A Credit Rating for CSL Company - Report Example

A Credit Rating Report for CSL Company Student Name: Student Number: Module Code: Number of words: Submission Date: Table of Contents 1.0 CREDIT RATING REPORT FOR CSL COMPANY 3 2.0. INTRODUCTION 3 3.0. CAPACITY ANALYSIS 4 3.1. Industry Structure Analysis 4 3.2. Industry Fundamentals 5 5.0 The Credit Analysis For CSL Limited 8 5.1. Leverage Ratios 9 5.1.1. DEBT/ CAPITAL 9 5.1.2. DEBT/EBIDTA 10 5.1.3. FFO / DEBT 11 5.1.4. FREE OPERATING CASHFLOW /DEBT 11 5.2. Profitability Ratios 12 5.2.1. EBIT/CAPITAL EMPLOYED 12 5.2.2. EBITDA MARGIN 13 6.0. COVERAGE RATIOS 14 6.2. EBITDA/INTEREST EXPENSE 14 6.3. EBITDA MARGIN 15 8.0. Conclusion 17 9.0. References 18 1.0 CREDIT RATING REPORT FOR CSL COMPANY 2.0. INTRODUCTION CSL Limited is a bio therapeutics company. This company develops and deliver advanced biotherapies. This helps to protect lives and assist people with poor medical conditions to live long. It is a global company (CSL Ltd. Annual Report, 2012). Therefore it undertakes its operations in different countries. Some of its branches are found in Germany, United Kingdom, Australia, USA, and Switzerland among others. It offers a range of quality products. Some of these products include Plasma –derived therapies, Ant venoms, pharmaceuticals, Vaccines and Diagnostic products. It faces competition from many other companies. Some of these companies may include Baxter International Inc., Grifols SA and Sanofi. As a result of this competition, there is need for credit rating in order to assess the performance of these companies. Credit rating is important since it helps investors to evaluate the credibility of different companies for them to make an investment decisions. Credit rating involves the estimation of the future capacity and legal responsibility of the issuer to pay a fixed income security. This security involves the principal and interest. There are numerous credit rating agencies which facilitate rating of different companies. Some of these agencies include Moody’s Investors Service (“Moody’s”), Standard & Poor’s (“S&P”), and Fitch Ratings (“Fitch”). These rating agencies provide issuer and issue ratings services Bae et al, (2015). The main objective of this paper is to carry out credit analysis for CSL Limited. Credit rating plays many roles in an entity. Bae et al (2015) lists some of these roles as; linking risks and returns and assisting investors in making investment decisions. It also help debt instrument issuers in pricing their issues appropriately. This is because with appropriate prices, the issuers will reach out to new investors. It also helps in improving the quality of markets. This will therefore help the lenders to determine whether the borrowers will default on the payment or not. By having this knowledge the lender may choose to lend to the people they wishes. 3.0. CAPACITY ANALYSIS Capacity Analysis is the ability of debtor to pay back the debt borrowed. This can also be explained in terms of assessment of a plant, manufacturing processes and machine hours (Ren and Dewan, 2015). This helps in determining the firm’s maximum production level (Capacity analysis is composed of three main parts which include Industry structure analysis, Industry fundamentals and company fundamentals. 3.1. Industry Structure Analysis Industry structure analysis is the process whereby the factors relating to political, economic and market influences the development of an industry (Ren and Dewan, 2015). These factors include, first the threat of entry. In industries where there is high barriers for new entrants in the market, there is high profit level. CSL Limited also experience the threat of new entrants into the market. This is as a result of the rising demand for polyvalent immunoglobulin, increase in the expenditure patterns in healthcare industries and increased market for their pharmaceutical products. However this industry requires high production costs which is a challenge for new entrants into the industry. CSL Limited has the capacity to handle the high production cost making it to survive in the market. There is also high levels of regulations surrounding the industry and rising production of similar products. This in turn discourage the new entrants. CSL experience competition from different companies. The second factor is the power of suppliers. Those industries having few number of suppliers experience low profitability levels and higher credit related risks compared to