Corporate Finance in the Breville Group Limited - Example

Corporate Finance: The Breville Group Limited Student’s Name: Instructor’s Name: Course Code and Name: University: Date Assignment is due: Corporate Finance The Breville Group Limited Breville Group Limited (BRG) is company that deals with marketing and designing household electrical appliances. Breville Group Limited (BRG) distributes and imports electrical consumer products in a number of markets which include USA, Australia, South Africa, Canada, Hong Kong and New Zealand. Shanghai and Hong Kong offices are responsible for trading and sourcing. The company markets espresso machines, kettles, citrus presses, vacuum cleaners, juicers, sandwich makers, toasters, cutlery, rice cookers among others. Breville Group Limited is a company that is publicly listed and is placed at position 805 out of the leading 2000 companies in Australia. The company gets most of its income by trading household goods in the Australian industry. The company’s product development is located in its center of business in Sidney. Capitals structure Capital structure is the composition of total financial of a company. It is the particular combination of equity, debt and other sources of finance that are used for purposes of long term financing. The portion of debt funding is measured by gearing (Baker & Wurgler 2002, p. 9-10). The main division is between equity and debt. Capital structure is the company’s long term financing that includes common stock, preferred stock, long-term debt and retained earnings. http://www.financescholar.com/modigliani-miller-propositions.html Modiglian and Miller (1958) proposition II maintains that the worthiness of value of a firm depends of debt/equity ratio of the firm, the firm’s cost of debt, and the required rate of return on the assets of the firm. M & M proposition I dictates that firm value is not dependant on its capital structure. This paper looks at the capital structure of Breville Group Limited and explores the historical and current leverage policy associated costs and risks and optimality, and the dividend policy of the company. Falling construction in household, compounded by with the swiftness with which retailers are able to go around wholesales in make growth in the industry not to be expected soon. The emerging and expansion of gardenware and hardware retail outlets like Bunnings, that possess enough market power in dealing directly with the manufacturer, has brought down the wholesaling activity in the industry, on which Breville used to make good profits. Besides, house prices that are falling and a construction sector focusing on industrial works has lowerd the demand of most of the industry good. Owing to this, sales revenue in the period 2011-2012 is expected to be 3.6% lower as compared to the previous year posting a figure of $2.13 billion. It has experienced a yearly decline of 2.7% for the past five years. Current leverage analysis The capital structure of Breville Group Limited seems to not fond of using debt capital as seen the figures posted from the previous years. The debt figure has drastically fallen. The last debt to capital ration posted in 2011 was 0.28%. The debt and equity had a gearing ratio of 29.93% in the previous years. It fell drastically owing to reduction of debt by a margin of 27% to reach a record of 2.93% in the year 2010. In mid last year it had gone down to a small value of 0.28%. This indicates the cutting down on credit fund and thus reducing the amount of debt capital to a very small figure by the end of the year. This is as resulting of some losses from default contracts and hence the company is carefully concerning debt funding. Breville increased its quick ratio and current ration after the global financial recession through reduction of debt. The company wants to cope with the effect of a slow growth in the global economy. ($miillions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Total debt 72.70 55.19 70.42 79.08 77.71 94.51 53.60 39.30 4.40 0.44 Total equity 127.0 141.9 158.7 159.6 157.7 117.1 131.7 131.3 150.2 153.6 Gearing 57.24% 38.91% 44.36% 49.55% 49.27% 80.7% 40.7% 29.93% 2.93% 0.28% In the year 2011, Breville Group Ltd increased its cash reserves by 14.0550m or 104.04%. The company went ahead to earn 46.997m emanating from its operations for a cash flow margin of close to eleven point nine four percent. The company spent 6.3080m on investing activities and spent 24.755m in financing cash flows. Between 2004 and 2006 and debt and equity was almost split into two equal ratios. In 2002, it was second higher that any other year in the period registering a ratio of 54.24%. In this case, debt capital exceeded equity capital. In 2007, it also went to tremendous ratio and the highest that any other fiscal year, debt/equity ratio was 80.7% indicating debt capital being dominant in the capital structure of the company. The evolution of the income statement is shown the figure below: Capital expenditures and its financing Breville Group sales revenue was steady in Australian dollars at $393.3, in spite of adverse foreign exchange movements on the translation of sales which were non-Australian and the residual impact of the completed exit of the North American home wares that are non-electrical. Despite these turn of events, the sales revenue increased by a margin of 7.6% as compared to the one posted in the year 