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University of Central Punjab
ANALYSIS OF FINANCIAL STATEMENTS
FINAL REPORT Submitted To:
Prof. ASIF BASHIR
Submitted By: WASEEM AZAM L1F09MBAM2141
Section:
A
Faculty of Management Date of Submission: 11-06-2011
1
PREFACE
The financial analysis of companies is usually undertaken so that investors, creditors, and other stakeholder can make decisions about those companies. Business environments are becoming more and more complex with the passage of time. To understand and deal with such riddle phenomena, one need a lot of energy and knowledge .So business education has become an evolving science, which helps to solve the business problems. Academic education provides general knowledge about business decision and policies. Financial analysis– as an integral part of MBA (Finance) , provides the opportunity of peeping into real professional life of the business people. It enables us to evaluate and understand the practical application of all the terms & techniques that we have studied during our course work. 2
AKNOWLEDGEMENT
Praises to Almighty ALLAH, who blessed upon me the potential and ability to accomplish the task. Salaam to Holy Prophet Hazrat Muhammad (S.A.A.W). I wish to express deep sense of gratitude to, SIR ASIF BASHIR, who provided me this opportunity to achieve this practical experience under his valuable supervision and helping suggestions to complete this report. I am thankful to all those people who help me a lot and provided me an Opportunity to understand and learn every aspect of analysis.
Waseem Azam
3
DEDICATED
TO MY
EVER LOVING PARENTS
4
Table of Contents PREFACE ....................................................................................................................................... 2 AKNOWLEDGEMENT ................................................................................................................. 3 Introduction: .................................................................................................................................... 9 Principal line of Business: .............................................................................................................. 9 Diversification: ............................................................................................................................. 10 Competitors:.................................................................................................................................. 10 Competitor Comparison: ............................................................................................................... 11 Sales Trend: .................................................................................................................................. 12 Table 1 ...................................................................................................................................... 12 Table 2 ...................................................................................................................................... 13 Sales trend Analysis: ..................................................................................................................... 13 Capitalization: ............................................................................................................................... 14 SECP Registration: ....................................................................................................................... 14 Ownership: .................................................................................................................................... 15 International: ................................................................................................................................. 15 Export Sales .............................................................................................................................. 15 Credit Analysis.............................................................................................................................. 16 Revenue Recognition .................................................................................................................... 16 Stock in trade ................................................................................................................................ 16 Factorization ................................................................................................................................. 16 Line of Credit ................................................................................................................................ 17 Restriction on sales of Assets ....................................................................................................... 18 Business Cycle .............................................................................................................................. 18 Analysis of current assets and current liabilities Composition: .................................................... 18 Current assets composition: ...................................................................................................... 18 Operating current assets cycle: ............................................................................................. 18 Line Graph of Assets composition:....................................................................................... 20 Finding: ................................................................................................................................. 20 Current liabilities composition:..................................................................................................... 21 Break down of Current Liabilities ............................................................................................ 21 5
Findings: ............................................................................................................................... 22 Working Capital: ........................................................................................................................... 22 Current Ratio:................................................................................................................................ 23 Graph of current ratio: .............................................................................................................. 23 Finding: ..................................................................................................................................... 23 Net Trade cycle: ............................................................................................................................ 23 Graph of trade cycle: ................................................................................................................. 24 Findings: ................................................................................................................................... 24 Cash Ratio: .................................................................................................................................... 24 Graph of cash ratio .................................................................................................................... 25 Finding: ..................................................................................................................................... 25 Operating Measures, Account Receivable: ................................................................................... 25 Account Receivable Turnover: ................................................................................................. 26 Collection period ....................................................................................................................... 26 Operating Measure, Inventory Turnover: ..................................................................................... 27 Inventory turnover ratio: ............................................................................................................... 27 Days to sell inventory: .............................................................................................................. 28 Conversion period: ........................................................................................................................ 28 Days in purchases in account payable: ......................................................................................... 29 Liquidity Index: ............................................................................................................................ 29 Acid Test Ratio: ............................................................................................................................ 30 Lines of credits:............................................................................................................................. 31 Credit analysis decision: ........................................................................................................... 31 Sensitivity analysis........................................................................................................................ 32 Pro-forma income statement: ........................................................................................................ 32 Pro- Forma balance sheet statement ............................................................................................. 34 Pro- forma cash flow statement .................................................................................................... 35 LONG TERM SOLVENCY ......................................................................................................... 38 Deferred Tax liability account: ..................................................................................................... 38 Liquidity Risk: .............................................................................................................................. 39 Pension, gratuity and provident fund ............................................................................................ 39 6
Unconsolidated subsidiaries.......................................................................................................... 39 Minority interest: .......................................................................................................................... 40 Inventory: ...................................................................................................................................... 40 Intangible Assets: .......................................................................................................................... 40 Computer software and licenses ............................................................................................... 40 Rights to future gas utilization .................................................................................................. 41 Contingent liabilities ..................................................................................................................... 41 Market value of assets:.................................................................................................................. 41 Borrowing to total capital: ............................................................................................................ 42 Debt to Equity ratio ....................................................................................................................... 43 Fixed assets to common equity ..................................................................................................... 44 Net tangible assets to long term assets .......................................................................................... 44 Total liabilities to net tangible assets ............................................................................................ 44 Time interest earned:..................................................................................................................... 45 Z- Score ......................................................................................................................................... 45 Long term solvency decision: ....................................................................................................... 46 PROFITABILITY ......................................................................................................................... 47 Return On Invested Capital ........................................................................................................... 47 Return on Equity: .......................................................................................................................... 47 Du-Pont Analysis .......................................................................................................................... 48 Return on Assets ........................................................................................................................... 49 Return on long term capitalization:............................................................................................... 50 Disaggregation of return of assets: ............................................................................................... 51 Sustainable rate ............................................................................................................................. 52 VALUATION: .............................................................................................................................. 53 Estimated required rate of Return: ................................................................................................ 53 Interpretation: ............................................................................................................................ 53 COST OF ASSETS PRICING MODEL (CAPM): ...................................................................... 53 Interpretation: ............................................................................................................................ 53 Regression line .............................................................................................................................. 54 Security Market line:..................................................................................................................... 54 7
Estimated price: ............................................................................................................................ 56 Price comparison:.......................................................................................................................... 56 Price valuation decision: ........................................................................................................... 56 Conclusion: ................................................................................................................................... 57 Reference: ..................................................................................................................................... 58
8
Introduction: At the end of 2009, Engro Chemcial Pakistan Limited (ECPL) demerged and transferred its core fertilizer business iinto a new subsidiary, Engro Fertilizers Limited. This demerger is part of Engro Chemical Pakistan Limited’s conversion into a holding company structure, namely Engro Corporation Limited. Engro Chemical Pakistan Limited is the second largest producer of Urea fertilizer in Pakistan. The company was incorporated in 1965 and was formerly Exxon Chemical Pakistan Limited until 1991, Exxon decided to divest its fertilizer business on a global basis. The employees of then Exxon Chemical Pakistan Limited, in partnership with leading international and local financial institutions bought out Exxon’s 75% equity. This was at the time and perhaps still is the most successful employee buy- out in the corporate history of Pakistan. Renamed as Engro Chemical Pakistan Limited, the company has gone from strength to strength, reflected in its consistent and enviable financial performance, growth of the core fertilizer business and successful business diversification into our fields. Its performance & outlook is following the declared vision, “To be the premier Pakistani enterprise with a global reach, passionately pursuing value creation for all stake holders”
Principal line of Business: Engro is an agricultural based company. The core business is manufacturing and marketing of chemical fertilizers. We are Pakistan’s one of the largest producers of urea fertilizer which is manufactured at Daharki and marketed under brand name Engro. We also produce crop specific NPK fertilizers at our plant at Port Qasim Karachi. Engro also markets imported MAP fertilizer under the brand name of Zorawar and imported DAP fertilizer. Engro Chemical Pakistan Limited produced a large quantity of fertilizers such as Engro Urea Engro DAP 9
Engro Zorawar ; and Engro Zarkhez.
