Analysis of Johnson Matthey Plc - Case Study Example

Analysis of Johnson Matthey Plc. Introduction Regulators, investors, tax ities, and lenders are concerned differently with the performances of corporations. Over a period of time certain parameters have been developed that provide more or less useful and necessary information to almost all of the stated concerned sections. These generalized parameters have been used to assess the performance of ‘Johnson Matthey Plc.’, a listed company with London Stock Exchange and included in the FT- All share index. FTSE-All Share Index in fact represents “98- 99% of the UK market capitalization. FTSE All Share is the aggregation of the FTSE 100, FTSE 250 and FTSE Small Caps Indices.”5 The operations of Johnson Matthey Plc. (JMP) cover its four global divisions, namely, Catalysts, Precious Metals, Pharmaceutical Materials and Ceramics. Incidentally, the company has sold out its Ceramics division. Contents 1. Introduction 2. Contents 3. Management and performance assessment 3.1 Profitability assessment 3.2 Efficiency 3.3 Liquidity 3.4 Gearing 4. Investor’ attractions 5. Forecast 6. Conclusion 7. References 8. Annexure- calculations 3. Management and performance assessment The company has aimed at under noted financial objectives (refer company’s Annual Report & Accounts 2007, page 7)3: To achieve consistent and above average growth in EPS To grow dividends in line with earnings. To deliver return on investment above group cost of capital. Pre- tax target of 20% ROA. In the light of above predetermined objectives, the company’s performance is assessed as under: 3.1 Profitability Analysis The year 2006/07 has been a great year for Johnson Matthey performance wise. But to judge such performances, we have used ‘Ratio analysis’ technique. For analyzing profitability over a period of proceeding five years, the ratios used are Net Margins, Return on assets (ROA), and Return on Equity (ROE). The calculations of such ratios are shown in the attached annexure. It would be observed that ‘Net margins’ of JMP in 2007 have been reduced to 3.05 when compared to 3.34 in 2006. However, year 2005 witnessed as low as 2.88. The reason for decline in 2007 is the huge stride taken by JMP in revenue enhancement. Revenue increased by 34.5% when compared to 2006 and therefore reduction in net margins for 2007 are natural effects of such increase. In fact net profit margin has been quite steady since 2003, when it was 2.75%. The company has maintained almost a static performance till 2006, when there was a huge growth in the net margins. So net margins profitability wise JMP has shown a good increasing trend till 2007, when there was a corrective fall of 0.29 due high influx in revenue. JMP is utilizing its assets in a very effective manner. ROA has gone up to 8.98 in 2007 from 7.05 in 2006, and this is certainly a great achievement despite the fact that there was depletion of fixed assets to the tune of 74.9m during the year due to closure of Ceramic division. Returns on assets have been 8.83% in 2003, 7.26% in 2004, and 7.38% in 2005. The trend shows that the company is very effectively and steadily utilizing its assets. The annual report of the company states that group cost of capital is about 8% and as the company intended to maintain return on investment above the cost of capital, we can safely assess that the company has certainly achieved its target in 2007 when ROA is 8.98% and that is more than the stated cost of capital. Similarly the company aimed at pretax target 20% of ROA. As per company Annual Report 2007, “Precious Metal Products achieved a return in excess of 20% in 2006/07. ‘Catalysts and Pharmaceutical Materials’ ROA were between the cost of capital and 20% target.”4 These factors contributed a lot in achieving the targeted ROA above 8% in 2007. JMP is also performing very well on account of its return on equities. In fact “The return on common equity (ROE) measures the return earned on the common shareholders’ investment in the firm. Generally, the higher these returns, the better off are the owners.”(Lawrence J.Gitman)7. ROE has gone up to 19.15 in 2007 from 14.49 in 2006 and 12.31 in 2005. This is certainly a progressive approach with well planned strategy. It appears the planning is with an eye on next issue of JMP. This is not the first time company has performed well. During 2003 it had given ROE to the tune of 16.98%. Looks like golden days are back again for JMP. 3.2 Efficiency The ratios chosen to assess the efficiency into the working of JMP are Gross Profit, inventory turnover, and assets turnover. Gross Profits margins measures the percentage of each pound or dollar of sales remaining after the cost of goods sold. Gross profit covers other overheads and contributes towards net margins. JMP’s gross margin performance is not as bright as it should have been considering the net margins of others in the industry. The gross margin in 2007 is 7.12% of sales, whereas the other leading entities like Teijin Ltd. are earning a gross profit ratio of 25.63%. Of course, no direct comparison is possible unless product line is absolutely similar in nature. JMP’s gross margins have