Financial Performance and Position of Spectris Plc as a Company Listed on the London Stock Exchange - Research Paper Example

SPECTRIS PLC RATIO & VALUATION ANALYSIS Prepared by (Student’s Name) Institutional Affiliation Professor’s Name Date Table of Contents Executive Summary……………………………………………………………………………3 Introduction/ Company Background................................................................................4 Objectives.......................................................................................................................4 Methodology...................................................................................................................5 A. Profitability Analysis.............................................................................................5 B. Liquidity Analysis.................................................................................................6 C. Gearing Analysis.................................................................................................7 D. Overall Position of the Firm.................................................................................8 E. Valuation: Prospective Price-Earnings Ratio Analysis Based On Forecast Normalised Earnings………………………………………………………………….9 Conclusion......................................................................................................................11 Appendices.....................................................................................................................12 References List...............................................................................................................14 Executive Summary The research paper focuses on Spectris Plc that engages in the supply of productivity-enhancing instrumentation and controls. It is listed in the London Stock Exchange under the Scientific and Technical Instruments industry. The research paper indicates that the firm’s profitability is only favourable on the management side but unfavourable on equity shareholders’ perspective. Both the gearing and liquidity ratios are also weaker in comparison to industry averages. This means that the firm is not able to meet its short term obligations whenever they fall due. The price/earnings based on forecasted normalised earnings indicate that Spectris Plc is overvalued in comparison to what is being offered in the current market Introduction/ Company Background The process of determining the financial soundness of a company is deemed paramount especially because it allows different stakeholders an opportunity to establish whether or not they will continue with operations. Different stakeholders portray different interests in relation to how the company operates. For instance, both the shareholders and management are directly affected by the profitability of a company given that they aspire to increase their wealth and bonuses respectively. Consequently, suppliers of both materials and creditors require establishing the exact financial situation of a company in order to ascertain whether they will continue conducting business in the future. Creditors and suppliers need to comprehend the liquidity and gearing position of a firm respectively in order to establish whether the business can pay off short-term obligations and long term ones. The focus of this paper rest with evaluation of Spectris Plc financial position as well as execute its immediate valuation in relation to the market value. Spectris Plc operates under the Scientific and Technical Instruments industry in the United Kingdom. It was founded in 1950s. It is one the leading suppliers of productivity-enhancing instrumentation and controls. Headquartered in the United Kingdom, the company boasts of more than 8,000 employees in more than 30 countries across the globe. It is a public company that has its shares listed in the London Stock Exchange (Spectris Plc, 2016). Objectives In conducting this analysis, the objectives are as follows; To evaluate the profitability of the firm in regards to management’s expectations as well as equity shareholders. To evaluate the overall financial position of the firm from both a short and long term perspective through the application of liquidity and gearing rations respectively. To conduct an overall analysis on the financial performance of the company as well as its immediate valuation position in comparison to the market value. Methodology For the case of determining the profitability, liquidity and gearing ratio position of Spectris Plc, the analysis adopts a financial ratio model that will be used to compute and interpret ratios for a three year period starting 2012 up to 2014. It is important to note that while doing the interpretations, the analysis will also compare these ratios to industry averages in order to establish the exact position of the firm in the sector. Furthermore, the valuation process will adopt a future dividend growth model whose value will be used for comparison with the market value of the company. Results & Discussion F. Profitability Analysis From Table 1, it can be noted that the company’s net profit margin increases slightly within the period from 11.48% to 11.51% in the three-year period between 2012 and 2014. According to CSIMarket (2015), the industry average in 2014 stood at 11.95% meaning that the company is operating below the expected margin. This can be fairly expounded by the 3% sales decrease in material analysis LFL as a result of weak demand in the metals, mineral and mining industries across the globe. Consequently, it is ascertained that the firm engaged in intensive acquisition process where at least 6 acquisition activities took place within the year thereby decreasing the level of profits posted. Other notable contributors of this performance related to intensive fluctuations in foreign currency especially because the sterling pound gained intensively in comparison to major world currencies. Thus, profitability in shareholders perspective seems to be dwindling and underperforming with time. The shareholders’ interests rest with high profit margins in comparison to the industry averages in order to foster a much higher dividend pay-out. However, with Spectris Plc operating below the industry average