Diversification: The Engro Corp holding the following business units Engro Fertilizers Limited Engro Vopak Terminal Limited Engro Polymer & Chemical Limited Engro Energy Limited.
Competitors: Fuaji Fertilizer Company Limited Dawood Hercules Pak Saudi Fertilizer Limited Pak Arab Fertilizer When we talk about Engro chemical’s competitor in the market, engro chemical’s main competitor is FFC (FAUJI FERTILIZER COMPANY). FFC was incorporated in 1978 as a private limited company. This was a joint venture between Fauji Foundation (a leading charitable trust in Pakistan) and Haldor Topsoe A/S of Denmark. The largest urea manufacturing facility of Pakistan consisting of two ammonia/urea units owned by FFC is built at Goth Machhi in district Rahim Yar Khan. Goth Machhi is situated at a distance of 2 kms from the main Lahore-Karachi highway and is adjacent to the main railway line. The two plants are based on natural gas from Mari Gas Fields and have an annual designed production capacity of 1.3 million tons of urea. Fauji Fertilizer Company currently has 1,769 employees with sales of 16.79 billion Pakistan. 10
The following tables provide a comparison of operating performance of ECPL with its closest competitor and market leader - Fauji Fertilizer Company:
Competitor Comparison:
Market
Engro Chemical
Fauji Fertilizer
16%
49%
share Capacity 850,000 tons per annum (2 1,300,000 tons per annum (1
Products
plants)
plant)
Aside from sale of Engro
Sells prilled urea.
urea, ECPL also sells imported DAP, NP, MOP
Affiliate (FFC Jordan)
and NPK fertilizers and
manufactures granular urea
hybrid seeds.
& DAP.
Brand Engro Urea – popular brand
Sona urea – very popular
in southern part of the
product, esp. in northern
country.
Pakistan. Sona is granular urea which is perceived to be better.
11
Sales Trend: Table 1 Year FY 2000 FY 2001 FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
Sales(Million Rupees) 8,080 8,006 10,620 11,884 12,798 18,276 17,602 23,183 23,317 30,172
Sales(Million Rupees) 35,000 30,000 25,000
20,000 15,000
Sales(Million Rupees)
10,000 5,000 -
12
Table 2 Year FY 2000 FY 2001 FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
Sales(Million Rupees) 8,080 8,006 10,620 11,884 12,798 18,276 17,602 23,183 23,317 30,172
Change in Change in Amount Percentage (74) -1% 2,614 33% 1,264 12% 914 8% 5,478 43% (674) -4% 5,581 32% 134 1% 6,855 29%
Change in Percentage 50% 40% 30% 20%
Change in Percentage -
10% 0% FY FY FY FY FY FY FY FY FY 2001 20022003200420052006200720082009 -10%
Sales trend Analysis: The table 2 shows that Engro chemical Pakistan limited sales were not consistent. In 2005 company shows a good financial performance in every field, the sales of that year were higher than 2004 by 43%. But in very next year 2006 sales drop down about 4% which was not good
13
sign for upcoming future. The company performs reverse to the expectation and got 32% increase in sales in 2007, but repeated the previous situation in 2008.
Capitalization: Current Price (4/3/2011): Rs. 227.10
Ticker:
ENGRO
Country:
PAKISTAN
Exchanges:
KAR
Major Industry:
Chemicals
Sub Industry:
Miscellaneous Chemicals
Employees:
873
Market Cap:
74,429,031,595
Shares Outstanding:
327,736,819
58,152,368,000 (Year Ending 2010).
2009 Sales
Pakistan Rupees
Currency: Fiscal Ends:
Yr December
Share Type:
Ordinary
Jan
Closely Shares:
Held 135,368,043
SECP Registration: Name: ENGRO CORPORATION LIMITED Registration # 0002159 Old Registration # 1879/19650907 Registration Date Tuesday, September 28, 1965 CRO Karachi 14
Ownership: Engro Corp (Engro chemicals Pakistan limited) is an independent company. Shareholder holding 10% or more voting interest in the company is Dawood Hercules Chemicals Ltd.
International: Export Sales
Subsidiary Companies Engro Foods Limited Engro Ploymer and Chemical Limited Avanceon Limited Engro Eximp (private) Limited
2009
2008
15,994
9,923
1,463,441
79,223
259,224
212,251
114,303
Nil
15
Credit Analysis Revenue Recognition Revenue is recognized to the extent that it is probable that the economic benefit will flow to the group and the amount of revenue can be measured reliably. Revenue is measured at the fair value of the consideration received or receivable and is reduced for marketing allowances. Revenue is recognized on the following basis:
Sales revenue is recognized when product is dispatched to customers or services are delivered.
Income on deposits and other financial assets is recognized on accrual basis.
Dividend income from investment is recognized when the Group’s right to receive payment has been established.
Revenue from the supply of electricity is recorded based upon the output delivered.
Stock in trade These are valued at the lower of cost and net realized value. Cost is determined using weighted average method except for raw material in transit which are stated at cost (invoice value) plus other charges incurred thereon till the balance sheet date. Cost in relation to finished goods includes application purchase cost and manufacturing expenses. The cost of work in process includes material and proportionate conversion costs. Net realized value signifies the estimated selling price in the ordinary course of business less all estimated costs of completion and costs necessarily to be incurred in order to make the sales.
Factorization There is no concept of factorization in Engro Corporation limited Pakistan.
16
Line of Credit Engro Corporation Limited has rated as TFCs-I TFCs-II
18-Apr-11 24-May-11
Ratings
AA AA
(April 2011)
ENGRO CORPORATION LIMITED (ECL) Entity Long Term Short Term TFCs Secured, Listed PKR 4,000mln Privately Placed PKR 4,000mln PKR 2,000mln
New
Previous
AA A1+ AA
AA A1+ AA
AA
AA
AA
AA
The above rating of ENGRO reflects relatively low business risk as from source a favorable demand and supply situation, stable margin an increasing dividend income from subsidiaries. The company start new urea expansion project, although the project increased leverage in ENGRO’s capital structure, but financial risk is predictable to remain within in acceptable limits. But when started project contributing towards profitability then rating has positive impact.
