Taylor Wimpey and Barratt Developments Plc - Interpretation of Financial Analysis - Coursework Example

Company Background Taylor Wimpey The Taylor Wimpey history dates back to 1880 when the George Wimpey Company was established. The company is as result of a 2007 merger between George Wimpey and Taylor Woodrow companies in 2007. Taylor Woodrow was started in 1912 by Frank Taylor as ac construction company that later diversifies into home building. Currently, Taylor Wimpey Plc, a member of the London Stock exchange and the FTSE 100, now focuses on the building, construction and sale of homes in United Kingdom and Spain. It is headquartered at High Wycombe in UK. The company has been trading on LSE since 1947 with a market capitalization of close to 5,000 pounds under the Home Construction sector (LSE website). The main source of revenue for the company therefore is private sales of homes (annual report pg. 109). The financial statements are prepared in accordance with the Companies Act 2006 for the financial period ending every 31st December of each calendar year. Barratt Developments Plc The history of Barratt can be traced to the 1950s when Sir Lawrie began building his house. The company became incorporated in 1968 and began trading at the London Stock Exchange. The company currently trades on the main market under the Premium Equity Commercial Companies on LSE. The Barratt Development Group operates three brands in its business : Barratt homes, David Wilson Homes and Barratt London ( Annual Report BDEV) It has headquartered its operations in market Place in London from where they deal in the buying of land, design and construction of homes and the sale of those houses (Barratt Development Plc website). The main sources of revenue for the company therefore included the sale of homes and commercial property (Annual Report BDEV pg. 117). The financial statements are prepared every year for the financial period ending on June 30th of each calendar year in compliance with the company act 2006. Financial analysis ratios An analysis of the financial statements of the two companies can be summarized in the following table. Barratt Dev Taylor Wimpey liquidity ratios 2016 2015 2015 2014 current ratios 3.2957693 3.3297933 3.8507781 3.9796493 acid test ratio 0.5718962 0.374823 0.3903957 0.3372991 profitability ratios gross profit margin 0.1889875 0.1899987 0.2507803 0.2381147 operating profit margin 0.1578202 0.1534247 0.2011275 0.1849522 net profit margin 0.1299348 0.1197766 0.1559972 0.1393842 Earnings per share(adjusted) 54.3 44.6 14.9 11.2 return on Assets 0.0857432 0.0761787 0.1080974 0.0904392 return on equity 0.1372251 0.1213321 0.1798553 0.1476748 Gearing Ratios debt ratio 0.3751636 0.3721473 0.398976 0.3875791 investment potential ratios price earnings ratio 9.0128913 10.973094 10.261745 13.651786 Efficiency ratios inventory turnover 0.7938797 0.7296339 0.6045436 0.5864015 total asset turnover 0.659894 0.6360068 0.6929443 0.6488478 The liquidity ratios show that both companies are fairly liquid although Taylor Wimpey had more assets in cash equivalents that BDEV in the financial year 2015. A more accurate measure of the liquidity, measured by the acid test ratio also shows the same trend. In the same financial year, TW had almost 40% of its operations being financed by debt instruments while BDEV only had 3% less of their assets being financed by its debt instruments. This show that the capital structure of the company is composed of less debt that equity. The leverage of both companies is fairly reasonable given the industry in which they both operate. The housing industry can sometimes be vulnerable and susceptible to bubbles hence lean debt coverage will ensure the company is safeguarded against risks. Efficiency ratios measure how fast a company is able to transform their assets into sales. The inventory turnover ratios for both companies show that BDEV is more efficient in terms of converting its inventories into sales. BDEV turns in inventories 0.7 times a year compared to TW’s 0.6 times a year. In terms of asset turnover, the ratio shows that TW is performing better that BDEV: TW turns over its assets 0.69 times a year compared to BDEV that turns over 0.63 times a year. This is an indication that the operations of both firms are a fairly efficient but TW has shown better effectiveness. The profitability of both firms is measured using the profit margins and the returns ratios. The profit margin ratios show that TW had better profitability during the financial year 2015 that did BDEV. Moreover, TW recorded a higher return on asset and return on equity. TW earned a higher amount on each pound of asset and equity it owned compared to BDEV. This implies that for each pound of investment in their asset, BDEV is earning 0.07 compared to the return of 0.10 earned by TW. However, BDEV recorded a higher amount attributable to each share held: a higher EPS than its counterpart. Both companies also showed improved profit level from their previous accounting period (London Stock Exchange BDEV; London stock exchange TW). The investments potential