then shareholders expectations have not been met at all. The ROA also decreased from 10.61% to 9.61% in 2012 and 2014 respectively. The industry average as at 2014 stood at 5.17%. This means that despite the decrease in the ratio the company’s management efficiency in utilising the readily-available assets is still way above the industry expectations. This can be linked to efficient asset management policies especially relating to wear and tear of important manufacturing equipment hence increasing their efficiency levels. The ROE also decreases from 20.45% to a low of 14.75% within a similar period. Despite the decrease, the ratio is also way above the industry average that stood at 10.94%. It basically means that the company’s management is efficient in utilising stakeholders’ equity to fund projects that generate higher income capacities (Benninga & Oded S, 1997). In fact, using the above analysis, it can be seen that Spectris Plc profitability in management’s perspective is considered top notch and healthy. It is quite clear that the management team has adopted policies that are deemed useful in propelling shareholders’ wealth to maximum levels. G. Liquidity Analysis From Table 2, it can be noted that the company’s current ratio increases slightly over the three-year period from 1.17 to 1.49 in the period between 2012 and 2014 respectively. The decrease in the ratio indicates unhealthy financial strength of the company since the recommended industry standard should be positioned at 2. Thus, it can be noted that the firm does not possess efficient and reliable capacity to meet possible short term obligations as and whenever they fall due. The decrease is attributed mainly by a significant decrease in the amounts of cash and cash equivalents and an enormous increase in the level of short term borrowings within the same period. The cash and cash equivalent decreases from £40.8M to £34.8M while the short term borrowing increases significant from £2.2M to £50.9M within a similar period. The company’s quick ratio increases slightly from 0.72 to 0.89 in 2012 and 2014 respectively. As at the end of 2014, the industry average quick ratio stood at 0.51meaning that the firm is operating above the recommended level. With this ratio positioned way above the industry average, it can be said that Spectris Plc enjoys a capacity to meet its short-term obligations even without depending on the sale of its inventories (Benninga & Oded S, 1997). The working capital ratio increases within the three-year period 0.05 to 0.10 in 2012 and 2014 respectively. The industry average stood at 1.53 within the period, which means that the firm is operating below the expected industry averages. With this level of ratio value performance, Spectris Plc is positioned unfairly in relation to meeting of its short term commitments. H. Gearing Analysis From Table 3, it can be postulated that the firm’s debt-to-equity ratio decreases within the three-year period from 0.41 to a low of 0.18 in 2012 and 2014 respectively. The industry as at that period stood at 0.72, which therefore means that Spectris Plc is operating below most of its immediate competitors in the global sector as a whole. The decrease in the ratio is an indication that the firm’s ability harmonise equity and debt is inefficient as most projects and day-to-day operations seems to be funded mostly by equity funds. It is important that the firm ensure to improve on its debt standings in order to record and sustain a positive credit score that can be beneficial in future when it will be in need of even more funds from creditors (Fisher, Heinkel, & Zechner, 1989). The equity multiplier also decreases slightly within the three-year period from 1.93 to 1.54 in 2012 and 2014 respectively. As at 2014, the industry averages stood at 1.78, which also means that the firm is operating way below its immediate competitors in the sector. The decrease in the ratio is an indication that the firm has opted to use more equity to purchase assets at the expense of the readily-available debt funds with manageable interest rates. It is important that the firm also embrace the funding of long term projects using long term borrowings in order to reduce pressure on the existing equity-base (Fisher, Heinkel, & Zechner, 1989). The firm’s interest coverage ratio increases significantly within the period from a low of 10.74 to 28.53 in the period between 2012 and 2014 respectively. On the contrast, the industry average stood at 61.14 within the same period, which is an indication that Spectris’ competitors are operating way above it. As a result of operating on a lower industry average, Spectris Plc seems not to be positioned fairly to pay-off interest-related costs to its outstanding level of both short and long-term debt levels. I. Overall Position of the Firm From the ratio analysis above, it can be seen that Spectris Plc profitability in relation to management efficiency is way better in comparison the industry averages. Management team has been able to utilise both equity and the existing asset-base in a more efficient and relevant manner to trigger enough income. The management team seems to have formulated an effective asset and equity policies, which have triggered enough profits in the end. On the contrast, the profitability on equity shareholders’ perspective is quite low and this can be observed with the decrease in the net profit margin. The decrease indicates that the equity shareholder’s wealth is not being maximised as most of the income is used for acquisition and other purposes. It is also established that this profitability has been low due to weaker demand in some of the company’s products. The overall liquidity position of the company remains unfavourable over the period. The company’s current and working capital ratios all remain below the industry averages meaning that the company’s ability to meet up with its short term commitment remains poor positioned. The firm’s gearing ratio is unfavourable given that most of the ratios are positioned way below the industry average. In fact, the company is making efforts to eliminate debt financing at the expense of equity held and this can be noted with the increase of equity financing on existing asset-base. While