Principles of Financial Markets - Retail Food Group Ltd - Case Study Example

Principles of Financial Markets Name Institution Course Tutor Date Table of Contents Executive Summary 3 Introduction 3 Food Service Industry: Retail Food Group Ltd 4 Their mission statement 5 Top-Down Approach of Performance Analysis of RFG 5 Global Factor 5 Political factors 6 Global acceptable standards 6 Australia’s Economic factors 6 Interest Rates 6 Inflation 7 Gross Domestic Product 8 Sector Specific Factors 8 Threats of Substitutes 8 Bargaining power of Consumer 9 Threats of new entrants 9 Rivalry amongst competitors 9 Business/ Company’s Factors 10 Competitive Advantage 10 Corporate Social Responsibility 10 Bottom-Up Analysis 11 Liquidity Ratio 11 Return on Equity 11 P/E ratio 12 Leverage ratios 12 Summary of Findings 12 Recommendations 13 Value Maximisation 13 Reduction in Government’s external borrowing 14 References 14 Executive Summary Australia’s vibrant economic background has been central and at the core of its stunning economic performance for decades. The massive growth of Industries with the spirit of ‘no relinquishing’ has been signified by various factors; global and local, that interplay in different strengths. This is evident in the sessions of boom and recession experienced in a country. In addition to these sentiments, globalization has come with it a horde of socioeconomic benefits that we can barely contest. Perhaps just to mention, it has seen industrial growth and development as the GDP of countries, particularly, Australia fairly competing on a level ground with other first world countries. What is more important, is how economic factors both at global, local and sectorial scales impact on the performance of companies and industries at large. The intuitive rationale being ascertaining the qualitative and quantitative driving forces of such factors in order to provide light to future economic growth and development. Excellent industrial performance is a function of multifaceted and interrelated fundamentals of economics or key drivers. Therefore, economic success may not be absolutely achieved but rather perceived, but growth suffices to be an evidence of favourable interplay among these factors that determine performance of industries. Introduction Industrial and firm performance has attracted concerns from economists in discerning implications of forecasting changes in economic factors that impact on firm and industry growth. The most used economic performance indicators such as Per Capita Income, rate of unemployment and poverty level, inter alia, have been used to gauge performance of countries but facing contentious forces from critics on their accuracy and relevance. In any economy, government plays an important role in directing a country. This can be through the use of tools of its monetary policies and fiscal policies. For a myriad of economic reasons, the government uses these tools to influence the demand for and supply of money in the economy. Ultimately, these counteractive approach to economic management of money supply impact on the rate of inflation, interest rates and the value of currency in the financial market. According to the economist Keynes, interest rate is determined by the demand and supply of money (Tily and Keynes, 2016, p.2). Demand and supply of money on the other hand, is dependent on the liquidity preference of individuals in a country. In the end, the net impact is felt by and manifests in the performance of industries and firms. In this report, we’ve sought to discuss company’s performance in relation to fundamentals of economic on a top-down and bottom-up approaches. We then outline and discuss findings of our study and provide recommendations for improving industrial or a firm’s performance. Food Service Industry: Retail Food Group Ltd Retail Food group is a company listed in the ASX operating in the consumer service industry. This company which was established in 1989 in Australia deals in wholesale sale of foods stuff and manages several cafes brands such as Donut king, Pizza Capers and Brumby among others. Up to date, the company swanks with over 2000 outlets across Australia and other international countries. The current market price of RFG in the ASX opened at $6.90 and the highest was at $7.07 as at 16th September as provided by the ASX. Their mission statement To continue to develop the organisation as a leader and innovator in retail food systems management in order to provide benefits to all stakeholders by maximising complimentary opportunities and delivering real value for our customers. Top-Down Approach of Performance Analysis of RFG Recent performance by the Retail Food Group has been contributed by revenue driving initiatives and acquisition synergies. According to sources, there has been a 27.1% revenue increase over the previous corresponding period (Business Wire 2016). Investment in strengthening shareholders’ earnings and growth according to the Managing Director Tony Alford was basically to facilitate global expansion of the company. Well, is there more into the global, industry and company factors that have significantly contributed towards this impressive performance track of RFG? We therefore, answer this question based on the top-down approach. Through