Financial Analysis of Johnson Matthey - Case Study Example

Financial analysis of Johnson Matthey FN 361 By Johnson Matthey is a speciality chemicals company that demonstrates an exceptional ability in sustaining world leadership by adapting constantly to rapidly changing customer needs. In 2009, the company remained accurate in its own environmental policies and developed environmentally friendly products with high added value using state-of-the-art technology. This paper evaluates Johnson Matthey's financial statements and non-financial statements. In Part A, Johnson Matthey's Balance Sheet, Cash Flow and Income Statement are analysed and evaluated, in terms of meaning of information within the statements, as viewed from the point of view of potential shareholders. In Part B, Johnson Matthey's Annual Report & Accounts 2009 is analysed and evaluated in terms of usefulness of the information within the report, as viewed from the point of view of potential shareholders. The paper concludes that Johnson Matthey's financial statements are clearly structured, facilitating the company's financial analysis. Also, non-financial statements communicate the group's quality, innovation and efficiency to shareholders in a comprehensive way that identifies the company's strategic objectives. Keywords: Johnson Matthey, strategic objectives, financial analysis Contents PART A: Financial Analysis 3 1. Company Summary 3 2. Strategic Objectives 3 3. Financial Ratio Analysis 4 3.1 Profitability 4 3.2.Liquidity 5 3.3 Investors Ratios 6 3.4 Management Effectiveness 6 3.5 Overall Performance 7 4. Comments on Johnson Matthey Financial Statements 7 PART B: Non-Financial Analysis 8 1. Evaluation of Strategy and Objectives 8 2. Evaluation of Key Performance Indicators 8 3. Evaluation of Financial Review 9 4. Evaluation of Operations 9 5. Evaluation of Research & Development 10 6. Evaluation of Risks and Uncertainties 10 7. Evaluation of Sustainability 10 8. Comments on Johnson Matthey Non-Financial Statements 11 CONCLUSION 11 References 12 Appendix A: Computation of Financial Ratios 13 Appendix B: Corporate Report Extracts 14 Consolidated and Parent Company Balance Sheets 14 Consolidated Income Statement 15 Consolidated and Parent Company Cash Flow Statements 16 PART A: Financial Analysis 1. Company Summary Johnson Matthey is a speciality chemicals company. Focusing on its core skills in catalysts, fine chemicals and precious metals, the company's main activities are organized through its Environmental Technologies, Precious Metals and Fine Chemicals & Catalysts Divisions. Johnson Matthey manufactures catalysts, pollution control systems, and fine chemicals, engages in the refining and fabrication of precious metals and produces active pharmaceutical ingredients (Annual Report, 2009). Important strategic acquisitions are: the acquisition of Argillon Group in February 2008; the selling of non-core Insulators and Alumina businesses to Lapp Insulator GmbH & Co in November 2008; the acquisition of the 49% Alfa Aesar China Limited in March 2009 (Google Finance, 2009) The common stock trades on the London Stock Exchange (LSE: JMAT.L). 2. Strategic Objectives (Annual Report, 2009) For 2009/2010, Johnson Matthey's strategic objective is to generate consistent growth in earnings by developing high added value products and services. The company aims at further supporting R&D and financing organic growth. Although opportunities for growth are on the agenda, the company plans on reducing capital expenditure to generate more cash. The group's financial objectives are: achieving constant and above average growth in earnings per share; achieving an ROI above the group's cost of capital; achieving a 20% ROA for all its divisions; maximizing dividends in line with earnings to ensure sufficient funds are retained to support organic growth The priorities given in strategic direction are: Focusing on its core skills in the manufacture of catalysts, fine chemicals and precious metals; Positioning the company in growth markets taking advantage of its core strengths; Using its state-of-the-art-technologies to differentiate itself from competition; Differentiating its business through significant investment in R&D; Focusing on continuous training of its human capital; Building and maintain strong relationships with its stakeholders through investment in joint projects to take advantage of future market opportunities; Implementing Sustainability 2017 Vision 3. Financial Ratio Analysis For the fiscal year ended 31 March 2009, Johnson Matthey's revenues increased 4.66% to 7,847.8m. Net income decreased 6.2% to 173.9m due to an increase in cost of sales (4.53%) and decrease in operating profit (4.66%). 