Shareholder Structure and Risk Profile of British Petroleum - Essay Example

British Petroleum Table of Contents British Petroleum Table of Contents 2 The Company: An overview 3 The objective of the Company: In accordance with the objective function in Corporate Finance 3 The composition of Share Ownership and Board of Directors 4 BP’s position on the life cycle: The opportunities and challenges 6 Risk Profile of the Company 7 Accounting Risk Profile 7 Market Risk Profile 13 Calculation of Weighted Average Cost of Capital 14 Reference 17 Bibliography 19 Appendix 20 The Company: An overview The origin of this company can be traced to the sands of Persia where the Anglo Persian Oil Company struck its first oil. This isolated discovery gradually mutated and emerged as British Petroleum (BP), the third largest integrated oil concern on the globe. BP continues its oil and gas exploration in around 29 countries with a large reserve of 18.2 millions barrels of oil equivalent. BP operates with more than 24000 gas stations globally and markets the products in above 100 countries. To encourage environmental sensitiveness, this enterprise has started an alternative Energy unit which incurred a cost of $1.8 billion initially to build up green energy sources (Hoovers, 2010). The objective of the Company: In accordance with the objective function in Corporate Finance One of the most important objectives of corporate finance function is to maximise the shareholders’ value. There are many avenues by which the shareholders’ value can be increased. A company can invest in those projects which would fetch them a return, greater than the minimum hurdle rate. In compliance with that the company is committed to maximise the value for their shareholders. Their strategy is to create value by investing in exploration and production business because they offer sustainable growth with high returns through out the operational activities. To sustain the momentum which increases the firm’s value, the company intends to reinvest in exploration and production while carrying out their target acquisition for expansion of their business activities. They are expected to make investments in their assets through out the business cycle to increase the operational productivity of the company. All these attempts have been put forward so that a sustainable growth can be attained in future. This would even help the shareholders to attain an enhanced continual growth in their earnings from this company. BP’s aim is to strike a balance for their shareholders between the earnings involving the dividend, persistent investment in long term growth opportunities and maintain a careful risk return level. The company has a proper dividend reinvestment for the shareholders who are willing to have their dividend in the form of stocks rather than in cash. The company also have dividend reinvestment plan for their US and Canadian shareholders. All these approaches have been taken in accordance with the shareholders’ interests. They have committed to a remuneration policy which is in accordance with the interests of the shareholders. In the current volatile scenario it is quite important to have talented as well as committed executives on board; because leadership is quite important to enhance the shareholders’ value. The management would go through a cautious and rigorous assessment of its operating and investing activities so that it adds value to the shareholders’ of this company. All strategies and activities would be implemented with a clear vision of the risk attached to it. In conclusion it can be said that the company is committed to offer higher return to the shareholders with a continual accumulation of value to their earnings (BP, 2008). The composition of Share Ownership and Board of Directors The board governance principles of BP enable the board and the management executives to operate and perform in a comprehensible framework. As per the principles, it is required that the half of the board, excluding the chairman, would consist of independent non executive directors. The number of directors has to be below or equal to 16. The board comprises of the chairman, nine non executive and four executive directors. The board determines whether the size and the composition is proper to administer BP. The directors possess the germane background, mix of knowledge, skill and experience to enhance the effectiveness of the company. The board is actively involved in methodical succession planning for both the executive and the non executive directors. The nomination committee assists the board in this task of planning and organising. This committee is responsible for reviewing the composition, diversity and skill of the board to ensure that the board is capable of carrying out its responsibility. The skill sets include engineering, operational, safety and financial expertise. At the same the board members need to have an expertise in leading capital intensive, long lead time industrial businesses. They need to have an insight of the significant changes in market environment; these changes would surely include the technological developments taking place all around. The chairman and the non executive directors of the company serve the company on the basis of letter of appointment, while executive directors have service contracts with the firm. New Board directors are elected by the shareholders of the company. The tenure of the board members is determined by their contribution and evidence of proper independent judgement exercises (BP, 2008). On 31st December 2008, there were 316, 320 ordinary shareholders of BP. Among which, around 0.25 % shareholders accounted for some 94.73 % of total share capital. Around 78 % of the shares in issue are held by the institutional shareholders and the rest 22 % lie with the individual shareholders. Among the American depository shares (ADS), 0.01 % of the total ADS shareholders held around 86.71 % of