Valuing the Company by Cash Flow Discounting - Case Study Example

BP PLC COMPANY VALUATION ANALYSIS Student’s Name Institutional affiliation Professor’s Name Course Name Date A. Financial Analysis Earnings; is best analysed using the return on equity ratio framework. The company’s ratio analysis is done as below; Year/ Ratio 2012 2013 2014 2015 2016 ROE= net profit/ total shareholder’s equity 11,816/118,546 =9.97% 23,758/129,302 = 18.37% 4,003/111,441 =3.59% (6,400)/97,216 =-6.58% 172/95,286 =0.18% The company’s ROE ratio decreases significantly within the five-year period from 9.97% to 0.18% in 2012 and 2016 respectively. The decrease in this ratio is an indication that the capacity of the firm to generate enough profits for each and every dollar held as shareholder’s investment has decreased significantly over the period. It is important to note that the level of profits for the company remain positive in the period between 2012 and 2015 but then faces a loss figure in 2015. The loss is attributed to enormous payments of litigation liabilities to both the federal, state and a majority of the local government claims that arose from the 2010 Deep-water Horizon incident. It is also associated with the enormous impairment charges, a net favourable fair value accounting effect that underlay the RC profit for the year ended in 2015. In addition to this, the reduction in overall earnings is attributed to the significantly lower levels of profits within the Upstream that was partially offset by improved overall earnings in the downstream operations. Cash Flows; the level of operating cash flows for this company decreases within the five-year period from $20,479M to $10,691M in the period between 2012 and 2016 respectively. The decrease in this level of cash flows is notably associated with the beginning of the claims attributed to the 2010 Deep-water Horizon incident. The company has also further engaged in investing with modern ways of research and development that seeks to keep current operations in check. Low cash flows can also be perceived to be a result of low revenues growth within the period starting from 2014 due to imminent decrease in the level of profits in the Upstream operations. Balance Sheet Financial Analysis Year/ Ratio 2012 2013 2014 2015 2016 Current ratio= current assets/ current liabilities 111,384/76,329 = 1.45 96,840/72,812 = 1.33 87,262/63,615 = 1.37 70,024/54,627 = 1.28 67,813/58,354 = 1.16 The company’s overall current ratio decreases significantly within the five-year period from 1.45 to 1.16 in 2012 and 2016 respectively. The decrease is an indication that the firm’s capacity to meet its overall obligations has dwindled with time. The level of current assets has decreased over the time from $111,384 to a low of $67,813 as a result of inefficient cash and cash equivalent items within the period. The overall amount related to total assets decreases within the period from $305,690M to $263,316M in 2013 and 2016 respectively. This decrease is attributed to enormous decreases in such items as trade and other receivables; as well as cash and cash equivalents. The decrease in the amounts of cash and cash equivalents is associated with intense reduction in the amounts associated with revenues and earnings within the period. On a positive note though, the company seems to have devised a proper way of translating its overall inventories into cash resource. It is crucial to note that an investor is always focused on how a company is able to translate stocks into liquid cash for purposes of short-term investment opportunities; an activity that guarantees growth of shareholders’ wealth at any given moment in time. Year/ Ratio 2012 2013 2014 2015 2016 Receivables turnover = sales/ accounts receivables 388,074/37,611 = 10.3 396,217/39,831 =9.9 358,678/31,038 =11.6 225,982/22,323 = 10.12 186,606/20,675 =9.02 The receivables turnover ratio remains stable within the five-year operational period. This means that BP has devised effective ways for which to fasten its overall speed relating to the collection of what it is owed, which translates to a stringent financial efficiency. The ability to collect this level of cash owed means that it has a substantial level of capacity to access enough that is needed for paying-off most of its underlying liabilities including those related to the Deep-water Horizon spill. The amounts related to fixed assets increases from $176,469M to $182, 868M in the period between 2012 and 2016 respectively. This increase in the figure is relative to the reality on the ground. In fact, the figures represent actual figures and this can be proved by the fact that the company recently sold almost $38B worth of fixed assets in order to offset a significant portion of the claim liability held as litigation payments relating to the oil spill. Year/ Ratio 2012 2013 2014 2015 2016 Debt ratio= total assets/ total liabilities 300,466/180,714 =1.66 305,690/175,283 =1.74 284,305/171,663 =1.66 261,832/163,445 =1.6 263,316/166,473 = 1.58 The debt ratio decreases insignificantly within the period from 1.66 to 1.58 in 2012 and 2016 respectively. The decrease in this value is attributed to the recent sale of assets by the company in order to offset a portion of the claims. Capital Structure Analysis Year/ Ratio 2012 2013 2014 2015 2016 Debt-to-equity= total debt/ total shareholders’ equity 10,033+38,767 /118,546 = 0.41 7,381+40,811 /129,302 =0.37 6,877+45,977 /111,441 =0.47 6,944+46,224 /97,216 =0.55 6,634+51,666/ 95,286 =0.61 The company’s debt-to-equity ratio increases over the five-year period from 0.41 to 0.61 in 2012 and 2016 respectively. The increase in this ratio is an indication that the firm is making significant efforts to harmonize the level of equity funds to that of debt. At the present moment, the company is highly dependent on debt funds to conduct its overall operations. The effect of this dependence can result to bankruptcy given that a huge amount of earnings and thus, cash flows is being utilised for the purpose of paying-off interest expense on debt finance. B. Risks Analysis Prices and markets; it is expected that the overall financial performance of the Group is set to experience lots of fluctuations in relation to prices of oil, gases and refined products, technological change, exchange rate fluctuations as well as an overall macro-economic outlook (BP Plc , 2016). It is ascertained that the prices related to both oil and gas-related products are subject to fluctuate in relation to international supply and demand. Other notable aspects that can contribute to the risk relates to political