2010. Breville EBITDA in Australian dollars went up by 16.3%, this is after underpinning by strong performances in North America and the corresponding International distributor trading. PAT went down by 40.5% whereas EBITDA increased by 22.6%. The international operations of the company performed well. Apart from the acquisitions which were completed in 2003 and 2001, Breville Group has not had any other acquisitions in the last nine years. Consumer commission of Australia opposed acquisition of Breville Group by GUD Holdings. Breville Group and GUD Holdings are the two largest in appliances and they take the largest share of sales in various product category. In other product they possess a sales share of over ninety percent. They are the closest competitor and place the strongest constraint on one another in whole supply of electrical accessories and appliances. The commission argued that if GUD Holdings went ahead and acquired Breville Group, there would be drastic reduction in competition making the single dominant company to rise prices and reduction in competition in relation to promotion, product range, and innovation. Capital structure of comparable companies Debt to equity ratio for the past five years BRG TLS SGT IIN 2007 80.7% 117.2% 31.0% 16.8% 2008 40.7% 126.6% 35.9% 17.5% 2009 29.93% 136.6% 36.6% 12.3% 2010 2.93% 114.6% 29.3% 23.6% 2011 0.28% 115.3% 29.9% 42.0% From the table above it can be depicted that debt to equity ratio of Breville Group has been decreasing over time until it hit a mark of 0.28% inn the 2011 fiscal year. Telstra Corporation Limited (TLS), Singapore Telecommunications Limited (SGT), and iiNet Limited (IIN) shows a clearly different picture. Although Singapore Corporation Limited debt to equity ratio is not quite large, it has remained steady of the past five years. At point it has fluctuated to remain at a stable level of around 29%. Telstra Corporation Limited uses a colossal amount of debt capital and its composition of capital is mainly made up of debt. Equity capital is low. The company’s operations are mostly financed through borrowing. iiNet Limited debt to equity ratio has been relatively low over the past four years, remaining below 25%. Last year it shot up to 42%, which indicate more than double increase in borrowing and hence shooting up the debtr capital to a point where it is almost equal to the equity capital. Debt to equity ratio measures the amount of money a corporation is able to safely borrow in long period of time. The Debt to equity ratio is normally given by dividing total debt by total equity. A debt/equity ratio that is high shows that a company is involved aggressively in financing its operation activities using debt capital. Interest expense occasion by this tendency can lead to earnings that are unpredictable since interest expense is calculated outside the firm at varying terms. There is high possibility that a firm can generate high earnings when it involves high debt since many operations will be financed. Debt capital helps the firm to do a lot that it was not able to do with the equity capital alone. The shareholders are bout to benefit from increased business that will result in more earnings. With more debt financing there is no need of increasing the number of share holders through sale of stock. Nevertheless, debt financing cost is normally more than the earnings that the corporation will make from it. The company can be overcome by borrowing and the unpredictable trading environment can mean that the company has high chances of being liquidated in case of losses as compared to another that used little debt financing. iinet Ltd and Singapore Telecommunication Limited have their debt capital relatively low as compared to Telstra Corporation Limited. Among the four companies, Telstra Telecommunication Limited records the highest debt to equity ratio. In case of a recession in the economy or turbulence in the general market economy, it is the first company to suffer the most consequences as compared to its peers in the same industry. More debt capital as compared to equity capital has been incorporated into its capital structure. Breville Group has decreased to a very small value its debt capital and it will be least affected in case of unstable conditions in the market and fluctuation of the interest rates. Many firm trust internal financing as compared to eternal financing where they are at the mercy of other financial institutions. Pecking order theory Pecking order theory brings into focus the costs of information that is asymmetric. In this theory companies order their financing sources basing on the least effort law, or having the least resistance and prefer to raise equity capital as a last resort means. Internal financing is applied first, and when it is exhausted, debt is subsequently issued, and when it does not make sense to use any more debt, equity is again issued. Internal financing is always preferred. Breville Group management has borrowed a lot of application of this theory in the running of the company. Despite hard economic conditions, the company was able to make substantial profit. Over the years it has also reduced debt capital tremendously and preferred to use internal financing. The earning made can now be used to pay dividend of shareholders and the expansion of business as the company seeks to strengthen its brand penetration globally. The