Introduction
Savola Group is a company trading in Saudi Arabia stock exchange and was founded in 1979, without the aim of packing and manufacturing edible oil. The company expanded into other sectors. After incorporation the companies shared packing products like sugar refining and opened various retailing outlets. It does not only retail in Saudi Arabia but has gone across other countries into Kuwait. The company has achieved many goals and is one of the major respected food company in Saudi Arabia. It manufactures food made for children and other. The company has many employees of diverse culture and this has made them one of the most diverse company in Saudi Arabia in the food sector. The company has expanded their operations out of Middle East into Africa such as Savola Sime Egypt a part of the business which is based in Egypt it is also in Jordan, Morocco, Kazakhstan, Sudan and it is exploring possibilities of entering into other parts of the world. A company with such history is no doubt worth studying for any finance student to equip himself with strategies of expanding business.
Purpose of Study
The main purpose of this study is to understand how performance evaluation of a company is carried out. The type of information required by investors while investing in the stocks of a company is obtained through performance evaluation therefore in carrying out this assignment I will be able to improve my professionalism in area of analyzing and evaluating the company.
The future generation of investors will find it difficult if proper information about the company is not provided therefore it is necessary to carry out this analysis. The economic performance focuses on the organizations impact on the economic circumstances prevailing in the market. This report emphasizes on profit ratios, growth ratios, performance in the market, and other vital information that is required by investing public. To asses the relative financial position of this company with respect to the market, the investor needs a financial analyst to have financial know-how to understand this. Therefore I will act as a bridge between investors and the company listed in the stock exchange.
Methodology and Sources of Data
Various methods have been used in analyzing the performance of this company. Ratio analysis has been extensively been carried out and all figures have been approximated to one decimal point except one instance where it was approx to one decimal point because the value could have been zero if one decimal point was considered. Break-even analysis has been carried out as well as degree of operating leverage for the company. This information has become very vital in decision making in the company. The information used in this case has been from internet sources where the companies’ website has been accessed to provide financial statements for the year 2005 and the year 2007. In the financial statement of the year 2007 it contains comparable financial statement of the year 2006 which has also been used, the same case applies for the financial statement of 2005 where comparable values of the year 2004 have been used. Generally both quantitative and qualitative approach has been carried out since there are figures graphs as well as analysis for the data. The information used has been extracted from books and internet sources.
Scope and Limitations
The scope of this research ends at the year 2007 beginning the year 2004. Financial analysis in terms of ratios has been carried out and not all ratios have been considered in the analysis. The limitations that are associated with this research paper are three fold.
To begin with there is not enough time to carry indebt analysis of the performance of the company. Secondly, financial statements have been obtained from internet sources. This limits the scale of analysis. Lastly the paper is only for academic purposes, and cannot be relied upon by a competent investor wishing to invest. Therefore this paper should not be used by anybody as a basis of making a financial decision and lay claim liability on part of the writer of the paper.
Production and cost analysis
Nature of product line and underlying technology
This company has many products which they produce and market in the world market. They own retail outlets where they sell various products but the product line they deal with is food sector. They sell fruit, vegetables
Product capacity and production volume
The company has a capacity of serving the local and international market and this is done through production in large volumes and opening of various branches in various parts of the world. To ensure that the product produced is of the right volume i.e. satisfying the market demand they have opened branched in Egypt, Morocco, Algeria, Sudan, Kazakhstan and many other countries. The Savola group production can meet the market countries which can meet as well as other countries where they are not able to make braches. This has made them one of the largest foods producing company. They have more than 6,000 employees by the year 2005 and the estimated to have more than 20,000 employees by the year 2010. Being a producer of variety products it is difficult to estimate volume of production unless you have information of each production unit to estimate.
