Financial Analysis of Oxford Instruments PLC - Case Study Example

Financial Analysis of Oxford Instruments PLC Name: Students ID: Unit Code: Instructor: Table of Contents Introduction 2 Strategy and Outlook 3 Industry, Economic Outlook and Competition 5 Key Risks 7 Accounting and Financial Analysis 8 Profitability 9 Efficiency 11 Liquidity 12 Discounted Cash Flow (DCF) Valuation 14 Asset and Market Basis Valuation 15 Conclusion and Recommendations 17 References 18 Appendices 20 Introduction Stowe et al. (2007) states that, “the valuation of a particular company is a task within the context of the portfolio management process.” In light of this statement, this report presents a detailed analysis and evaluation of Oxford Instruments PLC’s performance, and after that provide a recommendation for investors. Oxford Instruments PLC was founded in 1959. It operates as a holding company based in Abingdon, the United Kingdom. The company operates various subsidiaries through which it runs its businesses. It is mainly engaged in research and development, manufacturing and trade of hi-tech tools and instruments across many countries. The company’s products serve research customers in both the public and private sectors encompassing both physical and life sciences. The company’s activities are divided into seven operating segments, which have also been pooled into three combined reportable segments: (1) Nanotechnology tools segment, (2) Industrial product segment, and (3) Service segment (Oxford Instruments, 2015). Figure 1: Oxford Instruments Reportable Segments and Products Strategy and Outlook Porter (1998) points out that the valuation process ought to focus on the competitive strategy of the company. One key trend that is expected to give Oxford Instruments a competitive edge is the “convergence” of scientific research that is on the rise. Cognisant of this, the company is reacting to this convergence by applying its tools and proficiency to increasing market prospects. This creates major commercial opportunities for Oxford Instruments as tools that were earlier limited to one can at present be used across several research fields. Convergence gives Oxford Instruments an opening to apply the technical apparatuses plus the well-organized design method, traditional to physics and engineering, in life science research. The company will therefore be able to contact a new set of clienteles desiring to work at the molecular scales (Oxford Instruments, 2015). The company reports that by using fresh systems, formerly linked to physical sciences, in the biological sciences generates a key space of growth. For instance, the convergence of “Nano-Bio” (nanotechnology and biotechnology) will inspire ground-breaking developments in medicine, agriculture, energy, aerospace and manufacturing. To support this strategy, the company acquired Andor in 2013 and Asylum in 2012 so as to spread its scope into analytical apparatuses for Nano‑Bio studies. Long-standing demand for nanotechnology tools will go up and addressable markets will expand enabling contact with a different set of customers. In order to drive this strategy and at the same time maximise customer and shareholder value, Oxford Instruments intends to focus on four key areas: (1) People development (develop talent), (2), Product development (support innovation), (3) Market development (grow the market share), and (4) Process development (improve operational excellence) (Oxford Instruments, 2015). Figure 2: Oxford Instruments Historical Closing Share Price 2010-2015 Source: Hargreaves Lansdown (2015). SVT’s share price changed during the time period of 2010-2015 (see figure 2 above). The share price significantly went up from 2010 – 2014. Over this time the company posted good returns with increasing dividend payments (as indicated in appendix 1). However the share has been falling since 2014 up till now due to a declining profitability as the company devotes most of its earnings to acquisitions in a change in strategy that appears risky and the current economic situation in the United Kingdom and Europe. Industry, Economic Outlook and Competition Porter (1998) also indicates that the valuation process ought to focus on the industry the in which a company competes. In evaluating a company’s performance, the understanding as regards the overall industry and economic environment is mandatory. Stowe et al. (2007) points out that the understanding of industry and economy gives a good perspective regarding the rudimentary characteristics of the market and the factors that impinge on the company’s activities. This permits effective risk assessment and forecast of future cash flows. Oxford Instruments is a leading provider of tools and instruments used in scientific research. It operates in a wider electrical and electronics industry though its main focus is on the tools and instruments sector. The company has built strong partnerships but faces competition from, Alent PLC, E2V Technologies PLC, Jeol Ltd, TT Electronics PLC, AIXTRON SE, and Chemring Group PLC, among other companies. These competitors may well reduce the market share under Oxford Instruments and therefore reduce the earnings and profitability. The company may as well lose investors. However, the company has planned acquisitions it intends to undertake so as to increase its