General Dynamics and Lockheed Martin - Free Essay Example

Sample details Pages: 13 Words: 3772 Downloads: 4 Date added: 2017/06/26 Category Statistics Essay Did you like this example? Financial Statement Analysis General Dynamics vs. Lockheed Martin Executive Summary: This analysis provides a comparison of two major companies within the Aerospace and Defense industry, General Dynamics and Lockheed Martin. General Dynamics had an ROE of 25% whereas Lockheed Martin was 49% demonstrating LMT has a higher spread and generated a higher amount of return above its cost of equity capital as compared to GD. Don’t waste time! Our writers will create an original "General Dynamics and Lockheed Martin" essay for you Create order GD generates a higher NOPAT margin over LMT (9.4% and 7.8%, respectively) allowing GD to contribute more to ROE as a result of the decreased effect interest expenses have on net income with respect to total sales revenue. LMT has a considerable advantage for generating increased asset turnover, by generating $1.37 for every dollar as compared to GDs $1.08 for every dollar spent on company assets. General Dynamics stock is extremely undervalued (estimated $77.71 compared to closing price of $57.79) whereas Lockheed Martins stock was slightly overvalued ($85.93 compared to closing price of $84.08). Equity valuation indicates that investors were overly optimistic in LMTs earning potential and pessimistic for GDs earning potential. Despite the valuation, the destiny of this industry remains dependent on governments decisions to decrease military spending, which will have a negative impact on both companies. However, expansion of commercial airlines and partnerships with healthcare indust ries will have a positive effect on these companies and overall this industry will have a neutral outcome for the upcoming year. General Dynamics (NYSE: GD) General Dynamics is the sixth largest defense contractor in the world and the second largest maker of corporate jets. The company maintains four business groups including aerospace, combat systems, marine systems and information systems and technology. Net earnings for the company increased from 2006-2008 ($1.86 to $2.46), a 24% increase over 3 years. Sales for all groups increased from $24.1 to $29.3 billion from 2006-2008, a 17% increase. The company is based in Virginia and gets 67% of its revenue from the Department of Defense. The aerospace group generated $5.5 billion (19%) in sales in 2008, mostly due to Gulfstream business jet, which include long-range and ultra-long-range jets. In response to the downturn in the economy, the production of large-body and medium-size aircraft were reduced from 87 to 73 and 69 to 24, respectively, in 2008. In product development, Gulfstream introduced 2 additions, which are the ultra-large-cabin, ultra-long-range G650 and the super-mid-size G250. Production of both of these aircrafts, which enter into service in 2011 and 2012, are foreseeable income generators based on orders placed in 2008. The combat systems group generated $8.2 billion (28%) in sales in 2008, mostly driven by demand for combat vehicles, specifically Mine-Resistant, Ambush-Protected (MRAP) vehicles. The combat system group makes, repairs and supports wheeled and tracked armored vehicles and munitions. Combat system product lines include combat vehicles, guns and ammunition systems, mobile bridge systems, armor, chemical, biological and explosion detection systems. Future opportunities include delivering hundreds of tanks and armored vehicles to Saudi Arabia between 2010 and 2012. The marine systems group generated $5.6 billion (19%) in sales in 2008, extremely productive as compared to 2007. The group delivers destroyers, submarines, logistic ship and the first commercial product carrier. Upcoming contracts include doubling production to two submarines per year beginning in 2011, which is predicted to increase revenue and earnings over the next three years. The information systems and technology generated $10 billion (34%) of sales in 2008; its biggest achievement developing a battlefield communications network program and Joint Tactical Radio System (JTRS). Customers include federal civilian agencies and commercial customers, which primarily focus on electronics for land, sea and air-based weapons systems. The acquisition of two companies in the tactical communications and healthcare information technology field are indicative of the direction this group will be making in the upcoming years. Information gathered from Morningstar1, SP500 Industry reports2 and www.generaldynamics.com3 Lockheed Martin (NYSE: LMT) Lockheed Martin is the worlds largest military weapons maker, deriving 84% of its net sales from the United States government, including the Department of Defense. The company is comprised of four operating systems including aeronautics, electronic, space and information systems and global services. Net sales increased 7.3% from 2006 to 2008 ($39.6 to $42.7 billion) and earnings increased 21.8% over three years ($2.5 to $3.2 billion). The company operates in Maryland and employs 146,000 people. The aeronautics segment generated 27% of sales ($11.5 billion) in 2008. The segments primary production are the F-35 Lightning II combat aircraft which is projected to be completed in 2010. The aeronautics segment is focused on making fighter jets and military transport planes and on unmanned military aircraft. The segment also operates the Global Sustainment enterprise to ensure success throughout the life cycle of its aircraft. The electronics systems segment also generated 27% of sales in 2008 and primarily makes land, sea and air-based missiles and missile defense systems. Specifically, this segment is focused on maritime systems and sensors, missiles and fire control, and platform, training and energy. This system also manages and operates the Sandia National Laboratories for the US Department of Energy. Current projects include the Terminal Altitude Area Defense System (THAAD), the Ballistic Missile Defense system and the firehead control system for the Apache helicopter. The space systems segment generated 19% of sales ($8.2 billion) in 2008. This segment is comprised of satellites, strategic and defensive missile systems, and space transportation systems. The US government customers accounted for 96% of this segments sales in 2008. An ongoing partner is NASA; the LMT-built Phoenix Lander will continue to rove on Mars. Another venture is with Boeing, the United Launch Alliance, which provides satellite launch services to the US government. Information systems and global services segment account for 27% of sales in 2008. This segment contains mission