Financial report analysis - Essay Example

Billabong Financial Analysis Report 3210 AFE: Advanced Corporate Finance 4/26/11 Table of Contents Y Table of Contents 2 Executive Summary 3 2.Introduction 4 3.Firm Structure and Corporate Governance 5 4.Executive Compensation Analysis 6 5.Capital Structure and D/E funding 7 6.CAPM beta and factor model analysis 9 7. Firm –wide WACC 12 8.Growth project analysis using NPV, IRR and real options 13 9.M&A Analysis for Billabong 14 10.Risk Management and Hedging policy analysis 22 11.Conclusion 23 12.References 24 13.Financial Statements Ratios 25 1. Executive Summary This report analyzes various financial aspects of Billabong Group over the past year and draws conclusions about company’s financial health, its corporate governance and management, its growth projections, its growth strategies, cost of equity and debt, its recent mergers and acquisitions, risk management strategies and its future outlook. Billabong International is an Australian-based clothing company that deals in apparel, accessories, footwear, sunglasses, and watches and boardsports hardware including surfboards, skateboards and wetsuits. Its products include t-shirts, boardshorts, backpacks and swimwear. The public limited company is traded at Australian Securities Exchange. This report serves as final submission for the module on Advance Corporate Finance (3210 AFE). The objectives of this report are: 1. To get a general overview of Billabong International, its corporate structure and governance. 2. To assess Billabong’s financial strength and value from an investor’s point of view. 3. To assess Billabong’s recent acquisitions and its risk management and hedging policies. The document is organized in the following sections: Section Title Description Section 1 Executive Summary Overview of the entire report Section 2 Introduction Introduction to the company and its business Section 3 Firm Structure and Corporate Governance Company’s organization structure and constitution of the Board. Section 4 Executive compensation Analysis Analysis of remuneration/compensation policies and finances. Section 5 Capital Structure and D/E funding Capital structure of the firm and how it finances its assets. Section 6 CAPM beta & factor model analysis Calculation of beta, describing company’s returns with respect to financial markets. Section 7 Firm wide WACC Calculation of weighted average cost of capital for the company using capital asset pricing model. Section 8 Growth project analysis Decision analysis on a specific project to launch a new product using NPV, IRR and real options. Section 9 M&A Analysis Analysis of company’s recent acquisition of West 49 (a Canadian retailer merchandize firm). Section 10 Risk Management and Hedging policy Analysis Assessing the risks of the firm as well as its risk management/hedging policies. Section 11 Conclusions Concluding remarks on Billabong and its future outlook. 2. Introduction Billabong International Limiteds core business is the marketing, distribution, wholesaling and retailing of apparel, accessories, eyewear, wetsuits and hardgoods in the boardsports sector under the Billabong, Element, Von Zipper, Honolua Surf Company, Kustom, Palmers Surf, Nixon, Xcel, Tigerlily, Sector 9, DaKine and RVCA brands. Major competitiors for the firm include Addidas, Nike, Puma and Ripcurl. The company has approximately 6000 staff worldwide and its shares are publicly listed on the Australian Securities Exchange. Billabong Internationals products are licensed and distributed in over 100 countries (in approximately 11,000 doors), of which the major revenue sources are through wholly-owned operations in Australia, North America, Europe, Japan, New Zealand, South Africa and Brazil. The products are distributed through specialised boardsports retailers and through the Companys own branded retail outlets. The Companys brands are marketed and promoted internationally through its association with high profile professional athletes, junior athletes and events. Billabong is Australia’s largest surfwear manufacturer with product categories spanning into Garments, Accessories, Collections and Wetsuits; and is country’s largest. In 2010, as a result of international and regional economic crisis, foreign currency fluctuations, increased competition (growth of vertical private label brands) and supply chain pricing pressure, the profits of the company were down by 4.5%. The group is responding to these challenges by inorganic growth strategies such as acquisition of retail businesses around the world such as the recent RCVA acquisition, implementation of a new global product lifecycle management system, cost containment measures and new media alliances and strategic partnerships. 3. Firm Structure and Corporate Governance The following chart describes the organizational structure of Billabong International: The board of directors comprises of six non-executive (including the chairman of the board) and two executive directors (CEO and President-USA operations). Each board member is assigned to three executive committees that are Audit, Human Resource and Remuneration and Nominations committee. Mr. Gordon Merchant is a substantial shareholder of the Company and accordingly he is not considered to be independent of the Company (unlike other non-excecutive board members) based on the ASX guidelines. Mr. Merchant is a founder of the Billabong Group is curretly serving as the Managing Director of the group. All other Non-Executive Directors do not have any business interest or other relationship with the company. The company’s constitution directs that the company should not have less than 3 or maximum 10 BOD at any given time. The Company has implemented a risk management system based on AS/NZS 4360:2004; Risk Management standard and the ASX Corporate Governance Principles which includes risk identification, risk evaluation, risk treatment and mitigation and risk monitoring and reporting. 