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Restriction on sales of Assets Business Cycle Analysis of current assets and current liabilities Composition:
Current assets composition: Current assets composition is the understanding of factors that have caused changes in the amount of a company’s current assets over a period of time or mostly from one period to another period, for analysis it’s important to know the changes that have occurred in current assets composition. The importance of any company’s current asset composition depends on the proportion of current assets to current liabilities not the Rupees amount of current assets compositions.
Operating current assets cycle: The first three elements (inventories, accounts receivable and cash) are operating current assets; the cash is related to investment of excess cash.
Raw Material
Work-in Progress
Finished Goods
Cash and Cash Equivalent Account Receivable Cash is used to pay for raw materials and spent also on labor and other aspects that turn raw materials into work in progress and, finally, into finished goods. The finished goods are sold either for cash or on credit. In the case of credit customers, there will be a delay before the cash 18
is received from the sales. While the company is waiting for the cash payment to be received, it will record the amount of sales as accounts receivable. When the cash is received, the cycle is completed. The size and composition of current assets can vary between industries. ENGRO is a manufacturing business and typically invest heavily in raw material, work in progress and finished goods, and finished goods, and often sell its goods on credit, thereby generating trade debtors. Annua l Period
Annua l %
Period
Descripti on
2005
Cash and Cash Equivale nts Short Term Marketa ble Securitie s Account s Receiva ble Inventor y
1,142,4 85
8.10 1,805,2 % 40
138,01 6
0.98 %
228,51 8
543,31 6
3.85 %
1,922,9 82
13.63 %
Other Current Assets
1,264,7 56
Annual
%
2006
Period
Annual
%
2007
11.30 %
1,617,5 24
Period
Annual
%
2008
Period
%
2009
4.21 %
1,687,0 38
2.95 %
3,955,3 42
4.22 %
1.43 %
6,153,9 16.02 48 %
1,549,4 37
2.71 %
527,066
0.56 %
623,34 9
3.90 %
1,408,8 85
3.67 %
261,508
0.46 %
2,514,4 25
2.68 %
923,44 8
5.78 %
2,690,1 53
7.00 %
4,680,8 96
8.19 %
422,607
0.45 %
8.96 2,103,8 % 91
13.17 %
3,814,8 25
9.93 %
3,863,3 42
6.76 %
3,329,4 31
3.55 %
19
Total Current Assets
5,011,5 55
35.51 5,684,4 % 46
35.57 %
15,685, 40.83 % 335
12,042, 21.07 % 221
10,748, 871
11.47 %
Line Graph of Assets composition:
Break down of current Assets 18,000,000 Other Current Assets
Amounts in thousand of Rupees
16,000,000 14,000,000
Inventory
12,000,000 10,000,000
Accounts Receivable
8,000,000 6,000,000
Short Term Marketable Securities
4,000,000 2,000,000
Cash and Cash Equivalents
0 2005 2006 2007 2008 2009
Finding: The above graph shows that the ENGRO’s assets composition at the peak in 2007 company have less cash in account and more investment in short term marketable securities, collection from account receivable was low, major portion of inventory lied under inventory account. The 2007 world financial crunch also effects the ENGRO’s current assets composition. The table above is the current composition of ENGRO, the reason of decrease in inventory is the 29.40% increase in sales during the year 2009. During the year company is more successful in converting inventory into sales. Account receivable by following sales also increase 2.68%, cash and cash equivalent also increase 4.22% due to the increase in sales and making less investment in marketable securities and have more reserves in cash.
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Accounts Payable Short Term Borrowings Short Term Portion of LT Debt Other Current Liabilities Total Current Liabilities
1,969,001
1,081,745
3,752,945
2,915,274
3,160,852
0 707,730
1,299,961 1,103,977
0 1,318,662
1,866,435 94,934
935,796 830,700
123,363
156,732
193,067
1,122,710
1,468,121
2,800,094
3,642,415
5,264,674
5,999,353
6,395,469
Current liabilities composition:
Accounts Payable Short Term Borrowings Short Term Portion of LT Debt Other Current Liabilities Total Current Liabilities
13.95% 0.00% 5.02% 0.87% 19.84%
6.77% 8.13% 6.91% 0.98% 22.79%
9.77% 0.00% 3.43% 0.50% 13.70%
5.10% 3.27% 0.17% 1.96% 10.49%
3.37% 1.00% 0.89% 1.57% 6.82%
Amounts in thousand of Rupees
Break down of Current Liabilities
Break down of Current Liabilities 4,000,000 3,500,000
Accounts Payable
3,000,000 2,500,000
Short Term Borrowings
2,000,000 1,500,000
Short Term Portion of LT Debt
1,000,000
Other Current Liabilities
500,000 0 2005 2006 2007 2008 2009
21
Findings: The above graph shows the ENGRO’s current liabilities composition the account payable increase 3.37% during the year 2009, short term borrowing increase in 2008 to cancel out the effect of financial crises. Short term portion of the long term debt also increase in 2009. The reason of increase of account payable is purchase of large amount of raw material on credit, as mostly done in manufacturing companies they bought raw material at credit.
Working Capital: Working capital is the current assets minus current liabilities. It measures how much in liquid assets a company has available to build business.
Total Current Assets Total Current Liabilities Working Capital
2005 2006 5,011,555 5,684,446 2,800,094 3,642,415 2,211,461 2,042,031
2007 2008 2009 15,685,335 12,042,221 10,748,871 5,264,674 5,999,353 6,395,469 10,420,661 6,042,868 4,353,402
The above table shows the working capital of ENGRO. The company has positive working capital it means more in liquid assets the company have to build its business. It shows that in near future there is no chances of any financial difficulties that might arises. There is not much need to borrow, working capital available to make payments to creditor. 35,000,000 30,000,000 25,000,000 20,000,000
Working Capital Total Current Liabilities
15,000,000
Total Current Assets 10,000,000 5,000,000 0 2005
2006
2007
2008
2009
22
Current Ratio: 2005 1.79
Current Ratio
2006 1.56
2007 2.98
2008 2.01
2009 1.68
Graph of current ratio:
Current Ratio 3.5
Current Ratio
3 2.5 2 1.5
Current Ratio
1 0.5 0 2005
2006
2007
2008
2009
Period
Finding: The above graph shows that the EGNRO company has the current ratio which is higher than 1 throughout the period. It means that company has more current assets against current liabilities. This ratio is high in 2007 and decrease after the financial crisis.
Net Trade cycle:
Days to Account payable Days Required to Collect A/R Days in Inventory Net Trade Cycle
2005 50.14 11
2006 29.54 12
2007 75.01 16
2008 62.15 13
2009 49.64 17
31
39
36
79
40
-8.14
21.46
-23.01
29.85
7.36
23
Graph of trade cycle:
Trade Cycle 180.00 160.00 140.00 Days in Inventory
Days
120.00 100.00
Days Required to Collect A/R
80.00 60.00
Days to Account payable
40.00 20.00 0.00 2005
2006
2007
2008
2009
Findings: The above table shows the ENGRO’s net trade cycle, the trade cycle is negative in 2005 and 2007 means company has the strong financial position manage the cash conversion cycle and have excess cash to investment. In other years trade cycle is very high which means the company’s cash is caught up in trade functions and not available for other purposes such as for investment and expansion of project.