solutions, information systems and global services. The US government customers accounted for 93% of the segments sales in 2008. Major products/programs include communication systems, mission and combat support solutions, civil agency programs (US Census), the FAA Automated Flight Service Station, the FBIs Sentinel IT program, and various NASA programs. Collaborations and partnerships with companies around the globe enable Lockheed Martin to grow its international business both with government and industry. The establishment of Lockheed Martin Australia in 2009 indicates an international interest to grow and expand. Information gathered from Morningstar1, SP500 Industry reports2 and www.lockheedmartin.com4 Industry Outlook: Aerospace Defense The aerospace and defense industry relies heavily on US government allocation and the upcoming year will likely bring budget cuts to the defense budget in 2010. However, there are predictions that the conventional military equipment is aging and once the Iraq war ends, there will be a need for repair and replacement. Due to the high levels of deficit spending and an increasing trend for social spending, it is likely there will be cuts in defense spending and the outlook for this industry will decline. On the other hand, it is estimated that there will be an increased growth of global passenger air traffic in 2010 as compared to a decline in 2009. This is based on positive air traffic growth since comparison between 2009 and 2010. Aircrafts that are less fuel-efficient in the US will also need to be upgraded and replaced with newer aircraft. The industry predictions are moderate production cuts at Boeing and Airbus, and declines in the business jet markets due to falling corporate profits. The industry outlook is therefore at a neutral rating, due to decreased military budget but increased commercial air traffic for 2010. Competition in the industry (Boeing, Northrop Grumman, Honeywell and Raytheon) will strive for contracts within the industry. Many of these defense contractors will face uncertainty from upcoming government decisions in the next year and hence the neutral outlook for this industry. Information gathered from Morningstar and SP500 Industry Reports Financial Statement Adjustments The following table contains information on the cumulative adjustment to General Dynamics and Lockheed Martins financial Statements. Adjustments General Dynamics Lockheed Martin Income Statement Increase Net Income by $19 million from loss from discontinued operations net of tax Increase Net Income by $196 million from deferred portion of income tax Decrease Net Income by $70 million for gain on sale of LKEI and ILS net of tax Decrease Net Income by $56 million for gain on land sale Increase Net Income by $215 million to reverse impairment charge (215 = 314(1-.316) Increase Net Income by $72 million to unwind deferred taxes Subtract $246 million from Net Income for Pension Income Balance Sheet Increase assets by 75% of PV of capitalized leases ($709 million) Decrease assets by $7 million to unwind taxes (DTA) Adjustments for LIFO reserve not added to Total Assets. Added in denominator of ITR and Current Asset in Current Ratio Added 100% of PV of capitalization of leases to Total Liabilities ($946 million) Subtracted 25% of PV of capitalized leases to SE ($236 million) Decrease SE by $7 million to unwind deferred taxes effect (-DTA; +DTL) Increase assets by 75% of PV of capitalized leases ($699 million) Decrease assets by $5,390 million to unwind deferred taxes (DTA) Increase liabilities by 100% of PV of capitalized leases ($932 million) Decrease SE by 25% of PV of operating leases ($233 million) Decrease SE by $5,390 million to unwind deferred tax (-DTA; +DTL) Caveats Termination of A-12 program in 1991 is an unlikely contingency of $690 and is currently on appeal in the Appeals Court. Cost of Equity Capital Historically, LMT common stock has proven less sensitive to the broad stock market. With a beta of .923 and using the Capital Asset Pricing Model (CAPM), LMT investors require an annual rate of return of 10.2%. Although this is lower than the expected market return of 10.8% (see appendix for calculation and assumptions), it is greater than its industry (Guided Missile Space Vehicles) expected return of 8.7%. However, although LMT may be more volatile as a stock than its competitors, it enjoyed a Return on Equity (ROE) significantly higher than the industry average. In 2008, LMT had an ROE of 49.2% while the industry followed with a 23.4% average ROE. Just as significant and telling is the comparison of LMTs ROE to its own required rate of return. This spread of 39% is an impressive sign as it demonstrates the amount of return LMT generated above its cost of equity capital. This is also impressive to investors at first glance, and will warrant a deeper interest from prospective investors. Much the same can be said for GD when comparing its required rate of return to its ROE. Although the spread was only 12.9%, it is still a good sign that GD generates such a return above its cost of equity. However, unlike LMT GD has a beta greater than 1 and is therefore more sensitive to stock market moves; and has an expected return less than its industry return by approximately 1.25%. NOPAT Margin When we analyze the potential net income in the absence of debt, NOPAT, we observe that General Dynamics (9.4%) generates a higher margin over Lockheed Martin (7.8%), which allows General Dynamics to contribute more to ROE in comparison to Lockheed Martin as a result of the decreased effect interest expenses have on net income with respect to total sales revenue. However, when comparing NOPAT performance to the rest of their industry (Ship Boat Building Repair), General Dynamics comes in slightly below the 9.9% average that was established for 2008, but does not necessarily signify any under-performance in this area since the industry data only takes into account two firms when generating Industry NOPAT margin averages. Lockheed Martin was similarly compared to Industry data, generated by two firms as well, in which NOPAT margins were recorded that were more than double of what was found for similarly classified companies (Guided Missiles Space Vehicles 3.69%). Asset Turnover This portion of the ROE evaluates the efficiency to produce revenue based on the investment in assets made by the company. When we begin to evaluate the simplified Asset TO values provided by the multiplicative decomposition of ROE, we observe a noticeable advantage by Lockheed Martin since they reportedly generate $1.37 for every $1.00 spent on assets. General Dynamics generate slightly lower values at $1.08 for every $1.00 