The Profitability of Westpac Bank Representative of the Banking Industry, BHP Billiton and Dominos - Essay Example

MAF305 Banking Management Name Course Institution Date Executive summary The following report aims at highlighting the profitability of the Westpac bank representative of the banking industry, the BHP Billiton Company and Dominos for the period 2010 and 2011. A return on equity (ROE) DuPont analysis will be used in addition to profitability and leverage ratio analysis. Further, the report will look into riskiness of the firms by looking at the risk exposures. The analysis would help advice on investment decisions into the firms. The analysis will also inform as to whether the bank industry represented by WBC has been making exaggerated profits, Introduction The banking industry has come under attack that it is involved in unrealistic profiting. Large banks are increasing their profitability by taking advantage of the favorable market conditions in way of issuing bonds that would in the future cater for any cash deficits. Recent volatility brought about by the European credit crunch has meant that the banks’ customer base did readjust themselves to survive the hard financial times (Eun & Resnick, 2004, p. 56). The mining industry for example funds its own mining expeditions while individuals have resorted to debt payment in place of borrowing. As a result, banks, in the effort to maintain the excessive profiting have resulted to cost cutting expeditions through such measures as retrenching their employees while increasing lending interest rates. This paper is aimed at giving an analysis of Westpac banking corporation and comparing the bank’s profitability with and financial performance with that of the mining sector represented by BHP and that of the food industry represented by Domino’s pizza. This paper also compares leverage levels of each of the two companies that would inform a decision to buy shares any of the companies (Ross, 2008, p. 37). Company analysis The Westpac banking corporation (WBC) is one of Australia’s oldest financial institutions providing banking services to the country’s corporate and retail institutions. The bank’s commitment to risk management has enabled the bank capture a greater share of the country’s customer base. Performance Highlights (WBC 2011 P2) 2010 and 2011 (WBG2011 P78) The net profit after tax for the company was reported at $6346 million, which was a 50% increase from previous year’s profits. An earning /share of 214 for 2010 and 233 for 2011. Dividend per share standing at 139 cents for 2010 and 156 cents in 2011. Cash earnings for 2010 being $5879 million and $6301million in 2011. The cash earnings per share in 2010 was $1.978 and $2.093 for 2011. The net profit margin indicates a company’s profitability calculated as a ratio of profits after tax/revenues (Horne, 1977, p. 71) Dupont Analysis ROE The interpretation of this ratio is such that if a company’s ROE is lower in comparison to another company, it reduces the credit worthiness and thus capital accessibility. This then means that the company in question is not able to access funds for expansion and maintenance of market competitiveness. This is because industry regulations require companies to maintain an optimal ratio of assets to equity capital. This ratio is of greatest importance as it enables for trend analysis. The formulae = profit after taxation/total equity capital*100 ROA (Return on Assets) This ratio is a measure of management’s ability to make optimal use of resources availed to them. It is therefore merely meant to evaluate management performance. ROA formulae is profit/total assets *100 Leverage ratio = total assets/total equity. This ratio measures the extent to which a company uses its financial leverage. If the profit for Westpac bank for 2010 was $6346 with a total equity capital of $36471 and for 2011 was $6991 million with a total equity capital of$39275. The return on equity is 17.4% for 2010 and 17.8% for 2011 a 0.4% increase. The ROA for 2010 $6346/$577 billion=1.10% 2011: $6991 million/$622billion=1.12% Domino’s Pizza This company deals in the delivery of pizza. The company has branches in most parts of the globe. An average of one million pizzas is sold by the corporation divergent systems. The company has recorded tremendous results in recent years. In 2010, the company celebrated its fiftieth anniversary. The company attributes its success to the strong relationship established with its franchisees. The company recorded a net income of $19215million in 2011 up from $14149 million in the previous year. ROE = 100 × Profit after taxation ÷ Equity holding by BHP’S shareholders Dupont Analysis ROE = ROA * Leverage ratio 2010 14.1% 9.52% 1.482 2011 18.31% 12.00 1.526 BHP Billiton This is an Australian based company dealing in natural resources. The company deals in various commodities that they extract and sell. These products are non-ferrous ores, steel making and energy products. For the year ended 2010, the company recorded a $12722million in profit while for 2011, profit after tax increased to $23648million. (BHP 2011P.1) The net profit margin for the company calculated as a percentage of the