Breakeven analysis
Break even analysis focuses on the measurement of the breakeven point. Before we attempt any calculations, it is necessary to make certain assumptions about the behavior of costs and revenues. Thus we assume that costs and revenue patterns have been reliably determined and that they are linear over the range of output which is being analyzed. These assumptions also imply that costs may be resolved without difficulty into fixed and variable costs will vary proportionally with volume of output; and that all other factors will remain constant, that is that selling prices will remain unchanged that the methods and the efficiency of productions will not be altered and that volume is the only factor affecting costs. It is because these assumptions are difficult to maintain in a ‘real life’ situation that break-even analysis cannot pretend to be anything but a rough-guide. Its real value to management lies in the fact that it highlights the inter-relationships between the factors affecting profits allowing management to make certain assumptions about these factors and see the likely effects of changes in these assumptions. Hence, break even analysis is useful as a management decision model.
In estimating the break even point the contribution margin group used:
- Where break even point = fixed cost divide by contribution
However we are not given the fixed cost or the contribution. Fixed cost can be estimated as well as the variable cost. Using the following formula we are going to estimate the fixed cost of the product.
The graph method: This method involves using what is usually called a break even chart. This description is not very satisfactory because it gives undue emphasis to the break even point whereas other points on the graph are just as important.
A break even chart is easy to compile, but the accuracy of the readings will depend on the accuracy with which the data is plotted. The output sales in units may be drawn on the horizontal axis and the vertical axis is used to depict money values. The graph below depicts relationship between the costs, revenues volume of output and resultant profit. The area between the revenue curve and the variable cost curve represents the contribution to fixed costs and profit at each level of output. The point at which the revenue curve crosses the total costs are gradually recovered until the break-even point, and thereafter each unit of output contributes to profit. The excess of break even point is known as the margin of safety. The margin of safety ratio is the percentage by which sales revenue may fall before a loss is incurred and is expressed as follows:
- Margin of safety ratio = margin of safety revenue
Degree of operating leverage
The degree of operating leverage for the company will be calculated as percentage change before interest and tax and percentage change in sales. Percentage change in sales was 14.4% from year 2006 to 2007. The percentage change in earnings before interest and tax was 0.0792% from year 2006 to 2007. Therefore the degree of operating leverage is calculated as follows”
- DOL = PERCENTAGE CHANGE IN EBIT = 8.3% = 0.58
- PERCENTAGE CHANGE IN SALES 14.4%
Financial ration and trend analysis
Liquidity Ratio
Short term liquidity position of Savola group has been analyzed in Exhibit 1. Some ratios were calculated during the last 4 years for analysis purpose. The current ratio has fluctuated from time to time. It fluctuated from the year 2004 to year 200. In the year 2005, it fell to 0.9 times from 1 time. It went up in the year 2006 to 1.6 before coming down to 1.2 in the 2007. This ratio shows how unstable the short term financial position of the company is. And the fluctuation is due to the increase in debt and decrease in debt securities and accrual expenses. This ratio is supposed to be 2 times in a normal business environment. However it depends from industry to industry. The current liabilities which are included include creditors and short-term borrowing. In the year 2007, it means that for every dollar of current liability there is 1.2 dollar of current assets.
The quick ratio also depicts the same position as the current ratio. The current ratio for the company was 0.5 times in the year 2004, it went up to 0.6 times then it increased to 1.2 times before coming down to 0.8 times. The quick test although is greater in the year 2006 i.e. 1.2 times. It is still a show that the company is not stable financially since it comes down. This ratio is an indication of the ability of the firm in meeting its financial obligation from its financial records. It shows the firm is strong in its liquidity should we have technical default the firm will be able to liquidate the quick assets to raise funds to pay off the creditors. The recommended ratio for this form of is 1:1. In this case the liquidity position of this company is sound and has improved over time.
Exhibit 1
The cash ratio and equivalent for this company also showed the same trend of fluctuation between times. The graph one shows how the trend for all this liquidity ratios is taking position. The cash ratio in 2004 to 2005 was 0.2 times while in the year 2006 it was 0.8 and it came down to 0.4 in the year 2007. However cash from operations took a different turn as in the year 2006 which appears to have improved in the liquidity is seen to be performing poorly in the year 2007 this means that some of the available liquid assets did not emerge from operations but other activities. This ration measures the actual cash flows into the organization and the ability of the organization to general cash flows to meet organizational goals.