debt capital used by the company in the fiscal year 2011 was very little amounting to a debt/equity ratio of 028%. This shows that Breville Group succeed largely in its target of avoiding debt financing and preferring internal financing. The profits increased due to decreased interest rate expense and the shareholders got more earnings from their investment in the company. The general outlook indicates that the company has a bright future and more and more people will be preparing to invest in a profitable company. The company will attract investors who want to make quick earnings on their investment. A ten year total return of Breville reveals the following picture as should in the diagram. The project return on capital invested shows that the company is prepared to report more due to growth and expansion in the international market. M&M theory and tax shield Modiglian and Miller observed that splitting the capital structure of the company between equity and debt or any other finance resources is not the important thing. This is because through issuing financial assets, the company sold its real assets to people and it is not crucial whether if it sells its assets in total or through issuance of stock or divide them in components that are smaller and sell them to people separately (Aivazian, Booth & Cleary 2003). The sum of individual components should be equal to its total value. Owing to this fact, the company’s value is dependant on business risk and profitability. The investors are able to replace their personal leverage in the place of partnership company leverage and be able to return every capital structure to its original form. DIVIDEND POLICY Overview of Dividend Policy Miller and Modigliani (1958) applied logical analysis to give an explanation for dividend policy of a firm. They put across that in a market that is perfect, the firm’s value would remain independent of its dividend policy and subsequent change in the dividend policy will show a corresponding change in the management view concerning future earnings. Some of this view does not hold in the long term. An increase in dividend in a particular quarter may be as an outcome of good performance of a firm in preceding quarters, which may persists in future. This aspect supports a positive relationship between future earnings and current dividends. In another case, an increase in dividend in one quarter may result from the policy of the management to keep investors in a satisfactory mood and make them not to sell their stock when the future earnings are anticipated to go down or prevailing losses are expected persist. Some of the companies have applied this method, IBM decided to increase dividend in the 1990s when the company was persistently losing money (Baker 1999). Such a decision proved to bring good result because IBM’s shareholders continued to hold their stock despite the difficult times. This is a perfect case of rising dividends that is succeeded by earnings decline. Despite the hard economic times, Breville Group has increased its dividend payout as an effort perhaps to keep the shareholders happy. The fourth case is whereby an increase in payout of dividend in one quarter may cause decline in money that is to be invested by the firm and consequently cause a drop in future earnings. In real sense, this is the major reason why many companies stick to residual dividend policy in the case whereby they only pay dividend after all their reinvestment needs have been satisfactorily met. On the other hand, companies that maintain high dividend payout without putting into consideration their needs for investment may in future be faced with lower earnings. This case will support negative relationship from dividends to earnings. The company is at liberty to decide the amount of dividends to be paid and what should be kept within the company for reinvestment. Once a company makes a decision whether to pay dividends or not, they have to go ahead and come up with a dividend policy. Dividend policy is the trade off between payout and investment decision (Rosenbaum & Pearl 2009). The amount the companies pay as dividend present its performance in the market. Dividend can be split into shares and cash, or a combination of the two. Dividend payout is a crucial signal to the market. It is an important source of finding out the stage of the company in the industry, the value of the firm and future cash flows of the firm. The Correlation between EPS and DPS Increase in earnings per share dictates the funds available in future for reinvestment into the company. It has also an impact on equity and debt financing. Assists in setting cash income returns for shareholders and to some degree affects changes of prices of equity securities in future. Consequently, future estimates of earnings per share that is accurate are very crucial to any investor, financial manager, the financial analyst, and a student of corporate finance. One way of estimating future growth in earnings per share is normally to extrapolate past rates of growth. In a study carried out in several corporations between 1965 and 1950, there was apparently very little connection between relative growth in earnings per share and the period that followed (D’Souza 1999). Growth in one period rarely meant growth in the next period. The rate of return on equity capital and dividend payout ration is another method used to estimate