Cash Ratio: Cash ratio
2005
2006
0.4080
0.4956
2007 0.3072
2008 0.2812
2009 0.6185
24
Graph of cash ratio
Cash Ratio 0.7000 0.6000
Ratio
0.5000 0.4000 Cash Ratio
0.3000 0.2000 0.1000 0.0000 2005
2006
2007
2008
2009
Finding: The table above shows the cash ratio of ENGRO, company has low amount of cash available to meet the current liabilities or short term debt. The large amount of accumulated cash is not always better for company because the cash is the unproductive asset it is better to use it for investment.
Operating Measures, Account Receivable: 2005 Receivable Turnover Days Required to Collect A/R
34.29 11
2006 30.17 12
2007 22.82 16
2008 27.92 13
2009 21.74 17
25
Receivable Turnover 40 35 30 25 20
Receivable Turnover
15 10 5 0 2005
2006
2007
2008
2009
Account Receivable Turnover: The above table shows that the ENGRO’s management is effective in extending credit as well as collecting debts. The high account receivable turnover ratio of ENGRO implies that a company operates on a cash basis and its collection of account receivable is efficient. In 2008 the ratio is higher as compare to previous year and it decreases in 2009 due to the decrease in sales.
Collection period
Days Required to Collect A/R 18 16 14 12 10
Days Required to Collect A/R
8 6 4 2 0 2005
2006
2007
2008
2009
26
The figure expresses in the above table the average time, in days, that receivables are outstanding. It helps in determine if a change in receivables is due to a change in sales, or to another factor such as a change in selling terms. It is very useful to compare days’ sales outstanding with the company’s credit terms as an indication of how efficiently the company manages its receivables. The collection days of ENGRO’s is not much higher except 2009, this because of financial crisis, this depict that the credit policies that prevent higher sales are overlystrict; there is no problem in collection and pressure on cash flows.
Operating Measure, Inventory Turnover: 2005 Inventory Turnover Days in Inventory Days to Account payable Conversion Period
11.9 31 30.67 42
2006 9.4 39 38.83 51
2007 10.1 36 36.14 52
2008 4.6 79 79.35 92
2009 9.1 40 40.11 57
Inventory turnover ratio:
Inventory Turnover 14 12 10 8 Inventory Turnover
6 4 2 0 2005
2006
2007
2008
2009
The inventory turnover ratio measures the efficiency of the business in managing and selling its inventory. This ratio gauges the liquidity of the firm's inventory. The table above shows that the 27
inventory turnover ratio of ENGRO is high it means that the company is efficiently managing and selling inventory except in 2008 the sales also very low in this year. The company has the faster inventory sells it means the fewer funds the company has tied up in inventory. The high inventory turnover is not always better ENGRO should be careful to the stock outs problem. ENGRO should have the safety stock to handle the stock outs. 100 90 80 70 60
Days in Inventory
50
Days to Account payable
40
Conversion Period
30 20 10 0 2005
2006
2007
2008
2009
Days to sell inventory: The number of day's inventory is held measures the average numbers of days it takes to sell the average inventory held. The above table shows that the high no. of days in inventory of ENGRO is held are a sign of inefficient management and indicate the problem of stocking. The slower the inventory sells means the more cash tied up in inventory.
Conversion period: The conversion period is the sum of the days to account receivable and days to inventory. The lower the conversion the better it is, it take less days to collect and days to sell inventory. The conversion period of ENGRO is very high mean the management is inefficient in collection from account receivable and it also take higher days to sell inventory. Conversion period should be 28
less than the days to account payable. But in ENGRO’s case the conversion period is very higher than days to account payable.
Days in purchases in account payable: Days in purchase in account payable that measures how well a business is managing its accounts payable. The ENGRO has the higher days to account payable it means the slower the business in paying its liabilities. ENGRO has the better credit terms with its supplier.
Liquidity Index: 2005 Liquidity Index (Days) Acid Test Ratio Operating Cash Flow to Net Income
2006
13 0.65 0.54
2007
8 0.73 1.02
8 1.74 -1.72
2008 31 0.58 1.8
2009 6 1.09 1.06
Liquidity Index (Days) 35 30 25 20 Liquidity Index (Days)
15 10 5 0 2005
2006
2007
2008
2009
29
The liquidity index means the number of days during which assets are removed from cash. ENGRO takes the normal number of days except 2008 to convert accounts receivable and inventory into cash. And company has not the strong ability to generate sufficient cash to meet upcoming liabilities. 2 1.5 1 0.5
Acid Test Ratio
0 2005
2006
-0.5
2007
2008
2009
Operating Cash Flow to Net Income
-1 -1.5 -2
Acid Test Ratio: ENGRO’s quick ratio is less than 1 means it cannot pay their current liabilities and should be looked at with extreme caution. The company’s acid-test ratio is near to working capital ratio, it means current assets are not highly dependent on inventory. In 2007 and 2009 the ratio is quite wall but in 2008 the decrease as every in the history of company.
30
Lines of credits: Ratings
(April 2011)
ENGRO CORPORATION LIMITED (ECL) Entity Long Term Short Term TFCs Secured, Listed PKR 4,000mln Privately Placed PKR 4,000mln PKR 2,000mln
New
Previous
AA A1+ AA
AA A1+ AA
AA
AA
AA
AA
Credit analysis decision: After calculating the ratios given above I reached in a decision that ENGRO should not make short term borrowing, in 2009 actual working capital is negative it manipulate it as positive by buying bulk of inventory to increase current assets. Although it has high current liabilities, a large portion of its earnings has retained from previous five years, I suggest it should utilize its retained earning instead o f short term borrowings.
31
Sensitivity analysis Looking at the pro- forma statement of ENGRO, we find an approximate increase and decrease in pro-forma income statement. If we decrease cost of goods sold by 10 percent our income increase by 53.2 percent and decrease 53.2 percent if increase 10 percent. If change decrease by 10 percent in interest and tax then income increase by 2.3 and 3.2 percent respectively. By changing increase 10 percent in interest and tax our income decreases by 2.3 and 3.2 respectively. It means the interest and tax change have little impact on the net income but changing in sales and cost of goods sold have high impact on both sides whether we increase or decrease it.
Pro-forma income statement: The pro-form income statement of ENGRO is developed for the next five years. The revenue growth rate is take from the excel sheet of horizontal analysis. All other items of the income statement are based on the revenue or the percentage of revenue.