the top-down approach, we specifically look into global issues, country and industry-specific issues that can help understand the performance of RFG. Global Factor RFG has outlets in over 60 countries and have recorded astounding performance. While we discern that multinational businesses are often thwarted by political, economic, environmental and social factors of a country’s territory, it may appear that RFG has been able to manage such factors. The following are some of the global factors Political factors In different countries, the state of political atmosphere affects the consumers’ propensity to consume products and so is business operations. This is because different government policies are usually aimed at driving both politicised economic agenda that may or may not favourably affect foreign investors. The global expansion of RFG has been facilitated by favourable political climate which have seen regional cohesiveness and synergies. Political stability directly affects GDP and therefore, the success of RFG greatly depended on the nature of political stability in those countries which were signified with good GDP (Aisen and Veiga, 2013, P.151). Global acceptable standards Global standards have been established to ensure that consumer access products that do not affected them in anyway. For this reason, companies have strived to produce quality goods by instituting quality control measures both at national and regional levels. For companies that fail to meet these standards do not Performance well especially in an imperfect competitive market. Australia’s Economic factors Interest Rates The concept of demand and money supply has been at the core of economic discourses. The interest rates in Australia has been influenced by the supply and demand for money. Interest Rates directly affects business performance because it determines the prices of goods and services (Woodford, 2011, p.49). When the demand for money exceeds supply, the interest rates tend to go high as values of bonds increase. An increase in value of bonds causes stocks to drop in value, thereby affecting investments (Menike, 2010, p.50). When the interest rates increases, borrowers often shy away from taking loans and the supply for money in the economy decreases. Due to this, the propensity to consume or spend money in buying goods and services tend to decline. As this happens, businesses fail to maximise profits because consumers are willing to spend less. In addition, while increase in interest rates affects the consumers, even businesses whose capital structure comprise of interest-bearing loans tend to have liquidity issues. The WACC tends to be high thereby affecting the performance of a company’s share in the stock exchange market. The prices of shares decrease signified by decline in profits generated by the company as a result of decreased sales. Inflation Inflation refers to the process of a general increase in prices of goods and services. Inflation influences both the currency of country and demand for goods and services. The inflation rate for the second quarter in Australia is at 1.0% while the consumer price index exhibited a 0.4% decrease. With this rate, many industries have been performing well because low rate of inflation improves the purchasing power of consumers. Inflation results from increase in demand for goods and services with a shortage in supply of money in the economy. When this happens, the consumers’ purchasing power declines significantly. As a result, many businesses may end up closing down due to losses or poor financial performance recorded. For demand pool inflation, the government controls it through the use of monetary policies. However, imported inflation which many countries fear comes with another impact. Industries that are involved in exportation face crisis when their countries are faced with inflation. This is because inflation makes exports expensive and other countries may shy off from trading with such a country (Ayyoub, Chaudhry and Farooq, 2011, P.64). For the food industry, just like in any other industry, inflation directly affects the financial performance and the prices of shares in the stock exchange. Gross Domestic Product The GDP of a country is significant in ascertaining the performance of a country’s performance. Many foreign investors build their confidence in investing in other countries on the basis of their economic performance. Countries with a relatively lower GDP growth may face foreign investment problems which will consequently lead to high rate of unemployment. High rate of unemployment poses significant risk on companies since consumers will tend to have less money to spend on goods and services. This is due to high dependency ratio upon those who work and lack of sources of money by consumers. Therefore, the success of a company also depends on the rate of unemployment. In order to foster business growth and improve performance, the country must attract foreign investment in order to create employment for the people and thereby increasing the marginal rate of propensity to consume of consumers. Sector Specific Factors Threats of Substitutes Industries usually face the threat of substitutes especially those which come with different qualities and prices. Substitutes have an impact