CSL Limited Credit Rating Analysis - Case Study Example

CSL GROUP CREDIT RATING ANALYSIS AND REPORT Student’s Name Course Name Professor’s Name University Name Date of Submission Credit Rating Analysis and Report Introduction This report presents an analysis of the credit rating of CSL Limited using various models. The models that are used in the analysis include median rating model, Altman Z score model, capacity analysis (both historical and forecast), and the character analysis. The analysis is important in assisting in developing a ratings report. Credit rating analysis of CSL Group uses the publicly available information such as the annual reports to build up the models for recommendation. Additionally, the credit rating analysis of CSL Group will entail an analysis of the risks that are associated with its operations. The risks analysis provides an overview of the financial rations that affects the liquidity, profitability, leverage, and the activities of the organization (White 2010). This will involve an analysis of the level of bankruptcy of the firm in order to establish its credit rating of the company. Credit rating agencies provide various parameters within which firms are graded for their credit positions (Cheng & Neamtiu 2009). These include AAA, AA, A, BBB, BB, and B. The ratings indicate whether the company is highly credit worthy or not. Therefore considering these factors, the credit rating analysis for CSL Group will revolve around the financial analysis, accounting analysis, business strategy analysis, and prospective analysis. Our analysis will, therefore, be based on the models. CSL Group Credit Rating Analysis Credit rating analysis involves both the qualitative and quantitative publicly available data and information (Golin & Delhaise 2013). The analysis is aimed at establishing the ability of CSL to finance the debts that it owns in its capital structure. It helps in determining how the capability of the company to repay both the principal amount and the interest that is earned from the credit. Additionally, it focuses in the determination and evaluation of the risks that are involved in an investment using various financial models. The qualitative credit rating analysis of CSL uses the available information in establishing the character and determine its ability to repay the loans. Quantitative analysis, on the other hand, involves the analysis of the available data from the income statements and balance sheet through the use of financial ratios (Mischel 2013). The analysis of the financial statements using the ratios will indicate the efficiency and profitability of the firm and the probability of repaying the debts in the future (Golin & Delhaise 2013). The credit analysis, therefore, employs the use of various models and assessment criteria using the publicly available information to rate the company. These techniques include the credit risk assessment and character analysis as the qualitative methods of credit rating analysis. The median rating model, Altman Z score model, capacity analysis (both historical and forecast) and the financial ratio analysis are used as forms of quantitative analysis to establish the credit worthiness of the company (Sufi 2009). Credit risk assessment This involves the assessment of the level of risks that a company is exposed to (Palepu & Healy 2007). The credit risk assessment is used in credit rating for corporation to determine how the credit risks that the company are exposed to and the strategies that the company adopts in mitigating these risks and reduce their impact on the financial performance of the company both in the long run and the short-run (CSL Group 2015). Credit risks are the uncertainties that might arise within the management of CSL Group that might influence its ability to repay the long-term debts as they fall due. The credit risk assessment of CSL Group begins by the identification of risks that are associated with the company. According to the information that is available from CSL Group, the company is faced by the financial risks, operating risks, and credit risks. These risks have an influence in the financial performance of the company and are used in rating the credit capacity of the company. High credit risks indicate that the company has poor credit rating and therefore, there possibility of it repaying the debts is minimal (Golin & Delhaise 2013). The risks lower the profitability thus lowering the financial performance of the company. More specifically, the credit risks in a company would minimize the likelihood and ability of the company to repay the debts. As such, the company would be considered creditworthy thus poor credit rating. The credit risks that CSL Group is exposed to reduce its credit rating making it be poorly rated. Therefore, as one of the techniques that are used in credit rating, the credit risks assessment will provide the lenders with the information on the credit risks that are associated with and have effect on the creditworthiness of the company (Palepu & Healy 2007). Character Analysis The character analysis provides an assessment of the general impression that a company will provide to the potential lender or investor who may wish to