3.1 Profitability Strategies implemented: Product Development, Product Positioning, Cost Reduction To anticipate the global financial crisis, Johnson Matthey implemented a product development strategy. Through heavy investment in R&D, the company managed to maintain or strengthen its position in the markets that offer adequate added value to justify long term investment opportunities and anticipate potential risks and uncertainties associated with financial viability. Besides, Johnson Matthey implemented a product positioning strategy. Through the design of innovative products that uniquely distinguished Johnson Matthey from its competitors, the company managed to maintain or even strengthen its position in the markets it serves and to take advantage of the growth opportunities in emerging markets within the sustainability sector. Both strategies were successfully implemented considering that gross margin increased due to the increase in revenues by 4.66% (7,498.7m to 7,847.8m) suggesting a financially solvent company. On the other hand, Johnson Matthey experienced a significant decline in operating margin due to an increase in the cost of sales by 4.53% (7,006.7m to 7,324.3m), distribution costs by 13.45% (89.2m to 101.2m) and administrative expenses by 16.79% (106m to 123.8m). Similarly, net margin declined due a decrease in due to a decrease in net income by 6.2% (185.4m to 173.9m). All are attributed to a cost reduction strategy implemented in the Emission Control Technologies division in response to global downturn and fall in demand for light duty vehicle sales by 12% (60.3m from 67.54m) and production by 13%. In response to the fall in demand, ECT increased its cost reduction strategy, thus improving production efficiency and reducing reject costs and distribution costs. Conclusion: In terms of Profitability, Johnson Matthey is relatively strong. However, although it sustains a competitive advantage over competitive firms, the significant decline in operating and net profit margins may delay its objective to achieve an above average growth in earnings per share (EPS). 3.2 Liquidity Strategies implemented: Cost Reduction, Raising capital with long-term debt In the 2008/2009 financial year, Johnson Matthey performed well in spite of the credit crunch and economic downturn. The severe crisis in automotive industry in the North American and European markets caused a decline in global production of vehicles by 26% and a decline in consumer confidence. To adapt to the altering market conditions, Johnson Matthey implemented a cost reduction strategy in order to generate more cash and be able to continue investing in R&D. The strategy was successfully implemented as the current ratio in 2009 is over 1, suggesting that Johnson Matthey is capable of meeting its obligations. Besides, the company's short-term liquidity increased as a result of cost-reduction strategy. Johnson Matthey invested heavily in R&D to remain competitive and a leader in the global markets. However, short-term liquidity does not ensure long-term solvency. Johnson Matthey raised capital with long-term debt to generate cash. Gross borrowings of 628.8 million at 31st March 2009 included 609.1 million of long-term debt in the form of long term bond issues and long term funding from the European Investment Bank. The company did that to ensure adequate resources to fund its operations for the near future. Long-term debt is an area that the company must focus. The more long-term liabilities are undertaken, the more the company is exposed to higher financial risk. This may threaten its long-term solvency, possibly increasing the probability to default on its debt. Conclusion: In terms of Liquidity, Johnson Matthey is relatively strong. Yet, liquidity management is an area the company must focus. Given its international expansion in emerging markets such as China and India with banking systems possibly vulnerable to unexpected demand of funds, the company should consider the banks' standing in the markets and their ability to raise funds. Although the company reduced its total debt to equity, the raising capital with long-term debt strategy exposed it to a significant amount of financial risk. Johnson Matthey should diversify its investments to take advantage of the market fluctuations. A highly diversified company is less exposed to market changes in the perceptions of investors. This will boost the company's reliability and performance. 3.3 Investor Ratios Strategies implemented: Product Development, Product Positioning Through investment in R&D, Johnson Matthey supports its high technology business. The company implemented a product development strategy to increase R&D investment in order to sustain its world leading position and strong presence in global markets. Besides, Johnson Matthey implemented a product positioning strategy. Having positioned its products well to grow in Asia and having a well-established presence particularly in China and India, the company has been the least impacted by the current financial downturn. Both strategies were relatively successful considering the relative increase in Dividend Per Share (DPS). Being a company with high investment opportunities, Johnson Matthey grows dividends in line with