Global Operation and Risk Management of Qinetiq Group Plc - Essay Example

Global operation and risk management of Qinetiq Group plc INTRODUCTION QinetiQ is formed as a private company in 2001 after the decision of MinistryOf Defense (MOD) about the spilt of Defence evaluation and Research agency (DERA). Excluding Defence Science and Technology Laboratory unit, MOD separated all the other DERA’s functional units as a private business entity with the name of QinetiQ (QinetiQ, 2015a). The business headquartered in Farnborough, Hampshire, United Kingdom registered in London stock exchange as public private partnership in 2002 via appointing Carlyle group that is a US-based company as strategic partner. The company holds a business portfolio of military weapons and systems within mode of travelling including land, air and sea (QinetiQ, 2015b). According to QinetiQ (2014), the revenue of the company has been decreasing since 2011 such as 10.3% to £m 1191.4 and with net loss of £m12.7 in 2014. The reason is reduction in the expenditure of UK on defence equipment by 20% from 2007 and also other parts of the world (Clancy, 2014). Global company has major share in UK and USA. QinetiQ is considered for the assessment of performance and risk management due to its declining performance over last three years. Also the assessment of risk and risk management performance of the company will be reviewed. BUSINESS AND MARKET STUDY “Organic-plus” strategy drives QinetiQ’s with considering customers, people, innovation and productivity as core drivers (QinetiQ, 2014). Reported below financial trends of key indicators depicts continuous decline in performance (QinetiQ , 2014): Figure 1: QinetiQ Three Years Financial Performance (QinetiQ, 2014) However, company claims to be strong with increased dividends. Market segmentation of the business is depicted below. Figure 2: Regional Performance of QinetiQ for 2014 (QinetiQ, 2014) The industry added value to the Europe via achieving turnover of 197.3 billion Euro in 2013 with the growth rate of 5.6% from military and civil sector (ASD, 2013). While, the information graphic report of Deloitte (2014), maintained that there will be decline in the Defense sector’s revenue while and increase in commercial sector is forecasted for future. It is anticipated that by 2023, commercial production level of aircrafts will witness 25% growth (Deloitte, 2014). CSC, however; forecasting challenges and only moderate growth near in the future (CSC, 2015). As depicted by the industry trends discussed above, the industry is highly flourished and developed with huge industry players base that fierce the competition level of the industry. Being the 6th largest in UK and operating in global environment the company possess a huge base of competitors including local and global players. According to Morningstar, direct competitors of QinetiQ are United technologies corp. and Boeing Co (Morning Star, 2015). However, the industry possess higher barrier to entry status as because of huge investment, high technical expertise and more regulatory implications are imposed on the industry. COOPERATE AND FINANCIAL ACTIONS With a brief history of only one and a half decades, the company is operating its business with status of 52 largest defence contractor all over the world and sixth largest UK-based. The company operates its core business in two units namely EMEA services and Global products with around 6233 people and generated revenue of £1191.4m in 2014 (QinetiQ, 2014). However, the presented information of last three years in the annual report of QinetiQ (2014) shed light on the continuously declining revenue trend. Further, Due to the nature of products and services in which company deals, the company is highly exposed to risks associated with the internal and external environmental factors in globally operating scenario. Company follows the procedural action plan to counter the adversity of certain risks. In the annual report of the company, it is mentioned that company faced numerous challenges four years before and take financial strategic steps in terms of keeping focus on the capabilities that are required by the customers of that industry and developing a lean debt-free capitalization structure of the company (QinetiQ, 2014). Summary of the trends of key financials for the last five years is presented in next section including the year of challenges. FINANCIAL TREND ANALYSIS Below presented is the analysis of financial trends of the company to assess the viability of financial indicators in terms of explaining performance. Figure 3: Five Years Income Statement Review It is depicted from the graphic that company operates with almost negligible or negative net income due to higher operating costs of the business. However the year 2012 is seem flourishing in terms of net income and operating profits due to achievement of self help program through which company paid early debt to reduce interest expense, reduction in pension deficits, restructured business of US and generated more cash to reduce debt (QinetiQ, 2012). Profitability Gibson, (2008) explained the importance of profitability ratios as profitable outcomes of business actions. Profitability of a company refers to the gaining results that a company generated out from corporate actions (Ross, Westerfield, and Jordan, 2009). The profitability of the company is analyzed via utilizing operating and net margin of the company (Davies, & Crawford, 2011). Operating Margin Figure 4: Five Years Operating Performance The overall operating margin trend is fluctuating in terms of higher increase and decrease throughout the assessed period. Looking at the increasing trend till 2012 was due to increased operating overall profit. Closely analyzing for the said year it is revealed that while generating lower revenue from 2011, company reduced its operating costs and ended up with higher operating profits (QinetiQ, 2012). Net profit margin Figure 5: Five Years Net Profit Performance The similarity between both of the trends of operating margin and net income pointed