Financial Statement Analysis and Valuation - Essay Example

Financial ment Analysis and Valuation Executive summary: The energy sector of the UK comprises oil, gas, petroleum, nuclear power, and renewable energies. British Petroleum Company is a British global energy group delivering premium energy products and services around the world. BP features a diverse energy portfolio producing natural resources for more than 80 countries across the globe. The use of its products and services ranges from home to businesses and on the road. BP product lines include bio fuels, gas and fuel cards, industrial lubricants, marine fuels, Liquefied Petroleum Gas (or LPG), and solar powered energy. Global energy has strong impact on global economy. The implementation of energy policies is a relevant issue in conjunction with the alarming rate of climate change. Therefore, it is significant for the energy sector to focus on alternative energy production technologies to minimise the environmental impact while maximising environmental safety. Industry analysis: The world energy has been significant and crucial in the UK economy for a long while. If we look back into the history, oil price rise in the 70s radically changed the world fuel market resulting in global economic recession that also severely affected the UK economy. This was one of the reasons for the growth of a self-sufficient oil production market in the UK in the 80s. Coming back to the current scenario, the implementation of energy policies is a relevant issue to be addressed commonly by the governments as well as private sectors across the world. The main factor influencing policy implementation is undoubtedly the alarming rate of climate change happening globally. As the Third Special Report of Session 2005-06 ordered by the House of Commons, London (2006) states, climate change policy is now an integral part of the energy sector. The Committee makes it clear in the report that the development if a policy framework for CCS (Carbon Capture and Storage) in support of other technologies such as renewables and nuclear energy is indeed essential for addressing climate needs (p. 18). The energy sector of the UK comprises oil, gas, petroleum, nuclear power, and renewable energies. The oil and gas industry of the UK has been self-sufficient since 1980. However, the oil reserves are declining. More specifically, there has been observed a steady downward trend in energy intensity in the UK due to a number of reasons including technical changes, changes in industrial product mix and fuel mix, and others issues related to energy conservation and energy price rise (Bending and Eden, 1984, p. 54). High fuel prices and use definitely affect the economy as well as the environment, respectively. Therefore, going by the low carbon energy production, CCS technology is the need of the time to be adopted by the world energy scenario. Company background: BP plc or British Petroleum Company is a British global energy group delivering premium energy products and services around the world. As a multinational oil company, BP is the largest corporation in the UK as well as one of the largest energy companies in the world operating in more than 80 countries. Established a century ago, BP features a diverse energy portfolio producing natural resources for various countries across the globe. The use of its products and services ranges from home to businesses and on the road. BP product lines include bio fuels, gas and fuel cards, industrial lubricants, marine fuels, Liquefied Petroleum Gas (or LPG), and solar powered energy. The primary operations of the company are listed below. Oil drilling and natural gas exploration with the use of new technologies and advanced equipments Building oil or gas platforms with advanced and state-of-the-art production facilities in order to extract oil and gas from the depths of the climate or underwater environment Handling environmental concerns during the oil and gas production projects. While managing risks to the environment, efforts are done to minimise environmental impact during the various stages of the projects. Development and use of new technologies as well as experimentation of new techniques for drilling and extracting natural resources Transportation of oil and gas by means of building pipelines, shipping and global energy trading Refining and processing crude oil to produce high-quality gasoline, and production of usable chemical products Selling automotive fuels, fuels for air and sea, and oils at service stations and shops Generation of low carbon energy both from traditional sources as well as new alternative energies and technologies BP is particularly concerned with the relevance of sustainable environment prioritising health, safety and security of its people while securing the environment. The issue of climate change is also of its grave concern. The primary objective of the company is aimed at producing and delivering high quality diverse energy mix (including fossil fuels and renewables) that balances its efficiency in meeting the demands affordably, providing security of supply and addressing the issue of climate change. As the development of technology opens up new frontiers to explore, BP maintains it clearly that the use of new technologies is to optimise environmental safety concerns. Keeping this in focus, the company is contributing effectively to the growing low carbon energy sector with the production of alternative energy choices including bio fuels, wind power and solar power. As the company’s annual reports and financial accounts inform, BP is one of the world’s leading international oil and gas companies on the basis of market capitalization, proved reserves and production (source: BP Website). Business strategy: The first decade of the millennium has witnessed BP featuring upstream growth strategy. According to the statistical reports from the Third Quarter Results of 2009, BP significantly achieved an increase of 60% profit than previous quarter, a profit well above market estimates (source: BP Website). The strategy presentation reports of the company for the sessions 2009 and 2010 feature the upstream growth strategy as a key factor in the company’s continuous success. The period between 2008 to 2010 itself has observed