economies of scale. This will boost its earnings and will raise its competitive edge (Oxford Instruments, 2015). Porter (1980) analysed the market forces that have a direct influence on a company’s profitability and reputation. He was able to identify five forces that form a good model that is today used to assess a company's industry, and competitive position. The analysis of the five forces in the industry is as follows: (1) Competitive rivalry; There are several competitors in this industry, competition is not high given the specialised nature of the sector, (2) Bargaining power of suppliers; There are few suppliers in this industry, the suppliers have a high bargaining power, (3) Bargaining power of customers; The main customers are in the public and private sectors that can influence quality and pricing, there is a high bargaining power for customers, (4) Threat of new entrants; The initial spending required to penetrate this industry is massive and the current players enjoy a big economies of scale that can scare off new competitors; there is a low threat of entrants, (5) Threat of substitutes; The kind of tools and instruments produced in this sector have no close substitutes, the switching costs are prohibitive. Key Risks Businesses operate in uncertain environments. Companies are faced with many hazards that, if they explode, may well have serious harm to the business. According to the 2014 annual report, Oxford Instruments faces eight key risks. Given that the company pretenders hi tech systems and equipment, it faces a serious technical risk. Advanced technologies may fail to yield moneymaking products that may well be mass-produced and sold for a profit. This will reduce profitability and sales revenues and negatively affect the company’s reputation (Oxford Instruments, 2015). The unstable current economic environment possibly will cause lower spending both by the government and private entities. This will cut down the demand for the company’s products and, hence, reduce profitability and sales revenues. Oxford Instruments plans to expand through acquisitions so as to complement on its technologies. However, proper acquisition targets possibly will not be obtainable in the crucial timespan. Then again, once picked up, targets might fail to deliver the premeditated value. This will reduce the company’s profitability and sales revenues and may also divert management focus from the main business so as to manage integration matters (Oxford Instruments, 2015). Moreover, Oxford Instruments spends a substantial amount of their profit using foreign currencies. This leaves the company open to variations in exchange rates. Also this will reduce the company’s profitability and sales revenues. Besides, the company’s strategy permits outsourcing of a notable portion of the product expenses to make the most out of economies of scale and normal currency hedges. This will cause a failure of the supply chain and affect the company’s sales. As a result, customers will be disrupted and the company’s reputation be affected. The company’s computed pension arrears varies along with the variations in the actuarial assumptions. This is likely to cause a considerable effect on the stated annuity shortfall. This may call for extra money to bridge the deficit and reduce the company’s net assets (Oxford Instruments, 2015). Oxford Instruments depends heavily on a number of its critical employees. If these employees happen to leave the company. The company may at times fail to control the route to market of some of its products that are parts of advanced level systems. Both of this will result in reduced profitability and sales revenues (Oxford Instruments, 2015). Accounting and Financial Analysis This is, for the most part, what many investors look out for in making investment decisions. Accounting and financial analysis works around a company’s financial data for the past periods to assess its financial performance. This helps to inform to suitability of investing in the company. The results for each period or against the competitors, sector or industry can be compared in order to assess the company’s financial direction based on its underlying financial strengths and weaknesses. The data can as well be used to make future projections as regards the company’s future financial feat. There are various categories around which financial analysis is conducted. Each category focuses on a particular financial aspect as discussed below; Profitability Profitability is a measure of the company’s earnings performance relative to sales or investment. Oxford Instrument’s profitability has generally been on a decline as of 2011 to 2014 despite a growth in sales revenues, as shown by figure 2 below. The company has grown revenues through the convergence of instruments that can be used in both physical sciences and life sciences. However the profitability has declined as the company has devoted more resources to research and development and expansion of operations through acquisitions. Figure 3: Revenue versus Net Income 2010-2014 and Profit Margin Source: Moring star (2015) By the use of profitability ratios, the management’s abilities and the company’s actions can be assessed based on the profits generated by the business. The most common profitability ratios are the gross margin and the return on