towards the higher sensitivity of the COS trend of the company. Thus it can be evaluated that net income of company takes impact of increase and decrease in the operating margin due to COS fluctuation and that impact finally flow till the transparency level of net income. For instance, the increased operating margin positively impacted on the net income. However the decline in 2013 and 2014 is due to decrease in overall revenue and increase in COS as well as debt level which in turns increase interest expense of the company (QinetiQ, 2014; QinetiQ, 2013). Liquidity A balance of short term assets and liabilities in terms of ability of paying back short term liabilities via short term assets are termed as liquidity of a company (McLaney, 2009). Utilizing current ratio the liquidity of the firm is assessed below. Current ratio Figure 6: Five Years Liquidity Performance There is a steady decline in the current ratio of the company for the years 2011 and 2012 is depicted while overall trend is depicting the strong liquidity position of the company as company is able to pay almost one and half of the current liabilities via its current assets. Financial gearing Explaining long-term solvency of a company, financial gearing refers to the capital structure in terms of balance of equity and debt (Kaplan, and Atkinson, 1998). As reported above, company strategically reduced its debt to control the higher risk associated with the lower equity structure. Long-term debt/Equity Figure 7: Five Years Leverage Performance Assessing the trend and researching annual reports it is revealed that prior to 2012 company was exposed to higher risks due to higher financial leverage. However, intentional early payment for controlling debt level are made in 2012 as depicted above in the declining trend and movement towards higher equity is done through converting revenue into cash (QinetiQ, 2014, QinetiQ, 2012). The actions improved leverage position of the company but again a steady increasing trend is raising question on sustainability of the corrective measure. Efficiency Efficiency is measured in terms of operating business efficiently (Hilton, 2010). These ratios measures the firm’s to generate revenue on each spent dollar in the regard thus define operational efficiency of the company (Gitman, 2003). Asset turnover Figure 8: Five Years Efficiency Performance - Asset Wise The ratio above is explaining the company’s ability to generate sales via assets of the company. A steadily growing trend of asset turnover is favoring the improving financial drivers of the company as the higher ratio is considered better for generating more revenue against each spent dollar. Further, the ratio is not very high as company favors higher equity (QinetiQ, 2014) and in such scenario the turnover ratio depicts lower values. Investment Basically investment in terms of dividends is made when company generates sound net income thus earnings per share and payout ratio shows the strong or weaker position of company in financial markets (McLaney, 2011; Gitman, & Zutter, 2014). Earnings per share Figure 9: Five Years Earnings Performance Getting the direct impact of fluctuations in net income, the trend of earnings per share is highly similar to the net margin. An increase and decline in trend is due to change in net income of the depicted years. Dividend per share Figure 10: Five Years Dividend Performance In contrasting to earnings per share trend, the dividend per share trend is continuously increasing which depicts that company is actively increasing its dividend while having fluctuations in profits. The action is a call for depicting strong financial position of the company as done by many companies in such situations to signal positivity in financial markets. RISK MANAGEMENT A risk refers to the vulnerability of an entity in terms of future uncertainty (Fridson, & Alvarez, 2011). The term is inherited with the global environment in many aspects. The business entities that possess a global operating structure of the business are highly exposed to the global macro environmental risks (Gibson, 2012) so as to QinetiQ. Company is actively restructuring its business in US unit and is in the phase of changing capitalization structure and thus exposed to a comparatively higher degree of associated risks. Failure of strategic actions, uncertainty of economic indicators including exchange rates, political international environmental issues, complexity of business supply chain, moderate to low growth, saturation and firm’s internal measures failure are main risks for the company (CSC, 2015). Company is highly concerned in the regard and explains many risks associated with the firm in terms of external and internal environment. To manage the risks associated with the business the company applies a sequential model as depicted in the following Figure. Figure 11: Risk Management Process of QinetiQ (QinetiQ, 2014) With the strategy of “Risk appetite” company shows high concerns towards risk management and explains risks including Law and regulatory impositions of US and UK, economic indicators, tax and exchange rate risks, breach of laws and loss of internal information systems importantly. The section below is elaborated for the most common and evitable risks faced by many multinational companies in terms of exchange rate and political risks. Exchange Rate Risks A globally expanded company is strongly exposed to exchange rate risk in the scenario of highly fluctuated currency values (Arnold, 2008). Fluctuations in exchange rates often reduce the profitability of the firms and impact negatively on the overall performance of the firm (Pike, and  Neale, 2009). The revenue of the company is gathered from a certain percentage of three currencies including 50% UK, 40% US and 3% euro, so the impact on key financials is vital (QinetiQ, 2014). Company explains its concerns and management measures in terms of hedging policies. It was maintained in annual report 2014 that company not only hedge for the maintaining the drivers in volatile situations but also objectively reduced