significant changes in the energy scenario in the UK. Several factors can be attributed to the changes that are apparently present in the strategy policies of British Petroleum. For instance, the key points in the 2008 strategy agenda included the demand for focus and organization in alternative energy, resulting in the establishment of six integrated fuels value chains in the same year. Focus in new technology innovation and investment was another aspect to be considered in the strategy. With the alarmingly increasing global warming directing to adversely affected climate change, diverse energy mix and low carbon energy production became necessary requirements in conjunction with the development and use of CCS technology. Key points in strategy implementation of BP are cited below (source: BP Website). a) Strategy for 2009: Focus on technology investment with long-term commitment to research and development Investment in major technology programmes including resource business extensions, conversion technologies and low carbon technologies Focus on alternative energy, particularly, low carbon technologies with major investment policies for solar energy, bio fuels and carbon management or CCS Investment in the infrastructure of integrated fuels value chains Emphasis on performance delivery and efficiency along with safety of employees and environment b) Strategy for 2010: Focus on carbon pricing as part of major investment decisions Promote lowest cost energy pathways Investment in alternative energy production Implement employee safety programmes and promote leadership behaviours Promote organizational diversity and performance-based reward system in order to create a healthy work culture The company realises the availability of opportunities generated by capital and cost efficiency, technology and culture. Investment in new technologies as well as in alternative energy production has worked successfully for the company. By the end of 2009, the company has expanded its global exploration and access with the help of its technology flagships into deepwater, gas (both conventional and unconventional) and giant oilfields of regions across the world. Financial statement analysis: The Financial and Operating Information 2005-2009 (source: BP Website) reports the financial statements of the company in details. Being one of the world’s leading energy companies, BP operates in more than 80 countries providing customers with fuels, energy, retail services and petrochemicals products. The Report highlights financial performance of the company from 2005 to 2009 with replacement of cost profit from $20,168 million in 2005 to $13,955 million in 2009. Group balance sheet for the period of 2005-2009 features a significant growth of $21,348 million in total equity of the company. Interestingly, during this period, there has not been noticed any significant increase in net cash provided by operating activities. In fact, it reduced from $38,095 million in 2008 to a remarkable low of $27,716 million in 2009. In 2009, cash equivalents at the beginning was $8,197 million that reached a little growth of $8,339 million at the year-end. Considering the quarterly financial results, especially the fourth quarter of 2009, BP featured an increase of 33% from its replacement cost profit of $3,447 million in the last phase of 2009 compared to $2,587 million in the previous year (source: BP Website). Reportedly, there is a decrease in earnings per share (in cents) from 112.59 in 2008 to 88.49 in 2009. In other words, financial performance of the company has witnessed some significant fluctuation during the financial years of 2008 and 2009. Some of the key statistical figures in BP’s financial performance during 2008 and 2009 are cited below in order to get the clear picture. (Figures in $ million) 2008 2009 Dividends paid per share (in cents) 55.050 56.000 Equity per share capital 5,176 5,179 Equity per reserve 86,127 96,434 Sales and other operating revenues 320,039 213,050 Net cash provided by operating activities 38,095 27,716 Net cash used in investing activities (22,767) (18,133) Net cash used in financing activities (10,509) (9,551) Forecasting: With the success story in 2009 resulting in safer operations, volume growth, and solid financial performance, BP is expecting a better production growth increased at least by 1-2% for the year 2010. While focusing on cost efficiency, the company will also focus on the development of Greenfield projects with the key sources of growth - expanding deepwater, leveraging expertise in gas and managing world’s giant oilfields. Besides, investment in new technologies will be more focused. For efficiency growth, the most reliable elements are: creation of centralised developments organisation, deepening capability and enhancement of capital discipline. BP is the largest energy company in the UK and one of the world’s leading energy companies providing customers in more than 80 countries with fuel and energy for everyday life as well as for businesses. The financial statistics already discussed above is a testimony confirming the global leadership quality of the company in the energy sector. With the promotion of new technologies and alternative energy production, BP is already a brand name with revolutionary changes. Its low carbon technology and solar power are the key factors reflecting the changing scenario in the world energy in conjunction with serious concern of climate change. In terms of sustainability leadership, BP is inevitably the leading name in oil and gas sector with its application of alternative energy technologies in support of minimising adverse environmental impact. Therefore, investing in BP’s share can be considered an advantage as well as opportunity to work with the leading energy production company. Valuation: Discount rate used: 10% Long-term sustainable growth rate: 0% Forecasted 2007 Income from Operations 284,365 Adjustments: Taxes based on net income 0 Depreciation and amortization 10,579 Changes in working capital (26,554) Capital expenditures (17,830) Net debt free cash flow 250,560 Value using Capitalised Cash Flow Method 2,505,600 Valuation method analysis: The Dividend Discounting Model or DDM is a method for valuing a stock price by using predicted dividends and