of any company is measure by the performance of its shares and the returns that accrue to each share. Shareholders are more interested in the price earnings ratio is the share which measures the amount that an investor will be willing to pay for each unit of the company’s earnings. The ratio analyses results show that investor were willing to pay a higher amount for each unit of BDEV’s earnings than they would for TW’s unit earnings. This is an indication that in 2015, investors will be willing to invest in BDEV than TW. Corporate Social responsibility standards The triple line financial reporting model has been picking up in the recent times especially due to the increased concerns over the environmental impact of companies’ activities and their products. The triple line bottom framework include: social, environmental and financial aspects of a company’s performance. The construction industry is most prevalent in this regard. Therefore both TW and BDEV should disclose their environmental impact on the annual reports. There are no specific regulations that require that companies to disclose their social and environmental impact on their annual reports. However the companies Act 2006 was amended in 2013 has added and made it mandatory for a company to prepare a strategy report. In replacement of s417 of the Act, s414 of the Act states that a director of a company must prepare a strategic report for each financial year (S414A (1)) failure to which the directors at the time of the reporting and any other person responsible to have committed an offence (5) under the Act. The Act requires that quoted firm make disclosures on the environmental impact of the company’s activities; the company’s employees; social, community and human rights issues (7b). The amendments to the Act however do NOT specify the standards in which these report should be published. This lack of standards presents some issues from the reporting company and the users of that information in general. Moreover, companies are required to provide forward looking business reviews which do not have any substantial standards except their consistency and compliance to the reported accounts (Enhanced Business review 2009). Adam (2004) in her paper on CSR reporting, notes that the persistent issues with the requirements is lack of completeness in the information provided. This, she notes, is largely due to the minimal inclusion of stakeholders in the preparation of such reports. It becomes increasingly difficult for large companies whose operations extend beyond the home country and regional space: such is the multinationals. In worse situations, some companies actually chose not to disclose such information given that there are no mandatory requirements for the same (Belal and Cooper 2011). There is also possibility that the reporting entity will conceal some information to the extent that this information could be damaging to the reputation of the company (Economie Internationale 2011). The Business reviews also require disclosures before the risk; financial, operational, strategic risks; can is likely to impact on the activities of the company. Some of these companies comply with this regulation only to the extent of disclosing on financial risks (Durie n.d). Furthermore, the regulations leave the kind of information to be disclosed at the Directors discretion which poses a risk of lack of credibility and integrity on the disclosure (Lynch-Wood and Williamson 2008). The information being published is also at risk of being manipulated by those preparing it. This is especially so when the reporting entity provides more information than in necessary (Economie Internationale 2011). Another challenge is that there most of the companies place this strategic report within different places in the report hence reducing the probability of the information being useful. The distorted information is usually given in the probable event that they increase the information asymmetry between the shareholders and the management. The problem with information asymmetry is that the shareholders will always have an upper hand over the shareholders. However these issues are usually presented when it comes to small companies. The larger corporate company’s compliance to these regulations forms a very strategic point in their reputation one in which they cannot afford to lose. In a research on the CSR reporting on mining firms in China, Dong and Xu found that the firms complied with CSR reporting out of the regulatory requirements. The pressures of reporting were also from the fear of maintaining legitimacy in the stock exchange markets. However, the study show that the quality of the information provided was not up to standards (Dong and Xu 2016) In compliance with the required regulations, BDEV has on its annual report strategic report for which it outlines the social, environmental and human rights issue. The problem of ambiguity is clearly seen in their human Rights issue, where the company declares their support for the United Nations Universal declaration on Human Rights but does not expound on the