come down to 7.12% in 2007 from 8.15% in 2006 and 8.21% in 2005. One of the factors responsible for such decline is the increase in revenue from 4573.7m in 2006 to 6151.7m in 2007. Let us examine the Inventory turnover of the company as liquidity turnover measures the activity, or liquidity, of a company’s inventory. JMP’s inventory turnover is 16.96 in 2007 (or dividing it into 360 it can be converted into average age of inventory). Accordingly in 2007 this age is 21.22 days as compared to 27.21 days in 2006 and 23.88 days in 2005.Accordingly the performance in 2007 has improved over the last two years as the lesser the number of days inventory is held by the firm the better it is. The past performance shows that JMP has improved from 36.84 days in 2003 and 33.42 days in 2004 to 21.22 days in 2007. The company has in fact dealt with inventory in a very efficient way. Total assets turnover indicates the efficiency with which the company is using its assets. Higher turnover indicates better performance. JMP has this turnover of 0.34 in 2007 as compared to 0.47 in 2006 and 0.39 in 2005. JMP has certainly not done better in 2007 and need improvements in exploiting assts. But at the same time history is repeating as asset turnover was just 0.31 in 2003 that rose 0.47 in 2006. This gives a hope of JMP coming back winner in coming years again. 3.3 Liquidity In any industry a current ratio of 2.0 is occasionally cited as acceptable, but a value’s acceptability depends on the industry in which the company operates. “The logic underlying the conventional rule is that even if the value of current assets is reduced to half (50 per cent), i.e, current ratio is 1 instead of 2, the creditors would be able to get their payments in full and the enterprise can retain some amount as working capital in the business.” (Financial Management, page 274)8. From this point of JMP has progressively performed well. Current ratio has improved from 1.37 in 2003 to 1.49 in 2005 and finally settled at 1.94 in 2007. That means it will generally be easy for JMP to meet its short term obligations when those become due. The net working capital of JMP is also more than 1.0 as whenever the current ratio is 1.0 the firm’s net working capital is zero. A positive net working capital is good sign for the firm to meet its current obligations. Quick ratio is part of current ratio. The only difference is that inventory is not included into the calculations of quick ratio, as it involve cash and near cash current assets for the purpose. JMP has performed well on this count as well. Quick ratio in 2007 is 1.21 as compared to 0.89 in 2006 and 0.65 in 2005. A quick ratio of 1.0 or greater is occasionally recommended but an acceptable value depends upon the industry. Liquidity wise JMP is a strong company. It is ready to meet any eventuality of short term obligation 3.4 Gearing or leverage of Capital Structure Capital gearing of capital structure of a company (i.e., the mix of long term debt and equity maintained by the company) can significantly affect its value by affecting return and risk. Gearing is also called leverage. Debt ratio measures the degree of indebtedness and accordingly the degree of gearing. The higher the debt ratio, the higher is firm’s leverage or gearing and vice versa. From the calculations in the annexure debt ratio of JMP is 0.28 in 2007, 0.3 in 2006,0.31 in 2005 and 2004,.and o.34 in 2003. It is hovering around 0.3 figures throughout last five years. That means JMP is a low geared company all along and does not believe in gearing through debt capital. Equity holders are not taking the risks of fixed payments of debt capital and therefore they should not expect higher returns associated with the risk involved. Measure of the company’s ability to meet fixed interest payments on long term debts can be judged through ‘Times Interest Earned Ratio’ The smaller the ratio, the less is the company’s ability to meet long term interest obligations as they become due. JMP has this ratio described as 9.17 times of interest on long term debts in 2007, and that appears to be reasonable situation. In 2006 it was 9.02 times and in 2005 the comfort level was low at 7.69 times. As the company is low geared, it appears that company believes in equity investments and does not play the game of gearing of the capital structure. However it is suggestible that the company may take advantage of capital gearing in order to provide additional benefit to its investors. 4. Investors’ attractions Basically investors are interested in two ratios, i.e., earning per share and dividend payouts. “Earning per share is a traditional method used for determining corporate value”1. This certainly is a matter of attraction to present and prospective shareholders. JMP has been showing a fantastic EPS, both basic and diluted. Its basic EPS in 2007 is pound 96.91 as compared to 70.8 and 53.2 respectively in 2006 and 2005. The same is the situation with diluted EPS. It was 95.4, 70.5, and 53.1 in 2007, 2006 and 2005 respectively. So attractive is EPS that JMP is bound to be over subscribed in its next effort of going public. Dividend payout may be based on a policy that may be constant, or regular, or low –regular-and –extra dividend. Whatever may the policy adopted by the company, the investors are basically concerned with actual dividend received by them. Without going in depth into policy matters, the dividend payout of JMP has been very attractive so far, even though the payout is declining year by year. It declined from 0.51 in 2005 to 0.4 in 2006 and to 0.32 in 2007. It is still attractive comparing. In nutshell JMP has definitely adopted a policy to keep attracted investors of equity; and it has not shown any risk taking initiative through capital gearing of the capital structure of the company. 