industries with many suppliers. CSL Limited usually relies on few companies to supply them with raw materials and equipment. Sometimes there occurs an interruption in the supply or quality of essential materials in the operation of these firms. If the equipment are in need of repair or replacement, this company incurs extra cost and time is wasted affecting firms operations (Ren and Dewan, 2015). This industry also depends on plasma donors to supply them with plasma. Therefore, CSL Limited manages its donor’s appropriately to avoid destroying the company’s reputation. The third factor is the power of buyers. This is the company’s market share. Industries that depend on few buyers have greater credit risks. This is due to the fact that the power of bargaining depends on these buyers. This therefore puts this company at a risk of not making enough profits (Robison, 2012). CSL limited usually have diverse and complex market places making it to be prone to many challenges together with opportunities. Sometimes this company usually breaks the rules governing the industry codes of conduct leading it to financial faults and damage of their reputation. Whenever a company’s reputation is tarnished, it faces reduced demand for their product resulting to low profit levels. This therefore make this company to be prone to negative effects that affect their capacity to price and market their products well. The forth factor is threat of alternates products. Industries providing high quality goods to their clients with the absence of good alternative products experience stability in their product pricing, (Mägi et al 2016). Generally all pharmaceutical products usually have side effects. CSL pharmaceutical product also have negative side effects that causes adverse reactions. This may in turn cause clients to shift their loyalty to other Pharmaceutical industries. This will cause emergence of other substitute products. This will therefore lead to losses to this industry because of the reduction in the clientele. This will also ruin the reputation of this company. 3.2. Industry Fundamentals This is the analysis of the financial statements of the company. There are various principles that determines the nature of the industry (Robison, 2012). Over the years, pharmaceutical industries like CSL Limited do not rely on broader economic performance. This therefore makes them to be perceived as having fairly attractive stocks during economic instability periods of the broader index. Therefore, CSL stock will in turn improve attracting more investors. This is the contrast of its cyclical peers. The second industry fundamental is growth prospects. There are some industries that have low growth rate making them to consolidate through mergers and acquisitions. This may therefore be unfavorable to those who invest in corporate bonds. For those companies facing weak competition will usually have financial struggles which affects their credibility adversely (Robison, 2012). CSL offers best growth projections despite facing the threat of new entrants into the market with better products. They have a record of growth in earnings every year. This can be seen in the last five years. This company is expected to keep recording increase in growth of sales in future. The sales are also expected to grow yearly. CSL limited produces a variety of products from the raw input, blood plasma. The product which is in high demand than others is the IVIG which is used in varied medical specialties. This product usage is expected to increase with the increasing customer awareness and its usage in varied cases. Therefore, there is high likelihood that the demand for CSL Limited shares will face high demand. 3.3. Company Fundamentals. Company fundamentals is the analysis of the company’s statements of financial performance to analyze the company’s earnings growth, its debts-equity composition, its market position and the competition it is facing (O'Reiley, 2012). This analysis mainly focus on the wide situation of the economy and factors that result to fluctuations in borrowing rates. Fundamental analysis is usually carried out to forecast on the performance of the business, analyses efficiency of the management and analyses the credibility of the company by calculate its credit risks. The first company fundamental is competitive position of the company. This refers to the market share held by the company (LARIVIÈRE el al, 2015). This also entails analyzing how the market share