earnings. Dividend payout is low covering at about 2.5 times to ensure high retained earnings, indicating the company's intent to fund organic growth. In terms of book value per share, both strategies were successfully implemented considering the increase in stock price by almost 100% in one year (772.50 to 1,547) (BusinessWeek, 2009). Conclusion: Johnson Matthey currently trades at a P/E 18.56 (Financial Times, 2009) indicating a solvent company and a leader in the industry. However, the significant decline in cash flow per share due to a decrease in cash from operating activities by 4.92% (262.3m to 249.4m) may inhibit the company's strategic goal to generate cash to support R&D and fund organic growth. The EPS is in line and, therefore is not worth commenting on. 3.4 Management Effectiveness Strategies implemented: Investment in fixed assets In the 2008/2009 financial year, Johnson Matthey invested heavily in fixed assets. Belonging to a cyclical industry and being closely tied to the fluctuations of the national and global economy, it exposes high volatility in sales and consequently in earnings. This makes it imperative to invest heavily in long-term assets and to endure high fixed costs. Yet, this strategy led to a great increase in capital expenditure. For 2009/2010, Johnson Matthey aims at reducing capital expenditure by completing its new Emission Control Facilities in Macedonia and western Pennsylvania and investing in China on plate catalysts for the reduction of damaging NOx emissions from power stations. Conclusion: In terms of Management Effectiveness, Johnson Matthey is weak. The company does not use its assets efficiently to generate cash (ROA) or to invest (ROI), neither does it generate cash from the money shareholders have invested (ROE). This may inhibit its strategic objective to achieve an ROI above the group's cost of capital and a 20% ROA for all its divisions. 3.5 Overall Performance In the 2008/2009 financial year, Johnson Matthey performed well and maintained its world leading position and strong presence in global markets. In spite of a decrease 1.6%, mainly justified by the collapse in the global banking system and consumer confidence, the company maintains its overall performance at a high level related to capital employed. Johnson Matthey increased its focus on cash, generating 96.8 million of net cash flow. This was the result of the successful implementation of cost reduction, product development, and product positioning strategies. However, fixed assets investment may inhibit its strategic objective to achieve an ROI above the group's cost of capital and a 20% ROA for all its divisions. Also, raising capital with long-term debt strategy may threaten its long-term solvency. 4. Comments on Johnson Matthey Financial Statements For the evaluation of Johnson Matthey's financial performance, the consolidated financial statements of the company as included in the Johnson Matthey Annual Report & Accounts 2009 have been used. All financial statements, namely Balance Sheet, Cash Flow and Income Statement are clearly structured and facilitated the company's financial analysis. No obstacle has been met in analyzing the company's Balance Sheet to acquire information on fixed assets, current assets, current liabilities and non-current liabilities and analyze the relevant financial ratios. Similarly, Cash Flow and Income Statement provided clear and adequate information on cash flow, revenues, operating profit and net profit to analyze the company's overall performance. PART B: Non-Financial Analysis (Annual Report, 2009) The non-financial statements of a company are as important as its financial statements. Investors can derive valuable information by reading the executives' statements or by taking a quick look in the Annual Report's graphics provided they are reliable and relevant to the company's performance. 1. Evaluation of Strategy and Objectives In page 4 of Annual Report & Accounts 2009, Chief Executive, Neil Carson states: "A key element of our strategy has been to maintain a strong balance sheet to ensure that we have sufficient funds to support our investment in R&D and fund organic growth.... At the same time we are taking continued action to cut costs in all of our businesses and are maintaining a sharp focus on generating cash." Johnson Matthey uses advanced technology to identify new investment opportunities in R&D and develop high-end products. In spite of the economic downturn, it maintained its leading market position. By cutting costs, it will generate more cash to continue investing in R&D and funding organic growth. Johnson Matthey executives communicate the company's strategy clearly and concisely demonstrating the correlation between strong figures and strategic management. Shareholders derive necessary information to make well-informed investment decisions. 