5. Forecast The chairman in its statement in 2007 annual reports states, “the importance of our long term strategy is well illustrated by a key development that took place this year. The second half of the year saw major growth in our sales of catalysts for heavy duty diesel (HDD) vehicles, a market that has been brought by tough emission standards for buses and trucks that came into force in October 2006 and in the US in January 2007.” (Sir John Bonham)2 This sums up the future of the company. The products of the company like catalysts serve the humanity at large by controlling the environmental effects of automobile fuels. Products of the company are going to be in great demand as the governments world over are issuing stringent laws to control the emission effects of such fuels. The company is expecting a strong growth in its precious metal sector, with particular emphasis on Environment Technological Division. Also in the coming years the company expect to take benefit in HDD due new emission standards, that have already been introduced in Europe and will became applicable in Northern America in January 2007. It envisages expect a huge growth in sale in HDD division; and this despite the fact that industry is predicting a fall in sale of trucks in Northern America. The company expects to boost the sale on need to meet the emission legislation. As per Annual Report and Accounts 2007 the company’s, “Process Technologies is also experiencing strong demand, particularly for catalysts for synthesis gas and hydrogen production. Prospectus for Process Technologies is encouraging driven by the high oil price and the need to make more efficient use of hydrocarbon feedstocks.”(Johnson Matthey Annual Report 2007, page 8)6 There are certain precautions which an investor has to take from the point of long term investments. These are: The company should be of reasonable good size. From this point of view JMP is considered a company of more than of adequate size as it is one of FTSE 100 companies. The company should have a stable financial condition. JMP have never in red during the past five years. Net capital investments have crossed ₤1078 million. Profits before taxes rose 18%. Dividend growth is also one of main criteria for long term investors. Dividend wise, JMP has declared dividend on average of 16.63 pence per share since 2004/05 as clear from following figures: Final ordinary dividend paid in 2004/05 19 pence per share Final ordinary dividend paid in 2005/06 21 pence per share Interim ordinary dividend paid in 2006/07 9.9 pence per share The above figures have been taken from company’s annual reports. The above parameters clearly show that long term investment with JMP will not only be safe but also be highly remunerative. JMP operates in more than 30 countries. Certainly company has all the opportunities to grow with the growth of such countries. 6. Conclusion Johnson Matthey Plc. is performing well though its net margin has sliced a little due to turnover increment in 2007. Liquidity wise the company will meet all its obligations when due. Though its assets remain underutilized, still the company is performing very well for investors with a very good EPS and dividend payout policy. As the company’s business is focused on selling products that are technologically advanced or employ technological advanced process in their manufacture, the company is bound to take advantage of new technology in the market. Further, the company has a very bright future because of applicability of emission legislations in Europe and Northern America. Various segments of Johnson Matthey are going to get great benefits in the nearby future. 7. References: 1 Earning per share (EPS), 12 Manage Management Communities, viewed on 4th November, 2007, http://www.12manage.com/methods_eps.html 2 Sir John Banham, Chairman Statement, Johnson Matthey Plc., Annual Reports and Accounts 2007, page 2. 3 Johnson Matthey Annual Report & Accounts 2007, page 7 4 Ibid, page 7 5 FTSE UK Index Series, FTSE All-share Index, viewed on 23rd January 2008, http://www.ftse.com/Indices/UK_Indices/index.jsp 6 Johnson Matthey Annual Report & Accounts 2007, page 8 7 Lawrence J. Gitman. Principles of Managerial Finance, Eleventh Edition, Chapter2, Financial Statement and Analysis, page 69 8 Financial Management, Indian Institute of Banking & Finance, Macmillan India Ltd.,page 274 8. ANNEXURE Links for published accounts Johnson Matthey Plc. http://reutersuk.ar.wilink.com/asp/getpdf.asp?session_ID=BE9FE5AD5B9E40C7&virtual=V0010162702 Read More