provide funds to the company for investment (Palepu & Healy 2007). In credit rating of organizations, the character of the borrower are analyzed in order to establish whether the borrower is of good character or not. This form of analysis, however, is considered qualitative and is based on the judgment that the lender will make on the borrower. This will help the investor of the lender in determining the creditworthiness and establish if the company is trustworthy to repay the loan as advanced. The character will be determined based on the background of the company and the experience that it has in carrying out its activities in the industry. Based on the financial information that is available from CSL Group, the company is of good character and is able to repay its loans as they fall due. It is trustworthy in repaying the loans given that its credit history is clean. This is based on the reports that are provided by the director of the company and the board’s chairman. As such, it credit rating is high and would acquire any form of credit from any money lending agency when required. Median Financial Ratios Analysis The median financial ratios that show the credit rates of an organization include the Net Operating Profit after Tax (NOPAT) to net capital ratio, pre-tax interest coverage, cash flow from operations to total debt and the net debts to net capital ratios. These ratios determine the degree of bankruptcy of a firm based on the publicly available information. The higher the ratios, the higher the credit rates and vice versa. Based on the available information, the median ratios for CSL Group are calculated as follows; Median Financial Ratios 2014 2013 Net Operating Profit After Tax to Net Capital Ratio (NOPAT ÷ Net Capital) NOPAT = $$1,379 Net Capital = $2,746.90 ($1,379 ÷ $2,746.90) = 50.20% NOPAT = $1,455 Net Capital = $2,848 ($1,455 ÷ $2,848) = 51.09% Pre-tax interest coverage (Interest expense ÷ Net Operating Income) Interest expense = $59.6 Net Operating Income = $1,379 = ($59.6 ÷ $1,379) = 4.32% Interest expense = $53.45 Net Operating Income = $1,307 = ($53.45 ÷ $1,307) = 4.09% Cash flow from operations to total debt (Cash flow from operations ÷ Total debt) Cash flow from operations = $1,363.60 Total debt =$2,718.0 = ($1,363.60 ÷ $2,718.0) = 50.16% = ($1,047 ÷ $2,270) = 50.16% =46.12% Net debt to net capital ratio (Net debt ÷ Net capital) Net debt = $3,654 Net Capital = $2,746 ($3,654 ÷ $2,746) = 1.33 (Net debt ÷ Net capital) Net debt = $3,115.70 Net Capital = $3,162 ($3,115.70÷ $3,162) = 0.985 Table 1: Median Financial Ratios The median ratio analysis considers four major ratios in conducting the credit rating for a corporate organization. These include the net profit after tax to the bet capital ratio. The ratio compares that NOPAT earned by a company to its capital that is reported in the financial statements. According to the above analysis, CSL Group have relatively high NOPAT to net capital ratio of more than 50%. The analysis shows that the company had a ratio of 50.205 in 2014, a decline from the previous year’s ratio of 51.09%. This is considered to be high making the company’s credit rating to be high. It shows that the company is highly creditworthy and has the ability to repay its loans principal and interest as they fall due. The other median financial ratio that can applied in the credit rating for CSL group is the pretax interest coverage. The ratio is given by the quotient of the interest expense and net operating income. In 2013, CSL reported a pre-tax interest coverage ratio of 4.09% while in 2014, it reported a ratio of 4.32%. This is an indication of better credit rating for the company and it implies that the company has the ability to repay its long term and short-term credit as they fall due. Finally, the cash flows from the operations to the total ratios can be used in determining the credit rating of a company for the lending purposes. The ratios shows the ability of the company’s cash flows from operations to finance the total debts as reported in the balance sheet. CSL Group have higher ratio showing a higher credit rating for the two years as presented in the analysis. Therefore, based on the analysis, the company has an overall high credit rating which indicates a higher financial performance. Financial Ratios Analysis The financial ratios analysis of CSL Group as presented in the schedule below analyses the various components of the company. It presents four major components of the company’s performance that include the profitability, liquidity, leverage, and the activity ratios. These ratios are used as a measure of financial performance of a company and assists different users in determining their financial position. The financial ratios also provide a rating of the company’s credit (Beaver, Correia & McNichols 2011). The credit rating of CSL Group is based on the analysis of these aspects of the company over a period. As a measure of credit rating, the users of financial statements especially the lenders will consider these ratios in determining the ability of the company to repay the loans and their trustworthy in relation to the loan repayment. Higher financial ratios signify a better financial performance