on demand and supply of products. For instance, coffee and tea are perfect substitutes and an increase in price of one of the product leads to an increase in demand of the other product. FRG roasts coffee and most of their products are made from coffee. Therefore, the prices of their products depends on the prices of coffee as their input. Which means that if the prices of coffee is high, the effect will be transferred to the final product and therefore, the price of the final products will be high. If there is another company that provides products that serve the same purpose and are cheaper than their products, then the demand for RFG products will decline significantly. Therefore, a company requires to ensure that they invest in appropriate technologies and business processes that will provide tem security against threats from substitute goods. Retail Food Group offer substitutes goods so as to manage shift between products and ensure that they do not lose their market share. The low shifting costs that this company faces has been used as a competitive advantage strategy to enable them shift between substitutes. Bargaining power of Consumer The bargaining power of consumers affects the demand for a product but is dependent on the price elasticity of the product. Whilst foods remains to be a basic need, people may tend not to be very much sensitive on certain products. For product dealt in by RFG, for instance Pizza, may have been successful in various markets across tits branches because it has a low price sensitivity feature. In order to deal with the troubles of consumer bargaining, Retail Food Group opted to deal in a variety of products under different brands. Threats of new entrants New entrance of business in the industry may also impact on the financial performance of a business. An existing company may face challenges of new vibrant ideas brought in by these new firms. In addition, entrance of a new firm may also reduce the market share of a company if strategic measures are not take. Therefore, a company can hugely look into brands strength in the market since it is critical in determining a company’s position when new companies enter the industry. For this reasons, Rivalry amongst competitors In the food industry in Australia, the rate at which companies grow especially those which have reached saturation point may be intensely affected by the level of competition brought in by other companies. In order to escape from this, companies within this industry have strove to build strong industrial partnerships while other have acquired some companies. For instance, FFRG acquired Gloria Jean’s Food at an acquisition price of $163.5 million. With the strong brand strategy and the improved stock prices of FRG, they’ve been able to beat their competitors in the food industry, recording an improvement on income from $34.22 million to $61.30 million. Business/ Company’s Factors Retail Food Group operate 5 franchising systems with over 2000 outlets within and outside Australia. These franchise systems include Donut King, Michel’s patisseries, Brumby’s bakery, Coffee maximization Unit and QSR division. Under business factors, we look into competitive and business model. Competitive Advantage Retail Food Group has gained its competitive advantage through their brands and quality products they’ve produced across the franchise systems. Through processing of quality products, the company has been able to improve its financial performance and has seen its expansions help minimise the operating cost significantly. With sufficient financial resources, the company has also been able to engage into research and development programs which has seen its innovative capabilities increase overtime. Corporate Social Responsibility The company has an active public relations department which has seen Retail Food Group participate in corporate social responsibility matters. For instance, FRG support a charity in the Epilepsy Action Australia early this year. Bottom-Up Analysis Liquidity Ratio Liquidity ratio measures the number of times the current assets can pay off current liabilities. Companies with a liquidity ratio of below 1 have liquidity problems and therefore, becoming unattractive to investors. The liquidity ratio of RFG is computed as follows: Current ration= total current assets/current liabilities= 89,346/49519 = 1.804 Quick/Acid test ratio= Total assets-closing stocks/current liabilities= 89,246- 16103/49519= 1.477 Cash Ratio= 0.35 This ratio is only used to measure the company’s ability to meet its short-term debts. In this case, RRFG is able to meet its short-term liabilities 1.804 times. In addition, the current assets less exclusive of stacks is still able to meet its short-term liabilities since the ratio is more than 1. However, the available liquid cash is not able to pay off the short-term debts since the ratio is below 1. Return on Equity This ratio measures the earning power of the shareholders’ investment. It measures the amount earned when $1 dollar is invested by a shareholder. It is calculated by dividing net income after tax or cash flows with equity. ROE = Net Income/Total Equity ROE=14. 