2. Evaluation of Key Performance Indicators Johnson Matthey analyses its Key Performance Indicators in terms of financial analysis, market shares and sustainability. By using graphics for Sales Excluding Precious Metals, Underlying Earnings per Share and Return on Invested Capital (ROIC) investors clearly understand how the company has performed over the past five years in terms of profitability, sales and ROIC. The company uses also graphics regarding Share Price Five Year Performance vs. FTSE 100 portraying its remarkable performance very efficiently. a. Financial: The company explains which items are excluded from the calculations of earnings per share (EPS) and return on invested capital (ROIC), how ROIC is defined, and how sales growth and return on sales is measured. It is a comprehensive analysis of how performance is measured to meet the company's financial objectives. However, too much information is included in this section considering that financial review follows. b. Market Shares In the market shares section, the company provides as much information as required so that shareholders understand why the group achieves a leading position in global markets. c. Sustainability The sustainability section explains the relationship between the Sustainability 2017 Vision and sustainability performance as measured based on financial, social, governance, health and safety, and environment elements. However, too much information is included in this section, considering that sustainability is explicitly analyzed in a separate section. 3. Evaluation of Financial Review In page 10 of Annual Report & Accounts 2009, Group Finance Director, John Sheldrick, states: "Market conditions changed significantly during the yearCar sales in many of the world's major economies fell dramatically and have remained low since then. Global car production in the second half of Johnson Matthey's financial year was 26% down on the same period in 2007/08." Financial review section analyzes: sales; operating profit; exchange rates; return on sales; return on invested capital (ROIC); interest; profit before tax (EBIT); taxation; earnings per share (EPS); dividend; pensions; cash flow; and capital structure. It also provides information on the group's treasury policies and funding capacity. By using reliable graphics for Platinum and Palladium Prices, Rhodium Price, US Dollar Exchange Rates and Maturity Profile of Debt Facilities, the company covers the main areas that affected its sales on the second half as well its long-term solvency. Being elaborate, but not too sophisticated, this section is understandable by the average shareholder. 4. Evaluation of Operations Operations section analyzes the Environmental Technologies, Precious Metals and Fine Chemicals & Catalysts Divisions. For the Environmental Technologies Division, the company provides useful information on Emission Control Technologies (ECT), Process Technologies and Fuel Cells. For the Precious Metals Division, the company provides useful information on Platinum Marketing and Distribution, Noble Metals, Pgm Refining and Recycling, Colour Technologies, and Gold and Silver. For the Fine Chemicals & Catalysts Division, the company provides useful information on Catalysts and Chemicals, Macfarlan Smith, Pharmaceutical Materials and Services and Research Chemicals. For all three Divisions, the company provides key statistics, information on performance in 2008/2009 and a series of relevant graphics that demonstrate details on the business of each Division. Shareholders get a comprehensive idea about the group's global operations. 5. Evaluation of Research & Development In page 25 of Annual Report & Accounts 2009, the company states: "One of the group's strategies is to differentiate ourselves by using our world class technology and we invest significantly in research and development to develop new products and manufacturing processes." R&D is Johnson Matthey's motive force. The corporate information conveyed in the report is valuable as it provides details on the group technology centre at Sonning Common in the UK. Besides, it explains the next generation emission catalysts and fuel cell catalysts, and focuses on the importance of cleaner use of coal and the reduction of spoilage of fresh produce. Shareholders derive valuable information on how Johnson Matthey differentiate themselves by using state-of-the-art technology and resources, while being an advanced analytical science group. 6. Evaluation of Risks and Uncertainties Johnson Matthey explicitly states the risks and uncertainties that may pose potential threats on the group's long-term performance. The risk and uncertainties section is comprehensive including analysis on technological change; legislation; global, political and economic conditions; environmental liabilities; commercial relationships; foreign exchange; precious metals; pensions; customer market dynamics; competitor risk; litigation and investigations; energy and raw materials; and credit risk. This section is as inclusive as it should be so that shareholders become aware of potential threats that may have an impact on organizational performance. 