changed over time. It means to determine whether the market share has either increased, decreased or it remains constant. For CSL limited, the market share has increased steadily over the years. The company has to determine how competitive they are to their peers. By doing this, they will be in a position to know their market position. The main competitors for CSL Limited are Sanofi, Baxter International Inc. and Grifols SA. LARIVIÈRE et al (2015) says that the higher the market share a company holds the more its competitive advantage over the others. CSL limited enjoy a reliable competitive position in the plasma protein industry it operates in. The nature of the plasma protein business requires high capital investment and faces high legal regulations. As a result, this acts as a high barrier for new entrants into the industry. This acts as a shield for CSL Limited from competitors aspiring to enter into the Plasma market. Also, CSL Limited enjoys the advantages of large scale. This is because it holds the biggest Plasma collection centers thus it’s able to have a wide pool of the rare blood plasma (CSL Ltd. Annual Report, 2012). This enables the company to have sufficient supply of its essential raw input. Also as a result of large scale operations, the operational costs are highly reduced placing the company at a high competitive edge. The second company fundamental is the company’s operating history. This entails tracking the company’s past history on performance (KRIVKA, 2015). This is by analyzing the revenue patterns, profit growth patterns and the cash flow patterns over a period. Also, the balance sheet is analyzed to come up with the debt-equity composition of the company over a period. The third company fundamental component is the management’s strategy and execution. This entails the policy by the management to remain competitive in the market and expand. The board of directors and the management of CSL Limited ensure compliance to acceptable standards of corporate governance (CSL Ltd. Annual Report, 2012). They also ensures the operations of the company are all carried out towards achievement of the company’s objectives. Therefore, the company’s strategy is to increase shareholders wealth via proper planning, community responsibility, management of risks and transparency. CSL has an ongoing strategy to expand in the global market. The management and board members of CSL Limited regularly review the company’s rules and regulations to ensure they are up to date with the current market changes. In the year ended 30th June 2016, the CSL Limited board have reviewed its governance practices and it believes that they are in compliance with the international recommendations. These recommendations are as per the Australian Securities Exchange corporate Controlling principles. There are many ASX recommendations that CSL have complied with. This include; laying solid foundations for management and board structure. Also, ensuring that the company act responsibility to the community, respecting the rights of investors, managing of risks and ('CSL Ltd. Annual Report', 2012) having fair remuneration plans. The management for CSL has recorded a big achievement in its corporate responsibility in the year ended 30th June 2016. It has achieved its promise by achieving growth and expansion. This has achieved via proper execution its business policy. The achievement also included the increased investment in product research and development strategy to develop products for unmet therapeutic wants. This company also has diversified its products portfolio by introducing new products into the market and modifying the old products. This has led to efficiency in production and operations has been increase. 4.0. Financial Ratio Analysis. Financial ratio analysis involves the evaluation of different features of a company to determine its operating and financial performance. Some of this features includes the solvency, efficiency, liquidity and profitability of a company. When these ratios are calculated they help to assess whether the company is improving in value or deteriorating. The performance of the features originates from the company’s annual report. Some of these ratios include; the EBITDA Margin, return on capital, EBIT Interest coverage, EBITDA Interest coverage, FFO/Debt, free operations cash flow / Debt, Debt / EBITDA and Debt / Debt plus equity (HAIDONG et al 2016) 5.0 The Credit Analysis For CSL Limited Figure 1: Show the financial ratios of CSL Limited. This ratios are categorized in three parts. This include; profitability and cash flow, leverage and coverage. They are discussed as follows. 