and position of a company. Therefore, there will be better credit rating for a company with better financial ratios than the company with poor financial ratios. Financial ratios are thus used as quantitative technique using the available information about the company. Just like the profitability ratios, the liquidity ratios are more likely to be used in credit rating for organizations (Penman & Penman 2007). They compare the current assets and current liabilities of a company thus measuring its ability to meet its short-term financial obligations as they fall due. Companies with higher liquidity are more credit worthy and therefore given higher credit rating than the companies with poor liquidity ratios. Table 2: Ratio Analysis The ratio analysis assists in credit rating for organizations as it highlights the profitability, liquidity, and degree of leverage for corporate organization. The profitability analysis presents the profitability position of CSL based on the gross profit margin, operating profit margin, and the net profit margin. According to the analysis, CSL group profitability has been on the decline over the past three years. This is shown by the decreasing ratio for the past three years. In 2012, the company reported a net profit margin of 0.23 and retained the ratio in the following year at 0.23. However, there was a significant decline in the ration in the financial year ended 2014 to 0.22 representing a decline in the profitability of the firm. Similarly, the operating profit margin declined significantly over the years from 0.28 in 2012 and 2012 to 0.25 in 52014. Therefore, there was a decline in the level of profitability for the company. The reduction in the profitability of CSL over the three years shows that the company declined in its financial performance. Therefore, under such performance, the company would have lower credit rating as its ability to repay the credit advanced to him would reduce significantly. In corporate finance, a company would use its operating profits to finance its creditors. However, when there is reduced profitability, the ability to repay the debts declines. The leverage ratios provide an analysis of the capital structure of a company. It analyses the amount of equity and debt capital that are presented in the balance sheet of the company. The credit rating of CSL group is dependent on the amount of debts that it uses in financing its capital structure. According to the analysis, CSL had higher equity than the debt capital as shown by the total debt to equity ratios. However, the ratio declined over the years indicating a decline in the degree of leverage of the company. The higher the amount of debt in the capital structure, the lower the credit rating and vice versa. It therefore implies that the credit worthiness of CSL Group declined over the three years under analysis. Moreover, the long-term debt to equity ratio had a decline over the three years. The analysis reveal that the ratio declined from 0.11 in 2012 to 0.09 in 2013 and 2014 representing a reduction in the degree of leverage. The leverage ratios are also useful in establishing the financial risks that are associated with the company. When there is an increased amount of debt in the company through borrowing, it will be highly leveraged. The effect is an increase in the degree of leverage that might make the company unable to repay the loans thus making it non-creditworthy. Therefore, the analysis of the leverage ratios for CSL Group indicates that it is less solvent given the less amount of debt compared to the equity capital as presented in the income statement. As such, it has a higher credit rating than the other companies in the industry. Therefore, the money lending institutions will consider giving it more loans due to its ability to repay the loans as they fall due. In lending credit to organizations, credit lending agencies will consider the level activities for a company in establishing the credit rating for the company. The activeness of a company is thus measured using the activity ratios such as the inventory turnover, and the working capital turnover. The higher the level of activities of a company the higher the revenue it generates from the operations thus indicating a better financial performance. Additionally, the efficiency ratios also are used in determining the performance of a company thus making it more credit worthiness and ability to repay the loans as they fall due for payment. The liquidity ratios as also useful in the credit rating of organizations. These ratios include the current and quick ratio that measure the ability of the company to repay its debts as they fall due. Therefore, the lending organizations will conduct the liquidity analysis to determine whether the company has a higher credit rating or not. Higher liquidity for a company signifies a higher credit rating. Based on the liquidity analysis of CSL Group, the company has been highly liquid over the three years as presented in the schedule. This shows that it is highly liquid and is able to repay the loans when needed. Capacity Analysis Capacity analysis involves a study of the ability of a company to sustain its operations using the available