discounting them back to present value. The model briefly defines a share’s value as the net present value of the predicted dividends. The predicted dividends here include facts and expectations of the company’s business, its future cash flows as well as other risk factors associated with it. The model uses four basic components: the dividend per share, the appropriate rate of return, the beta value of the stock, and the dividend growth rate. DDM forecasts the dividends directly assuming that the dividend always stays the same and the stock price, equal. That is to say, DDM values assumptions made about growth rates and discount rates allowing the investors to see how assumptions can change the valuation of equity. So the good point is that the investors can assume different situations in relation to how the market is pricing the stock. Just like DDM, in order to evaluate the potential for investment, Discounted Cash Flow Model (or DCF) uses future free cash flow projections and discounts them in order to arrive at a present value. DCF can be used to determine the value of different business ownership interests including equity and debt holders. There are characteristic similarities between DDM and DCF. Firstly, growth rates and discount rates are integral part of both models on the basis of which the models develop the assumptions. Moreover, the cost of equity is taken into account by both models. However, difference lies clearly between DDM and DCF in the context that while DDM values the equity of the firm or company, DCF values the firm as a whole. Besides, the discount rate for DDM means the cost of equity; whereas for DCF, it means a weighted cost of debt and equity. Along with the price of a stock, the earnings generated from the shares are essential for valuing the company’s expected growth. This includes the Price/Earnings to Growth ratio, or PEG Ratio - another valuation tool. PEG is widely used to determine the possible true value of a stock, particularly for comparing companies with different growth rates. Investors prefer the PEG Ratio as it puts a true value on the expected growth in earnings of a company. However, PEG can be applicable only to companies that are growing earnings significantly faster than the market. Besides, the model cannot provide an accurate growth rate of a company as the latter is subject to limitations of projecting future events. So PEG can be described simply as a rule-of-thumb valuation metric. Nonetheless, PEG offers to suggest promising growth prospects for the company. Assumptions: Going by the self-sufficient energy sector of the UK, investing in BP technologies and programmes is a strategic corporate decision. In terms of financial performance and production growth, BP will be eventually cover most of the global energy operations. The application of alternative energy technologies is an effective and revolutionary step by the energy sector in support of minimising adverse effects on climate change. With its enlarged employee base, BP is a company featuring organisational diversity and culture. Recommendations: By the year-end in 2009, the company’s share prices (in pence) stabled at 600.00 with the high of 613.40 and the low of 400.00 (source: BP Website). Some of the key figures in the share data are cited below. Share price (pence per ordinary share) 600.00 Dividends paid 36.417 Dividend payout ratio Based on replacement cost profit for the year 75% Based on profit for the year 63% Earnings per share - cents Basic profit of BP shareholders 88.49 Diluted profit 87.54 Profit of BP shareholders $16,578 million Shares issued at year end (thousand) 18,755,378 Number of ordinary shareholders as at 31 December 2009 314,294 Number of ADS holders 133,300 Number of beneficial owners Institutions 79 Individuals 21 Going by the shareholding information of the company, following recommendations can be made: For new technologies to be developed and implemented effectively, employee training and leadership promoting programmes are highly recommended. With more global opportunities opening up business scopes, a global employee base with a diverse set of cultural and ethnic background is the answer to the success of global companies. Centralised developments organisation is significant in order to effectively and efficiently maintain organisational, management and production activities. References: 1. Bending, R. and Eden, R., 1984. UK Energy: Structure, Prospects and Policies. New York: Cambridge University Press. 1. British Petroleum, http://www.bp.com/. 1. Cottle, S., Murray, R. F. and Block, F. E., 1988. Graham and Dodd’s Security Analysis. 5th edition. Baskerville: McGraw-Hill. 1. Damodaran, A., 2002. Investment Valuation: Tools and Techniques for Determining the Value of any Asset. New York: Wiley. 1. Fernandez, P., 2002. Valuation Methods and Shareholder Value Creation. California: Academic Press. 1. Fridson, M. and Alvarez, F., 2002. Financial Statement Analysis: A Practitioner’s Guide. 3rd edition. New York: Wiley. 1. Gibson, C. H., 2009. Financial Reporting and Analysis. Mason, OH: Cengage. 1. Hitchner, J. R. (ed.), 2003. Financial Valuation: Applications and Models. New Jersey: Wiley. 1. 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Financial Statement Analysis: The Investor’s Self-study Guide to Interpreting and Analyzing Financial Statements. New York: McGraw-Hill. Appendix: Financial performance: 2005 2006 2007 2008 2009 Replacement cost profit for the year ($ million) 20,168 22,222 18,370 25,593 13,955 Per ordinary share (cents) 95.46 110.95 95.85 136.20 74.49 Per American depositary share (dollars) 5.73 6.66 5.75 8.17 4.47 Group balance sheet: (in $ million) 2005 2006 2007 2008 2009 Total assets 206,914 217,601 236,076 228,238 235,968 Total liabilities 126,149 132,136 141,424 136,129 133,855 Total equity 80,765 85,465 94,652 92,109 102,113 Group cash flow statement: 2005 2006 2007 2008 2009 Net cash provided by operating activities 26,721 28,172 24,709 38,095 27,716 Net cash used in investing activities 1,729 9,518 14,837 22,767 18,133 Net cash used in financing activities 23,303 19,071 9,035 10,509 9,551 Cash and cash equivalents at beginning of year 1,359 2,960 2,590 3,562 8,197 Cash and cash equivalents at end of year 2,960 2,590 3,562 8,197 8,339 Read More