Performance of Cobham Plc and Its Risks Management - Case Study Example

Performance of Cobham Plc and Its Risks Management Contents Contents 2 Introduction 2 Five Year Financial Trend Analysis of Cobham Plc 4 Revenue Movement 5 Profitability 5 Gross Profit Margin 5 Net Profit Margin 7 Liquidity 8 Current ratio 8 Financial gearing 9 Debt Equity Ratio 9 9 Investment 10 Earnings per share 10 Pay-out Ratio 11 Corporate and Financial Actions 11 Risk Management of Cobham Plc 12 Exchange Rate Risk Management 12 Country and Political Risk Management 14 Global Risk Management 15 Conclusion and Recommendations 15 Introduction Risk is the fundamental phenomenon for any company as the return expectation of organizations is associated with this risk factor. Hence, risk management that involves identification of risk factors, critical assessment of such factors and prioritization of risk is very important for any company to sustain in the competitive business environment and expand business activities in global platform (Gia, 2009). This paper will concentrate on business performance and risk management strategies of the British manufacturing company Cobham Plc. The London based defence company is 51st largest in the world and in United Kingdom, it is the 5th largest according to the total revenue (ADS, 2014). Cobham Plc is a distinct part of Aerospace, Defence, Security & Space Industry of United Kingdom which is a high technology manufacturing oriented sector that contributes £22.1 billion in the GDP of the UK economy. Among that the contribution of Cobham Plc is approximately of £1,789.7 million (The Telegraph, 2014). However, the industry is characterised by the presence of a large number of domestic competitors such as BAE Systems, GKN and QinetiQ as well as overseas companies including Boeing, Finmeccanica, Airbus Group and GE Aviation Systems. The industry contains huge potential for employment generation. Accordingly, the industry directly employs 113,000 people among which the three divisions of Cobham involve more than 10,000 employees on the five continents in which they operate (ADS, 2014). Considering the source of raw material, Cobham Plc puts huge emphasis on augmenting superior quality of raw materials. In order to ensure the quality of raw materials, the company initiates detailed government inspection to obtain Government Quality Assurance in specifications, technical instructions, drawings and architectures as well as engineering data. The whole process of raw material sourcing and processing should align with Certification of Compliance (Cobham, 2015). This paper aims to study the financial performance and foreign exchange rate risk and political risks management of the company. Five Year Financial Trend Analysis of Cobham Plc In order to analyse the financial trend profitability, liquidity, investment and financial gearing ratios must be studied (Sinha, 2009). Table 1: Five Years Consolidated Financial Statements of Cobham Plc 　 2013 2012 2011 2010 2009 Income statement 　 　 　 　 　 Revenues 1789.7 1749.4 1854.4 1902.6 1880.4 Cost of sales 628.2 597.9 1271.1 1298.1 1284 Gross profit 1161.5 1151.5 583.3 604.5 596.4 Operating expense 1633.5 1513.6 1565.8 1671 1593.8 Operating profit 156.2 235.8 288.6 231.6 286.6 Net profit 114.3 171.7 187.9 152.7 185.8 Balance sheet 　 　 　 　 　 Total assets 2419.2 2371.6 2283.5 2570.9 2442.1 Total liabilities 1375.8 1317.8 1264.9 1495.1 1494.1 Total equity 1043.4 1053.8 1018.6 1075.8 948 Key ratios 　 　 　 　 　 Profitability 　 　 　 　 　 Gross margin 31.78% 32.93% 31.45% 31.77% 31.72% Net profit margin 6.39% 9.81% 10.13% 8.03% 9.88% Efficiency 　 　 　 　 　 Asset turnover 0.75 0.75 0.76 0.76 0.75 Receivables turnover 6.37 6.36 6.03 5.89 5.7 Liquidity 　 　 　 　 　 Current ratio 0.98 1.07 1.31 1.36 1.07 Financial gearing 　 　 　 　 　 Long term debt/Equity 0.3 0.3 0.35 0.45 0.4 Investment 　 　 　 　 　 Payout ratio 90.47% 55.07% 47.62% 45.21% 33.52% Source: Global business browser (2015) Revenue Movement Figure 1: Revenue Trend of Cobham Plc Continuous decrease in revenue of Cobham Plc is a reflection of the gross profit trend of the company. The graph shows that revenue of Cobham has substantially decreased in 2012-2013 as compared to 2009-2010 mainly due to excessive volatility in exchange rate market and economic instability in the post-recession period (Cobham Plc, 2013). In addition, the company is stymied by US defence cutbacks. According to Hoyos (2013), the further growth of the company remained highly uncertain as the further deterioration of USA budgetary. Profitability Gross Profit Margin Figure 2: Gross Profit Margin Trend of Cobham Plc From the graphical representation of the movement of gross profit margin incurred by Cobham Plc it can be interpreted that the gross profitability of the company has been very volatile over the five years period. During the period of 2009 to 2011, the company was experiencing moderate profit margin due to slow movement of the economy as an after-effect of the financial crisis of 2008. Though the profit margin sharply increased from 2011 to 2012 as a result of contribution from the Cobham’s newly formed strategic business unit SATCOM. However, the profitability markedly decreased again in 2013 as the company sold off their one of their operating unit Chelton Flight Systems to Genesys Aero systems to fulfil the requirement of additional cash for future expansion (Cobham Plc, 2013). Net Profit Margin Figure 3: Net Profit Margin Trend of Cobham Plc The net profit margin of Cobham Plc decreased immediate after the the global recession of 2009 due to slowdown of international business especially in UK