive brand (GDB) volumes 2009 +4.0 2010 +7.0 2011 +9.0 2012 +3.0 2013 +1.9 Source: BAT Annual Report 2009 to 2013 In terms of GDB volumes, the performance has been a mixed one with undulating values recorded. It is however a source of worry that from 2011 to 2013 there has been a downward trend in the percentage increase in value earned. It is important to note however that the fact that there are positive values mean the company has been improving but in a declining manner. Figure 1: Adjusted profit from operations Source: BAT Annual Report 2009 to 2013 Based on figure 1, it is seen that even though the company has been recording increasing values of adjusted profit from operations, the percentage change has been declining significantly since 2009. Figure 2: Cash generated from operations 2009 to 2013 In terms of cash generated from operations, the situation is worse because it is the only performance indicator with declining raw values. In 3 years running. From 2013 however, the values started rising marginally. For the two other indicators which are total shareholder return and EPS, the trend was the same as the first three where the raw values increased by the percentage increase were declining. As comprehensive as the performance indicators can be said to be for BAT’s environment, key indicators including working capital and return on equity, even though captured in all annual reports were not treated as KPIs. Ratio analysis In all its annual reports from 2009 to 2013, BAT emphasises on the use of two major variable which are free cash flow per share as a ratio of adjusted diluted EPS (%) and earnings per share (dividends declared per share) as the major indicator for ratio analysis. For these, the figure and table below show the corporation’s performance since 2009. Figure 3: Cash EPS percentage from 2009 to 2013 Source BAT Annual Report 2009 to 2013 From figure 3, it is seen that as far as cash EPS percentage is concerned, the firm has been recording undulating performances because from 2009 to 2010 and from 2012 to 2013, there were increases in values but from 2010 all the way to 2012, value fell. Explaining the relevance of cash EPS as a measure of financial performance, Zane B., Kane and Marcus (2004) noted that it helps to realise the case flow generated by the firm on per share basis. That is, for each share that the firm gave out, the cash flow that was yielded on it is calculated as the cash earnings per share (Williams, Haka & Bettner, 2008). The fact that BAT’s values have all been positive since 2009 means that the corporation’s shares are cashed valuable. This is because the higher the cash EPS, the better the firm can be considered to have performed well over the period of measure (Groppelli & Ehsan, 2000). In terms of the actual earnings per share, the table below gives earnings made from 2009 to 2013 for basic unadjusted, diluted unadjusted, diluted adjusted, and dividends declared per share. Table 3: Earnings per share for BAT Earnings per share (pence) 2009 2010 2011 2012 2013 Basic unadjusted 135.7 142.9 154.4 195.8 205.4 Diluted unadjusted 134.9 142.1 153.5 194.8 204.6 Diluted adjusted 151.6 173.4 191.9 205.2 216.6 Dividends declared per share 99.5 114.2 126.5 134.9 142.4 Source: BAT Annual Report 2009 to 2013 Table 3 shows that between 2009 and 2013, BAT became investor friendly as far as its EPS is concerned. This is because within the period, there corporation’s EPS kept increasing very significantly along all major parameters. As noted by Kane and Marcus (2004), the EPS is a good indicator for future earnings or risk of loss as it measures the net income earned on each share. This means that for investors who believe in a company’s past performance as basis for future performance, the EPS is a good course for them to select BAT. Financial management Share price performance Share price performance has been considered as one of the major financial management indications of a corporation. This is because according to Groppelli and Ehsan (2000), the share price performance is an indication of the monetary interest in the company by investors. That is, the decision of investors to decide on putting their monies into the company depends on the assurance of monetary interest that will come from the company, which in turn is determined by the share price performance (Williams, Haka & Bettner, 2008). Meanwhile, the company needs the capital injection from investors for it to gather sufficient operating income to run its regular business. It is for this reason that how the share price performs on the stock market is of great interest to global firms such as BAT. In figure 4, the share price performance of BAT within the period of January 3, 2014 to September 30, 2014 is graphically presented and compared to the FTSE-100 index for the same period. Figure 4: Share price performance from Jan 3, 2014 to Sept 30, 2014 (pence) Source: Yahoo Finance (2015) From figure 4, the overall indication developed is that BAT’s share performance is generally below the average FTSE-100 index for the periodic under review. However, the general behaviour of the corporation’s share price is highly synonymous to that of the FTSE-100 index. That is, the two graphs in figure 4 behave relatively same. For example both graphs started on lower rates but continued rising steady with closing values higher than what was started. Again, both graphs experience declines and falls in value around the same times. For example in February 2014, both graphs experienced a fall in value. The same pattern was experienced in August 2014 when falls were experienced. Between March and July however became active rising points for the two graphs. The interpretation that can be given here is that BAT’s share price performance is highly correlational to the overall stock market performance in UK. That is, when the stock market is generally low in performance, the firm’s share price becomes affected. When the general stock market performance improves, the company’s shares also improve. In sum, BAT has a highly sensitive share price performance that correlates with the overall market event. Company rating BAT has been receiving ratings from such rating agents such as Moody’s, Standard Investment Bank, and Standard & Poor (S&P). Over the last five years, BAT’s rating according to the S&P has been in the range of BBB+/Stable/A-2. This is a generally impressive rating indicating the corporation’s corporate credit discipline and investment performance. According to the S&P (2013), some of the major strengths of BAT include the fact that the company has a strong market position as one of the world’s top two international tobacco companies. This makes BAT a global leader in its industry with an impressive and ever growing market share. S&P also acknowledged the fact that BAT has an unequalled geographic diversification, meaning that the company does not shy away from location based competition on the global market. The outcome of this situation is an exposure to markets that are growing in volume and value, which have ultimately accounted for BAT’s growing market capitalisation. Another strength that has accounted for the company’s BBB+/Stable/A-2 rating is