32
Annual
Annual
Annual
Annual
Annual
Period
Period
Period
Period
Period
2010
2011
2012
2013
Gross Revenues
36,254,241
43,563,267
Growth Assumptions
20.16%
20.16%
Cost of Goods Sold
(27,812,658)
(33,419,822)
Growth Assumptions
76.72%
76.72%
(620,329) 1.71%
Enter Your Forecast Periods =>
2014
Pro Forma Income Statement 52,345,827
62,898,992
75,579,726
20.16%
20.16%
(40,157,415)
(48,253,340)
76.72%
76.72%
(745,391) 1.71%
(895,665) 1.71%
(1,076,235) 1.71%
(1,293,209) 1.71%
7,821,253 21.57%
9,398,054 21.57%
11,292,746 21.57%
13,569,417 21.57%
16,305,076 21.57%
(2,623,450) 7.24%
(3,152,350) 7.24%
(3,787,879) 7.24%
(4,551,533) 7.24%
(5,469,144) 7.24%
Growth Assumption
5,197,803 14.34%
6,245,704 14.34%
7,504,868 14.34%
9,017,884 14.34%
10,835,932 14.34%
Interest Expense
(1,214,391)
(1,459,218)
(1,753,404)
(2,106,898)
(2,531,659)
Growth Assumption
3.35%
3.35%
3.35%
3.35%
Associated Company (loss) Gain
2,909,300
3,495,828
4,200,604
5,047,465
Growth Assumption
8.02%
8.02%
8.02%
8.02%
Income Tax Expense
(1,667,033)
(2,003,115)
(2,406,953)
(2,892,206)
Growth Assumption
4.60%
4.60%
4.60%
4.60%
5,225,677.53
6,279,198.77
7,545,114.87
9,066,245.62
20.16% (57,981,441) 76.72%
Other operating Expense Growth Assumptions Gross Profit Growth Assumption Selling, General & Expense Growth Assumption Operating Income
3.35% 6,065,058 8.02% (3,475,288) 4.60%
Total Income 10,894,043.50
33
Pro- Forma balance sheet statement Pro Forma Balance Sheet 5,265,667 549,941
7,010,078 573,809
9,332,376 598,713
12,424,005 624,697
16,539,828 651,810
3,625,424 2,900,339 2,356,526 14,697,898
4,356,327 3,485,061 2,831,612 18,256,887
5,234,583 4,187,666 3,402,479 22,755,816
6,289,899 5,031,919 4,088,435 28,458,955
7,557,973 6,046,378 4,912,682 35,708,671
120,143,254 171,915,927 Fixed Assets 6,518,395 5,768,027 Accumulated Depreciation 126,661,649 177,683,954 Net Fixed Assets 15,275,544 17,421,851 Longterm Investments 2,787 2,787 Investments in Other Companies 53348.16 131650.78 Intangibles and Other Assets 141,993,328 195,240,243 Total Non Current Assets
233,701,143 4,991,024 238,692,167 19,774,528 2,787
307,435,272 4,186,439 311,621,711 22,353,336 2,787
395,429,166 3,353,293 398,782,459 25,179,921 2,787
324883.29 258,794,365
801735.90 334,779,570
1978496.49 425,943,663
156,691,225 213,497,130
281,550,181
363,238,525
461,652,334
Cash and Cash Equivalents Short Term Marketable Securities Accounts Receivable Inventory Other Current Assets Total Current Assets
Total Assets
6,163,221 7,405,755 8,898,791 10,692,829 12,848,553 Accounts Payable 4,350,509 5,227,592 6,281,499 7,547,879 9,069,567 Short Term Borrowings Short Term Portion of LT 2,029,370 4,957,677 12,111,424 29,587,768 72,281,841 Debt 2,175,254 2,613,796 3,140,750 3,773,940 4,534,784 Other Current Liabilities 14,718,354 20,204,820 30,432,463 51,602,415 98,734,745 Total Current Liabilities Long term Debt / Borrowings Other Long term Liabilities Total Non Current Liabilities Total Liabilities Preferred Equity Common Equity Additional Paid in Capital Retained Earnings
95,398,550 136,543,655
183,278,335
236,357,790
296,639,804
1,352,352 1,465,975 96,750,901 138,009,630
1,589,145 184,867,479
1,722,663 238,080,453
1,867,399 298,507,204
111,469,256 158,214,450
215,299,943
289,682,868
397,241,949
0 4,531,336 24,580,620 (3,465,978)
0 5,211,037 24,580,620 (9,014,498)
0 5,992,694 24,580,620 (15,404,004)
0 3,426,340 24,580,620 5,572,289
0 3,940,292 24,580,620 1,362,212
34
Adj for Foreign Currency Transl Treasury Stock Total Equity External Financing Required (EFR)
1,422,670
(6,164,883)
26,714,415 (115,762,114)
501,634,318
4,717,498 39,719,416
4,717,498 28,435,738
4,717,498 57,077,891
4,717,498 521,521,125
5,502,554
26,846,942
9,172,347
4,717,498 (90,267,458)
163,823,114 (457,110,740)
Pro- forma cash flow statement
35
Pro Forma Cash Flow Statement Sources of Operating Cash Flow: Net Income Depreciation and Amortization Financial Charges paid Payment to Engro Foods Limited for acquisition of tax losses Other operating Tax paid Retirement and other service benefits paid (Increase) Decrease Defer Taxes (Gain) Loss on Sale of Assets (Increase) Decrease Current Assets Increase (Decrease) Current Liab Operating Cash Flow Investment Sources of Cash Flow: Planned Sale of Assets Planned Sale of Investments Other Investment Sources to be used Total Investment Sources of Cash Planned Investments: Capital Expenditures Acquisitions in Other Co's Purchases of Investments Total Investment Applications of Cash
5,225,678 724,644 (1,421,896) (489,227)
6,279,199 7,545,115 9,066,246 10,894,044 750367.288 777003.4361 804585.1002 833145.844 (2,663,939) (4,990,921) (9,350,549) (17,518,364) (531,873) (578,238) (628,643) (683,443)
131,710 (1,557,013) (183,767)
162,519 (1,557,013) (240,124)
200,535 (1,557,013) (313,766)
247,443 305,324 (1,557,013) (1,557,013) (409,993) (535,730)
766,460 0 960,226 6,293,515 10,450,331
1,773,396 0 (1,973,437) 2,558,159 4,557,254
4,103,194 0 (2,371,291) 3,073,896 5,888,515
9,493,765 0 (2,849,355) 3,693,608 8,510,095
21,966,198 0 (3,423,798) 4,438,257 14,718,620
350,986 124,061 2,401,670 2,876,716
2,110,669 139,065 3,096,922 5,346,655
12,692,586 155,884 3,993,440 16,841,911
76,327,351 174,738 5,149,489 81,651,578
458,997,434 195,872 6,640,199 465,833,505
(43,382,703) (51,772,673) (61,785,216) (73,734,129) (87,993,894) 0 0 0 0 0 (2,082,041) (2,285,372) (2,508,561) (2,753,546) (3,022,457) (45,464,744) (54,058,045) (64,293,777) (76,487,675) (91,016,351)
Cash Flow from Financing Activities: Proceeds from Loans & Debt Proceeds from Minority Interest Other Financing Activities Total Financing Sources of Cash
36,286,810 0 0 36,286,810
41,202,761 0 0 41,202,761
46,784,701 0 0 46,784,701
53,122,852 0 0 53,122,852
60,319,665 0 0 60,319,665
Cash Flow Applied for Financing: Payments on Loans & Debt Dividends Paid to Shareholders Purchase / Retire Stock Other Financing Activities Total Financing Applications of Cash
(66,456) (2,011,650) 0 0 (2,078,107)
(57,656) (2,206,962) 0 0 (2,264,618)
(50,021) (2,421,237) 0 0 (2,471,258)
(43,397) (2,656,315) 0 0 (2,699,712)
(37,650) (2,914,218) 0 0 (2,951,868)
2,071,007
(5,215,993)
2,750,092
Total Change to Cash
64,097,138 446,903,570 36
Beginning Cash Balance Forecasted Ending Balance
3,955,342 6,026,349
6,026,349 810,357
810,357 3,560,448
3,560,448 67,657,586 67,657,586 514,561,156
37
LONG TERM SOLVENCY Deferred Tax liability account: ENGRO recorded its deferred tax on liabilities side in current liabilities. The company defer (delay) taxes for some period of time, the longer the period, the longer it has use that cash, which means it use it to make more money. ENGRO delay its tax payments, it create deferred tax liability account to reflect future tax obligations. The reason of deferred tax liability accounts is depreciation. When company buys property, plant, or equipment, it makes assumptions that reduce the value of such assets slowly or quickly. To impress shareholder company showing higher income by reducing depreciation slowly. Eventually when the company able to maintain profit reverses the procedures and will have pay up taxes. Deferred income tax is provided on temporary differences arising from investments in subsidiaries and except where the timing of the reversal of the temporary difference is controlled by the Group and it is probable that the difference will not reverse in the foreseeable future. In ENGRO deferred tax is recognized using the balance sheet method. Providing for all temporary differences between the carry amount of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is measured at the rates that are expected to be applied to the temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. A deferred tax asset is recognized to the extent that is probable that future taxable profits will be available against which temporary difference can be utilized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that is no longer probable that the related tax benefit will be realized.