capital employed (ROCE). Table 1: Profitability Ratios Gross margin % 2010 2011 2012 2013 2014 Oxford Instruments PLC 42.84 42.66 43.67 44.56 44.38 E2V Technologies PLC 30.43 37.58 38.35 38.97 38.53 Return on Capital Employed % 2010 2011 2012 2013 2014 Oxford Instruments PLC 16.08 37.10 23.11 16.62 6.54 E2V Technologies PLC 0.68 12.90 14.91 16.07 14.66 Source: Moring star (2015) Oxford Instruments has had a high gross margin compared to E2V Technologies. The company’s revenues have been increasing through the expansion of their customer market in life sciences. However, the ROCE has been on a decline despite its rival showing an increase in ROCE. This is because fresh investments undertaken by the company would take time before they return profits (Steven, 2006). Efficiency Efficiency is a measures of how well the company employs its assets or investments. The efficiency ratios assess the gains produced by specific assets. Below the focus is on how well the Oxford Instruments used its creditors and debtors. As indicated in figure 4 and table 2 below, the payables turnover and receivables turnover have been reducing. This points a lower management effectiveness in handling its creditors and debtors (Jackling et al., 2010). Figure 4: Oxford Instruments Payables Turnover versus Receivables Turnover Table 2: Efficiency Ratios Payables turnover 2010 2011 2012 2013 2014 Oxford Instruments PLC 109.44 109.09 101.14 84.92 63.05 E2V Technologies PLC 63.64 64.67 61.03 59.09 51.63 Receivables turnover 2010 2011 2012 2013 2014 Oxford Instruments PLC 4.13 5.54 7.16 6.28 5.39 E2V Technologies PLC 4.36 5.57 6.09 5.48 5.10 Source: Moring star (2015) Liquidity Liquidity is an assessment of the company’s ability to meet up its short-term obligations using its current assets. The two common measures used are the current ratio and the quick ratio. Figure in table 3 below show that during the past five years, Oxford Instruments liquidity has been relatively constant but is below what is expected (current ratio of 2:1 and acid test of 1:1). This means that the company’s ability to pay for its day to day operations is not strong (Marshall et al., 2009). This puts the company under financial pressure that may lead to insolvency. Its rival shows higher liquidity particularly in 2013 and 2014 where is performance was above the expected norm. Table 3: Liquidity Ratios Current ratio 2010 2011 2012 2013 2014 Oxford Instruments PLC 1.36 1.42 1.41 1.45 1.46 E2V Technologies 1.56 1.49 1.87 2.13 2.15 Acid test 2010 2011 2012 2013 2014 Oxford Instruments PLC 0.86 0.85 0.85 0.9 0.89 E2V Technologies 1.06 0.82 0.87 1.14 1.32 Source: Moring star (2015) Financial Health This is a measure of the company’s assets vis-à-vis its liabilities. As indicates in figure 3 below, Oxford Instruments assets have been increased almost with a similar trend to the increase in liabilities. This indicates that the company has grown its investments. However majority of the investments have been financed through debt that is not a high-quality source of funds (Deegan, 2009). Figure 5: Oxford Instruments Total Assets versus Total Liabilities Source: Moring star (2015) Also by comparing the ratios, Oxford Instruments financial leverage and gearing ratios have been high compared to E2V Technologies. Its shows a bad financial health. Table 4: Financial Health Ratios Financial leverage 2010 2011 2012 2013 2014 Oxford Instruments PLC 3.78 2.23 2.24 2.33 3.44 E2V Technologies 2.56 2.04 1.82 1.51 1.47 Gearing 2010 2011 2012 2013 2014 Oxford Instruments PLC 0.38 0.11 0.05 0.09 1.01 E2V Technologies 0.67 0.33 0.29 0.14 0.08 Source: Moring star (2015) Discounted Cash Flow (DCF) Valuation The DCF model is used to assess the future valuation of an entity. Investors largely invest their money in a company with a vision of getting their money back plus some extra returns. The market value of their venture is measured by the future cash flows. However, these values have to be discounted, at the most suitable cost of capital, in order to arrive at the actual value of a business operations. The DCF model is used because it captures whether or not the firm really generated cash from its operations and it is simple to apply (Arnold, 2005). The model works around seven key value drivers. Below are the drivers alongside the assumed value for each drives: Table 5: Key Value Drivers and Assumptions for Oxford Instruments Sales Growth per Annum 4% Operating Profit Margin 7% Incremental Fixed Investment 6% Incremental Working Capital 8% Corporate Tax Rate 30% Number of Years 5 Required Rate of Return 6% The DCF model indicates that the company’s shareholder value is underestimated. The current shareholder value is £57.3 million while the estimated shareholder value is £543.5 million (detailed DCF model calculations are in appendix 2). The difference in the value can be explained by the current underestimation of the company and the drawbacks of the DCF model. The present evaluation method assumes that the value drivers are constant all through the preferred horizon. However, in reality the values change as the economic situation in and out of the company changes frequently. The model does not also consider major factors, such as the economy, interest rate fluctuations and speculations in the market that can affect the Oxford Instruments shareholder