policies in place to ensure these rights are upheld. The report also includes the company’s compliance to the Occupational Health and safety standards and its high ratings at British Safety Council. They have also given a disclosure on the risks that the company is likely to face. However these risks does not include all aspects of the risks as required by the Company Act 2006. This shows the problem of lack of completeness in information that is given. BDEV has also not included a business model in their strategic report. Taylor Wimpey has also included a strategic report in their annual report. It is included in the report a business model as within the requirements of Company Ac t 2006. The company has disclosed its risks managements, its environmental impact, including the GHG emissions footprint for the financial year, its health and safety standards for its employees. The report does not however include the company’s diversity in terms of the gender of its employees. This presents yet another issue that comes with the lack of disclosure standards: the manipulation and incomplete or no disclosure of certain information. Essentially, the strategic report for TW is not as comprehensive as they ought to be according to the requirements of the standards. Financial Analysis & Recommendations Barratt Development Plc BDEV Company is one of the biggest players in the home construction industry. The share price of the company is currently trading at 486.20p. An analysis by the London Stock exchange show that the company’s share has been fairly stable” not much deviations has been seen in the last few months. The profits for the company in the last few years have been increasing: since 2012, the profit has been on an increase (London Stock Exchange BDEV). Key fundamentals also show that the EPS of the company’s share has been growing tremendously. The ratio analysis has also shown that the Barratt Development Plc is highly liquid. A liquidity ratio of 3.3 in 2015 shows high liquidity. This is however a risky level as it could be a representation that the company is not using its resources efficiently. This level of liquidity is also reflected in the debt ratio of the company. With a leverage level of 37%, it goes to shao that the company is not likely to go into liquidation or bankruptcy. The profits of the company as reported by LSE shows that there has been an increase over the years. In 2015 alone, the company realised a net profit of close to 500 million pounds. This profit level has been reflected on the profit margin ratios. The company reported a gross profit margin of 0.19 and a net profit margin of 0.12. This shows that for every unit sale of homes the company makes, 0.12p is the profit. This is fairly reasonable considering there was an improvement of the same in the current year. The earnings per share in 2015 were 44.6: interpreted to mean that for each share that is held, the company earns 44.6. This is quite an attractive amount for the investors willing to invest in the company. This value would only prove meaningful in comparison to the amount that has been paid off in terms of dividends. The dividend paid to shareholders has over the last four years increasing at a faster rate: in 2015, the company declared a dividend amount of 13p for each share held (London Stock Exchange Barratt Developments Plc). The return on asset on equity showed that the company earned less than 0.2 on each money amount held in assets or equity. Further the analysis included the investors return on the shares bought. The price earnings ratio for the company in 2015 was recorded at 10.91. This translates to mean that investor is willing to pay 10.91p for each unit of earnings the company makes. The financial ratios also show that BDEV is quite efficient in using its resources to generate revenues. It turns its inventories 0. Times a year compared to its assets, o.6 times a year. Taylor Wimpey The home construction company is virtually the benchmark of home construction companies in UK given that it form a part of the FTSE 100 companies. The financial reports of the company show that the profitability of the company has improved over the last few years. As a reflection of this profitability, the margin ratios indicate that only 0.2p of its gross income is reserved as profits while 15% of its net income is considered to be profits. This level of profit is very low considering the industry in which the company operates. The shareholders get to enjoy an EPS of 14.9 for the 2015 financial year with a dividend amount of 15p per share held in the same year. The return on asset and equity show that the shareholders of the company are only receiving less than 0.2p on each unit of investment amount on either assets or equity. This is considerable a low amount. The leverage of the company is at 40%: higher than that shown by BDEV. This liquidity position is also reflected on its liquidity ratios that indicate that the company is fairly liquid: with an acid test ratio of 0.39. Both the companies show strong performance for the year in question. However in terms of