Financial Ratio Analysis of BT Group Plc - Case Study Example

Financial ratios: BT Group plc Name: Tutor: Course: Date: Table of Contents Table of Contents 2 1.1 Introduction 3 1.2 Financial ratio analysis 3 1.2.1 Efficiency ratios 3 1.2.2 Liquidity ratios 5 1.2.3 Capital structure ratios 6 1.2.4 Investment ratios 8 1.3 Summary 10 1.1 Introduction BT is one of the oldest communications and IT solutions companies in the UK serving global customers in 180 countries. The company is a leader in broadband, cloud services networking and fixed-voice to about 900,000 customers in the Republic of Ireland and the UK. Some of the other services it offers include mobile services, BT sport channels and TV. Listed in both London and New York stock exchanges, BT is a wholly owned subsidiary of BT Group Plc and provides services and network products to more than 1400 communication providers in the UK. BT is an international company serving wholesale B2B customers who in turn provide audio and data transmission solutions as well as real-time video to about 500 media distribution and production customers globally. The company is very enthusiastic about the performance of its broadband revenue with Ethernet rental base expected to increase by 17% in the second quarter of 2016/17. In order to order Ethernet circuits online, the company launched a new platform which is easier and quicker for its customers. Furthermore, the media and broadcast business completed upgrades of ultrafast fiber to 20 leading stadiums in the UK; hence delivering live footage of matches to global and national audiences. The company is expected to grow immensely in the Ethernet solutions as it is the next generation service. The UK has a vibrant internet economy which will be facilitated by BT’s vital infrastructure after it grew by 3% in 2014. 1.2 Financial ratio analysis Ratio analysis helps BT Group plc to be accountable to its creditors, financial institutions and investors. In the BT case, assets in balance sheet have been derived from the current purchase price identical to modern equivalent asset or new asset with the same service potential. In this analysis, the financial ratios to be considered are efficiency, liquidity, and capital structure and investment ratios of BT in comparison to Vodafone, a major competitor. 1.2.1 Efficiency ratios Key ratios under consideration are inventories turnover period ratio, trade receivables collection period ratio, and trade payables payment period ratio. i) Inventories turnover period ratio Inventory turnover ratio = Cost of Goods sold (CoG)/Average inventory From the table above, it shows that BT’s turnover ranges .57 to .65 which shows that BT Group sold more than half of its inventory during the year. Compared to 0.5 of Vodafone, which is about two years, the company takes less than two years to complete one turn or sell its entire inventory. BT Group, in other words, has a fairly not good inventory control. The company is storing non-salable inventory and could be overspending in the purchase of too much inventory. BT managers should effectively sell the entire inventory they buy within one year or less. ii) Trade receivables collection period ratio Trade receivables collection period = 365days * Trade receivables/ Credit sales As shown in the table above, the trade receivables collection period represents the time lag between receipt of payments from the customer and the credit sales. Totals sales were used in the place of credit sales figure because the amount of credit sales was not separately available in the income statement. The table shows that it takes the business about 57 to 64 days to collect cash from trade receivables each year compared to 42 days taken by Vodafone. As this period is about two months, it shows that the company is good in liquidity perspective but could be reducing its administration costs and level of bad debts on collecting receivables. BT could be having a tight credit policy that aims to lower the collection period but could be actually reducing the level of sales. iii) Trade payables payment period ratio Trade payables payment period = 365 * Trade payables / Credit purchases This represents the time lag between making payment to supplier and receiving credit purchases. Again, total purchases were used in this case because the amount of credit was not available in the income statement. The table above shows that BT takes on average 130 days (about 4 months) to pay its creditors compared to 15 days of Vodafone. This is a lengthy period which is preferable and shows that BT has good relations with its suppliers. It may also indicate that BT is in financial distress as it has no cash available. On the other hand, caution needs to be taken as it may result in the loss of credit worthiness. As a result, it could lead to interest charged on overdue amounts, delays in processing of orders by suppliers and withdrawal of credit in future. 