and US. After a moderate increase in net profit during 2010 to 2012, the company has been experiencing a sharp decline the profit margin from 2012 to 2013 due to increase in the cost of sales, general and administrative expenses. Profitability also decreased as a result of excessive expansion activities taken by Cobham Plc. Hence, corrective actions are reqired to be taken and calculative restructuring strategy should be taken in order to maintain a standard profitability level (Cobham Plc, 2013). Liquidity Current ratio Figure 4: Liquidity Trend of Cobham Plc Measuring the current ratio that shows the balance between current asset and current liability of Cobham Plc for the period of 2009-2013, it is evident that the ratio is always close to 1 for the company, indicating a sound financial health of Cobham Plc. However, in the recent years, especially in 2010 and 2012, the ratio is deviating from 1. Though the magnitude of deviation is very less, the company should always focus to maintain its current ratio above 1 so that it doesn’t encounter difficulties in liquidating the short term assets in order to meet the short term liabilities (Bloomberg, 2015). Financial gearing Debt Equity Ratio Figure 5: Debt- Equity Trend of Cobham Plc The debt equity ratio shows a steep declining trend from 2010 to 2013 which indicates that Cobham Plc has taken a long term strategy of reducing debt component in their capital structure. The company has understood that using more debt component will increase their riskiness of business; hence, it has gradually increases equity participants. Such decision has also liberated the company’s obligation of huge interest payment in a timely manner (Bloomberg, 2015). However, Cobham Plc must forgo the benefit of debt in terms of tax savings. Hence, in order to smooth running of business, Cobham Plc should not reduce the level of debt furthermore (Cobham Plc, 2013). Investment Earnings per share Figure 6: Earning Per Share of Cobham Plc Year on year, the divident per share has grown by 10% whereas the earning per share has declined by 33.14%. Such decline in earning per share of Cobham Plc can be attributed to a number of factors. The declining trend of EPS is a reflection of the company’s deline in net profit. The series of of acquisitons have been conducted by using the company’s cash balance. Hence, the company’s interest income decreased, reducing the company’s distributable profit level. Hence, EPS decreases (Equities, 2014). Pay-out Ratio Figure 7: Payout Ratio of Cobham Plc Payout ratio signifies percentage of earnings paid out to the shareholders in the form of dividend. A trend of increasing payout ratio of Cobham Plc is unfavourable for the financial health of the company because net income is exhausted, lowering the net profitability as the company is paying out huge dividend (Equities, 2014). Corporate and Financial Actions The corporate level actions of Cobham Plc can be attributed by the company’s strategic actions in terms of a series of merger, acquisitions and other means of corporate restructuring. Recently in 2013, the company diversified their business by acquiring Axell Wireless, an antenna systems business. This can help the company differentiate its business and customers and reduce the loss of defence business as the defence cutbacks of the UK and US. In addition, in order to strengthen the helicopter business segment, Cobham Plc bought FB Heliservices in a partnership agreement with Bristow Helicopters. On September 15th, the company completed a deal of $1.46 billion by acquiring Aeroflex Holding Corporation. The company’s intension behind all such acquisitions is to strengthen the foundation of Cobham Plc, reduce competition in the market and enhance market share. Considering financial actions, on May 20, 2014, Cobham Plc placed total of 60 million ordinary shares of 2.5 pence each through Merrill Lynch International and UBS Ltd. The total size of gross proceeds is approximately $180 million. Expecting that the admission will take place on May 23. Merrill Lynch International and UBS Limited acted as joint book runners in respect of placing. The placing of shares signifies approximately 5.6% of the ordinary share of Cobham Plc prior to the placing (Cobham Plc, 2014). Risk Management of Cobham Plc Exchange Rate Risk Management The geographical coverage of Cobham Plc integrates Germany, USA, UK, France, Singapore, Denmark, Brazil, Australia and many more countries. Such well expanded business operations force the company to experience exchange rate confusion as a result of having differences in exchange rates and regimes of those countries. For instance, while calculating profitability or operating income, like any other multinational company, Cobham has to integrate the revenue it has generated from the three subdivisions in all the countries in which it is operating. While the company shows a profit in terms of pound sterling in UK, the profitability in USA is calculated in dollars and in Australia it is in Australian dollars (AUD). In this scenario the company experiences translation risk. Translation risk originates while converting the entities of balance sheet from the currency of subsidiaries to the MNC’s domestic currency. The higher the volatility in exchange rate market and exchange rate differential, higher the degree of risk experienced by the company. Transactional risk arises as a consequence of time differential between entering into a business contract and its settlement. It has also been experienced that different accounting standards are adopted in different countries (Chowdhry and Howe, 