the stock amount. As on the date, the number of preference shareholders summed to 1,622. The company’s capital is mostly dominated by the capital raised from the issue of ordinary shares. Ordinary shareholders accounted for 99.56 % of the share capital; rest has been contributed by the preference shareholders. The holdings have miscellaneous representation, which include the shareholders below the 100, 000 stock threshold and the unidentified shares, which have been awaiting substantiation of the individuality of the valuable shareholder (BP, 2010). BP’s position on the life cycle: The opportunities and challenges Any business can have different stages through out the life cycle. These stages include Start up, Early Success, Sustained Success, Maturity and Decline. At the early stage the investment is supposed to be quite high to launch a new business. The company can expect to make losses at this stage, though it can expect a high growth in revenue term. At early success stage a company would mainly focus on customer acquisition and retention and prefer to invest in working capital. At this stage the company would have high growth tendency in revenue with an emergence in the profit level. The later stage is related to sustained success. In this stage the companies is expected to have steady revenue trend with strong growth trend in profit. Investment needs would be reduced to a certain amount as the operational processes would start to generate free cash flows. Companies would focus at customer retention, diversification of the business and offer a high return to the shareholders. Maturity stage usually shows a trend of stable revenue growth, although the profit level can decline at this stage. At this period companies usually try to expand their customer base beyond the existing one. The last stage is called the decline stage. At this period, both the revenue and profit tend to decline for the company. Capital erosion takes place hence more capital is needed for rejuvenation. At this stage often companies prefer to exit. Sometimes they try to reverse their fortunes by rejuvenating the business procedures for the succession of the business. Looking at the income statement of BP, it is quite apparent that the company has managed a steady and strong revenue and profit level through out these five years. Although in 2009, the revenue and profit both have seen a dip in values, but that was mostly because of the financial downturn around the globe. Apart from this till 2008, the company has been able to generate a steady operating cash flow with a continual growth attached to it. Investment in working capital of the company has been reduced by a good amount through out these years. In 2009, the change in working capital was on a decline and it reduced to $ 9, 920 millions. All these statistics gives an idea that the company is in its sustained growth stage. The challenges would come as the company approaches its maturity stage. At this stage the company should focus on customer retention and expansion to stay ahead of the competitors. At the same time they should look for diversification and expansion of their business activities with an offering of continual growth on shareholders’ value (Rogg, 2010). Risk Profile of the Company Accounting Risk Profile To maintain a sustainable growth and profitability, an organisation has to undergo operating, investing and financing activities. It is very important to measure the various financial risks attached to it so that sustainability is maintained in short as well as long run. To calculate the ratios, data have been collected for the last five years. It would be provide a better picture of the emerging trends in those ratios. The accounting risk profile of an organisation can be measured by using the financial ratios of that company. Key financial ratios include leverage ratio, liquidity ratio, activity ratio profitability ratios, and payout ratios. Volatility Measures The highest percentage change in the sales value has been in 2008 and the lowest has been in 2005-06. Cost of sales has followed the same path as the sales of the company for most of the years except in the period 2005-06. This period is quite significant as the cost of sales has seen an abrupt growth and then a steep decline. Change in earning before interest and tax (EBIT) and the earning per share (EPS) are quite in accordance with the sales change. Risk Indicators Leverage is an unpredictable factor which the company needs to take into account. Sometimes it benefits the company while on some other occasions it pushes it to a risky situation. The year 2005 has seen the lowest possible leverage for BP although the situation changed in 2006. Financing ratios Debt equity ratio for this company has been quite low which indicates that the company prefers to have a low debt in its portfolio, which is appreciable. Still, it can prove to be disadvantageous for the company as they can lose on the tax shield provided by the debt component. So it is very much necessary to strike a balance between the two. Interest cover ratio is quite high for this company. This is surely a good sign as it indicates that the company has got enough cash to pay off the interest expenses. Liquidity ratio Current ratio is calculated as current assets to current liabilities. In 2008, the value of current ratio was decreased drastically, which indicates that either the company has decreased their current assets or else they have taken more current liabilities on its accounting book. In the same year, BP also increased the current liabilities. The company had a low current ratio in 2008. Activity ratios Asset turnover ratio saw a steep growth from the year 2008.From the year 2005 till 2007, the fluctuation was quite low. Profitability ratios Although the return on assets had increased in 2008, the profit margin declined in the same year. The negative change in profit margin was because of an increase the tax