profit after tax divided by the company’s revenue, shows an improvement of company performance over the two years 2010 and 2011. ROE = 100 × Profit after taxation ÷ Equity holding by BHP’S shareholders = 100 × 23,648 ÷ 56,762 = 41.66% DUPONT ANALYSIS ROE = ROA * leverage 2010 year ended June 41.66% 22.98% 1.81 2011hyear ended June 26.22% 14.32% 1.83 BHP Billiton is more profitable in comparison to WBC. The DuPont analysis above it is clear that the banks return on equity is lower than that of the mining firm, BHP. BHP improved in performance from 2010 to 2011 based on the return on equity ratio. The lower ROE for the bank therefore means that it the firm is less credit worthy in comparison to the mining firm. This ratio indicates that the banks will in the future have fewer funds available for expansion and the maintenance of its operational costs (Shapiro, 1992, p. 67). Part 2: Leverage comparison for the two companies Leveraging means the taking up of loans to finance company activities. Thus, an investment path avails funds to a company. Companies that take up leveraging to finance their activities do so in the hope that their activities will yield more to pay up the principle amount plus interest and still make a gain. Some of the risk that any one firm is subject to include, interest rate risks, capital risks, liquidity risks and credit risks (Ehrhardt and Brighamh, 2010, p. 345). Leverage affects a firm’s rate of growth. This is partly because the equity multiplier affects the size of ROE, which determines a firm’s ability to grow. Leverage ratios thus are used to determine a company’s financial leverage, thus giving information on a company’s financing choices in addition to the company’s ability to meet its financial obligations. The debt to equity ratio is the most common leverage ratio. The most favorable ratio for any company is 2:1, meaning that only a third of company finances is in long term debts. A high debt/equity ratio indicates a company’s inability to meet its financial debt obligations. Liquidity risks can be defined as a company’s ability to have ready funds for lending and for current account withdrawals in the case of banks and funds available and for day-to-day transactions for other companies. Interest rate risks are a measure of a firm’s margin of safety. That is, the numbers of times that interest payments are capable of being made by the company. A greater proportion is more favorable for the firm. Margin of safety=earnings before interests and taxes/interest expense Analysis (for the period’s ended September forWBC and June for BHP billiton) (Bloomberg 2011 p.1) Westpac Banking Corporation (millions) BHP Billiton D/E RATIO 2010 $578159/$40118=14.4 $16070/58400=0.3 2011 $626420/$43808=14.2 $11570/53950=0.2 MARGIN 2010 $4028+34/34= 119 $22240+223.81/223.81=100 2011 $4283+33/33= 130 $31710+249.53/249.53=128 Investment decision based on the debt equity ratio, WBC has a greater ratio as compared to BHP and Dominos. This means that the company is less capable of meeting its financial obligation to its customers. However based on the interest rate margin of safety, the bank can meet its interest expense. However based on company profitability BHP offers better returns to equity in comparison with Dominos. It is better to buy shares in BHP. Question Are Australian banks taking up more risks; case of Westpac banking corporation. The liberalization of the Australian financial system coupled with the flexibility of the exchange rate has exposed the banks to increased foreign risk. This is in addition to individual market based risks that face the individual banks. An increase in risk exposure for banks translates into an increase in the rates of interest for lending to their customers (Shamsuddin, 2009, p. 2). However, in the case that a bank hedges itself from risks but the events hedged against do not occur, as has been the case for most Australian banks, the firms end up making supernormal profits (Ferguson, 2011, p. 1). In Westpac, banking corporation has taken up various credit risk management measures aimed at ensuring that the bank did not suffered great deal due to the possibility of increased default on loan repayments. References Ehrhardt, MC and Brighamh, EF 2010, Corporate Finance: A Focused Approach, New York: Centage Learning. Eun, C. S., & Resnick, BG 2004, International financial management, 3rd ed., McGraw- Hill/Irwin, Boston. Ferguson, A 2011, Westpac result points to profit crest for banks, Retrieved from http://www.smh.com.au/business/westpac-result-points-to-profit-crest-for-banks- 20110504-1e7le.html#ixzz1LYzs0Ihp Horne, JC 1977, Fundamentals of financial management, 3d ed., Prentice-Hall, Englewood Cliffs, N.J. Ross, SA 2008, Modern financial management, 8th ed., McGraw-Hill/Irwin, Boston. Shamsuddin, AF 2009, Interest rate and foreign exchange risk exposures of Australian banks. The Berkley electronic press http://www.marketwatch.com/investing/stock/bhp/financials/balance-sheet Shapiro, AC 1992, Multinational finaSncial management, 4th ed., Allyn and Bacon, Boston. Westpac Group 2011. Annual report 2011. Retrieved from Mhttp://www.westpac.com.au/docs/pdf/aw/ic/2011_Annual_Report.pdf Read More