5.1. Leverage Ratios 5.1.1. DEBT/ CAPITAL This is a leverage ratio. This ratio show the rate of percentage of the company that has been financed by debt. If the percentage rate of the debt is low, it clearly indicates that the credit risk is low. When we look at the CSL Limited financial statements, we realize that the ratio is alternating from period to period. For instance in 2011 it was at 1.7, 2012 at 1.4, 2013 at 1.6, 2014 at 1.3, and 2015 at 1.3. There is no consistency in the percentages. On average, this company financed its activities by 1.5 within five years (2011-2015). In 2012, the ratio reduced by 0.3 meaning that this company reduced their financing by debt. However, in 2013 it rose again by 0.2. This shows that the company raised the rate of debt to finance its operations. This company reduced financing its activities with debt in 2014 and 2015 by 0.3. This therefore implies this company is picking up with time by not relying on the debt to finance its activities. Based on this data there is a likelihood of CSL Limited evading the use of debt to finance its activities in future? Figure 2 shows the debt/capital ratios for the 5 years 5.1.2. DEBT/EBIDTA This is also a leverage ratio. Its show the rate of financing by debt of a company. This ratio shows the instability of a company. If it is high there is the likelihood that the company has more fixed costs. If this ratio is low it shows that the company is less financed by its debt. In addition, when it is high it implies that the company is in state of high debt levels. This means it is at a higher risk of experiencing high credit risk. For CSL Limited the rate for the five years is not consistent. This means that there is no a clear trend in the use of this debt. For instance, in 2011 it was 2.2, in 2012 it was 1.7, in 2013 at 2.8, 2014 at 4.1 and in 2015 it was 3.7. On average, this firm has the ratio of 2.9 (2011-2015) which is not good for the company. However, in 2012 it reduced by 0.5 which was a good progress for the company. The reason for this could be the company’s assets were still in good condition making them to increase the value. In 2013, the company’s rate rose by 1.1. This is not a good indication for the company. The acquisition of the new plant must have been on credit making the ratio to rise further. In 2014 the rate rose by 1.3. This is because the company was using more cash than it was making. This condition became better in 2015. This is because the firm debt rate reduced by 0.4. The reason for this was improvement in the operations of the firm. Generally, in 2015 this company shows a good indication of performing well in the near future Figure 3: Shows the Debt/ EBIDTA ratios for five years. 5.1.3. FFO / DEBT This is also a leverage ratio. This ratio indicates the ability of a firm to finance its debts from its operations. When the ratio is high it indicates that the firm is making more cash that can enable it to pay its debtors. Based on the analyses of CSL Limited financial report, this ratio does not follow any clear pattern. For instance, in 2011, it was 0.7, 2012 at 0.5, 2013 at 0.4 and 2014 at 0.4 and in 2015 it was 0.4. On average, this firm had a ratio of 0.5 within the five years. In 2011, this firm was in a better position to finance its debt form its operations. In 2012, the rate reduced by 0.24, in 2013 by 0.05, and further by 0.07 in 2014. This indicates that this firm could not generate enough cash to finance its debts. In 2015, the rate rose again by 0.07. This is good for this company as it implies the company can finance its debt from the cash generated from the company. This company is likely to perform well in future. Figure 4: shows the FFO/Debt ratios for 5 years 5.1.4. FREE OPERATING CASHFLOW /DEBT This is leverage ratio. This ratio shows the amount of cash that a firm generates to finance its debt. This means the very liquid cash that a firm uses to finance its debt. Whenever a firm finances its debts with cash generated from its operations it becomes better in terms of performance improvement. Based on the financial report of CSL limited, it cannot finance its debt by cash and cash equivalent. In 2011, the rate was -0.61, -0.64 in 2012, -0.5 in 2013, -0.4 in 2014 and -2.5 in 2015. On average it was at -52%. Based on these ratios, the company cannot pay its debts from its cash and cash equivalent. There is no consistency in this ratios. In 2012, there was a decrease by 0.03. In 2013, there was an increase by 0.14 and further by 0.1 in 2014. In 2015 the rate decreased by 2.1. This clearly shows that the company has less cash to finance its debt. Therefore the company will not be in a good liquidity position. Figure 5: shows the FFO/Debt ratios for 5 years. 