4. Executive Compensation Analysis The remuneration and compensation benefits of the Directors and Key Executives is decided by the The Human Resource and Remuneration Committee that consists only of Non-executive members. The current maximum aggregate remuneration pool for Non-Executive Directors is currently $1,500,000 per annum that was approved by shareholders on 26 October 2010 with no Directors retirement benefits other than statutory superannuation. Remuneration of senior executives is organized in a combination of fixed and variable components: 1. Fixed Compensation: This includes basic salary based on executive’s contract. 2. Short-term Compensation Plan: Short-term incentives or bonuses are given to reward meeting of personal objectives and KPIs. This compensation is either provided in the form of cash salary, cash bonus and non-monetary benefits (including equity). 3. Executive Performance Share Plan: The five-seniormost executives are provided with an equity based reward opportunity based on Group’s threeyear earnings per share performance. Other participants of this plan are provided with an equity based retention opportunity based on their continued service. The Executive Performance Share Plan awards performance shares or conditional rights which are defined as: Performance Shares are not legally entitled to shares in the Company unless the relevant performance and service conditions are achieved. However, the executive can vote and receive dividends in respect of performance shares allocated to them in the vesting period. Conditional rights: An executive awarded conditional rights is not legally entitled to shares in the Company unless the relevant performance and service conditions are achieved. Once the rights vest, each right entitles the executive to receive one share in the Company. The Executive Directors have a higher Variable (‘at risk’) remuneration than fixed one whereas it is the inverse for Non-executive directors. This is to ensure a continued excellent performance by the management team. The total remuneration realized for senior executives in 2010 was $10.2 million. Even though the total remuneration seems to be withing the limits of the industry average, still there seems to be a case of over-remuneration of senior executives. Despite the company’s profit falling for the second year in a row (and sales dropping by almost 15% in the important American market), Billabong’s board doubled the short-term bonus of CEO Derek O’Neill (Schwab, 2010). O’Neill’s short-term incentives leapt from $578,000 in 2009 to $1.19 million in 2010. 5. Capital Structure and D/E funding The purpose of Capital structure analysis of Billabong International is to determine if the proportion of debt to equity enables the entity to create wealth without unduly jeopardizing the firm. The figure in the inset describes the balance sheet structure of Billabong Internation (2010). Profitability Analysis: Profitability analysis focuses on Return on equity, return on assets and Leverage ratios. The profitability analysis is further examined to include margin, turnover analysis and capital structure analysis. The Return on Equity of Billabong in 2010 was 12%, a 1% decrease from the ROE of 2009. If we compare this ratio with that of the industry (Reuters, 2011)is 14%, indicating a marginal under-performance. The return on assets for Billabong in 2010 was 6.6% where as that of industry was 9%. The total D/E ratio in Dec 2010 was 0.51 indicating the company is relatively well balanced in financing its assets equally by debt and equity. Financial Health: The financial health of the company is sound with a high current ratio of 2.48. The company is fairly liquid with the quick ratio of 2.53 as it is fairly within the acceptable limits of the industry. This indicates that the current assets are used well to finance their debts. The ratio of cash flow from operations to that of net income is greater than 1 (1.28) indicating a cash rich company. Company’s efficiencies: The efficiency of the company is indicated by its operating and profit margins and compared with respect to the industry. The operating margin of the company is 14% while the profit margin is 7% (Dec 2010). Both operating and profit margins are slightly higher than that of the industry (6%) though it is lower than S&P 500 (11%) indicating that the industry is not as profitable as other industries. The following figure illustrates the operating margins of Billabong with its direct competition. As you can see, Billabong has considerably higher profit margins than Nike, Addidas and Quiksilver. 6. CAPM beta and factor model analysis The calculation of Beta provides a method to measure the degree of company’s systematic (non-diversifiable) risk. The beta measures the degree to which a companys returns vary with the return of the overall market (here represented by S&P/ASX 200 index) (Yahoo Finance, 2011). It would be worthwhile to note that the beta calculations done through Capital Asset Pricing Model (CAPM) are that of the leveraged beta. Nine years of monthly returns from Jan 2002 to Jan 2011 are used in the analysis, as provided below: S&P/ASX 200 BBG.AX Date Adj. Closing Price Monthly Return Date Adj. Closing Price Monthly Return Jan-02 3464.2 1.2% Jan-02 9.15 13% Feb-02 3414.3 -4.8% Feb-02 8.72 -6% Mar-02 3414.8 1.1% Mar-02 8.75 1% Apr-02 3350 -4.0% Apr-02 8.31 -5% May-02 3373.6 -4.7% May-02 8.7 5% Jun-02 3216 0.7% Jun-02 8.76 0% Jul-02 3086.2 -1.9% Jul-02 7.33 -16% Aug-02 3120.1 0.0% Aug-02 7.98 10% Sep-02 2970.9 -1.4% Sep-02 7.14 -11% Oct-02 3042.9 2.4% Oct-02 6.55 -8% Nov-02 3061.4 0.6% Nov-02 6.68 -1% Dec-02 3007.1 -1.8% Dec-02 6.8 2% Table 1: Selection of monthly returns for market index and Billabong 2002 The cost of equity is computed using the analysis below. Billabong’s beta is 1.3621, which is similar to JP Morgan’s published beta of 1.35 (J.P Morgan, 2011). Throughout the course of this report, we would rely on the internally computed value of 1.36. As shown below, the cost of equity of Billabong is 12% (using the CAPM model) and the tax-adjusted cost of equity is 6.13%. Corporate tax rate is assumed to be 35%. CAPM cost of equity calculations           Bilabongs beta 1.3621046 Read More