2000). Therefore, accounting discrepancy arises while aggregating all the statistics for constructing Annual Report. Cobham Plc also experiences all such kinds of exchange rate risk as a result of operating in multiple countries around the globe. In order to mitigate the all these types of exchange rate risk, the company has to involve in hedging (Cobham Plc, 2013). It is known that differences in currency exchange rate may increase or decrease a firm’s profitability while translated into home currency. Hedging tends to limit the degree of such firm specific foreign exchange rate volatility so that the level of profitability does not get affected to a large extent. However, disadvantages of such activities are also experienced because hedging activity tends to reduce the return from investments on underlying assets as the hedging cost is subtracted from the actual return of investment (Chowdhry and Howe, 2000). Experiencing significant complications regarding exchange rate volatility, especially during the financial crisis in 2008, Cobham Plc as identified a four step process for managing risk. Priority as been given on identification of risk well in advance depending on the information obtained from economic and financial forecast reports, reports from credit rating agencies and study of internal research and development department. Identification of project viability and riskiness of the project is also considered to be critical before expanding or establishing business in a foreign location (Cobhaminvestors.com, 2013). Once the risk factors associated with the company activities are identified, the next step taken by Cobham is to analyse the risk factors and develop an action plan in order to mitigate risks. The third step involves implementation of the action plan or selection of a project on the basis on internal and external analysis report. The final step leads to monitor the effectiveness of implementation procedure which includes examination of the implementation process at a regular interval (Cobham Plc, 2013). According to the Annual Report of Cobham Plc (2013), the company uses interest rate swap and forward foreign exchange contracts for stabilizing their exposure against currency risk but Cobham seldom uses derivative financial instruments for speculation. Inflationary risks are also mitigated by timely hedging of own currency as against foreign currency (Borghesi and Gaudenzi, 2012). Derivative financial instruments are initially recognised at a fair value on the date in which company enters into the contract (Ghosh, Wolf and Wolf, 2002). In this way, the company mitigates the transactional risks. The technique of interpreting the gain or loss arising out of hedging depends on whether the derivative is entitled to the hedging instrument and on the nature of the underlying assets being hedged (Moffett, Stonehill and Eiteman, 2012). According to Bryan and Lilien (2008), where Cobham uses hedging at on-going basis in order to counterweight the risk associated with cash flows, the interest rate swaps are designated to mitigate the risk in foreign exchange reserve which has a direct impact on profit and loss account of the company. The aggregate accumulation in reserves is recycled to the profit and loss account when the result of hedging tends to affect the profitability of the company (Hicks, 2008). Whenever a hedging activity fails to meet the criteria of countering foreign exchange rate risk, the transaction is also reflected in the profit and loss statement of the Cobham and if it is understood that the hedging is no longer required in a particular point of time, the position taken by the company in derivatives market is squared off and realised gain or loss is instantaneously transmitted to the profit and loss account (Cobham Plc, 2013). The fair value of hedging barring the one expecting for maturity whining 12 months is assigned in the balance sheet of the company under current asset or liability (Kallianiotis, 2012). In cases, where the hedge accounting is not applicable, the fair value movement of such derivatives are classified under non-current asset or liability and place in the P&L statement of the company, depending upon the maturity of the contract (Cobham Plc, 2013). Such efficient management of risk has resulted Cobham Plc to achieve a beta of 0.92 (which measures the risk responsiveness of the company) which indicates that the securities of the company will be less volatile as compared to the degree of market fluctuation. Country and Political Risk Management For a multinational company, political and country specific risk arises when the political and economic decision of host country affects adversely the global financial performance of the company. Country and political risk can originate in both macro and micro level of an economy (Wilkin, 2004). In macro level, an MNC may experience country risk as a result of changes in policy regulations, legislations regarding international trade, imposition of trade barriers and tariffs, alteration in corporate taxation and the like (Ramady, 2012). A business experiences risk at micro level in terms of internal corruption, unethical trade practices, bribery etc. in absence of stringent anti-corruption and anti-bribery policy (Cobhaminvestors, 2013). Firm Based As a result of operating in a multiple countries, it is obvious for Cobham Plc to come across political risk which is beyond control of the company. Hence, the company strives to establish and exercise internal control in order to enhance their risk absorption capacity (Cobham Plc, 2012). Cobham Plc safeguards itself from political