resources and finance its capital structure. The analysis uses the publicly available information about a company to establish its capacity to repay the credit that has been advanced by the lenders. The capacity analysis considers a number of aspects of a company. It involves the cash flow analysis to establish the level of cash flows for the company and thus its ability to repay its financial obligations. Capacity analysis is thus useful in credit rating and assists the lender in determining the ability of the company to repay any credit advanced to it. The credit analysis of CSL Group indicates that the company has the capacity to service its loans and is thus credit worthy. The capacity is given by the nature of its financial structure and the level of gearing that the company has in its capital structure. Altman Z score model The Altman model is based on five financial ratios that assist the lenders in determining the level of bankruptcy of a company. These ratios include the working capital to total assets ratio, retained earnings to total assets, sales to total assets, EBIT to Total assets, and the market value of equity to total liability (Anjum 2012). The model is based on the following formula in consideration of the identified financial ratios. Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E where; A – (Working Capital/ Total Assets) B - (Retained Earnings ÷ Total Assets) C – (Earnings before Interest & Tax ÷ Total Assets) D – (Market Value of Equity ÷ Total Liabilities) E – (Sales ÷ Total Assets) (Ng, Wong & Zhang 2011). Based on available information about CSL Group, the ratios are calculated as follows for the three years. 2014 2013 2012 A Working Capital $ 63,880.00 0.487139 $ 56,978.00 0.513686 $ 46,077.00 0.491236 Total Assets $ 131,133.00 $ 110,920.00 $ 93,798.00 B Retained Earnings $ 86,471.00 0.659414 $ 72,546.00 0.654039 $ 78,980.00 0.842022 Total Assets $ 131,133.00 $ 110,920.00 $ 93,798.00 C Earnings Before Interest $ Tax $ 16,496.00 0.125796 $ 15,403.00 0.138866 $ 12,760.00 0.136037 Total Assets $ 131,133.00 $ 110,920.00 $ 93,798.00 D Market Value of Equity $ 104,500.00 3.923704 $ 87,309.00 3.69781 $ 71,715.00 3.247521 Total Liabilities $ 26,633.00 $ 23,611.00 $ 22,083.00 E Sales $ 66,001.00 0.503313 $ 55,519.00 0.500532 $ 46,039.00 0.490831 Total Assets $ 131,133.00 $ 110,920.00 $ 93,798.00 Table 3: Three year Altman Z-score model Three Projections 2015 2016 2017 A Working Capital $ 67,074.00 0.464996 $ 59,826.90 0.490336 $ 48,380.85 0.468908 Total Assets $ 144,246.30 $ 122,012.00 $ 103,177.80 B Retained Earnings $ 89,546.00 0.620785 $ 92,544.00 0.758483 $ 97,584.00 0.945785 Total Assets $ 144,246.30 $ 122,012.00 $ 103,177.80 C Earnings Before Interest $ Tax $ 18,145.60 0.125796 $ 16,943.30 0.138866 $ 14,036.00 0.136037 Total Assets $ 144,246.30 $ 122,012.00 $ 103,177.80 D Market Value of Equity $ 104,500.00 3.736861 $ 87,309.00 3.521724 $ 71,715.00 3.092877 Total Liabilities $ 27,964.65 $ 24,791.55 $ 23,187.15 E Sales $ 72,601.10 0.503313 $ 61,070.90 0.500532 $ 50,642.90 0.490831 Total Assets $ 144,246.30 $ 122,012.00 $ 103,177.80 Table 4: Projected Altman Z-score model Z-Score (2014) = 1.2 (0.487139) + 1.4 (0.659414) + 3.3 (0.125796) + 0.6 (3.923704) + 1.0(0.503313) = 4.780 2013 = 1.2 (0.513686) + 1.4 (0.654039) + 3.3 (0.138866) + 0.6 (3.69781) + 1.0(0.500532) = 4.709 2012 = 1.2 (0.491236) + 1.4 (0.842022) + 3.3 (0.136037) + 0.6 (3.247521) + 1.0(0.490831) = 4.655 Projected Z-Score 2014 = 1.2 (0.464996) + 1.4 (0.620785) + 3.3 (0.125796) + 0.6 (3.736861) + 1.0(0.503313) = 4.588 2013 = 1.2 (0.490336) + 1.4 (0.758483) + 3.3 (0.138866) + 0.6 (3.521724) + 1.0(0.500532) = 4.722 2012 = 1.2 (0.468908) + 1.4 (0.945785) + 3.3 (0.136037) + 0.6 (3.092877) + 1.0(0.490831) = 4.682 The Z-score results for the years 2012, 2013, and 2014 were higher than 3 indicating that the company is less likely to be bankrupt. According to the analysis, CSL had a Z-Score of 4.780 in 2014 and 4.709 in 2013. This is an indication of a better financial health of the company. In 2012, CSL had a Z-score of 4.655. Therefore, based on the analysis the company is less bankrupt and therefore has a higher credit rating. Similarly, the projected Z-score shows high credit rating for the company in 2015, 2016, and 2018. In 2015, CSL forecast the Z-score to be 4.588 while in 2016 it is expected be 4.722 and in 2017, the Z-score is expected to be 4.682 as presented in the analysis. Therefore, the company has a high credit rating as given by the z-score of more than 3. According to the Altman Z score model, a Z-score of more than 3 represents a lower bankruptcy and therefore higher credit rating and a Z-score of less than 3 represents a higher bankruptcy thus lower credit rating (Ng, Wong & Zhang 2011). SWOT Analysis The SWOT analysis is the analysis of the strengths, weaknesses, opportunities, and threats (Gerantonis, Vergos & Christopoulos 2009). The analysis involves an overview of these aspects of a company in determining various performance parameters. The SWOT analysis for CSL Group is useful in establishing the credit rating for the company so as to provide a recommendation on whether the company is credit worthy and uncredit worthy. Strengths Based on the publicly