7. Evaluation of Sustainability In page 29 of Annual Report & Accounts 2009, the company states: "Throughout Johnson Matthey we are committed to the principles of sustainable development and strive for outstanding resource efficiency and carbon neutrality. Going forward, we aim to further develop and enhance sustainability as a core competence and key driver of competitiveness for our business. This will be delivered through our Sustainability 2017 initiative." The company provides analytical information on the progress of Sustainability 2017 Vision since its launch in December 2007 and analyzes how it aims to proceed in 2010. Besides, shareholders are informed about the company's sustainable products; policies and management systems in regards to environment, health and safety; human resources; business integrity & ethics; communication with stakeholders; and community investment. All this information is conveyed in a straightforward and concise way that helps shareholders identify and appreciate Johnson Matthey's sustainable business. 8. Summary on Johnson Matthey Non-Financial Statements Johnson Matthey's Annual Report & Accounts 2009 provide adequate information to shareholders. Addressing issues of technology, competition, global markets, organizational culture, and sustainability, it provides a clear description of the drivers of organizational performance. In this context, performance measurement encompasses also cognitive assets that create organizational value (Bontis, 2001). Knowledge, experience, skills, processes, and leadership style, all are communicated to shareholders clearly and effectively. Following the pattern of global organizations, Johnson Matthey exploits its intangible assets, clearly separating in the corporate report its business strategy and financial budgeting (Kaplan & Norton, 1996). The company handles the negative results of second half with sincerity. Executives reliably attribute the decline of Emission Control Technologies division sales on the credit crisis and the decline of consumer confidence on automotive markets in Europe and North America. All graphics used are perfectly understandable by the average investor. They are relevant to the description of each section; reliable to the explanations they provide; and they convey the information in a timely manner. Although they don't really highlight trends, they are an asset. Conclusively, Johnson Matthey's Annual Report & Accounts 2009 communicate the group's quality, innovation and efficiency to shareholders in a comprehensive way that identifies the company's strategic objectives. CONCLUSION After having analysed various relationships among components of Johnson Matthey's consolidated financial statements as well as its non-financial statements as included in the Annual Report & Accounts 2009, it becomes obvious that it is a highly reliable company. From a financial perspective, Johnson Matthey is a speciality chemicals company that belongs to a cyclical industry. As such it exposes high volatility to sales and profitability depending on the broader economic conditions. The company has to invest in fixed assets and endure high fixed costs. Although this strategy has created a high long-term debt, Johnson Matthey creates value for its shareholders. The company's financial statements are well-structured and, by all means, they convey the message of a solvent company that is able to meet its obligations. In spite of the global economic downturn, Johnson Matthey was able to restructure its processes and recover. From a non-financial standpoint, the company's policies, procedures, and processes as explained in the corporate report demonstrate an organized company with an experienced management team, able to adapt to the rapidly changing market conditions. Besides, the company's executives use a clear and understandable language to communicate their strategic objectives. Their aim is to address the important issues of sustainability, exchange rates, financial risk, operating profit and many others to a growing number of stakeholders, who can potentially become their shareholders in the foreseeable future. References Bontis, N. (2001) Assessing knowledge assets: a review of the models used to measure intellectual capital, International Journal of Management Reviews BusinessWeek (2009) http://investing.businessweek.com/research/stocks/charts/charts.aspric=JMAT.L Financial Times (2009) http://markets.ft.com/tearsheets/performance.asps=UK:JMAT Google Finance (2009) http://www.google.co.uk/financeq=LON:JMAT Johnson Matthey Annual Report & Accounts (2009) http://www.matthey.com/investors2004/reports.htm Kaplan R., Norton D., (1996) Using the Balanced Scorecard as a Strategic Management System, Harvard Business Review, Jan-Feb 1996 Reuters (2009) http://www.reuters.com/finance/industries/overviewindustryCode=51113 Appendix A: Computation of Financial Ratios Appendix B: Corporate Report Extracts Read More