Financial Statement Analysis †Solution is just a click away

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.