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Liquidity Risk: In order to maintain adequate liquidity for its working capital requirements, the board had approved short term funded facilities of Rs. 7.0 billion. ENGRO’s policy is to ensure that adequate medium term funding and committed bank facilities are available to meet the forecast peak borrowing requirements. We mitigate liquidity risk by careful monitoring of our cash flow needs, regular communication with our credit provides, and careful selection of financially strong banks to participate in our operating lines.
Pension, gratuity and provident fund The company maintains plans that provide post employment and retirement benefit s to its employees. These include a contributory provident fund, a defined contributory (DC) pension plan, a non contributory gratuity scheme for all employees and a defined benefit (DB) pension scheme for the annuitants retired before july1, 2005. The above mention plans are funded schemes recognized by the tax authorities. The latest actuarial valuation of management pension and gratuity schemes was carried out at December 31, 2009 and the financial statements of June 30, 2009. The company has fully paid all its obligations on all the above schemes.
Unconsolidated subsidiaries Engro Vopak Terminal (EVTL) a 50% share joint venture of ECPL is an unlisted public limited company incorporated in Pakistan under the companies’ ordinance, 1984. EVTL has been granted the exclusive concession, right and license to design, finance, insure. Construct, test, commission, complete, operate, manage and maintain an integrated liquid chemical terminal and storage firm at the south western zone of port Qasim on build. Operate and transfer (BOT) basis. In ENGRO subsidiary companies are consolidated are consolidated from the date on which more than 50% voting rights are transferred to the group or power to control the company is established and are excluded from consolidation from the date of disposal or reduction of control.
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Agrimall (private) Limited
Agrimall limited is a private company ENGRO invested 4096 (thousand rupees) in it for year 2009.
Arabian Sea Country Club Limited
ENGRO invested 3197 (thousand rupees) in the year.
Minority interest: Minority interest is that part of the net results of operations and of net assets of subsidiary companies attributable to interest which are not owned by the holding company.
Inventory: These are valued at the lower of cost and net realized value. Cost is determined using weighted average method except for raw material in transit which are stated at cost (invoice value) plus other charges incurred thereon till the balance sheet date. Cost in relation to finished goods includes application purchase cost and manufacturing expenses. The cost of work in process includes material and proportionate conversion costs. Net realized value signifies the estimated selling price in the ordinary course of business less all estimated costs of completion and costs necessarily to be incurred in order to make the sales.
Intangible Assets: Computer software and licenses Computer software and licenses cost rerated as intangible assets are amortized from the date the software is put to use on a straight- line basis over a period of 3 to 5 years. The net book value of computer software and licenses in during the year is 20,392 (thousand rupees).
40
Rights to future gas utilization Rights for gas utilization represents premium paid to the government of Pakistan for allocation of 100 MMCFD natural gas for a period of twenty years from Qadirpur gas at predetermined price for a period of ten years commencing from the date of commercial production. The rights will be amortized on straight line basis. The net book value of rights to future gas utilization in year is 102312 (thousand rupees).
Contingent liabilities
Claims, including pending lawsuits, against the company not acknowledge as debts amounted to Rs. 47,658 (2008: 27,911)
Corporate guarantees of Rs. 173,482 (2008: Rs. 500,600) have been issued in favor of third parties.
The company is contesting the penalty of (2008: Rs. 99,936) paid and expensed in 1997, by imposed by the state bank of Pakistan (SBP) for alleged late payment of foreign exchange risk cover fee on long term Loans and has filed a suit in the High Court of Sindh. A partial refund of Rs. 62,618 was, however, recovered in 1999 from SBP and the recovery of the balance amount is dependent on the court’s decision.
Market value of assets: Current Price (4/3/2011): Rs. 227.10
Ticker:
ENGRO
Country:
PAKISTAN
Exchanges:
KAR
Major Industry:
Chemicals
Sub Industry:
Miscellaneous Chemicals
Employees:
873
2009 Sales
58,152,368,000 (Year Ending Jan 2010).
41
Currency:
Pakistan Rupees
Market Cap:
74,429,031,595
Fiscal Yr Ends:
December
Shares Outstanding:
327,736,819
Share Type:
Ordinary
Closely Held Shares:
135,368,043
Borrowing to total capital: Borrowing to total capital Total borrowing Total share holders’ equity Total Capital
2005 2006 2007 2008 2009 2,889,789 2,889,789 1,800,000 15,422,520 28,674,764 7,375,566 9,370,097 15,740,651 21,053,606 26,888,238 10,265,355 12,259,886 17,540,651 36,476,126 55,563,002 28.15%
Borrowing to Equity
23.57%
10.26%
42.28%
51.61%
Borrowing to Total share holders' equity 60.00% 50.00% 40.00% 30.00%
Borrowing to Equity
20.00% 10.00% 0.00% 2005
2006
2007
2008
2009
The graph above shows percentage of debt in total shareholder equity. The higher the borrowing to total shareholders’ equity, the more debt the company has compared to its equity. This tells investors whether a company is more prone to using debt financing or equity financing. As this ratio increases the default risk increases with the borrowings.
42
The borrowing of debt increases over a period of time. In 2008, due to the financial crises of 2007 the percentage of borrowing increases to 42% and in 2009 it is 51% of total shareholder equity. The portion of debt in equity is high it may cause of failure firm’s position in future.
