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Sample About Financial Analysis Report

A Case Study About the Financial Analysis Report

Introduction About Financial Analysis

Financial Analysis Report

Investors want to analyze the performance of the company in order to evaluate its securities. It can be achieved by the concept of company analysis. It involves collection of various types of data and information regarding company’s profile, services, products and its profitability. Many times it is also referred as fundamental analysis of an organization. It includes defining the mission statement, values and goals of the company (Tan, Plowman and Hancock, 2007). While analyzing the firm, investors are also interested in its past performance which provides information about the main events which helped it in growing. This process also involves analysis of goods or services delivered by the firm. For instant, if the firm deals in manufacturing of goods, in that case product manufactured by the company along with its quality and demand in the market are also analyzed. On the other hand, it the organization is involved in delivering of services, in that case services is studied by the analyst (Costa and Lorente, 2007). The basic steps involved in analyzing any company consist of following steps:

  • The first step deals with identifying the type of analysis that can be used. It can be either fundamental or technical.
  • Before starting the study, it is important to define the expected outcome. The analyst must be able to highlight all the good and bad related to the organization which is evaluated by the study (Jenster and Hussey, 2001).
  • The third step deals with selecting an appropriate financial analysis method to analyze the financial performance of the company. In addition, various internal and external factors must also be examined which can impact the performance.
  • The analyst must have statistical data to support all of his findings.
  • The last step is about reviewing the outcomes. The entire process helps in finding out the issues that are hampering the growth of the company and respective solutions (Fleig, 2008).

Thus, company analysis helps in providing the real picture of the firm for a given time period. It helps organizations in enhancing the quality of their product or services.

Part 1

A: Overview of the company

United Utilities Group PLC is involved in the business of providing water and wastewater services in the North Western parts of England such as Cheshire, Cumbria, Merseyside, Lancashire and Greater Manchester. It serves around seven million people, and focuses more on providing excellent customer service with enhancing its operational performance. It was founded in 1995 by the merger of NORWEB and North West Water and presently is considered as Britain’s largest listed water company. It has staff of around 9,000 people and is listed on FTSE 100 Index and London Stock Exchange. As North West part of the England is the wettest part of the country and water there is not having standard ph value, so United Utilities process the water and make it suitable for consumption (United Utilities, 2012).

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The company maintains all its reservoirs which totals to 184 and is responsible for supplying water in all the regions. Apart from these, there are some reservoirs which are situated outside North West of England, for example, Longdendale in Derbyshire. It has planned to invest around £3.6 billion between 2010-2015, so as to improve the quality of water, and side by side using some eco friendly methods to achieve this so as to protect environment and to make their process more reliable.

Its activities can be segmented into two businesses: regulated activities and all other segment (United Utilities, 2012).

Regulated Activities

UUG supplies around 2,000 million liters of water every day and serves approximately 3.2 million houses and businesses in the North West of England. It has around 57,000 hectares of catchment land from where it collects water. There are some other sources also from where it collects water. The collected water is then stored in its reservoirs. Then water is treated in its water treatment plants. It is having around 96 fresh water treatment plants. Fresh water is then supplied to different areas through water pipes which are spread over 42,000 kilometers in area. It has designed its supply in such a way that no pumping is required to distribute the water in most of the area as most of the water flows due to the gravitational force only (United Utilities, 2012).

On the other hand, UUG has a wide network of sewers which is used to collect wastewater. It treats the water and supply it back safely to the nature. The residual waste form the treatment of water is then treated further to turn out into a byproduct which is then used for recycling purpose. Presently, each household has to pay around £1 per day for getting the services of UUG. But, the company believes that in the coming next five years the figure will reduce to £9 per month. This in the views of UUG is excellent as it will have dual effects. One, the household will get better water to meet their requirements at lower cost and secondly, it will help in maintaining ecological balance (United Utilities, 2012).

Other Segments

In November 2010, UUG decided to focus on only its core activities of treating water and wastewater, and started a non-regulated disposal program. Under this program, it disposed many of its operations such as its investment in Northern Gas Networks and Manila Water. Moreover, it also disposed of operations and maintenance of its electric operations in North West of England. Further it also discontinue some other businesses such as installation of gas and electric meter, treating municipal solid waste, it Australian business. So, after completing the disposable program the company now only focuses on its core activities (United Utilities, 2012).

Regulatory Commitments

Regulatory capital expenditure is one of the key performance indicators for any company. It is defined as total capital expenditure of an organization during a particular year. Under Ofwat regulatory framework, it expects its capital expenditure will deliver appropriate benefits to the shareholders if Ofwat gives green signal on its efficiency. As stated earlier, UUG is planning to invest £3.6 billion in its investment plan for 2010-2015. Till now it has achieved even progress as investment made by it are remained at high levels this has helped in meeting all the environment and the company is now delivering better services to the customers as compared to earlier. They have invested around £680 million in their water and wastewater program which are in line with their investment program (United Utilities PLC, 2011).

As far as retail price control is concerned, it is imperative for the regulator to take into consideration the socio-economic conditions of the region, address the discrepancies between different organizations, maintains the RPI inflation link plus make alterations to show the number of people receiving simply water or wastewater services. Annual price limits are published by Ofwat in its final price determination which is based on the calculated allowed revenue of the company for the regulatory period. Inflation which is determined by the adjustment factor (K) and retail price index (RPI), decides the price limits for each company. Thus, it is the company’s adjustment factor that is, K, which decides how much can a company increase or decrease its price for a particular financial year as allowed by the Ofwat. Thus, in UK, price cap regulation is based on the performance of the organization so the companies have to be very efficient related to their financing, capital structure and operating cost. The benefits thus achieved by the firm through its efficiency savings is kept with it for the period of five years and then is passed to the customers. On the other hand, if any firm is not able to perform well, its cost related to under performance will be borne by the organization only. Moreover, if they are not able to perform well enough, they can be penalized also (United Utilities PLC, 2011).