5.2. Profitability Ratios 5.2.1. EBIT/CAPITAL EMPLOYED This is a financial ratio. It shows the company’s profit levels. Whenever the ratio is high, it indicates that the company is more profitable. Higher ratios indicate that the company is more profitable and lower ratios imply low profits. In 2011, the ratio was 6.4, 4.7 in 2012, 3.6 in 2013, 4.3 in 2014 and 4.3 in 2015. There is no consistency in these ratios. The profit reduced by 1.7 in 2012 and 1.1 in 2013. In 2014, it rose by 0.7 and remained constant in 2015. This is a clear indication that the firm is performing well because of the reduction in expenditure. In the near future, the firm will continue doing well. Figure 6: shows the EBIT/Capital ratios for 5 years. 5.2.2. EBITDA MARGIN This is a profitability and cash flow measure. This ratio indicates the earnings of the company before interest, taxes, depreciation, and ammotization expressed as a percentage of the total revenue. CSL Limited has EBTDA margin that is not consistent in nature. In 2011 it was 0.2, 0.3 in 2012, 0.2 in 2013, 0.2 in 2014 and 0.2 in 2015. This ratio was 0.16 in 2011. The rest of the years it was reducing. This means that the compnay is not performing well. In the near future this company will not perform well in term of growth in earnings. Figure 7: shows the EBITDA margin ratios for 5 years 6.0. COVERAGE RATIOS 6.1. EBIT/INTEREST EXPENSE This is a coverage ratio. It shows the credit quality of an entity. This ratio does not include depreciation and ammortization. This means that the ratio is conservative interms of measuring the coverage of interests. CSL Limited had a decreasing ratio over the period. For instance, in 2011 it was 6.7, 2011 at 1.3, 2013 at 0.96, 2012 at 0.91 and in 2015 at 0.77. on average the ratio was 2.1. This company has a decreasing interest coverage ratio. This means that the company has less earnings that facilitates the payment of interest. This compnay will therefore not be in a better position to pay its intersest with its earnings. Figure : shows the EBIT/INTEREST for five years 6.2. EBITDA/INTEREST EXPENSE This is a coverage ratio that show a compnaies credit worthiness. Any company with a high ratio indicate higher credit worthiness. CSL Limited had a ratio of 3.7 in 2011, 1.2 in 2012, 0.6 in 2013, 0.5 in 2014 and 0.4 in 2015. In 2011 and 2012, this compnay had enough cash to pay its debts. This is shown by the ratio which is greater than one. In 2013,2014,2015, the ratios were less than one indicating that this firm does not have enough cash to pay their interest. The trend in this ratio is reducing from year to year. The trend implies that the firm has fewer chances of repaying its debts. In the long brun, this company may face financial difficulties. 6.3. EBITDA MARGIN The margin is a profitability and cash flow measures. This ratio that indicate the earnings of the company before interest, taxes, depreciation, and ammotization expressed as a percentage of the total revenue. CSL Limited has EBTDA margin that is not consistent in nature. In 2011 it was 0.2, 0.3 in 2012, 0.2 in 2013, 0.2 in 2014 and 0.2 in 2015. This ratio was 0.16 in 2011. The rest of the years it was reducing. This means that the compnay is not performing well. In the near future this company will not perom well Figure 9: shows the EBITDA margin ratios for 5 years 7.0. Z SCORE FOR CSL LIMITED The Altman Z score is a realistic financial model developed by Edward Altman in 1968. The purpose for this model is to foretell the probability of a firm undergoing financial difficulties. Altman carried the study on 66 public manufacturing companies. Half of the companies studied had undergone bankruptcy while the other half was financially steady .He did this by analyzing each company’s financial reports and calculating different ratios. The prediction is believed to be 72% accurate. This model is widely used by practitioners throughout the world to date. CSL limited is a manufacturing company. The following ratios are used in computation of the Z score: X1=Working capital/ Total assets X2=Retained earnings/ Total assets X3= Earnings before interest and tax/Total assets X4 =Market value of equity/ Book value of total debt X5 = sales/ Total assets Therefore; Z > 2.99 implies “safe” zone 1.81 Z 2.99 implies “Gray” zone 1.82Z implies “Distress” zone The Z score for CSL Limited Variable Ratios X1 = Working capital/ Total assets =2403000000/6401000000 X1=0.375 X2 =Retained earnings/ Total assets =6000800000/6401000000 X2=0.937 X3 =EBIT/Total assets =176000000/6401000000 X3=0.027 X4 Market value of Equity/ Total liabilities =2746900000/3654100000 X4=0.752 X5 Sales/ Total assets =5458600000/6401000000 X5=0.853 Z= 1.2 (X1) + 1.4(X2) +3.3(X3) + 0.6(X4) + 1.0(X5) Z= 1.2(0.375) + 1.4(0.937) + 3.3(0.027) + 0.6(0.752) + 1.0(0.853) Z= 0.45+1.3118+0.0891+0.4512+0.853 Z= 3.1551 The Z score for CSL Limited is 3.1551. This means that the company is in the “safe” zone. This means that it is financially stable and there is no probability of the company experiencing bankruptcy in the near future. I would forecast the Z score for CSL Limited to be 3.0 in the following year. This will mean that the company will still be in a “safe” zone. This is same as saying that it will be in a state of financial stability. 8.0. Conclusion CSL Limited is a bio therapeutics company. This company develops and deliver advanced biotherapies. This helps to protect lives and assist people with poor medical conditions to live long. It is a global company. Therefore it undertakes its operations in different countries. Credit rating is done to assist investors to know the best company. The main objective of this paper was to prepare a credit rating report for CSL Company. Capacity Analysis helps in rating CSL limited. It is composed of three main parts. This include Industry structure analysis, Industry fundamentals and company fundamentals. This discusses different ratios. These include; EBITDA Margin, return on capital, EBIT Interest coverage, EBITDA Interest coverage, FFO/Debt, free operations cash flow / Debt, Debt / EBITDA and Debt / Debt plus equity. The Altman Z score is a realistic financial model developed by Edward Altman in 1968. This purpose for this model is to foretell the probability of a firm undergoing financial difficulties. It is given as follows: 9.0. References Bae, K, Kang, J, & Wang, J 2015, 'Does Increased Competition Affect Credit Ratings? A Reexamination of the Effect of Fitch’s Market Share on Credit Ratings in the Corporate Bond Market', Journal of Financial & Quantitative Analysis, vol. 50, no. 5, pp. 1011-1035 'CSL Ltd. Annual Report', 2012, Reportal Company Reports, p. 1. HAIDONG, F, VIKSNE, K, & LUNARDI, A 2016, 'LEVERAGE CONTROL AND QUANTITATIVE MANAGEMENT: THE ANALYSIS OF AMPLIFICATION EFFECT ON FINANCIAL SYSTEM', [SVERTŲ KONTROLE IR KIEKYBINIS VALDYMAS: POVEIKIO FINANSŲ SISTEMAI ANALIZĖ], Regional Formation & Development Studies, no. 19, pp. 7-16. KRIVKA, A, & STONKUTĖ, E 2015, 'COMPLEX ANALYSIS OF FINANCIAL STATE AND PERFORMANCE OF CONSTRUCTION ENTERPRISES', Business, Management & Education / Verslas, Vadyba ir Studijos, vol. 13, no. 2, pp. 220-233. LARIVIÈRE, B, KEININGHAM, TL, AKSOY, L, YALÇIN, A, MORGESON III, FV, & MITHAS, S 2016, 'Modeling Heterogeneity in the Satisfaction, Loyalty Intention, and Shareholder Value Linkage: A Cross-Industry Analysis at the Customer and Firm Levels', Journal of Marketing Research (JMR), vol. 53, no. 1, pp. 91-109. Lecture 5 notes 2016 Li, B, Yang, H, Wei, Y, Su, R, Wang, C, Meng, W, Wang, Y, Shang, L, Cai, Z, Ji, L, Wang, Y, Sun, Y, Liu, J, Wei, L, Sun, Y, Zhang, X, Luo, T, Chen, H, & Yu, L 2016, 'Is It Time to Change Our Reference Curve for Femur Length? Using the Z-Score to Select the Best Chart in a Chinese Population', PLoS ONE, vol. 11, no. 7, pp. 1-12. Mägi, A, Unt, E, Prans, E, Raus, L, Eha, J, Veraksitš, A, Kingo, K, & Kõks, S 2016, 'The Association Analysis between ACE and ACTN3 Genes Polymorphisms and Endurance Capacity in Young Cross-Country Skiers: Longitudinal Study', Journal of Sports Science & Medicine, vol. 15, no. 2, pp. 287-294. O'Reiley, T 2012, 'Bid for damages fails in lawsuit against attraction', Las Vegas Business Press (10712186), vol. 29, no. 16, p. 12. Ren, F, & Dewan, S 2015, 'Industry-Level Analysis of Information Technology Return and Risk: What Explains the Variation?’ Journal of Management Information Systems, vol. 32, no. 2, pp. 71-103. Robison, J 2012, 'Small-business optimism increases, but hiring doesn't', Las Vegas Business Press (10712186), vol. 29, no. 16, p. 12. Read More