Debt to Equity ratio 2005 2.29
Total debt to Equity Capital
2006 1.34
2007 2.27
2008 2.23
2009 2.93
Total debt to Equity Capital 3.50 3.00 2.50 2.00 Total debt to Equity Capital
1.50 1.00 0.50 0.00 2005
2006
2007
2008
2009
The above graph shows the debt to equity ratio of ENGRO limited over the five years. A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. The ratio is high in 2008 and 2009.it means a lot of debt is used to finance increased operation, the company could potentially generate more earnings than it would have without this outside financing. High debt to equity ratio of ENGRO is better if the utilize debt in efficient way to generate more earnings than the cost of debt, in other words the earnings from debt easily meet the
cost
of
debt
and
they
still
left
out
some
portion
after
it.
43
Fixed assets to common equity
Fixed assets to common equity
2005 0.927
2006 0.700
2007 0.878
2008 1.594
2009 2.585
Fixed assets to common equity is a measure of the extent of an ENGRO’s investment in nonliquid and often over valued fixed assets. The ratio is more than .75 except 2006 it means the possible over- investment and causes a large annual depreciation charge that will be deducted from the income statement. The ENGRO’s depreciation expenses increases over period of time, one reason of high investment in fixed assets.
Net tangible assets to long term assets 2005 2006 2007 2008 2009 7,353,948 9,352,035 15,606,784 20,930,748 26,765,534 Net tangible Assets 3,935,970 2,968,304 17,410,060 30,111,780 60,425,731 Long term Borrowing 1.87 3.15 0.90 0.70 0.44 Net tangible assets to long term debt This ratio measures that a firm has sufficient tangible assets to meet the long term obligations without the intangible assets in case of liquidation. In first two years ENGRO easily meet the its long term borrowing, but after that the company has less tangible assets to meet long term borrowing in case of liquidation. The long term creditors’ of the firm are uncomfortable with the firm’s situation of fewer tangible assets to meet the long term obligations.
Total liabilities to net tangible assets
Net tangible Assets Total Liabilities total liabilities to net tangible
2005 2006 2007 2008 2009 7,353,948 9,352,035 15,606,784 20,930,748 26,765,534 6,736,064 6,610,719 22,674,734 36,111,133 66,821,200 0.9160
0.7069
1.4529
1.7253
2.4965
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This ratio yields a still more conservative assessment of debt-paying ability when the carrying amounts of tangible assets are understated. The ratio is lower means the firm have less tangible assets to meets total liabilities in the case of liquidation which is also a bad signal for the creditors.
Time interest earned: 2005
2006
2007
2008
2009
12
11
9
4
5
Time Interest earned
It measure how many times a company can cover its interest charges on pretax basis. The ratio is high in 2005, 2006 but it fell to down to 5 times in 2009. In previous years the earnings are significantly greater than annual interest obligations. In lower times to interest earned into means fewer earnings are available to meet interest payments. It is an indicator to tell if a company is running into financial trouble. Failing to meet interest obligations could force a company into bankruptcy.
Z- Score
Z Score
2005 7.66
2006 11.79
2007 3.49
2008 1.52
2009 1.30
Z- Score measure the long term solvency of the company. If Z-Score < 1.2
high chances of bankruptcy
Distress Zones
Z-Score > 2.9
low chances of bankruptcy
Safe zones
1.2
Ambiguity
Grey zone
Z-score measures the probability of failure of firm in future. The overall situation of company is favorable in first three years and lies under the safe zone and in last two years the company has little weak financial situation, ambiguity and lies under grey zone. The reasons of decrease z45
score is the decrease in the ratio of market value of capital to book value of debt in last two year it is .43 and .55 respectively and in previous year it is 5.22,9.56 and 2 respectively.
Long term solvency decision: After the deep analysis of capital structure and debt ratio of ENGRO, I decided that ENGRO should take the long term loan but only for mega project and for exiting project expansion. ENGRO started urea expansion project on the basis of the long term loan. And they expect high production on completion of it. According to debt to equity ratio the firm should not take long term loan because firm has 51.6% debt in total capital of the firm. The portion of debt increase continually, in first 2 years the z-score is very high which has positive impact on image of company but in last three years especially in last year the z-score is 1.30 and company lie down under grey zone which could be dangerous in future, so suggestion of long term debt might be another punch on face firm in his financial bad condition.
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PROFITABILITY Return On Invested Capital
Operating Income Tax rate Income after tax Total Capital ROIC
2005 2006 2,354,634 2,468,353 35%
35%
2007 2,939,275
2008 3,959,192
2009 4,562,058
35%
35%
35%
1,530,512 1,604,429 1,910,529 2,573,475 2,965,338 7,375,566 9,370,097 15,740,651 21,053,606 26,888,238 20.75% 17.12% 12.14% 12.22% 11.03%
Return on invested capital used to measure efficiency at allocating the capital under its control to profitable investments. It gives sense of how well a company is using its money to generate returns. If the ROIC is 10% or less than of it, means company invested in neutral project that generate less return. The ROIC of ENGRO is more than 10% it means the company invested in profitable projects that generating excess return on investment.
Return on Equity:
Percentages
Return on Shareholder Equity 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Return on Shareholder Equity
2005
2006
2007
2008
2009
79%
52%
32%
26%
17%
47
ROE indicates what return a company is generating on the equity, the rate that shareholders are earning on shares. It tells investors how effectively their capital is being reinvested. The ROE of ENGRO is very high it means company pays its shareholders off handsomely; the reason of periodical decrease in ROE is the increase in the total shareholder capital. In shareholder capital retain earning continuous increases over period of time. High and growing ROE always attract the investors and shareholders. When I compare ROE of ENGRO with industrial ROE, company’s ROE is greater than the industry.
Du-Pont Analysis Title of Ratio Financial leverage
2005 1.9
2006 1.7
Total Asset Turnover
1.3
Net Profit Margin Du-Pont Analysis ROE
2007
2008
2009
2.4
2.7
3.5
1.1
0.6
0.4
0.3
13%
14%
13%
17%
15%
31.92%
26.34%
18.67%
18.81%
16.97%
When we compare simple ROE with the Du-Pont analysis ROE, it is lower than of simple ROE. In 2006, the ROE decrease as compare to previous year but it is good sign that the net profit margin ratio increases in this year and decrease in financial leverage. ROE decreases over all periods.
Financial leveraged increases over last three years, it means firm taking debt more aggressively and the portion of debt in equity increases over a period of time. The planning and controlling area of ENGRO is little weak and not efficiently manage the capital structure of firm.
Assets turnover decrease over period of time. It means ENGRO’s management not efficiently utilized the assets to generate the sales; they generate less than on sale against each unit of asset.
Net profit margin has little fluctuation and decrease in last year. It is because the sales increase over a period of time. It has less portion of profit in sales.
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Return on Assets
Percentages
Return on Total Assets - Company 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%
2005
Return on Total Assets 15.41% Company
2006
2007
2008
2009
16.93%
11.60%
8.91%
5.25%
The return on assets will be lower than the return on capital. The ROA gives investor an idea of effectively the company is converting the money it has to invest into net income. In 2006 ENGRO was earning more money on less investment. But in last two year the company has 9% and 5% ROA respectively; the company earns less money on more assets invested.