risks while signing business agreements with host governments by purchasing investment insurance. This is a protocol used by the company to secure itself from potential loss from the investment done in foreign countries. In most of the cases of operation in foreign countries, Cobham Plc tends to adapt the production and business process of the host country so that the process complies with the political, socio economic and cultural norms of the country in order to avoid the risk arising out of goal conflict (Ramady, 2012). Cobham Plc also appoints political risk analysts who are responsible for forecasting the political risk associated with the foreign business and according to the reports from the risk management departments, they take preventive measures to defend such risks (Cobhaminvestors.com, 2013). Identification of political risks by professionals also influences the decision of the firm. Cobham Plc analyses the cost-benefit trade off of the business in order to decide whether such business engagement will prove to be beneficial for the company in future or not (Cobham Plc, 2012). Political risks are country specific and degree of such risk varies depending upon the political stability, existing economic condition, relationship of the country with its neighbour countries, level of terrorism attacks and many more factors (Ramady, 2012). Hence, Cobham Plc first understands the nature of political risk the firm may encounter and accordingly choose strategies to mitigate such risks (Cobhaminvestors.com, 2013). Global Risk Management Cobham Plc has to deal with a multiple number of governments of several countries around the globe in order to run their international operations and align their business according to the laws and regulations of every such country. The company tries their best to bring transparency in international business and abides by the regulations incorporated by European Union (EU) and World Trade Organization (Cobhaminvestors.com, 2013). Well established risk management team of Cobham Plc continuously monitors the implementation of action plans for risk management in the global arena and immediately makes decision if any contingency arises. While managing global risk, the company takes into account both financial and non-financial business interest (Ramady, 2012). Hence, while designing the production and manufacturing process, Cobham Plc puts maximum efforts to make their business process environment friendly and hazard free. As a part of global risk management, Cobham Plc includes local people in the human resource team. In this way, it becomes easy for the company to communicate and deal with the local suppliers and other stakeholders of the region and mitigate the region specific risks in global framework (Cobhaminvestors.com, 2013). Conclusion and Recommendations Analysing the UK defence industry, its nature and scope, it is clear that Cobham Plc has been able to secure a decent position in this competitive industry segment. However, evaluation of financial performance of the company over a five years period of time in terms of gross and net profit margin, liquidity and debt-equity ratio as well as other investment ratios, has shown that the financial health has become weak due to a number of contributory factors. During the period of 2009, the global business was affected by the great recession. Such recession adversely affected the business of Cobham Plc as well. Apart from that, in the last five years time period, the company has taken massive expansion strategy through continuous acquisition and selling of business units. Such activities impacted the cash flow of the company which in turn affected Cobham Plc’s bottom line. The paper has also revealed the risk exposure of Cobham Plc. Being a multinational company, Cobham Plc experiences exchange rate risk and political risk to a great extent. Such risks are impossible for any company to eliminate but efficient risk management department of Cobham Plc strive to rectify the business risks well in advance and formulate strategies to mitigate such risks. However, the company should expertise more in identifying the exchange rate and global risks. The parent company being located in UK, a country with hard currency, they should obtain strong bargaining position while negotiating with foreign subsidiaries or host countries for financial transactions. Cobham Plc. should also emphasize on establishing long term relationship and enhance their dependability on local suppliers of raw materials from host countries. In this way, they will be able to reduce cost of operations and ensure uninterrupted supply for smooth business running. Acquiring cheap loans from host countries will also prove to be cost effective for Cobham Plc. In order to manage political and region specific risks, workforce diversification, inclusion of more local human resource and elimination of gender biasedness will aid the company to construct a sustainable global workforce. Including local people in the host country subsidiaries will be help the company to reduce their expenses on human resource department as well. If the company concentrates on the above mentioned recommendations, Cobham Plc. will evolve as one of the greatest company in UK defence industry over certain period of time. Reference List ADS, 2014. 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International Financial Transactions and Exchange Rates: Trade, Investment, and Parities. Basingstoke: Palgrave Macmillan. Ramady, M. A., 2012. Political, Economic and Financial Country Risk. Berlin: Springer Science & Business Media. Read More