spent on company assets. We then continued to analyze Asset TO, now based on the additive decomposition of ROE to see how other variables affect the turnover rates. When this approach is taken, average assets for both companies in 2008 needed to be adjusted, and was done so by pulling out all non-interest bearing liabilities (NIBL). This is where we noticed that NIBLs for Lockheed Martin ($20,742) were 62.8% higher than those reported by General Dynamics ($12,735). As a result, the Asset TO ratios increased significantly for both companies (LMT 2.05 and GD 4.09 ) with respect to assets dollars invested by each company. As we can observe, unexpected losses in each companys pension fund had led them to classify their losses as liabilities since they will still needed to be accounted for in the near future. The 32% drop in the fair value of the LMT pension fund ($27,259 down to $18,539) in 2008 and the 35% drop in the fair value of the GD pension fund ($7,452 down to $4,823)was felt somewhat more extensively by LMT, since the higher amount lost reflects LMTs larger workforce of 140,000 employees. GD, although enduring a similar percentage drop in fund value, only accommodates a workforce of 91,000, and therefore lost less in overall value amount. Leverage When we analyze leverage, we are analyzing each companys ability and efficiency in using interest bearing debt to generate revenue. The higher the leverage value, the better the ability of a company is at using invested funds (IBLs) to obtain desired revenues. When evaluating LMTs and GDs effect of leverage as a result of their 2008 results, we observe that the numbers generated by LMT (0.17) are over three times higher than those generated by GD (0.05) during the same time period. As we continue to drill down into the effect of leverage, we notice that ROA is also higher for LMT as a result of the large variation in NIBLs between the two companies. Although a higher leverage effect value may indicate that LMT relies more on interest bearing debt to generate more sales revenue, an analysis of interest bearing liabilities for both LMT and GD was performed based on data available at the end of 2007 and 2008. This analysis revealed that LMT had reduced their interest bearing liabilities ($4,407 down to $3,805) while GD, whom recorded a smaller leverage effect, had done the opposite and showed to have increased their interest bearing liabilities ($2,791 increased to $4,024) by the end of 2008. Selected Ratio Comparison: Accounts Receivable Days General Dynamics Industry Lockheed Martin Industry 39.51 32.50 43.62 57.12 From the results presented above, General Dynamics demonstrates that it under-performed the rest of the industry by exceeding the average account receivable days by 7 days. In contrast, Lockheed Martin out-performed the rest of its industry by having recorded an account receivable average of 43.62 days, which means LMT was collecting from customers on an average of 13.5 days ahead of the rest of the industry. Accounts Payable Days General Dynamics Industry Lockheed Martin Industry 33.88 31.50 20.09 19.66 GD is collecting from customers on average over 2 days past the industry average of 31.50 days LMT is collecting just day over the industry average of 19.66 days Inventory Days General Dynamics Industry Lockheed Martin Industry 25.97 56.62 17.35 13.55 GD is turning inventory on average over 30 days under the industry average of 56.62 days LMT is turning inventory on average over 3 days over the industry average of 13.55 days Interest Coverage General Dynamics Industry Lockheed Martin Industry 29.57 30.43 14.49 5.49 GD could cover its yearly interest expenses 29.57 times in 2008, just under its industry average of 30.43 times LMT could cover its yearly interest expenses 29.57 times in 2008, significantly over its industry average of 5.49 times Equity Valuation The equity valuation of General Dynamics for 2008 produced an estimated share price of $77.71. This price is significantly higher than the closing per-share price of $57.59 for 2008 showing the companys stock was extremely undervalued. According to analyst reports5, some concerns about growth for General Dynamics stem from shrinking credit markets, which would impair the ability to finance business jets. Additionally, it is possible that investors were concerned the aerospace and defense industry would decline with a shift from government defense spending to social spending and deficit spending. Abnormal net income was computed as predicted net income less the cost of equity capital. Predicted net income was computed using 2008 pro forma net income of $2,674 and implementing annual growth rates suggested by Goldman Sachs earnings forecasts5. The growth rates from 2009 through 2013 were -2.9%, 7.3%, 5.2%, 7.3% and 7.8% respectively. The same earnings forecasts were used to calculate the predicted dividends. The predicted dividends from 2009 to 2013 are 577, 617, 643, 671 and 700 respectively. The terminal value assumption used in computing abnormal net income was the competitive equilibrium on incremental real sales assumption. This strategy was chosen because the government is one of General Dynamics most significant customers, comprising approximately 67% of the companys revenue. This lead to the assumption that General Dynamics may not need to invest a large amount of resources in developing new customers and that most of their future growth would be lead by existing custo mers. This assumption provided a terminal value of $21,999. The cost of capital for General Dynamics was calculated using a beta of 1.119, a risk free rate of 5% and a market risk premium of 4%. This produced a cost of capital of 9.5%. The present value of abnormal net income was calculated to be $20,265, by dividing abnormal net income by a discounting factor derived using the cost of capital. The present value of abnormal net income was combined with the initial book value of $9,810 to produce an estimated predicted price of $30,075. This price was divided by the number of shares outstanding according to the 2008 annual report to arrive at an estimated share price of $77.71. The equity valuation for Lockheed Martin for 2008 produced an estimated share price of $85.93, which is slightly higher than the actual share price as of the end of 2008 of $84.08. This shows the stock was slightly overvalued. This shows investors may have been overly optimistic in their opinion of Lockheed Martins earnings potential. Abnormal net income was computed just as that of General Dynamics. Using analysts reports6, estimated (negative) growth rates of (6%), (7%), (6.6%), 11% and 8.92% were applied to the 2008 pro forma net income of $3,114. The