Activity Ratios
Exhibit 2
Looking at the activity ratios of this company one will conclude the activity ratio improved in their performance because the company improved in both fixed and total assets. Total assets turn over ratio remained constant for three years that is the year 2004 to the year 2006. Then it went up to 1.4 times. Fixed assets turn over fluctuated from time it was 1.5 times in the year 2006 it went up to 1.6 in the 2005 then it scrambled to 1.1. in the year 2006 before going up to 1.3 times in the year 2007. This trend although is not appealing it shows that the firm is at least striving to improve its performance. They have a low assets turn over which shows that profitability for the firm is high and this is a good show for the company. This ratio assists the management in deciding which pricing strategy to follow when setting prices for the company. Looking at account receivable turn over and inventory turnover one sees a great improvement in the management of inventory and receivables. It shows that the management is managing well the working capital for the company. The firm used inventory for 4.8 times in the year 2004, 5.4 times in the year 2005, 6.1 times in the year 2006 and 6.7 times in the year 2007. this ratio shows how the inventory was turned over into sales and it shows an improvement. It means that efficiency at which the firm is utilizing the stock to generate revenue is improving over time. If this is converted into the number of days in which stock is being held in days which will be a saving in terms of obsolete stock and storage costs. The accounts receivable has also been turned over 7.6 times in the year 2004, 7.3 in the year 2005, 7.6 in the year 2006 and 10.2 times in 2007. This ratio shows a fluctuation from time to time. Although it was temporary set back in 2005 it improved in the year 2007. It shows the rate at which the management converts debt into cash. The graph below shows the trend taken by the activity or operations of the company.
Leverage ratios
Exhibit 3
This ratio measures the capital structure of the company. It shows how much of the company assets are financed by debt or equity. From the exhibit we see that the company is reducing its reliance of creditor financing steadily starting from 56.4 percent in the year 2004 to 32.9 in the year 2007. At the same time the company is building equity fiancé during the last four years and this is due to retained earnings of the company. The company has been paying dividends although they did not pay in 2004. Still, the ratio leaves some amount for investment. The financial statement depicts an injection of new shares in the year 2006 which generated over 2.391 billion to the company’s cash flow system. This assisted the company in reducing the ratio of debt to the capital. There is also a decrease in current liabilities during the period. Even the total liabilities have reduced to what was in 2006 to a low in the year 2007. This reduction of liabilities has contributed to this improvement in capital structure. The chart below shows how debt has been measured for the last 4years as compared to the industrial average. The long term debt to equity was also reduced at a faster rate from a 39.2 % in the year 2004 to 5.4 % in the year 2007. Indeed this is a complete turn of events for the financial ability of the company. This two ratios measures how much savola companys assets have been financed by debt and the financial risk of the company. From my judgment the company is stable.
Profitability Ratios
The gross profit margin for the company remains almost the same level during the first years showing their no major change in trading or operations of the company. The gross profit margin measures the profit demanded by the company before expenses. However, the operating margin of the company fluctuated from time to time. It improved from 2005 before coming down in 2007 from the financial statement the company’s finances are not very much affected but this ratio shows that the expenses increased over time and it was the lowest in the year 2005. It seems that the management focused their effort in managing expenses and they forgot the gross margin profit and elements. The profitability ratio measures how the company manages the operation and how efficient they use the company. The average of the two shows that the company improved although by a small margin. The gross profit margin was 16.4 % in the year 2004 it went up to 16.9 % in the year 2005 before slightly increasing to 17.5 % however, in 2007, it was a bad period because it went back to 16.4 %. The profit margin was 10.6 % in year 2004, it went up to 20% before slighting back to 14.8% in the year 2006 and it settled to 14% in the year 2007.