For
acceptance of any new project is necessary that ROA rate should be greater than borrowing rate. ENGRO need to invest more money to continue generating earning.
49
Return on long term capitalization:
Return on long term capitalization 25.00%
percentages
20.00% 15.00% 10.00% 5.00% 0.00% Return on long term cpitalization
2005
2006
2007
2008
2009
20.50%
20.65%
9.52%
8.32%
4.54%
Return on long term capitalization measure the firm’s return on equity and long term debt respectively. This ratio shows the decrease trend over the period. It means firm generates less income by utilizing equity and long term capitalization. The other reason of decrease in ratio is the dramatically increase in long term debt over last three year.
50
Disaggregation of return of assets:
Disaggregation 1.4 Percentages
1.2 1.0 0.8 0.6 0.4 0.2 0.0
2005
2006
2007
2008
2009
Total Asset Turnover
1.3
1.1
0.6
0.4
0.3
Net Profit Margin
13%
14%
13%
17%
15%
16.43%
15.94%
8.21%
7.45%
4.23%
Disaggregation of ROA
Disaggregation ROA is lower than simple ROA. The above chart shows the decrease trend in assets turnover over the period. It means the ENGRO’s management generates fewer sales by utilizing its assets. The utilization of assets is not efficient in the firm. There is little fluctuation in net profit margin. The firm has little control on expense relative to sales. Sales increase over the period of time in ENGRO and sales have less portion of profit in it. ENGRO’s can improve the ROA by increasing profit margin ratio or asset turnover ratio or both.
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Sustainable rate
Sustainable Growth rate Percentages
90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Retention ratio ROE
2005
2006
2007
2008
2009
35.56%
30.53%
64.58%
69.32%
53.73%
79%
52%
32%
26%
17%
15.74%
20.37%
18.15%
9.33%
Sustainable growth rate 27.99%
How much a firm grows without utilizing external borrowing money is a sustainable growth rate. When firm achieves this growth rate it must borrow from other resources for further growth. It is the lenders major concern while lending money to company. Sustainable growth rate is very high in 2005, and in decrease in 2006, 2008 and 2009. It is because the ROE is higher in 2005 and decrease in respective years. ENGRO has more in retained earnings and pays less as dividend. ENGRO should make invest instead of save money in retained earnings.
52
VALUATION: Estimated required rate of Return: K^= (D1/P) + g Sustainable growth rate
gs
9.33%
Current Price of stock in stock exchange
P
194.3
Dividend in period one
D1
6.728694
Estimated Required Return
K^
12.80%
Interpretation: I have calculated the sustainable growth rate by multiplying ROE into RR of year to 2009. P is the current price of ENGRO’s stock on 31 may, 2010 in stock exchange. And D1 is the dividend on period one after growing dividend with growth rate.
COST OF ASSETS PRICING MODEL (CAPM): K= Rf + β (MRP)
Risk free rate
Rf
13.2%
Sensitivity of market
Beta
Market risk premium
MRP
8.00%
current dividend paid
Do
6.1543
Required rate of return on stock
Ks
19.72%
0.814984
Interpretation: In CAPM the risk free rate, the rate on 3 month treasury bills that we convert it into annually basis, the rate compensates the investors for placing money in government over a period of time. The other half of the formula represents risk and the amount of compensation the investor needs
53
for taking on additional risk of beta (beta is the market sensitivity) with the market risk premium on taking of risk.
Regression line 40.00% 30.00% 20.00%
KS
10.00%
-60.00%
-40.00%
0.00% -20.00% 0.00% -10.00%
Km 20.00%
40.00%
Linear (Km)
-20.00% -30.00% KM
-40.00%
Linear regression line analyze the relationship of X and Y variables. In this case we take the market return KM of indices on the X-axis as independent variable and return of stock KS on Yaxis as dependent variable. The regression line fit between the data, it means the market return and stock return have strong correlation during the period of time.
Security Market line: Beta
K 0
13.2%
0.814983656
19.72%
1.314983656
23.72%
1.814983656
27.72%
2.314983656
31.72%
2.814983656
35.72%
54
Security market line graph shows the relationship of systematic risk or beta and the required rate of return. Beta is the market risk on X-axis and Return on Y-axis. SML shows all risky assets. The blue line shows the required rate of return which is the 19.72%. The area below the intercept line is the risk free rate which is 13.2%. K > K^
Stock Overvalued
K< K^
Stock Undervalued
K=K^
Fairly valued
The estimated return that I calculate is 12.08% at the beta of 0.815, which means the stock is overvalued.
The stock is overvalued because for a given amount of risk (beta), the return is
lower as compare to required rate of return.
55
Estimated price: P^=D1 / (K-gs) Sustainable growth rate
gs
9.33%
Required rate of return
K
19.72%
Dividend of period one
D1
6.728694
Estimated value of stock
P^
64.78498
Price comparison: Estimated Price of P^ stock price in stock exchange P Price to Earnings (P/E)
64.78498 194.3 10.8
11.3
16.3
4.8
13.8
When we compare estimated price with the current stock price, the current stock price is greater than the estimated price so stock is overvalued, ENGRO should sell the stock. The price to earnings ratio of EGNRO in 2009 is 13.8 times due to the high earning investor more buy the stock of company and stock is overvalued, but the stock should be traded at Rs. 64.78. So, we can say that the price to earnings ratio is the one of reason of being stock overvalued.
P > P^
Stock Overvalued
Sell the stock
P< P^
Stock Undervalued
Buy the stock
P=P^
fairly valued
nor buy and sell
The earnings ratio of company is much higher than its competitor and investors willing to pay more for ENGRO’s stock because the company has superior growth potential.
Price valuation decision: The value of stock is overvalued and the price of the stock should be fall in future. 56
Conclusion: The ENGRO LMITED PAKISTAN is manufacturing company and major operation of ENGRO is fertilizer but it also has unrelated diversification in energy sector, food, chemicals and joint venture with some firms. It has unconsolidated firms in which they invest money and not mention these firms in balance sheet. ENGRO is financially strong companies its market worth is high and behind the FFC, which is its major competitor. It has good market share as compare to the competitors. Company’s management manipulate the current assets in 2009, and they acquired inventory just before the end of financial year to increase current assets, working capital of firm is negative during the year but they have not mention it in statement. Debt ratio continually increases over a period of year which is not good sign of firm, it might at other hand helpful for firm because they start urea expansion project with the help of it.
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Reference: http://www.kse.com.pk/ http://www.corporateinformation.com/Company-Snapshot.aspx?cusip=C58640650 http://www.engro.com/ http://www.engro.com/investors/financial-reporting/engro-corporation-limited/ http://engro.com/wp-content/themes/engro-v1.0/pdf/pastanualreports/ar_engro2009.pdf http://www.marketwatch.com/ http://www.brecorder.com/market-data/karachistocks/stock/568/?currExchange=K&currPageType=W&currSector=29&currDate=2011-0606&scrType=1366%7C768
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