liquidity, TW proves to be more liquid than the other though it has a greater gearing ratio than BDEV. Moreover, Taylor Wimpey gives an indication that shareholders are like to gain more from investing its company that investing in BDEV: the company’s profitability ratios show that the TW is more profitable than BDEV. However, BDEV has a higher P/E ratio that does TW. Much as this amount reflects that willingness of investors to buy BDEV shares more than TW, the dividend policy of TW is better( at 15p per share compared to 13p/share for TW). The efficiency with which TW converts its assets in sales is better than BDEV. Therefore in terms of which company offers a better investment choice, based on the financial ratio analysis, then an investor should invest most in TW than BDEV. Limitations of Ratio Analysis The ratio analysis is an effective way of establishing the performance of a company in relation to its previous year’s performance and other industry players. However, this analysis is not full proof of its limitations. The ratio analysis depends mostly on the reports that have been given on its financial statements of a company: all of which are assumed to be audited and confirmed to be true and fair. However, this single source of information also provides the opportunity for limited analysis. The further interpretation of the ratio therefore only considers the given information and disregards other effects of the changes in the financial statement. This includes the effects of inflationary pressures on the company. Inflationary pressures affect companies in very many different ways and therefore if the ratios cannot capture this effect, then their interpretation runs the risk of incompleteness. Given the single source of information, any use, analysis and interpretation of ratios calculated from the financial statements cannot be verified to be the true and fair representation of the situation. The financial statement, though assumed to be drafted according to the required standards, has the possibility of being distorted. Moreover, the differences in the accounting policies present a challenge in the matching of the contents of the statements for the companies in comparison. The issue of seasonality also proves a challenge in the evet that the companies in comparisons do not have the same financial year period. Such is the case for BDEV and TW where BDEV calendar ends every 331st December while TW calendar ends ever 230th June. The ratio analysis is also only useful in making comparisons for companies that are within the same industry or sector. For TW and BDEV this was particularly easy since both companies are part of the home construction industry. However where two companies are different sectors, then the interpretation of the ratio would not exactly bear the same meaning. The use of ratio analysis also presents the problem of misinterpretations. The most effective use of ratio analysis involves a comparison with an industrial benchmark that allows for the investment analyst to correctly place the deviation from the benchmark. This analysis faces the challenge of not being able to use the benchmark to estimate the deviation of both the performance of BDEV and TW. Moreover, in cases where this gap is identified, either in comparison with the benchmark or other competitors, the ratio analysis only provides a view on the areas of concern but does not exactly indicate the reason for the gap. Furthermore, one ratio cannot be used in isolation to evaluate the performance of a company. A true analysis requires that a full ratio analysis be done for the overall performance of the company to be established.  References Annual Reports and accounts 2015 Taylor Wimpey Plc: Creating Value by Delivering Quality Annual Reports and Accounts 2016 Barratt Developments Plc: Building Sustainable Values Belal and R and Cooper S the Absence of Corporate social responsibility reporting in Bangladesh Critical Perspectives on accounting 2011Elsevier Dong S and Xu L 2016 the Impact of explicit CSR regulations: evidence from China’s mining firms Journal of Applied Accounting Research vol 17 issue 2 pp237-258  Durie A legal Requirements for CSR reporting in the United Kingdom, Denmark and Australia Journal of the Australian Law Teachers Association pg. 11-27. Economie Internationale 2011 Corporate Disclosure: a review of its (direct and indirect) benefits and costs. Lynch-Wood G and Williamson D 2008 Social and Environmental Reporting in UK company law and the issue of integrity. Corporate Governance pg. 128-140 The Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013 [online] available from: www.legislation.gov.uk/ukdsi/2013/9780111540169 accessed 21/11/2016 London Stock Exchange: Barratt Development PLC ORD 10P [online] available from: www.londonstockexchange.com/exchange/price-and-markets/stocks/summary/company-summary/GB0000811801GBGBXSET1.html accessed 21/11/2016 London Stock Exchange: Taylor Wimpey PLC ORD 1P [online] available from: www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary/GB00008782301GBGBXSET1.html accessed 21/11/2016 Read More