amount. The profitability ratios had been high in the year 2005. Return on Equity High return on equity is important for the equity investors of any company. The investors consider it as a sign of strong operation and financial processes. Return of equity had been lowest in 2004 and was highest in 2005. Pay out Indicators The dividend cover ratio had seen a high growth in 2006. That was because of an increase in both the earnings and the dividend payments. A high dividend cover ratio is indicative of a growth oriented organisation. In all the risk profile of BP was quite moderate through out this period. Market Risk Profile The above figure is a graphical representation of the return on company’s stock against the return on the benchmark index. Here the benchmark index is taken as S&P 500. From the scatter diagram it is very apparent that both the stocks have shown the same direction of return. In 2009, the stock had outperformed the index return, which means the company made quick recovery than the market index. The market risk profile of the company can be calculated using the co-efficient of determination, market beta and other risk measuring methods. Co-efficient of determination is quite important because it gives an idea about how much of the stock variation is determined by the market variation. 85.6 % of the variation in the stock return for BP can be explained by using the return of S&P 500 index. The estimation has been done with a standard error value of 9.5 %. The beta of this company has a value of 0.75 which means that if the market moves 100 %, the stock would move 75 % in the same direction of the market. In short, the company has shown a strong association with the market risk return profile. Calculation of Weighted Average Cost of Capital Cost of Capital is the cost incurred to fund the capital required for the company. Weighted Average Cost of Capital (WACC) takes proportion for each type of capital. WACC = Weight of Debt * Cost Of Debt + Weight of Equity * Cost of Equity Cost of Debt is calculated as the percentage of interest to the debt amount. As the company moves to a more steady and strong position, the cost of debt states decreases. This was precisely what happened with this company. The cost of debt has decreased from 14.82 % to 3.21 %. This means as the company will start to grow and reach a stable state; investors will find the company less risky to invest in. The model used to calculate the cost of equity is Capital Asset Pricing Model. As per the model cost of equity is calculated as follows. Cost of Equity = Risk Free Rate+ (Market Return- Risk Free Rate) * Beta The risk free rate has been taken as the 3 months Treasury yield (US Department of Treasury, 2010). The beta value has a value of 0.75 (Yahoo Finance, 2010). The return for S&P 500 index has been taken into account for market return. (Standard and Poors, 2009). As per the CAPM model the cost of equity was calculated as 7.45 % in the year 2009. Values for other years have been calculated and shown in the table below. Weighted Average cost of capital (WACC) has been calculated as per the formulae. The WACC had been 6.37% and 8.61% for the years 2009 and 2005 respectively. In the year 2008, due to the financial downturn, market return went down to a negative value of -36.10 %. This resulted in a negative weighted average cost of capital for the respective year. Investors perceive this percentage value as the minimum return the company would be offering. So the weighted average cost of capital is quite significant for the organisation. Reference BP. 2008. Annual Review 2008. [Pdf]. Available at: http://www.bp.com/liveassets/bp_internet/annual_review/annual_review_2008/STAGING/local_assets/downloads_pdfs/BP_annual_review_2008.pdf [Accessed on February 24, 2010]. BP. 2008. BP board performance report. [Pdf]. Available at: http://www.bp.com/liveassets/bp_internet/globalbp/STAGING/global_assets/downloads/I/BP_ara_2008_governance_board_performance_report.pdf [Accessed on February 24, 2010]. BP. 2010. Ownership Statistics. [Online]. Available at: http://www.bp.com/extendedsectiongenericarticle.do?categoryId=9010453&contentId=7019612 [Accessed on February 24, 2010]. Dailyfinance. February 25, 2010. BP PLC (BP) Average Monthly Returns. Available at: http://www.dailyfinance.com/quotes/bp-p-l-c/bp/nys/average-monthly-returns [Accessed on February 24, 2010]. Hoovers. 2010. Company Description. [Online]. Available at: http://www.hoovers.com/company/BP_plc/hxxkti-1.html [Accessed on February 24, 2010]. Reuters. 2010. Financial Statements For BP Plc. [Online]. Available at: http://uk.reuters.com/business/quotes/incomeStatement?stmtType=BAL&perType=ANN&symbol=BP.L [Accessed on February 24, 2010]. Rogg. 2010. Business Life Cycle. [Online]. Available at: http://www.rocg.com/Articles/library/WhoWillBuy_BusinessLifeCycle.gif [Accessed on February 25, 2010]. Standard & Poors. 2009. Standard & Poor’s Index Services. [Online]. Available at: www2.standardandpoors.com/spf/xls/index/MONTHLY.xls [Accessed on February 25, 2010]. US Department of Treasury. 2010. Daily Treasury Yield Curve Rates. [Online]. Available at: http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield_historical_2005.shtml [Accessed on February 25, 2010]. Yahoo Finance. 2010. BP Plc (BP). [Online]. Available at: http://finance.yahoo.com/q/ks?s=BP [Accessed on February 25, 2010]. Bibliography Cameron, A. 2009. EXCEL 2007: Multiple Regression. [Online]. Available at: http://cameron.econ.ucdavis.edu/excel/ex61multipleregression.html [Accessed on February 25, 2010]. Mallit. No Date. Excel - A Regression Example. [Online]. Available at: http://mallit.fr.umn.edu/fr4218/assigns/excel_reg.html [Accessed on February 25, 2010]. Proactiveinvestors. 2009. British Petroleum. [Online]. Available at: http://www.proactiveinvestors.co.uk/companies/news/4680/bp-total-return-potential-4680.html [Accessed on February 25, 2010]. Appendix Market Risk Profile Read More