future growth in the rate of earning per share. This method has an assumption that changes in the rate of return on equity capital are insignificant. If the rate is kept constant, then the growth of earnings per share will be equal to the rate of return on equity multiplied by the percentage or amount of earnings retained. The Breville Group has maintained a high dividend payout ratio despite the economic conditions prevailing in the market. This could be supported by the revenue sales posted by the Group despite hard economic times. The operation of the business to a profitable level has been boosted by the Breville Group international business which has been positive despite a adverse economic condition at home evidenced by a weakening currency. Code Div Amount Ex Div Date Record Date Date Payable % Franked Type Further Information BRG 5c 13/09/2010 17/09/2010 06/10/2010 0% Final UNFRANKED NIL CFI D.R.P. SUSPENDED BRG 9.5c 08/03/2011 15/03/2011 08/04/2011 42% Interim 4C FR @ 30%; NIL CFI D.R.P. SUSPENDED BRG 7c 16/09/2011 22/09/2011 12/10/2011 100% Final 7C FRANKED @ 30% DRP SUSPENDED The current Earning per share and dividend per share stand at 27.6 and 16.5 respectively. Both earning per share and dividend per share; not including extraordinary items growth, increased 42.19% and 50.00% respectively. The positive move in payment of dividend in not significant since most companies engaged in retail industry do not pay dividend. Moreover, when analyzed on a five year annualized criteria, both earning per share and dividend growth, ranked the same as the average rank of peers in the industry. Whether a particular capital structure is optimal relies on that firm on individual basis. In the case of Breville Group, the competition in the industry is quite high and hence cash flow is not predictable to large extend. Consequently, the debt financing has to be kept at a manageable degree. In the year 2009, the debt financing for Breville was 30% and it had dropped by a margin of 25% as compared to the year before. By the time of financial crisis, it was 60% less. Other competitors in the market also reduced their credit fund to a significant margin. The interest coverage ratio went down for Breville Group since the net income decline, on the other hand the four point five two interest coverage from basis of earning and 6.57 from the basis o0f cash flow demonstrated the company had no problem in paying back its debt. After all the debt amount had been decreased tremendously. Sustainable growth for Breville Group went down from 11.4 in the year 2008 to around 6.18% in the year 2009. The tremendous decline was directed by increasing dividend payout and decreasing net income. By history, Breville Group has maintained a high dividend payout but it brought down it s dividend payout following the financial crisis experienced in the year 2007. The objective of increasing dividend payout is to increase the shareholder’s faith in the company. In another perspective, Breville directors are hopefully of a bright future for the company. Breville Group has proved to be a formidable company with the announcement of 40.5% in its net profit for the fiscal year 2010-2011. In the report posted by Australian Security Exchange, the company posted that net profits after tax for the year grew to $31.7 million whereas as the sales revenue stabilized at $393.6 million. Breville underlying EBITDA (Earnings before interest, tax, depreciation, and amortization) went up by 16.3% to reach $58.3 million, emphasizing the core strategy of the Group of building the Breville brand allover the globe through leveraging its capabilities and products across different geographical areas. Whereas Breville sales revenue went down by 3.5% in Australia, 4.2% in North America and 2.5% in New Zealand, Breville’s international trading recorded a growth of forty point one percent in sales revenue for the fiscal year. Breville Group remains determined to broaden its distribution networks particularly over the vast region of Asia-Pacific. Breville Group pointed out difficulties in the retail market of Australia as a basis that culminated in the dismal revenue in the home market. Retail conditions were not easy in the second part of the year which saw; consumer spending reducing and deflationary pressure mounted as the market came under pressure to a higher exchange rate between the Australian dollar and the United States Dollar. In markets that were competitive, there was a positive responsive from consumers to a strong pipeline of launches of new products which were duly supported by programs of marketing in the entire year. The multi-brand strategy of the group continues to show its relevance in the market in Australia. With a differentiated position that is clear across brands portfolio, Breville Group has gone ahead to maintain its leadership in the market in the core appliance category in the kitchen. Astralian underlying EBITDA went down by a margin of ten point five percent, but this was corrected by a rise in the international underlying EBITDA of thirty six point three percent. In spite of a solid first half performance, consumer spending in the subsequent half became weak causing a fall of the overall demand in the market. Breville concentrated on ensuring a first position at the premium price upper end points appliance category in the kitchen, whereas Kambrook did perform well