same terminal value assumption was used for Lockheed Martin as was used for General Dynamics. The US government is a substantial customer of Lockheed Martins, which lead to the assumption that a large portion of future growth could be attributed to existing customers and few resources could be devoted to developing new customers. The terminal value assumption provided a terminal value of $41,132. The cost of equity capital was calculated using a beta of .923, a risk free rate of 4% and a market risk premium of 5%. The 8.7% cost of capital was used to find the present value of abnormal net income of $37.936. This present value was combined with an initial book value of ($2,758) to produce an estimated price of $35,178. The estimated price divided by the number of s hares outstanding per the Lockheed Martin annual report to arrive at a per-share price of $85.93. References: 1www.Morningstar.com 2www.netadvantgage.standardandpoors.com 3www.generaldynamics.com 4www.lockheedmartin.com 5Richard Safran, Noah Poponak, Goldman Sachs, January 26, 2009. Noah Poponak, Chun-Yai Wang, Sai Krishna, Goldman Sachs, January 27, 2010 6Richard Safran, Noah Poponak, Goldman Sachs, January 22, 2009. Noah Poponak, Chun-Yai Wang, Sai Krishna, Goldman Sachs, January 29, 2010 APPENDIX CAPM = Rf Rate + (Beta*Rmrkt) Given Data Risk Free rate = 3.77% (10 Year Treasury as of 2/18/10) Market Premium (Rmrkt) = 7% (given on page 26 of class notes) LMT Beta = 0.923 Industry Beta = 0.697 GD Beta = 1.119 Industry Beta = 1.298 CAPM Calculations LMT = .0377 + .923*.07 LMT = 10.23% Industry = .0377 + .697*.07 Industry = 8.65% GD = .0377 + 1.119*.07 GD = 11.60% Industry = .0377 + 1.298*.07 Industry = 12.86% Financial Statement Analysis GD LMT 2008 2008 Beginning assets 25,733 28,926 Ending assets 28,373 33,439 Beginning equity 11,768 9,805 Ending equity 10,053 2,865 Beginning interest-bearing liabilities 2,791 4,407 Ending interest-bearing liabilities 4,024 3,805 Net income (pro forma) 2,674 3,114 Sales revenue 29,300 42,731 Other revenue 0 0 Research development expense 474 1,220 Selling, general administrative expense 1,700 2,344 Income tax expense 1,126 1,485 Income tax rate 0.31 0.32 Interest expense 133 341 Beginning inventory 1,621 1,718 Ending inventory 2,029 1,902 Cost of goods sold 25,647 38,082 Beginning accounts receivable 2,874 4,925 Ending accounts receivable 3,469 5,296 Beginning accounts payable 2,318 2,163 Ending accounts payable 2,443 2,030 Shares outstanding 386 393 Closing price per share 57.59 84.08 bloomberg.com Average assets 27,053 31,183 Average equity 10,911 6,335 Average interest-bearing liabilities 3,408 4,106 Average non-interest bearing liabilities 12,735 20,742 Average accounts receivable 3,172 5,111 Average inventory 1,825 1,810 Average accounts payable 2,381 2,097 After-tax interest rate 0.03 0.06 Multiplicative Decomposition of ROE ROE 0.25 0.49 Net profit margin 0.09 0.07 Asset turnover 1.08 1.37 Leverage 2.48 4.92 Additive Decomposition of ROE ROE 0.25 0.49 Market-to-book 2.21 11.53 NOPAT Margin 0.09 0.08 Asset turnover 2.05 4.09 ROA 0.19 0.32 Spread 0.17 0.26 Leverage 0.31 0.65 Effect of leverage 0.05 0.17 Gross profit margin 0.12 0.11 RD to revenue 0.02 0.03 SGA to revenue 0.06 0.05 Accounts receivable days 39.51 43.65 Inventory days 25.97 17.35 Operating cycle 65.48 61.00 Accounts payable days 33.88 20.09 Cash-to-cash cycle 31.60 40.91 Interest coverage 29.57 14.49 Debt ratio 0.65 0.91 Appendix C: General Dynamics Lockheed Martin Financial Statement Adjustments Cumulative Financial Statement Adjustments Summary of Income Statement Adjustments Summary of Income Statement Adjustments Net Income as Reported: $ 2,459 Net Income as Reported: $ 3,217 Discontinued operations 19 Loss on sale of property, (126) Unwind tax effects 196 land, equipment Adjusted Net Income $ 2,674 Reverse of Impairment charge 215 Unwind tax effects 72 Pension Income (264) Adjusted Net Income $ 3,114 Summary of Balance Sheet Adjustments Summary of Balance Sheet Adjustments Total Assets as reported $ 28,373 Total Assets as reported $ 33,439 Constructive capitalization of 709 Constructive capitalization 699 operating leases of operating leases Unwind tax effects (DTA) (7) Unwind tax effects (DTA) (5,390) Adjusted Total Assets $ 29,075 Adjusted Total Assets $ 28,748 Total Liabilities as reported $ 18,320 Total Liabilities as reported $ 30,574 Constructive capitalization 946 Constructive capitalization 932 of operating leases of operating leases Adjusted Total Liabilities $ 19,266 Adjusted Total Liabilities $ 31,506 Total SE as reported $ 10,053 Total SE as reported $ 2,865 Constructive capitalization (236) Constructive capitalization of operating leases (233) of operating leases Unwind tax effects (5,390) Unwind tax effects (7) (DTA+DTL) (DTA+DTL) Adjusted Total SE $ (2,758) Adjusted Total SE $ 9,810 Adjusted Total Liabilities + SE $ 29,075 Adjusted Total Liabilities + SE $ 28,748 General Dynamics Pension Income Pro Forma Calculation 1 Net pension cost (benefit) $ 20 Net postretirement plan cost 56 Total cost $ 76 Net earnings $ 2,459 Percentage 3.1% 2008 2007 2 Funded status pensions $ (2,922) $ 383 Funded status other postretirement plans (640) (642) Total funded status (3,562) (259) Difference $ (3,303) 3 Rate of return on U.S. plan assets 8.1% Expected return 593 Implied asset base 7,330 = 592 / .081 Actual return percentage -32.20% = 2360 / 7330 4 Implied asset base $ 7,330 Pro forma expected rate 7.0% Given Pro forma expected return 513 Less: Original expected return (593) Difference (reduction in pension income) (80) 1 Effective tax rate 68.8% =1-.312 Adjustment (reduction) to net income $ (55) OR: [(.081-.070)*7,330] * (1-.312) = $ 55 Adjusted income $ 2,404 = 2,459 55 Lockheed Martin Pension Income Pro Forma Calculation 1 Net pension cost (benefit) $ 462 Net postretirement plan cost 46 Total cost $ 508 Net earnings $ 3,217 Percentage 15.8% 2008 2007 2 Funded status pensions $ (11,882) $ (879) Funded status other postretirement plans 1426 2017 Total funded status (10,456) 1,138 Difference $ (11,594) 3 Rate of return on U.S. plan assets 8.5% Expected return $ 2,184 Implied asset base 25,694 = 2184 / .085 Actual return percentage -28.62% = 7354 / 25694 4 Implied asset base $ 25,694 Pro forma expected rate 7.0% Given Pro forma expected return 1,799 Less: Original expected return (2,184) Difference (reduction in pension income) (385) 1 Effective tax rate 68.4% =1-.316 Adjustment (reduction) to net income $ (264) Adjusted income $ 2,953 = 3,217 264 General Dynamics Capitalization of Operating Leases Enter interest rate below: 0.039 Enter operating lease commitments below (in millions): 2009 205.0 2010 174.0 2011 131.0 2012 97.0 2013 70.0 