available information, CSL has its financial strength on the revenue and profitability that it generates from its operations. The company is highly profitable and therefore have a stable financial position. The high profitability provides an assurance to the lenders on the ability of the company to repay the debts when it falls due. Therefore, the high profit ratios shows that the company has stronger financial performance and is highly credit worthy. Additionally, there is high efficiency in its operations given by the high activity ratios generated by the company over the period under analysis. This is an indication of a better financial performance. Weaknesses The weaknesses are the areas that the company is not performing well that is likely to have an impact on its financial performance and stability (Frost 2007). According to the company’s financial reports, the major weakness of the company are the stability in the growth of revenue and profitability. There are high fluctuations in the revenue growth and profitability thus limiting its growth potential in the long-run. This has an effect on the credit rating of the company. The higher the fluctuations in the revenue and profitability, the lower the ability of the company to pay off its debts as they fall due. Opportunities CSL Group has several opportunities that it explores for its growth and expansion. These opportunities are useful to the lenders in determining the avenues that are available for growth. The more the growth opportunities the more credit opportunities that the company will have. Most financial lenders are attracted to a company to provide funds if they have several opportunities that can be explored for growth and increase the value of the company. Based on the information about the company that is publicly available, these opportunities increases the possibility of existence for unforeseeable future for the company. Therefore, there will be high credit rating for CSL Group based on the opportunities. Threats The major threats to CSL existence and continuous operations are the risks that are associated with the operations of the company. The company has several risks that it is exposed to. They include the credit risks, financial risks, business risks, and the operations risks. These risks are a threat to the success of the company and therefore require proper management strategies to minimize their effect on the performance of the company. The credit worthiness of CSL Group is highly dependent on the credit risks that it is exposed to. According to the CSL risk assessment, the credit risks for the company are relatively high that have an effect on its credit rating. The lenders of the funds will consider the degree of credit risks that the company is exposed to and establish a credit rating for the purposes of lending. When there is a high risk level in the company, the credit rating reduces and a lower risk level increases the credit rating. The level of risks also affect the other aspects of the company such as the gearing, efficiency, and profitability. The higher the level of risks that are associated with the company, the lower the financial position of the company. Therefore, there will be a higher credit rating for the company. Similarly, higher operational risks influence the efficiency of the company thus lowering the credit rating. CSL Group Credit Rating Report The credit rating report is based on the credit rating analysis using various models as discussed above. According to the Altman Z-score model, CSL has a higher credit rating that implies it is highly credit worthy and can be given credit by the credit advancing agencies. CSL Group, therefore, has a higher credit rating as given by the outcome of the models. The financial statement analysis shows that the company has a better financial performance given by the high financial ratios. High credit rating for the company is significant to the lenders as it provides an assurance to them of the ability of the borrower to repay the loans when they fall due. Moreover, as seen in the character analysis, CSL is of good character and is therefore trustworthy and can be given loans for financing. The rating scale considers all these factors and models in determining the credit rating of a company. Therefore, CSL group can be given a rating of BBB. This rating a favorable one as it shows that the company is trustworthy and can be trusted with loans and repay the principal loan and the total interest payable on the credit. Therefore, based on the credit rating analysis, CSL Group has a high credit rating thus a better financial performance. List of References Anjum, S. 2012. Business bankruptcy prediction models: A significant study of the Altman’s Z-score model. Asian Journal of Management Research, 3(1), 212-219. Beaver, W. H., Correia, M., & McNichols, M. 2011. Financial statement analysis and the prediction of financial distress. Now Publishers Inc. Cheng, M., & Neamtiu, M. 2009. An empirical analysis of changes in credit rating properties: Timeliness, accuracy and volatility. Journal of Accounting and Economics, 47(1), 108-130. CSL Group. 2015. 2014 Annual report. 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