it might look good to use equities to fund most projects and in purchasing assets, it is important that the company improve on its equity multiplier in order to remain relevant in respect to competition. J. Valuation: Prospective Price-Earnings Ratio Analysis Based On Forecast Normalised Earnings In computing the P/E ratio based on forecasted normalised earnings, it is assumed that the earnings power is the fundamental driver of the entire investment values. Consequently, it is assumed that the differences that arise in price-earnings ratio should be related to the differences in the long run average returns. Furthermore, the market value per share is based on the most recent date: March 9, 2016, which is £17.67(Spectris Plc, 2016). For the purpose of this research paper, the approach related to historical average of ROE is used. The normalised EPS is calculated as the average returns on equity from the three-years under analysis: 2012 to 2014 multiplied by the current book value per share. Therefore, Normalized EPS is calculated as follows; Three-year ROE value = 0.2045+0.2369+0.1475/3 = 0.1963 In 2014: Current book value per share= total shareholder equity- preferred equity/ total outstanding shares = 916-231.4/125 = 5.48 Hence normalised EPS = 5.48*0.1963 = 1.08 Normalised P/E ratio= market value per share/ normalised EPS = 17.67/1.08 = 16.36 The current market value of the company is overvalued at £17.67 in comparison to the actual valuation of £ 16.36 per share held. This might mean that Spectris Plc enjoys a significant level of public reputation by market analysts hence a higher market value. Advantages of the Model The use of the recent book value per share in the course of calculating normalised P/E ratio reflects a higher and much accurate effect on the overall EPS of growth or even shrinkage in the company’s overall size (Ou & Penman, 1989). Therefore, it provides analysts and potential investors with a much advanced and clearer picture of the company over a given period of operation. Disadvantages First, there is a probability that EPS can result to a negative number, which presents a challenge especially because P/E ratio would not make economic sense (Nissim &Penman, 2001). Secondly, it is assumed that the components of earnings that are deemed to be on an on-going framework or even recurrent should be only used in the determination of intrinsic value. On the contrary, earnings will often portray volatile components thereby making the entire analysis process an enormous challenge (Ramakrishnan & Thomas, 1998). Subsequently, Barker (1999,p.394) argues that there is a possibility that the management team might engage in discretion activities that fall within the accounting policies and practices in order to alter earnings per share as a crucial reflection of the company’s overall economic performance, which will result to greater variation when computing P/E across the different sectors. Conclusion To sum up the discussion above, it can be noted that Spectris profitability is fair in management perspective at the expense of equity shareholders. The management seem to have devised effective ways of utilising both equity and asset-base to make profits that are in turn used for funding other projects like the recent six acquisitions, which hinders shareholders’ wealth maximisation objectives. The liquidity and gearing of the firm indicate an unfavourable position over the years hence there is need to come up with clear guidelines on how to harmonise equity and debt funds in financing projects and conducting daily operations. In relation to valuation, the P/E ratio based on normalised earnings postulate the firm’s current stock is overvalued and this might relate to its ability to minimise debt funds. Appendices Table 1 Year/ Ratio 2012 2013 2014 Net profit margin=net income/ sales 141.3/1,230.8 *100% =11.48% 200/1,202 *100% =16.64% 135.1/1,173.7*100% =11.51% ROA= net income/total assets 141.3/1,331.7 *100% = 10.61% 200/1,308.8*100% = 15.28% 135.1/1,406.5*100% = 9.61% ROE= net income/ total equity 141.3/691.1*100% = 20.45% 200/844.1*100% =23.69% 135.1/916.0*100% = 14.75% Table 2 Year/ Ratio 2012 2013 2014 Current ratio=current assets/current liabilities 422.0/ 359.3 =1.17 427.1/ 249.8 =1.71 444.2/ 298.7 =1.49 Quick ratio= current assets-inventory/current liabilities 422.0-163.8/ 359.3 = 0.72 427.1-162.0/ 249.8 =1.06 444.2-175.7/ 298.7 =0.89 Working capital ratio= working capital/total assets 422-359.3/1,331.7 =0.05 427.1-249.8/1,308.8 =0.14 444.2-298.7/1,406.5 =0.10 Table 3 Ratio/ Year 2012 2013 2014 Debt-to-equity ratio= total debt/total equity 82.8+ 200.3/ 691.1 = 0.41 2.2+ 145.7/ 844.1 =0.18 50.9+ 109.5/ 916.0 =0.18 Equity Multiplier=total assets/ total equity 1,331.7/ 691.1 =1.93 1,308.8/ 844.1 =1.55 1,406.5/ 916.0 =1.54 Interest coverage= EBIT/ Interest Cost 196.5/18.3 =10.74 185.9/13.7 =13.56 168.3/5.9 =28.53 References List Benninga, S, and Oded S, 1997, Corporate Finance: A Valuation Approach, McGraw-Hill, New York Barker, R.G., 1999. Survey and Market‐based Evidence of Industry‐dependence in Analysts’ Preferences between the Dividend Yield and Price‐earnings Ratio Valuation Models. Journal of business finance & accounting, 26(3‐4), pp.393-418. CSIMarket. 2016, Scientific and Technical Equipments Industry Averages. Retrieved fromhttp://csimarket.com/Industry/industry_Financial_Strength_Ratios.php?ind=1009 Fisher, E, Heinkel, R and Zechner, J. 1989, Dynamic capital structure choice: Theory and tests, Journal of Finance, 44, 19. Nissim, D. & Penman, S.H., 2001. Ratio analysis and equity valuation: From research to practice. Review of accounting studies, 6(1), pp.109-154. Ou, J.A. & Penman, S.H., 1989. Accounting measurement, price-earnings ratio, and the information content of security prices. Journal of Accounting Research, pp.111-144. Ramakrishnan, R.T& Thomas, J.K., 1998. Valuation of permanent, transitory, and price-irrelevant components of reported earnings. Journal of Accounting, Auditing & Finance, 13(3), pp.301-336 Spectris Plc. 2016. About us. Retrieved from http://www.spectris.com/ Spectris Plc. 2015. 2014 Annual report. Retrieved from http://www.spectris.com/~/media/Files/S/Spectris/annual-interm-reports/2015/annual-report-2014-interactive.pdf Read More