developments; improved supply from both new oil and gas sources; technological change as well as global and economic circumstances that emanates from OPEC would definitely impact attributes of both supply and demand as well as prices for the products at hand (BP Plc , 2016). Notably, the level of decreases in oil, gas or even product prices can have a very adverse effect on revenues and cash flows going forward. In essence, an improvement in oil and gas related product prices cannot result to major improvement in earnings margin performance given that there could be increased fiscal take; cost inflation as well as limited access to cash resources. The profitability of the company’s refining as well as petrochemical operations can be volatile with seasonal over-supply or even supply longevity in underlying regional markets (BP Plc, 2016). The imminent level of exchange rate fluctuations can develop possible currency exposures as well as directly impact on the level of underlying costs as well as earnings. It is safe to ascertain that the crude oil prices is set in US currency all across the globe while the fact that products indeed vary in relation to their currency. Certainly, most of the major project development expenses are purely overseen in terms of local currencies that might be a subject to intense degree of fluctuations in comparison to the US currency. Risks associated with intense project delivery; that can result from investing in the perfect level of opportunities or even deliver fundamental projects can adversely impact on the financial performance (BP Plc, 2016). In consequence, in relation to this risk; there are operational challenges and inefficient investment choices of any given major project that could jeopardize possible growth in production hence affect the degree of financial performance as a whole. Liquidity, financial capacity as well as possible credit exposure; defines a form of risk that can results to major impact in the capacity-level needed for operations and thus, result to imminent financial loss. A failure to correctly forecast and even manage sufficient liquidity as well as credit could possibly affect the capacity to conduct operations and thereby results to imminent level of losses (BP Plc, 2016). Adverse competition; defines a risk-level that could render the company unable to maintain an efficient and innovative skilled workers hence this could result to a negative provision of the underlying strategies within the already competitive environment (BP Plc, 2016). In the case where the competitors offer superior products and services as well as terms of sale then there is an imminent possibility of losing customers to rivals. There is also a possibility of the company losing their intellectual property in case of poor protection mechanism. Ineffective and inefficient insurance framework; can adversely affect the level of exposure to material uninsured losses. It is noted that the Group only engages in the purchasing of insurance only in circumstances whenever it is legally and contractually needed (BP Plc, 2016). In the case of uninsured losses, it can have material adverse effects on the company’s immediate financial position especially in the event that the firm is facing material costs due to significant operational events that can emanate from imminent pressure from both liquidity and cash flows within any given moment in time. C. Valuation Analysis As can be seen from the appendix, the DCF-FCFF indicates that the estimated target share price of the company is placed at $ 89.16 against the current market price offer of $34. Variables; NOPAT (net operating profit after tax); is a formula that is used in the measurement of a company’s overall earnings in the event that it is ascertained that the company has already met its overall commitments in paying-off its existing debt burden. NOPAT is computed using the formula shown below; NOPAT = EBIT* (1-Tax Rate) Free Cash Flow to Firm (FCFF): is a valuation model that seeks to expound on the remaining cash-base that has still exists within the company after it has positively afforded to pay-off all of its underlying expenditure for purposes of ensuring a future smooth level of operations. To effectively get the FCF value, the existing amounts of cash-resource that has been consumed by the company from its underlying net operating profits after taxes. To arrive at FCF value; the valuation process assumes a sequence of formulas that are described as below; Free Cash Flow (FCF) = NOPAT – Net Investment on Working Capital (NIOC) NIOC = Operating Capital CURRENT YEAR – Operating Capital PREVIOUS YEAR Operating Capital (OC) = Net Operating Working Capital (NOWC) + Fixed Assets Net Operating Working Capital (NOWC) = Operating Current Assets (CA) – Operating Current Liabilities (CL). Considerations; Tax rate for this company is assumed to be 35%. D. Sensitivity Analysis The differences in these prices can be attributed to a higher level of expectations in regards to the company’s overall earnings performance. It can also be associated with the current reputation of the company and brand image as a whole. Despite the fact that the company has recently experienced a huge disaster that relates to the Deep-water Horizon oil spill, the firm has made enough efforts to rebuild its reputation within the market hence attracting a significant target share price value. The demand financial analysts are of the opinion that whenever the profitability levels of a company improves over a given period of time, then it goes without saying that the demand of the shares increases substantively to reflect the immediate demand of these shares within the market (Fernández, 2007). Considering that the estimated target price is positioned over and above the current market price, the best decision lies in purchasing the shares to benefit from a future likelihood of enjoying immense dividends as a maximised shareholder’s wealth. References List Fernández, P., 2007. Valuing companies by cash flow discounting: ten methods and nine theories. Managerial Finance, vol.33, no.11, p.853-876 BP Plc. 2016. 2016 Annual report. Retrieved from http://www.bp.com/en/global/corporate/investors/results-and-reporting/annual-report/annual-reporting-archive.html BP plc 2014 annual report. Accessed from http://www.bp.com/en/global/corporate/investors/results-and-reporting/annual-report/annual-reporting-archive.html BP plc 2012 annual report. Accessed from http://www.bp.com/en/global/corporate/investors/results-and-reporting/annual-report/annual-reporting-archive.html Appendix DCF Model Read More