value. The advantage of using the DCF model is that it indicates how the particular value drivers impact on the shareholder value (Ryan, 2006). Steven (2006) states that it is imperative that additional valuation methods be used to give an accurate recommendation for investors. Asset and Market Basis Valuation Appropriate valuation of a company is vital. According to Stowe et al. (2007), comparative valuation models characterise one of the important types of going-concern valuation models. Comparative valuation allows for easy comparison on comparable measures. The following comparative valuation is based on the price-earnings (P/E), price to book (P/B), price to sales (P/S, and dividend yield. The measures are compared to the industry figures. Price-Earnings (P/E) P/E is a ratio of a stock’s market price to the company’s earnings per share. Table 6: Price-Earnings Valuation Valuation Oxford Instruments PLC Industry Price-Earnings 71.15 26.40 Source: Moring star (2015); Reuters (2015) The current P/E for the industry is 26.40 (Reuters, 2015). The current P/E for Oxford Instruments is 71.15 (Reuters, 2015). Therefore, it is clear that the valuation of Oxford Instruments is overestimated. Net Asset Value (NAV) NAV is a ratio of net asset value to the number of outstanding shares (Stowe et al., 2007). Table 7: Net Asset Value Valuation Oxford Instruments PLC Industry Price/Book 3.76 2.94 Source: Moring star (2015); Reuters (2015) The current NAV for the industry is 2.94 (Reuters, 2015). The current NAV for Oxford Instruments is 3.76 (Reuters, 2015). Therefore, it is clear that the valuation of Oxford Instruments is overestimated. Dividend Yield This measure the return realised solely from amounts invested for dividends. Table 8: Dividend Yield Valuation Oxford Instruments PLC Industry Dividend Yield 1.53 0.84 Source: Moring star (2015); Reuters (2015) The dividend yield for the industry is 0.84 (Reuters, 2015). The dividend yield for Oxford Instruments is 1.53 (Reuters, 2015). This shows that the valuation of Oxford Instruments is overestimated compared to the industry. Conclusion and Recommendations Investors invest their money mainly to get a return. Therefore, the managers of the company must on this aim in order to lead the company to greater financial health (Copeland et al., 2000). Oxford Instruments value is underestimated according to the DCF method calculations. However, based on equity and market methods of valuation, the share value is overestimated. Moreover, Oxford Instruments has had declining profitability, liquidity, efficiency, and financial health. However, the company has a good strategy in place as it takes on the new legislation that permits the use of tools and instruments used in physical sciences to be used in life sciences. Oxford Instruments is also planning to undertake major acquisitions so as to expand its economies of scale and hence boost earnings, profitability and competitiveness. Apparently, Oxford Instruments is going through some difficult financial moments due to increased expenses to further this growth, but its performance is healthy. Therefore I recommend that investors HOLD on to their shares. References Arnold, G. 2005. Corporate Financial Management (3d ed.). Harlow: Pearson Education Ltd. Copeland, T., Koller, T., & Murrin, J. 2000. Valuation: Measuring and Managing the Value of Companies (3d ed.). New York: John Wiley & Sons, Inc. Deegan, C. 2009, Financial accounting theory, 3rd edn, McGraw-Hill, North Ryde. Hargreaves Lansdown 2015, . Jackling, B. Raar, J. and McDowall, T. 2010, Accounting: A Framework for Decision Making, 3rd edn, McGraw-Hill. Marshall, D.H. McCartney, J.P. vanRhyn, D. McManus, W.W. and Viele,D.F. 2009, Accounting: What the numbers mean, 2nd ed. (revised), McGraw-Hill. Morning star 2015. Oxford Instruments PLC Valuation and Price Ratios. Porter, M. E. 1998. Competitive Advantage: Creating annd Sustaining Superior Performance. New York: The Free Press. Reuters 2015. Oxford Instruments PLC Financial Highlights. . Reuters 2015. E2V Technologies PLC Financial Highlights. . Ryan, R. 2006, Corporate Finance and Valuation, Thomson Learning, London. Steven, M.B. 2006, Financial Analysis: A Controller's Guide, 2nd edn, Wiley. Stowe, J. D., Robinson, T. R., & Pinto, J. E. 2007. Equity Asset Valuation. Hoboken, N.J.: John Wiley & Sons, Inc. Yahoo finance, 2015, Oxford Instruments PLC, . Appendices Appendix 1: Oxford Instruments Dividend Payment 2010 - 2014 Financial year end Type Amount Ex-dividend date Payment date 31/03/2014 Total 12.40p     Final 9.04p 24/09/2014 23/10/2014   Interim 3.36p 05/03/2014 07/04/2014 31/03/2013 Total 11.20p     Final 8.15p 25/09/2013 24/10/2013   Interim 3.05p 06/03/2013 08/04/2013 31/03/2012 Total 10.00p     Final 7.228p 26/09/2012 25/10/2012   Interim 2.772p 07/03/2012 10/04/2012 31/03/2011 Total 9.00p     Final 6.48p 28/09/2011 27/10/2011   Interim 2.52p 02/03/2011 07/04/2011 31/03/2010 Total 8.40p     Final 6.00p 29/09/2010 28/10/2010   Interim 2.40p 03/03/2010 08/04/2010 Source: Hargreaves Lansdown (2015), . Appendix 2: Discounted Cash Flows Calculation Appendix 3: Asset and Market Value Basis Calculation Price/earnings NAV per share Dividend yield Source of Data: Share price: Reuters, 2015 Average P/E ratio for industry/S&P 500: Reuters, 2015 Other data: Annual Report 2014 Read More