63 Therefore, for every one dollar invested in RFG Company, $14.63 is earned in return. This is an indication of progressive performance of the company. The earning power of the company is quite attractive to investors. Therefore, if other company’s would have lower ROE, then investors may shy away from such companies because of fear of future reduced returns. P/E ratio This ratio measure the earning power of RFG’S shares based on its market price. RFG has a P/E ratio of 18. 79 (TTM). The growth or valuation of RFG therefore, is based on this P/E. Leverage ratios The company has a total debt to equity of 47.62 which means that the company’s capital structure of the sum of total equity to debt is made of 47.62% of debt. The rest is equity. Therefore, RFG may face high cost of capital if it does not manage its debts as it may dilute equity in the long run. Huge long-term debts affect the returns to shareholders. In addition, total debt grabs 32.26% of the total capital structure and an interest coverage of 10.79%. This translates into slow growth of the business based on ROE and retention ratio. The company will retain much and pay little dividends to its shareholders due to high relatively high leverage ratio. Summary of Findings The astounding performance of Retail Food Group Ltd can be traced through various factors. The reason as to why RFG marked recorded significant improvement in its operation across its outlets is due to economic factors within Australia. The rate of inflation in Australia dropped at 1.0% and this meant that prices of food in the food industry dropped relatively to the plummeting inflation rate. In addition, recent Australian’s GDP per capita was at $51,358, quite lower than the previous GDP per capita in USD. The economic growth rate is expected to be 2.8%, 0.3% higher than the previous year’s GDP rate. This is based on anticipated increase in economic activities and strengthening of industrial policies. Nevertheless, the political and social environment both in Australia and abroad have facilitated growth of industries significantly. The rate of interest rates have affected the consumers’ purchasing power and affecting the cost of capital of RRFG, which has in turn impacted on the operating profit. The net impact is felt in the earning per share and dividends per share. Apart from this, RFG sought to produce substitutes of other products they sell in order to gain a competitive advantage over those new companies entering the market, or competitors in the local and global arena. Therefore, the business model RRFG uses is to help them compete effectively and expand their market. The Company’s expansion and establishment of additional outlets have logistically enabled RFG save on costs more than their competitors. The low earnings per share of the company is due to a huge proportion of debt in their business. Accounting for 47.62% of the sum of debt and equity, debt or high leverage ratio makes the cost of capital to be too much to the company, thereby affecting returns. A return on equity of 14.63% is quite lower compared to the standards returns in the same industry. The implication is also reflected in the cash ratio, where the liquid cash of the company is not able to meet its short-term debts. Therefore, there is too much risk and investors may not be confident enough to invest in Retail Food Group Recommendations Value Maximisation I recommend that the company effectively direct their efforts towards maximizing shareholders’ wealth rather than concentrating on expansion while dividend growth is minimal. The benefit of this is that the company will strategically find ways of minimising operational costs and costs of capital which impact on the earning of the company. Reduction in Government’s external borrowing The GDP is greatly affected by the amount of debt a country has (Checherita-Westphal and Rother, 2012, p.1392). Therefore, the slow growth of Australia’s GDP may be due to high public expenditure and debt which needs to be reduced. With reduced public debt, the government is able to facilitate direct foreign investment thereby creating employment. This will eventually improve performance of industries. References Aisen, A. and Veiga, F.J., 2013. How does political instability affect economic growth?. European Journal of Political Economy, 29, pp.151-167. Ayyoub, M., Chaudhry, I.S. and Farooq, F., 2011. Does inflation affect economic growth? The case of Pakistan. Pakistan Journal of Social Sciences, 31(1), pp.51-64. Checherita-Westphal, C. and Rother, P., 2012. The impact of high government debt on economic growth and its channels: An empirical investigation for the euro area. European Economic Review, 56(7), pp.1392-1405. Menike, L.M.C.S., 2010. The effect of macroeconomic variables on stock prices in emerging Sri Lankan stock market. Sabaragamuwa university journal, 6(1). Tily, G. and Keynes, J.M., 2016. Keynes's General Theory, the Rate of Interest and'Keynesian'Economics: Keynes Betrayed. Springer. Woodford, M., 2011. Interest and prices: Foundations of a theory of monetary policy. Princeton university press. Internet sources: RFG to the rescue with $50,000 donation Read more at http://www.franchisebusiness.com.au/news/rfg-to-the-rescue-with-$50-000-donation#8JMeAB2cWBs3xEJt.99 RFG Financial Reporthttp://quotes.wsj.com/AU/XASX/RFG/financials http://www.focus-economics.com/countries/australia Read More