in a segment of the market that was very competitive. Breville Group persisted with its investment in brand marketing in spite of tradition conditions that were difficult. The general performance of Breville Group shows that there is brand strengthens in the market internationally in response to major appointment overseas. This includes Damian Court being appointed the USA president of Breville Group. Damain Court joined the Group after having served as the Sunbeam’s marketing manager for sometime. The position at Breville gave him an opportunity to show his skill at ensuring international growth of Breville Group. Clientele Effect and Transaction cost Investors who need current income will be attracted to firms with payout ratios which are high. Consequently, the strategy of Breville Group to maintain high payout ratios is a very good strategy of attracting investors. Those investors who want just to avoid taxes will invest in companies or business issuing low payout ratios. The type of clientele of the firm will be dictated by the dividend policy maintained by that particular firm. Firms have to be very carefully when making changes in the dividend policy and rush decisions should be avoided at all costs (Higgins 1972). Breville clientele is likely to be made of investors who are fond of high income and they do not avoid taxes. A change in dividend policy gives signal in the financial position of the firm. An increased in dividend is a signal of future earnings that are good. A dividend decrease on the other hand may be a signal for future earnings that are poor. Earnings should be retained and reinvested as long as investments are more than returns of stockholders which can be obtained on other investments of same risk. This is demonstrated in the graph below. A company has to retain all earnings necessary to invest until the point of intersection marginal cost of capital (red line) and invested opportunity schedule (blue line) functions. The remaining earnings are to be distributed to the respective shareholders. Percent Amount of capital ($millions) Lintner’s analysis This model states that dividend policy has normally two aspects which are: the speed at which current dividend adjust to its target and the target payout ratio. Corporations decide to payout a fixed portion of the net profit realized as dividend to holders of common stock or ordinary shareholders; but in this regard their well understood preference for dividends that are stable may try to achieve the target only by a small amount of the indicated target of the payout ratio whenever there are changes in the profits (Amidu & Abor 2006). Breville Group in its case, has been stable in payout dividend ratio and the shareholders have been least perturbed by the turn of events. They expect Breville Group to continue trading strongly in the international market as its brands gain dominance and popularity. The long term dividend payout for Breville Group is expected to remain high as the company looks forward to a optimal trading period. Comparable to other firms When compared to the four firms, Breville Group has maintained a high payout ratio that any of them. iiNet Limited has maintained a very low share dividend and in some occasions there has not be any share dividend paid out. Singaro Telecommunication Limited has not at times been having any dividends payout at all considering the poor trading in the market and the loss realized. Telstra Corporation limited as gone for long without declaring dividend payout to the ordinary shareholders. Breiville has done well as compred to its peers. iinetNet Limited has also tried to do well when it comes to dividend payout ratio. Optimal dividend policy The company is assumed to be operating in a perfect market as proposed by Modigliani and Miller (1961). The dividend policy of a company has no effect on the wealth of the shareholders. There is no agency and no information asymmetry. In practice, companies have to deal with brokerage fees, tax, transactions cost among many others. Dividend reinvestment plan for Breviklle Group does not conflict the transaction cost. Transaction costs can be saved through payment of shares for dividends instead of cash remittance. The value of the company is dependant on its investment. Continued investment of Breville Group is anticipated to boost the worthiness of the company in the industry. List of References Aivazian, V, Booth, L & Cleary, S 2003, “Dividend policy and the organization of capital market,” Journal of Multinational Financial Management, vol. 13, no. 2, pp. 101-121. Amidu, M & Abor, J 2006, “Determinants of Dividend payout ratios in Ghana,” The Journal Of Risk Finance, Vol. 7, no. 2, pp. 136-14. Baker, HK 1999, “Dividend Policy issues in regulated and unregulated firms: a managerial perspective,” Managerial Finance, Vol. 25 No. 6, pp. 1-19. Baker, MP & Wurgler, J 2002, “Market Timing and Capital Structure," Journal of Finance, Vol. 57, No. 1, pp. 1–32. D’Souza, J 1999, “Agency cost , market risk, investment opportunities and dividend policy-an international perspective,” Managerial Finance, Vol. 25 No. 6, pp. 35-43. Higgins, RC 1972, “The corporate dividend –saving decisions,” Journal of Financial and Quantitative Analysis, Vol. 7, No. 2, pp. 1527-41. Rosenbaum, J & Pearl, J 2009,  Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions, John Wiley & Sons, Hoboken, NJ. Read More