1.2.2 Liquidity ratios In this case, current ratio and acid test ratio are considered. Current ratio measures the ability of the company to pay long-term and short-term obligations. It considers its total liabilities relative to total assets. i) Current ratio Current ratio = Current total assets/current total liabilities The table above shows that BT is liquid because it is able to generate cash faster than the bills due. BT is in a good current position (about 1:1) because of its quick cash conversion and indicates that it has adequate resources to meet its short-term obligations. Conversely, Vodafone (0.69:1) is illiquid and suggests that it pays its bills with working capital and not cash which is dangerous to the sustainability of the company. This may not be an industry trend and could be disadvantageous to Vodafone. Increase in BT ratio from 0.98 to 1.03 in 2014 and 2015 respectively shows declining use of overdraft facilities. The company indicated in its annual report that it is focusing on reducing unsustainable debt levels. Moreover, BT in 2015 had a pension deficit investment on television content (BT sports) and infrastructure (Openreach). ii) Acid test ratio Acid test ratio or quick ratio is used measure how the company uses quick assets to pay its current liabilities within 90days or in the short-term. Acid test ratio = (Total current assets-inventory-prepaid expenses)/current liabilities The table above shows that BT has higher quick ratios 1:1 implying that it is able to pay its current liabilities easily by converting its assets into cash. BT may not have to sell its capital or long-term assets to pay-off its obligations but will use it to generate revenues. On the other hand, Vodafone has lower quick ratio implying that it has high level of liabilities compared to assets and may find difficulty in converting some of its assets into cash to pay its current liabilities. High quick ratio for BT shows a good sign for investors and credits who know that they will be paid back on time. 1.2.3 Capital structure ratios The ratios to be considered in this case are; gearing ratio, interest cover ratio and the equity ratio. i) Gearing ratio This ratio compares funds borrowed by the company to capital or owner’s equity. Gearing ratio = (Long-term debt + short-term debt + bank overdrafts)/shareholder’s equity As shown in the table above, the gearing ratio is high. For example, the gearing ratio of BT in 2014 was 1395% which indicates a great deal of leverage. BT is using debt to pay most of its continuing operations but shows that it risks bankruptcy because have trouble meeting its debt payment schedules. It will even be worse when interest payment problems arise from debt arrangements with variable interest rates. High gearing ratio is applicable to ongoing and large fixed asset requirements. On the other hand, Vodafone has low gearing ratio which shows a conservative financial management and cannot overextend when faced by downturn in sales and profits. BT can convert its loans by swapping existing debt for company shares or reduce inventory levels. ii) Interest cover ratio The ratio shows how outstanding debt can be met by paying from interest expenses. Interest cover ratio = Earnings before Interest and Taxes/Interest expense From the table above, BT’s interest cover ratio is more than 1 and has been increasing over the last four years. This implies that the company meets the acceptable minimum of 1.5 required by lenders to lend the company more money because its risk to default is not too high. On the contrary, the company has high interest cover ratio which shows that it has dipped further into paying interest from loans to expand Ethernet and broadband and the debt itself and do not have to worry much. On the other hand, Vodafone is paying more of its interest payments and not the debt itself which is indicative of a dangerous practice. iii) Equity ratio This ratio is indicative of the company’s level of leverage and measures the total asset’s proportion that stockholders finance. Equity ratio = total equity/total assets From the table above, the equity ratio is about 1 to 5 percent indicating that investors are funding more assets by only 5 percent. It shows that 95 percent of the BT’s assets are in the hands of creditors with only 5 percent being owned by shareholders. Besides, it implies that BT has high debt service costs and huge financing or TV, broadband and Ethernet services. In the communication industry, this is not a healthy ratio since Vodafone also shows that shareholders only own 13 percent of the company’s assets. This also indicates that the company is not worth investing by potential shareholders but potential creditors find it less risky and more sustainable to lend its future loans. 