Exhibit 4
ROA (Return on Assets) is also used for the same purpose of measuring the overall performance. However to be meaningful to calculate the ROA it should be adjusted for implicit interest which is difficult to estimate and hence makes the process unnecessarily complicated. The figures show that performance is improving and the performance ratio is positive and more than ten percent for the last four years. This shows that the stockholders have not sent the face of profit for the last four years. However one needs to compare its position with the market and also its rival companies to have a clearer picture. The rate of return on Equity or ROE can be taken as a good measure to estimate the firm’s performance, from the shareholders’ point of view. However it fails to measure an overall performance of the firm. The higher this ratio is the better. If ROE is less than the ‘cost of equity’ the firm can be said to be destroying value. In the above statistics it seems that the shareholders’ view the firm performance to be increasing from years 2003 to 2007. The ROE was 18.6% in 2004 it went up to 33% came back to 16.7 the settling at 16.8% this trend by return on Assets. It was 10% then up to 16% then went down to 11.9% before going down to 12.5 % in the years 004 to 2007 respectively. From this point we can carry out DuPont analysis. In a DuPont analysis, the expression for ROE is broken up into three parts – profit margin, asset turnover and equity multiplier. The profit margin measures the operating efficiency of the firm concerned, asset turnover measures the asset use efficiency and the equity multiplier throws light on the financial leverage of the company under analysis. This identity helps one to understand where the superior or inferior return comes from.
Therefore, we may express ROE as follows:
- (Net profit / Sales) * (Sales / Assets) * (Assets / Equity) = (Profit margin) * (Asset turnover) * (Equity multiplier).
If we look at the individual values of these components for the three companies we shall be able to find the origin of the fall or rise in returns on equity. The increase in the value of ROE is due to the increase of profits. The asset turnover has shown some growth followed by a steady recovery. Therefore the use of assets has been inefficient and we may say that operating efficiency and financial leverage is responsible for this high return. The graph below shows the trend taken by the ratios under analysis
Growth
Exhibit 6
Earnings per share show how the company makes profit as per each share. Earnings per share are in two forms basic and diluted. The shareholders always consider earnings per share, when making decisions to buy the shares of the company. The earnings per share of this company have been fluctuating from time to time although it reduced from 16.75 to 3.07. in the year 2004 it was 16.7 it went up to 40.07 in the year 2005 before scrambling down to 3.28 in the year 2006. It went further down to 3.07 in the year 2007. This trend is worrying bearing in mind that profitability was improving. What it means is that the company has been financing most operations by increasing the share capital. This can be seen from the balance sheet of the company. Return on investment for the company showed also a fluctuation from time to time.
Capital investment and financing
Analysis of capital expenditure
In the year 2007, the company undertook various projects that required huge financial outlay. The products are undertaken and the aim was to increase production so that they will be the market leader. The projects were in North Africa, Middle East and North Asia. The company planned to invest in eastern and Europe in Far East. There was also a green field operation in Algeria which required huge financial outlay. In the year 2007, various projects of acquiring in new buildings have been approved. This projects required huge financial outlay and they needed serious investment analysis before acquiring the project.
The average rate of return on investment
The average return on investment for this company improved and it was assumed to be average return on assets. And this was 12.825 for the company. Return on investment gives investors a clue on how their investments are going to be returned.
Short term Vs Long term sources of financing
There are various short term and long term sources of finance in the company. Looking at the financial statement for the year 2007, the company financed their operations in the long term through issue of equity in 2006 towards 2007. They also increased retained earnings by not distributing all profits. They also used long term debts, long term payables as other sources of long term finance.
Short term financing they used bank loans although they were reducing trade payables and accrued expenses as forms of short term financing for the company. Each method has its advantages and disadvantages
Debt ratios
The company’s debt ratios were reduced since the year 2004, a clear indication that they were reducing reliance on debt capital. The total debt to total capital reduced from 56.4 in the year 2004, to 32.89% in the year 2007. This ratio was steadily coming down. Long term debt to equity debt also was facing a similar trend where it reduced from 39.2 % to 5.9 % in the year 2006 to 2007.
This ratio shows that most of the company’s assets were financed through equity as opposed to debts.