the fact that it has strong conversion of profits into cash and a moderate financial policy (S&P, 2013). The positive rating given the company however comes with some weaknesses, which when addressed will make the company even more viable. One of these is the fact that the company is battling rising price sensitivity in mature markets (S&P, 2013). In situations like this, Ciborra (2006) recommends the use of such theories as the Ansoff matrix in finding new corporate strategies that will make it possible to identify new markets where both existing and new products can be introduced. Another weakness has to do with litigation risks experienced in a number of foreign markets, particularly the U.S. It is therefore important that country risk mitigation strategies be put in place to ensure the minimisation of these forms of litigation risks. Strategic management From a strategic position, it can be said that BAT uses the cost leadership strategic option in the management of its brand. As part of the cost leadership strategic option, the company produces at low cost and offers products at one of the lowest prices that can found on the market (Deardorff, 2005). This strategic option can be considered as generally viable because of the dominated area of production of the corporation, which is the manufacturing of tobacco products, particularly cigarette. As cigarettes are considered fast moving consumer goods (FMCG), people usually consume them on high demand, thereby requiring buying as many of them as possible (Doherty, 2007). Meanwhile, when people are always buying particular goods in high frequency or demand, pricing is a major strategic variable to consider ensuring that as many times as they require, they can make purchases (Clegg, Hardy, Lawrence & Nord, 2013). Once this is ensured, the purchasing behaviour of consumers becomes adaptive rather than detractive (Eisenhardt, Davis & Bingham, 2009). Based on this, the cost leadership strategic option can be said to be ideal for BAT’s consumer outlook. The above point made, it would be admitted that there are very crucial challenges faced by the company in maintaining the cost leadership strategic option. In the first place, the issue of high taxation on tobacco products in most countries of the world is a major setback for this strategic option. Due to the health implication involved with smoking, most governments put high taxes on the importation of tobacco. Meanwhile, Davido (2003) observed that when using the cost leadership strategic option, manufacturers avoid making losses only by ensuring that their cost of production is as minimal and low as possible. This way, even when prices are low, it is still possible to make profits. With increasing cost on taxes even for the sourcing of raw materials, BAT is faced with increased cost of production. In order to deal with this situation, it will be important that the BAT adopt as part of its strategic management, lean production thinking which will ensure that waste is avoided right at the production level even before raw materials are refined into finished products. Once this is done and the cost of production is extra low, issues of taxation can be well covered because when accumulated, it will still keep the cost of production low. Going into the future, it will be important also that the company varies its strategic option to include aspects of focus differentiation. This positioning can be used by ensuring that there is a line of consumers who are targeted and presented with high value tobacco products. This could be celebrities and other high social class citizens who will be focused to buy these value rated products at additional cost. The value addition could be done in a number of ways including the customisation of product packages and the variation of product content. Whilst the company’s existing global drive brands such as Dunhill, Kent, Lucky Strike and Pall Mall are maintained for the cost leadership, some of its famous international brands like Peter Stuyvesant, Craven A, Benson & Hedges and John Player Gold Leaf could be upgraded for the focus differentiation strategic option. Within growing global restriction on the sale of tobacco in most countries, it will also be important to look into diversity, where new product development (NPD) could be envisioned for the creation of new investments for the company (Coelho, 2011). But as at now, the sale of tobacco is its major source of revenue. Conclusion and recommendation Based on all the evaluation and analysis above, there are two major conclusions that can be drawn. The first is the fact that the company has over the years been depending largely on its brand equity which was earned several years back. The rationale for this conclusion is that even though the company has been recording improved raw values in most of its financial indicators and ratios, the rate of growth or increase has been declining. This is an important situation that requires fixing. To adequately fix this situation, it is recommended that the company develops a new growth strategy that will aim at attracting new customers and discovering newer target segments. In the absence of this, declining growth rate would eventually even up at 0%, after which there will decline in financial indicators and ratio. The second conclusion that can be drawn is that BAT is highly dependent on the happenings within the larger global market, given the fact that its share performance is sensitive to the FTSE-100 index. Based on this, it is once again recommended for the company to look to new opportunities for growth. Specifically, diversification into newer emerging markets will be a key. Once this is done, the company will be having other determinants for growth other than the performance of the FTSE-100 index. References BAT (2011). Annual Report 2011. [Online] Available at http://www.bat.com/ar/2011/index.html [May 10, 2015] BAT Annual Report, 2009 to 2013. Burrows R. (2011). Corporate governance statement. [Online] Available at http://www.bat.com/ar/2011/corporate-governance/corporate-governance-statement/index.html [May 10, 2015] Choo, S. (2013). “Determining the Critical Success Factors of International. 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[Online] Available at http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245185339726 [May 10, 2015] Samantha, M. (2012). "Stakeholders: essentially contested or just confused?". Journal of Business Ethics Vol. 108 No. 3, pp. 285–298. Samuelson, P. A., Fischer, S. & Dornbusch, R. (2007). "Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods". American Economic Review Vol. 67 No. 5: pp. 823–839. Tsai, W. (2000). Social capital, strategic relatedness and the formation of intraorganizational linkages. Strategic Management Journal, 21(9): 925. Williams, J. R. Haka S. F. & Bettner M. S. (2008). Financial & Managerial Accounting. New York: McGraw-Hill Irwin. Yahoo Finance (2015). BAT Historical Prices. [Online] Available at https://uk.finance.yahoo.com/q/hp?s=BATS.L [May 11, 2015] Zane B., Kane A. & Marcus A. J. (2004). Essentials of Investments, 5th ed. New York: McGraw-Hill Irwin. Appendix Separate share performance for BAT and FTSE-100 Read More