2014 thereafter 405.0 Solution: Present value of operating lease commitments $ 945.9 Calculation of Present Value of Operating Lease Payments: 0 205.0 1.000 205.0 1 174.0 1.039 167.5 2 131.0 1.080 121.3 3 97.0 1.122 86.5 4 70.0 405.0 1.166 60.1 5 70.0 335.0 1.211 57.8 6 70.0 265.0 1.258 55.6 7 70.0 195.0 1.307 53.5 8 70 125 1.358 52 9 70 55 1.411 50 PV of operating lease commitments 946 Total Assets (increased by.) $ 709.5 Total Shareholders Equity (decreased by.) $ (236.5) Total Liabilities (increased by..) $ 945.9 Lockheed Martin Capitalization of Operating Leases Enter interest rate below: 0.083 Enter operating lease commitments below (in millions): 2009 262.0 2010 223.0 2011 184.0 2012 148.0 2013 114.0 2014 thereafter 165.0 Solution: Present value of operating lease commitments $ 932.2 Calculation of Present Value of Operating Lease Payments: 0 262.0 1.000 262.0 1 223.0 1.083 205.9 2 184.0 1.173 156.9 3 148.0 1.270 116.5 4 114.0 165.0 1.376 82.9 5 114.0 51.0 1.490 76.5 6 51.0 0.0 1.614 31.6 7 0.0 0.0 1.748 0.0 8 0 0 1.893 0 9 0 0 2.050 0 PV of operating lease commitments 932 Total Assets (increased by.) $ 699.2 Total Shareholders Equity (decreased by.) $ (233.1) Total Liabilities (increased by..) $ 932.2 4

William Blakes Legacy - 800 Words

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Question: Analyse the financial statements and valuation. Answer: Introduction This report is a financial statement analysis and firm valuation report assessing the financial performance and position of the company, Tassal. Tassal is a Tasmanian Salmon company trading Atlantic salmon. The company has been into operations since 1986 and is a public listed company since 2003 (Tassal, 2016). In this report, the last five years financials i.e., from 2010 till 2015 are analyzed with the help of financial ratios to assess the financial performance and financial position of the company. The details of the analysis have been discussed in the further sections of the report. The financials are obtained from their website from the Annual reports section and the annual reports of 2015, 2013 and 2011 are downloaded to obtain the data for the years 2010 to 2015. Based on the existing data, forecasts have been projected for the coming five years i.e., from 2016 to 2020. The forecasted projections have been used to value the company and the valuation methods considered in the report include Price multiple method, Discounted Dividend model, Discounted Abnormal Earnings model, Discounted Abnormal Operating Earnings model and the Discounted Free Cash Flow model. Thus the report has been majorly classified into two sections: Section I which discusses about the financial statements analysis based on the existing financials of the company from 2010 to 2015; Section II which discusses about the valuation models of the company. Overall it is observed that the company has been doing good business with its profit margin improving from 2010 onwards generating profit margin upto 16% as on 2015. Even the returns of equity and assets are observed to be satisfactory with ROE at 13% and ROA at 8% respectively as on 2015. The company has not given any dividend in the year 2010 and 2011 but then onwards, dividend has been paid to the potential investors of the company. The earnings per share also have been observed to be improving year on year. Regarding financial position of the company, the liquidity and leverage position of the company is quite strong and stable. The assets turnover position is observed to be very less with only 50% of the total assets being realized as sales as on 2015. Rest all aspects of the company are satisfactory and stable (Ready Ratios, 2016). Further details are discussed in depth in the following sections of the report. Reformatted Financial Statements and Financial Analysis Financial Statements Financial statements refer to those statements of the company where the financial information has been recorded. Being a public listed company, Tassal has to be share the financial statements in public to keep the investors updated about the operations of the business and its performance. The key financial statements are Income Statement or Statement of Comprehensive Income, Balance Sheet or Statement of Financial Position and Cash Flow statement (Warren et al., 2008). Income statement or statement of comprehensive income captures the revenue generation and expenses details of the company and thus helps in assessing the financial performance of the company during year and facilitates in assessing the performance by comparing the financials across the periods (Weygandt et al., 2009). Balance Sheet or statement of financial position records the sources and utilization of the funds by the company. The sources have been categorized as the liabilities and the equity while the utilization has been made in terms of assets. Thus this statement recording the sources and utilization of funds helps in assessing the financial position of the company (Porter Norton, 2016; Spurga, 2004). Cash flow statement refers to the actual cash flows happening in the company. The revenues and expenses are accrual in nature while the cash flow statement captures the actual cash inflows and outflows to the company thus giving a detailed view about the liquidity and cash position of the company. (Accounting Tools, 2016). The financials of the company Tassal have been obtained from their annual reports and re are formatted as tabulated below for the study and analysis. The reformatted financial statements include the key particulars in each of the financial statements including Income sheet, Balance Sheet and the Cash flow statement. The financials of the last 6 years from 2010 to 2015 are tabulated as below: Income Statement (Amt in $000) 2015 2014 2013 2012 2011 2010 Revenue 304405 260777 272805 262683 225635 216775 Finance Costs -4722 -5067 -5999 -6491 -6752 -5465 PBIT 70875 58061 47502 38705 40580 34568 Net Profit 49992 41061 33457 28087 30280 28009 EPS 0.3405 0.2803 0.2287 0.192 0.2078 0.1996 Balance Sheet (Amt in $000) 2015 2014 2013 2012 2011 2010 Cash Equivalents 13324 7656 14998 15830 7960 4265 Trade Receivables 14034 7636 13349 8677 8477 24627 Inventories 60151 53407 50150 60230 48346 39965 Current Assets 313603 260982 241695 232035 214060 196822 Total Assets 612927 536545 506784 490708 460543 420072 Current Liabilities 83582 77258 81073 90412 89094 62613 Borrowings 61273 37144 30674 42258 49116 55943 Total Liabilities 239594 194622 191237 195650 184862 174870 Equity 373333 341923 315547 295058 275681 245202 Cash Flow Statement (Amt in $000) 2015 2014 2013 2012 2011 2010 Cash flows Operations 42696 50626 49718 50387 41522 28487 Cash flows Investing -36639 -29842 -19945 -29570 -39398 -47797 Cash flows Financing -389 -28126 -30605 -12947 1584 19880 Dividends paid -19097 15383 -12436 -8778 0 0 Net Cash flow 13324 7656 14998 15830 7960 4252 Based on these financials, ratios have been computed to assess the financial performance and position of the company. The various financial ratios computed and discussed in this report are explained in the next sections of the report. Financial Ratios Financial Ratios analysis refers to the financial statements analysis using financial ratios. Financial ratios are the tool to assess various aspects of the company including Liquidity, Leverage, Turnover and Profitability aspects. This section discusses about each of those ratios considered in this study and their implications. The study has considered the following ratios under Profitability to assess the profit earning capability of the study and its financial performance. These include Gross Margin, Net Margin, Return on Equity (ROE), Return on Assets (ROA) and the Earnings per share (EPS). Gross and Net profit margin refers to the ratio of the Gross Earnings and Net Earnings to the Sales respectively. Higher is the margin, better is the financial performance of the company (Tracy, 2012 ). To assess the liquidity aspect of the company, Current and Quick Ratios have been computed which refer to the ratio of the Current Assets to the Current Liabilities and Quick Assets to the current liabilities. Current assets include the cash equivalents, Inventories, receivables and other short term assets of the company. These current assets if excluded with Inventories will lead to quick assets. The ratio of these assets to the current liabilities would compute current and quick ratios respectively. The ratio if maintained above 1 indicates satisfactory position, with the company able to meet its current liabilities with the help of current assets (Gibson, 2008). Further leverage ratios, which assess the debt or long term borrowings position with respect to the assets or equity position of the company, have been computed. The leverage has to be optimally used to avoid the higher credit risk but to take advantage of the leverage having debt facilities. Turnover ratios assess the performance of the company by computing ratio of the assets of the company with respect to its own sales during the year. Higher is the ratio, better is the performance of the company with higher percentage of the assets realized into sales. (Joe Lan, CFA, 2012) The results of the financial ratios as computed for the years 2010 to 2015 for the company Tassal are as tabulated below: FINANCIAL RATIOS 2015 2014 2013 2012 2011 2010 Gross Profit Margin 23% 22% 17% 15% 18% 16% Net Profit Margin 16% 16% 12% 11% 13% 13% ROE 13% 12% 11% 10% 11% 11% ROA 8% 8% 7% 6% 7% 7% EPS 0.34 0.28 0.23 0.19 0.21 0.20 Current Ratio 3.75 3.38 2.98 2.57 2.40 3.14 Quick Ratio 3.03 2.69 2.36 1.90 1.86 2.51 Debt to Equity 0.64 0.57 0.61 0.66 0.67 0.71 Debt Ratio 0.39 0.36 0.38 0.40 0.40 0.42 Assets Turnover (ATO) 0.50 0.49 0.54 0.54 0.49 0.52 Inventory Turnover 5.06 4.88 5.44 4.36 4.67 5.42 Cash Flow Indicator Ratios Financial risk ratios which assess the cash flows of the company include the Net Operating Cash Flows to the Sales, Free Cash Flow to the Sales, Coverage ratios and Dividend Payout ratios. These ratios assess the cash flow position of the company and evaluate the liquidity risk position of the company (Sawyer, 2014 ). NOCF (Net Operating Cash Flow) represents the net cash flow from the operating activities during the period considered. This component NOCF with respect to the sales indicates actual cash flow happening with respect to the revenues recorded under sales. Higher is the ratio; better would be the performance of the company. Similar to above is an assessment based on the free cash flow to the company with respect to the sales (Sawyer, 2014 ). Capital expenditure coverage ratio is the ratio between the net operating cash flow with the capital expenditure or the fixed assets of the company. It assesses the realization performance of the company in terms of its fixed assets getting converted to operating cash flows. Better the performance better is the ratio (Sawyer, 2014 ). Dividend payout ratio referring to the % of the net earnings paid as dividends to the investors. The dividend payout attracts investors accordingly and thus affects the investments into the company. (Ready Ratios, 2016) The cash flow risk indicator ratios computed for this study are as below: CASH FLOW INDICATOR RATIOS NOCF / Sales 0.14 0.19 0.18 0.19 0.18 0.13 FCF/ Sales 0.04 0.03 0.05 0.06 0.04 0.02 Capex Coverage 0.14 0.18 0.19 0.19 0.17 0.13 Dividend Payout Ratio 0.38 0.37 0.37 0.31 - - Interpretation Results This section of the report interprets and discusses the results obtained as discussed above. The financial ratios of the company are computed as discussed above with the help of MS Excel, used as the tool to perform financial ratios analysis. The profit margin of the company Tassal are noted to be at 23% at gross level and 16% at net level as on 2015 which are quite good. It is also observed that the margin ratios have been constantly improving since 2012 indicating an improving performance of the company. Thus having profit generating capacity to the tune of 16% of the total revenues and in the pace of increasing margin, the performance of Tassal is good. The ROE, ROA which are considered as the return ratios are observed to be at 13% and 8% respectively. These are ok and satisfactory but needs to be improved to generate higher returns especially equity if looking forward for higher investment. Compared to previous years, the ratios have been observed to be improving. The EPS also has been observed to be increasing since 2010. The current and quick ratios are very strong with the current assets positioned almost at 3 times the current liabilities indicating very strong liquidity position of the company. Even these ratios have been observed to be improving year on year. The leverage position of the company is stable with the debt raised to the tune of requirement. The debt has been cleared by the company every now and then indicating a fall in debt ratio in between showing the capability of the company to meet its borrowing liabilities. The weaker aspect of the company is its turnover position which is observed to be poor with only 50% of the assets are being realized as sales even after these many years of operations. This indicates that the assets of the company are realized only to the tune of 50% during 2015. Overall the company has been improving its sales and net profits which have strongly affected the profitability ratios and