New common stock issue
Should any project arise the company has many options they can issue new common stock to the public or they can issue a bonus issue and exploit the existing reserves or they can issue a rights issue to the existing shareholders. From the consultated cash statement one realizes that the company issue new shares and the profits were 2391 million. This issue helped to improve the cash flow statement of the company.
Dividend policy
For the last four years under consideration, the company has paid dividends. IN the year 2004, they paid dividends of 289.37 million. In the year 2005, they paid dividends of 338.726 million. In the year 2006, they paid dividends of 433.607 million and the year 2007, they paid dividends of 558.802 million. This dividends are increasing from year to year meaning that the company had a good dividend policy to the shareholders. The dividend pays out ratio for the year 2004, did not exist while in the year 2005, it was 0.749. this means that there is no laid down ratio on how dividends were going to be paid by the company.
Sources and uses of funds
The sources of funds that are being used in the company are from banks, existing shareholders, Saudi Arabia stock exchange market and some funds from venture capitalist.
Cost of capital estimation
In estimating the cost of capital, capital asset pricing method will be used to estimate the cost of equity capital while the total capital will be estimated using weighted average cost of capital. The company beta as at the same date was 2.5253.this means that the risk free rate is7% and market rate will be therefore, 7% + 7% = 10%.
Rs = Rf + Bs (Rm – Rf)
Where:
- Rs – cost of equity capital
- Rf– the return that can be earned on a risk–free investment = 7%
- Rm – the average return on all securities (e.g , S & P 500 stock index)= 14%
- Bs – the securities beta (systematic) risk. =2.5253
It is easy to see that the required return for a given security increases with increases in it’s a beta.
Substitute this data into the CAPM equation, we get.
Rs = 7% + {2.5253 (7%) = 24.68%
In estimating the cost of capital using CAPM some steps are followed. The model is important applications that field of capital budgeting and is known as the capital asset pricing model. It is operated by determining for each project an appropriate discount rate for use in calculating its net present value. This rate is the risk free cost of capital plus a risk premium where the premium is determined according to the degree of risk attached to the project in the content of its addition to an existing portfolio. The existing portfolio has a rate of return which is regarded as being a risk reel rate of return plus a risk premium appropriate to that portfolio. It could write this as Rf + Rp. The risk premium appropriate to new project to be evaluated is determined by the application of a factor known as the β(beta) factor. Thus the rate of discount for the individual project is Rf + β Rp.
Using book values of 31st December, 2007 and market capitalization date of 11th July, 2008.
Evaluation of stock price performance in the market
Par value: The par value of the shares of this company, was ten each and at the end of 2007, there were 375 million fully paid shares.
Book value: The book value of the shares of this company was 19.08 which is calculated as follows:
- Book value = the book value of shareholders equity
- Number of shares = 7156.901 = 19.08
- 375million
Market value: The market value per share as at on the 10th January 2009 was 46.75 this means the market is overvaluing the shares.
EPS: The company earnings per share as at 2005, 2004 and 2003 was 33.39, 25.12, 18.82 respectively.
DPS: The current dividends issued to the company shareholders were 7.6 per share at the time with a dividend yield of 5.4 percent. However the dividend yield is 7.52
P/E: The price earning ratio of the company currently stands at 9.43 and the decrease is associated with the financial crisis currently affecting the world.
Summary and Conclusions
As competition becomes more and more intense, companies such as Toyota Motors Corporation which are leaders in their industries can not afford to become complacent. Rather they must again pioneer developments in their fields. These companies have to integrate all their resources, use these resources efficiently and effectively to attain organizational goals.
As the workforce becomes varied and as competition within industries becomes more intense, the need to effectively and efficiently manage human resources to gain, develop and sustain competitive advantages is becoming more important.
This company is food manufacturing and distribution of foods. However, the company has diversified its principle activities. The company has been making huge profits for the last few years including the year 2004, 2005, 2006 and 2007 under this case study. From the analysis carried above, the shareholder who is interested in the profit should sell the shares because there are no returns. However for shareholders who are interested in future returns should hold the share because it is over valued. The inclusion of this share into a portfolio will be of a low risk.
References
Savola Group consolidated financial statements. Web.