volatility from earnings and cash flow. Explaining the exchange rate effects on the company, Qinetiq explains the currency disparity as depicted below. Figure 12: Exchange Rate RIsk for 2014-2013 (QinetiQ, 2014) The company explains that management of that disparity is done through depicting income and expenditures in the functional currencies including US dollar and pound sterling. Two other important measures that are practiced by the company to counter the effects of exchange rates are borrowing the currency in which subsidiary is dealing and hedging all committed transactions for exchange rate disparities. The borrowings in local currency allow company to mitigate the risk associated with the exchange rate volatility and also aid in saving uneconomic hedging costs. This is done by intentionally matching the net investment level in the local currencies (QinetiQ, 2014). As depicted by the model of the company of risk management, the company after managing a risk closely monitors and reviews the risks and corrective measures to sustainably perform in the global market. Hedging is an important tool in dealing with the exchange rate volatility. At one place in enables the business in fixing the amount attributable to certain the transaction and save business from fluctuation in the currency. However, it is also important to mention that companies have never been able to escape the risk through hedging due to the complexities and large number of factors involved. Forward contract system employed the company for hedging risk is another tool ; however, it is also faced with similar risks and opportunities as discussed for hedging (Gandolfo, 1995 and Pugel, 2008). Political Risks Uncertain political conditions all over the world have gained higher concerns of the multinational businesses. With the exposure of global risks company is also highly exposed to the country based risks as well as internal risks. Explaining the risks associated in the regard, Qinetiq maintained that it is exposed to the risks of reducing defense budgets from both of giant buyers UK and US as well as company also addressed the prospect increase in regulation and competition. Country Based Risks Usually the country based risks are accounted for uncertain political conditions, regulatory matters and other political and security events. Specifically for 2015, political risks associated with the UK are weaknesses of Europe and arrival of elections as reported by Deloitte (Deloitte, 2015). The risks associated with country are mitigated by the company in terms of actively participating in MOD for regulation building, dealing with a diversified portfolio and managing well for any OCI conflicts. Also, company enjoys support by the MOD for being its principle supplier (QinetiQ, 2014). In addition to this, company has produced code of conduct that clearly states that no bribery and corruption will be tolerated in the business. Additionally, the employees’ base is also recruited from worldwide in order to effectively make use of the local knowledge of employees (QinetiQ, 2014). Hence, by being aligned with the systems developed by government, the company is in a well position to deal with the growing political risks that are posed to business. (Arrow, 2008). Firm Based Risks Firm based issues are including various factors. Engaging wider markets in a competitive environment, government’s budgetary cuts, contractual losses and monetary obligations imposed by the government are some of the examples (Aswathappa. n.d.). QinetiQ manage the said risks via holding a diversified portfolio to retain customers, market efficiently to compete, and reviewing contract to keep healthy relationships with the customers and keep higher concerns for monitoring internal control to counter the risk of system losses. In accordance with the Moffet et al (2012), company can avoid these risks by adopting host countries system with respect to the political, cultural and social, economic, and other factors. The internal control systems has developed three categories of the risk appetite including hunger, balanced and cautious which in turn determines the level of focus and type of the measure to be employed to effectively deal with it (QinetiQ, 2014). Global Environment Risks Multinational structure of a business inherits the global environmental risks including laws fulfilment of many countries, threat of terrorism, currency disparity, cultural differences and international reputation of a business. QinetiQ explains that company is exposed to the reputational, taxation, regulatory, political uncertainty, adverse events and civil uncertainty of several countries. Mitigating the risks company has certain policies to deal with the regulatory matters of the US government, gaining insight about emerging image risks, concerns for people retention via cultural difference priorities and keeping traditional functionalities to only UK and US (QinetiQ, 2014). CONCLUSION AND RECOMMENDATIONS Meticulous analysis of the company’s overall environmental factors, financial performance and risk management strategies, it is concluded that company is operating with sound strategies to mitigate risks associated with the performance in international operating scenario. However, continuous decline in financial performance is contrary to the growth trend of the industry as presented above. Furthermore, the viability of the action of balancing debt and equity is plausible. Considering the overall health and concerns of the company some recommendations are developed below. Market saturation impact can be reduced via entering to the new markets. Continuous focus on portfolio diversification and focus on commercial industry segment is vital to survive in future as depicted by the forecasting industry trends. Control and sustainability of financial drivers in terms of performance is necessary to survive in a highly competitive market. References Arnold, G. 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(2009). Fundamentals Of Corporate Finance Standard Edition. New York, McGraw-Hill. Read More