the turnover position improving them year on year. The liquidity position of the company is also noted to be very strong with the current assets positioned at a very high level as compared to the current liabilities. Thus the company as mentioned above is stable and strong with improving performance. Prospective Analysis This section of the report forecasts the results of the company and assesses the prospects of the company in future. It performs the valuation of the company using different methods possible and discusses the results. Before forecasting the financials and performing the valuation, the assumption becomes very critical for the estimates. The assumptions considered are as discussed below. Assumptions The growth rate in sales is assumed to be at 7% which is the average growth rate in the last 6 years from 2010 to 2015. The sales are forecasted at this growth rate every year for the years 2016 to 2020. Further for estimating the Net Operating Assets (NOA), Asset Turnover Ratio of 0.50 has been assumed which is the last ATO as on 2015. The net profit margin also has been assumed to continue at the same rate of 16% as on 2015 for the forecasts. The dividend payout ratio is noted to be at 38% as on 2015 and the same has been assumed to continue for the year 2016 to 2020 for the forecasts The cost of debt is computed using the finance costs and the long term borrowings and is observed to be at 8% as on 2015. The same cost of debt has been assumed to continue for the following years from 2016 onwards. Along with these assumptions considered for forecasts, while valuation 13% cost of equity which is the ROE estimated as on 2015 has been assumed to continue. With these assumptions, the forecasts and the valuation models are computed to determine the value of the company Tassal as on 2015. Forecasts Forecasts have been estimated using the following steps which include: Estimate the sales using the assumed sale growth rate Estimate the Net Operating Assets using the assumed ATO (Assets Turn Over ratio) Estimate the NOPAT using the assumed PM (Profit Margin) Estimate the FCF (Free Cash Flow) using the NOPAT and change in NOA Estimate the Dividend payouts estimated using dividend payout ratio assumed Estimate the payments to the debt holders from the FCF and the dividend payouts Calculate the cost of debt Estimate the comprehensive income from the NOPAT and the cost of debt estimated above The forecasted results of the Tassal salmon company is as below for the years 2016 to 2020. FORECASTS OF TASSAL 2016 2017 2018 2019 2020 1.Forecast sales Sales growth rate - estimated 7% 7% 7% 7% 7% Sales 326737 350707 376435 404051 433693 2.Forecast ATO and calculate NOA forecast ATO 0.50 0.50 0.50 0.50 0.50 Calculate NOA (NOA=sales/ATO) 657892 706157 757962 813567 873252 3.Revise sales forecasts 4.Forecast PM and calculate NOPAT Forecast PM 16% 16% 16% 16% 16% Calculate NOPAT (NOPAT = Sales x PM) 53660 57596 61821 66357 71225 5.Forecast any other operating income (unusual items) 6.Calculate free cash flow (NOPAT change in NOA) change in NOA 44965 48264 51805 55605 59685 calculate FCF 8694 9332 10016 10751 11540 7.Forecast net dividend payout estimated as a % of NOPAT 38% 38% 38% 38% 38% 20498 22002 23616 25348 27208 8.Calculate net payments to debt holders payments = FCF - dividend -11804 -12670 -13599 -14597 -15668 9.Forecast cost of debt and debt balance 8% 8% 8% 8% 8% Forecast cost of debt after tax Opening debt balance 61273 77799 96464 117498 141150 Calculate cost of debt (net financing after tax) 4722 5996 7434 9055 10878 Calculate closing debt (opening + interest - repayment) 77799 96464 117498 141150 167696 check leverage (debt/noa ratio) 0.12 0.14 0.16 0.17 0.19 10.Calculate comprehensive income NOA 657892 706157 757962 813567 873252 NOPAT 53660 57596 61821 66357 71225 Dividend payment 20498 22002 23616 25348 27208 Cost of Debt (NFEAT) 4722 5996 7434 9055 10878 Closing NFO 77799 96464 117498 141150 167696 NOPAT - NFEAT 48938 51600 54387 57302 60347 11.Calculate equity (and check it works both ways) equity = assets - liabilities 580094 609692 640464 672417 705556 closing equity = opening equity + income - dividend 580094 609692 640464 672417 705556 Valuation From the forecasted results above, the valuation of Tassal is performed using different models. They are as discussed below: Price Multiples Model In this model, a price multiple has been assumed to determine the various particulars including Sales, Earnings and based on these forecasts the average valuation of the company is estimated. This company Tassal being into niche business of trading Atlantic Salmon, assuming multiples would be difficult and thus only four models of Discounted techniques have been applied to estimate the value of the company in this study. Discounted Dividend Model In this model, the dividend payouts forecasted as per forecasts above have been discounted at the cost of equity assumed at 13%. The growth rate in dividend is observed to be constant at 7% and thus discounted dividend perpetuity model with constant growth has been applied as below: MODEL 1- Discounted Dividend Actual Forecasts 2015 2016 2017 2018 2019 2020 Year 1 2 3 4 5 1.Forecast net dividend payout 19097 20498 22002 23616 25348 27208 2. estimate cost of capital for equity 13% 1.13 1.29 1.46 1.65 1.87 3. Calculate forecast dividend growth patterns 7% 7% 7% 7% estimate TV method 4. Calculate TV (div from next year / cost capital - growth) 449381 5. Discount dividend stream to TV year (2015) 66721 18077 17112 16198 15333 14515 Discount TV 271835 271835 Total Equity value = 338556 No of shares outstanding 146819 Share price 2.31 The Terminal Value (TV) of the company as on 2019 is estimated by computing the formula: Applying discounting technique on the forecasted dividends at the cost of capital on equity at 13%, the net value of the company as on 2015 is computed to be $ 338, 556,000 and the share price is estimated to be $ 2.31. Discounted Abnormal Earnings Model Another approach to estimate the value of the company is based on the abnormal or the net earnings of the company. The future net earnings of the company are discounted at the cost of capital on equity to determine the value of the company as on today. The results are as below: MODEL 2- Discounted Abnormal Earnings Actual Forecasts 2015 2016 2017 2018 2019 2020 Year 1 2 3 4 5 1.Forecast comprehensive income 49992 48938 52510 56344 60457 64870 2. Forecasted Dividend payout 19097 20498 22002 23616 25348 27208 3. Residual Income 30895 28440 30508 32728 35108 37662 3. Discounting factors 13% 1.13 1.29 1.46 1.65 1.87 3. Discount earning stream to TV year (2015) 112587 25081 23728 22448 21237 20092 4. Growth rate