1.2.4 Investment ratios In this case, dividend cover, and dividend yield, P/E ratio and earnings per share (EPS) ratio were considered. i) Earnings per share (EPS) ratio This is the share of common stock allocated from the company’s profit. EPS = (Net income – preferred dividends)/ Weighted average common shares outstanding From the table above, diluted EPS included the shares of warrants and convertibles in the outstanding share number. BT did not have preferred dividends for the four year period which is normally set-aside for preferred shareholders. Compared to Vodafone (0.01), BT has higher EPS (0.26) in 2015 implying that it is more profitable and has profits good enough to distribute to its shareholders. As a result, the company’s stock price is likely to rise as potential shareholders show interest in investing in the company. ii) P/E ratio Price-earnings ratio measures per-share earnings to the current share price P/E per share = Market value per share / Earnings per share From the table above, the P/E ratio for BT was 16.85 which falls in between the market range of 15-25 but has been fluctuating significantly depending on economic conditions. This shows that investors are willing to pay £16 to £1 of its current earnings. However, Vodafone has a higher P/E ratio (39.8) yet they fall in the same industry meaning that investors are more likely to invest in Vodafone that BT Group plc. Relative to its past trends, BT is doing exceptionally or could be currently undervalued. iii) Dividend yield Dividend yield is the dividend taken as percentage of current share price. Dividend yield = Annual dividend per share / stock price per share In the close of 2015, as shown in the table above, BT has a dividend yield of 3.97% compared to Vodafone’s 4.92% which was higher. This shows that both companies have good dividend yields and thus good dividend payers. The companies have stable inflow of rental payments and payment from services in TV, broadband and internet that they offer. This means well to an income investor who see stock dividend yield as a useful financial valuation measurement. iv) Dividend cover Dividend cover measures the ratio of dividend paid to shareholders to that of net income (earnings). Dividend cover = (Net profit – dividends paid on preference shares (irredeemable))/ Dividends paid on ordinary shares From the table above, the dividend cover (x) was 4 times in 2015 for BT group and was also 3.93 times for Vodafone. This implies that BT group has sufficient earnings to pay about 4 times the dividends due to the shareholders during the dividend payout period. In line with the market expectations, BT Group is maintaining a reasonable payout despite dividend payments being discretionary. The dividend cover is generally above 1.5 which implies that in the event of future variation in profit, the company is able to maintain the present level of dividends. Similarly, BT group is retaining higher portion of earnings for higher future dividend payouts and financing requirements. 1.3 Summary The analysis above has shown that BT Group plc does not have good inventory control and should sell the entire inventory they buy within one year or less. Compared to Vodafone, BT Group is doing well in liquidity perspective as it pays its bills with working capital and not cash. However, they need to reduce their administration costs and level of bad debts by collecting receivables. BT shows a good sign for investors and credits who know that they will be paid back on time given the high quick ratio. Nevertheless, it is using debt to pay most of its continuing operations but shows that it risks bankruptcy compared to Vodafone that is paying more of its interest payments and not the debt itself. BT is more profitable and has profits good enough to distribute to its shareholders and relative to its past trends, BT is doing exceptionally well. Above all, just like Vodafone, it has sufficient earnings to pay the dividends due to its shareholders. Bibliography BT Group plc (2016). Regulatory financial statements. Available at: http://www.btplc.com/Thegroup/RegulatoryandPublicaffairs/Financialstatements/index.htm. Drake, P.P. (2015). Financial ratio analysis. Available at: http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf Poznanski, J. Sadownik, B. & Gannitsos, I. (2010). Financial Ratio Analysis. Vancity Community Foundation. Thompson, A.A & Strickland, A.J. (1996). Strategic management: Concepts and cases, 9thed. Irwin: Chicago, p. 326-7. Copyright, Irwin: Times Mirror Higher Education Group. Vodafone (2015). Vodafone Group plc Annual report. Available at: http://www.vodafone.com/content/annualreport/annualreport15/index.html Appendices BT Group plc financial information Available at: http://shares.telegraph.co.uk/fundamentals/?epic=BT.A ; http://www.marketwatch.com/investing/stock/bt/financials and http://www.redmayne.co.uk/research/securitydetails/financials.htm?tkr=BT.A Note: Due to unavailability of a specific CoGS, the payable days ratio was calculated from operating costs and not CoGS in the case of BT Group as shown in its annual report. Vodafone financial information Available at: http://www.tradingeconomics.com/vod:ln:eps Read More