in Earnings 7% 7% 7% 7% 5. TV 615745 6. Discounted TV 372470 Total Equity value = 485056 No of Shares outstanding 146819 Share price 3.30 The equity value as on 2015 is computed to be $ 485,056,000 as shown above and the share price is computed to be $ 3.30. Discounted Operating Earnings Model Similar above, discounting only the operating earnings of the company as forecasted above, the value of the company is as computed below: MODEL 3- Discounted Abnormal Operating Earnings Actual Forecasts 2015 2016 2017 2018 2019 2020 Year 1 2 3 4 5 1.Forecast NOPAT 53660 57596 61821 66357 71225 2. Change in NOA 44965 48264 51805 55605 59685 3. Residual Operating Earnings 8694 9332 10016 10751 11540 4. Discounting factors 13% 1.13 1.29 1.46 1.65 1.87 5. Discount earning stream to TV year (2015) 212659 47323 44796 42404 40140 37997 6. Growth rate in NOPAT 7% 7% 7% 7% 7. TV 190601 8. Discounted TV 115296 Total value = 327955 No of shares outstanding 146819 Share Price 2.23 The discounted operating earnings of the company at the discounting rate of cost of capital on equity at 13% as on 2015 are estimated to value at $ 115,296,000 and the share price is estimated at $ 2.23. Discounted Free Cash Flow Model Another approach to estimate the value is to compute the value on the basis of the free cash flow to the company as forecasted above. The free cash flows are discounted at the cost of capital of 13% and the terminal value of the company on the basis of FCF is as below: MODEL 4- Discounted FCF Actual Forecasts 2015 2016 2017 2018 2019 2020 Year 1 2 3 4 5 1. Forecast FCF 13324 8694 9332 10016 10751 11540 book value of debt 61273 2. estimate cost of capital for the firm 13% 1.13 1.29 1.46 1.65 1.87 3. Calculate forecast FCF growth patterns 7% 7% 7% 7% 4. Calculate TV (perpetuity with growth) 190601 5. Discount ae to TV year 28299 7667 7258 6870 6504 6156 Discount TV 115296 115296 Total value of the firm 143595 value of debt 61273 Total value of equity 82322 No of shares outstanding 146819 Share Price 0.56 The value of debt as on 2015 is $ 61,273,000 and thus the discounted value of FCF with terminal value as per formula explained above is noted to be $ 143,595,000. Thus the value of the company as on 2015 is $ 143,595,000 and deducting the debt obtained, the value of equity as on 2015 is $ 82,322,000. The share price is estimated to be $0.56. These are the various models of valuation and their discussion. On comparing the different model derived share prices, the decision on the shares of the Tassal Group are as tabled below: Valuation Model Share Price ($3.12) Equity Value Buy or Sell DDM $2.31 338556 Sell DAE $3.30 485056 Buy DAOE $2.23 327955 Sell DCF $0.56 82322 Sell The opening price of Tassal group as on 30th June 2015 is noted to be $3.12. Thus comparing the derived prices, it may be noted that only DAE (Discounted Abnormal Earnings) model derived price infers to buy the stocks at current price as it is likely to increase to derived price to establish equilibrium. All other models have share price derived at lower price as compared to current market price and thus better to sell it at current price as it intends to reduce. Sensitivity Analysis Sensitivity analysis has been performed to assess the change in share price with respect to different parameters which include Sales Growth, ATO (Asset Turn Over), Profit Margin, Dividend Payout, Cost of Debt and Cost of Capital. The above valuation models have been used to estimate the share prices on different values of the above mentioned parameters and the changes are as explained below: Sales Growth % Share Price % 10.27% 40.00% $5.29 60.12% 8.80% 20.00% $4.60 39.24% 7.34% 0.00% $3.30 0.00% 5.87% -20.00% $2.56 -22.51% 4.40% -40.00% $2.07 -37.34% ATO % Share Price % 0.70 40.00% $3.41 52.66% 0.60 20.00% $2.93 31.17% 0.50 0.00% $2.23 0.00% 0.40 -20.00% $1.25 -44.04% 0.30 -40.00% -$0.43 -119.25% PM % Share Price % 22.99% 40.00% $4.86 47.11% 19.71% 20.00% $4.08 23.50% 16.42% 0.00% $3.30 0.00% 13.14% -20.00% $2.53 -23.42% 9.85% -40.00% $1.75 -47.03% Dividend Payout % Share Price % 53.48% 40.00% 2.34 -29.17% 45.84% 20.00% 2.82 -14.64% 38.20% 0.00% 3.30 0.00% 30.56% -20.00% 3.78 14.42% 22.92% -40.00% 4.27 29.25% Eiat (+/- 2%) % Share Price % 9.71% 25.95% 2.94 -11.01% 8.71% 12.98% 3.13 -5.26% 7.71% 0.00% 3.30 0.00% 6.71% -12.98% 3.46 4.73% 5.71% -25.95% 3.59 8.66% Cost of capital (+/- 2%) % Share Price % 12.97% 18.24% 3.30 0.00% 11.97% 9.12% 3.30 0.00% 10.97% 0.00% 3.30 0.00% 9.97% -9.12% 3.30 0.00% 8.97% -18.24% 3.30 0.00% Highest variation in share price is observed with change in Sales growth and Asset Turnover as may be observed form table above while the Profit Margin (PM) and dividend payout affect the share price to medium extent followed by Cost of debt and capital. Conclusion Thus overall, from this study various concepts of financial statements analysis and valuation are understood. It is noted from this study that the company Tassal has been doing good in terms of financial performance and has a strong financial position as discussed above through financial statements analysis. Based on these financials, forecast for the years 2016 to 2020 are made for the Tassal salmon company. These forecasts include forecasted dividend payouts and the free cash flow estimates as well. With the help of discounting techniques, the valuation of the company Tassal has been completed and the share price varies at $ 3.00 per share as on 2015 based on forecasted dividends and free cash flows valuations discussed above. The market share price as on 30 June 2015 is noted to be $ 3.12. Overall it is observed that Sales growth and Asset Turnover act as strong factors which control the share price of the Tassal Group. References Accounting Tools, 2016. Financial Statements Definition. Gibson, C., 2008. Financial Reporting and Analysis: Using Financial Accounting Information. Cengage Learning. Joe Lan, CFA, 2012. Financial Ratios. Porter, G.A. Norton, C.L., 2016. Financial Accounting: The Impact on Decision Makers. Cengage Learning. Ready Ratios, 2016. Cash Flow Indicator Ratios. Sawyer, T.Y., 2014. Financial Modeling for Business Owners and Entrepreneurs: Developing Excel Models to Raise Capital, Increase Cash Flow, Improve Operations, Plan Projects, and Make Decisions. Apress. Spurga, R.C., 2004. Balance Sheet Basics: Financial Management for Non-financial Managers. Ronald C. Spurga. Tassal, 2016. Tassal Tasmanian Salmon About Us. Tracy, A., 2012. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. RatioAnalysis.net. Warren, C.S., Reeve, J.M. Duchac, J., 2008. Financial Managerial Accounting. Cengage Learning. Weygandt, J.J., Kimmel, P.D. Kieso, D.E., 2009. Financial Accounting. John Wiley Sons.