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B: Financial Analysis of the company

1. Comparison of Company’s PE Ratio to that of Sector

Price to earnings ratio is one of the most important ratios which an investor uses for selecting a particular stock. It is calculated as follows:

PER=  (Market Price of Share)/(Earning Per Share)

It tells about the amount an investor is ready to pay for each penny or earning of a firm. Presently the company’s PE ratio is 16.14. On the other hand, PE ratio of this sector is 13.90. This means it is having higher PER as compared to the sector. This shows that utility sector has higher expectation from the organization in coming months or year (Nissim and Penman, 2006). So now it becomes very important for the company to live up to the expectation of the sector by increasing its earning or otherwise the share price of the stock will need to drop. Moreover, PE ratio of its competitor Severn Trent Plc is 17.4 with EPS growth of 4.2%, while EPS growth of United Utilities is around 7.7%. This shows that its stock is not overpriced and has growth potential (Altman, 2012).

2. Existing gearing Level

Gearing level tells about the financial leverage of a company. It means, how much activities of the firm are funded by the owner and how much are funded by the creditor. If any firm enjoys higher level of financial leverage, it means the company is more risky and so as the money of creditors (Ahrendsen and Katchova, 2012).

 United Utilities

Figure 1: Gearing Level
(Source: United Utilities, 2012)

The above chart shows the gearing level of United Utilities. The green line shows how the gearing has moved over the last two years. It’s showing that the debt level is decreased between March 2010 and March 2011. This is mainly because of its non-regulated disposal program (Sudarsanam and Taffler, 1995). Financials of the company shows currently it’s gearing is at level 59 per cent and has been stable over the last years. This stability of because of the three factors: growth of its RCV, accelerated pension deficit repair payment and indexation of the principle of its index linked debt. If £92 millions are also considered as its debt, then its debt per cent will to 60%. Moreover, its gearings are in the range of Ofwat’s range of 55 per cent to 65 per cent, helping the company in getting A3 credit rating. It means it have efficient access to the debt capital market (Bertoneche, 2001).

3. Company’s ability to service debt payments

Before granting any debt or loan, investors or financial institutes checks whether the company will be able to service its debt or not. It can be determine by calculating interest coverage ratio of the company. The financial reports of United Utilities show that it has generated revenue of £1564.9 million in 2012 for continuing activities. Further, its operating expenses of the firm are 973.4 million in 2012 from the continuing activities. This means, its operating profit is 591.5 million. Moreover, interest paid by the company is 311.1 million in 2012 (Brigham and Houston, 2009).

The above table shows net cash flow from operating activity in 2012 was around £560 million which is lower by £3 million as compared to last year. The pension deficit repair payment has impacted the operating cash flow by £100 million. This was partly offset by the tax rebate it got in earlier year. The statement shows that the investment activities of the organization are higher side as it is progressing in its capital investment program. Finally, the net cash flow by financial activities was £6 million which was due to profit earned from borrowings of £215 million which was to some extent offset by £209 million paid by the company in dividends (Damodaran, 2010).

If comparison is made between FCFF and EBITDA, then FCFF gets an edge because it shows the net cash available to all the investors after deducting all the expenses. Moreover, most of the organizations keep on adding or modifying or replacing their fixed assets, this capital expenditure reduces the cash flow of the organizations which can be depicted through FCFF (Kwok, 2002). 

C: Debt Structure of United Utilities Group

The above table shows that company’s cash position is increased by £66 million at reached to £321 million. This is due to proceed from the EIB loan, which is partly offset by the early repayment of loan. The repayment amount was £150 million. In order to fund its capital investment, the firm’s net borrowing is increased as compared to last year. Moreover, its decision to accelerate the payment of pension deficit repair has also added to its net debt. Under IAS 19 has also helped it to improve its pension deficit. Earlier it was around £2.2 million, but now is reduced to £92 million. Because of impact of deferred tax credit, its retained earnings are improved by £88 million (Chandra, 2008).

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In order to provide economic hedge of its regulatory assets, it issues large proportion of bonds. As these bonds are linked to RPI inflation, it provides economic hedge to its assets. Specifically, as compared to normal debt, index linked debt provides cash flow benefits. As inflation adjusted index linked liabilities results in deferred cash flow, this it delivers better match to the inflation adjustment. Thus, it helps in delivering non-cash uplift to the RCV (Power,  Salin and Park, 2012).

D: Advantages and Disadvantages of bullet bonds

The main advantage of issuing bullet bonds is that, it minimizes the impact fluctuation of interest on the returns and the investor can realize handsome returns on the investment. Another advantage of bullet bonds is that it is maturity matching. That is once the investment is made, investor don’t have to worry until the maturity date arrives. On the other hand, there is a disadvantage also associated with bullet bonds. It is that, at the time of lower returns when the economy is not doing well, they carry lower rate of interest as compared to callable bonds. Moreover, they are riskier also as issuer has to repay the entire amount on one particular date rather than series of smaller repayment (Choudhary, Cross and Harrison, 2003).

For analyzing a fixed income investment, a comparison is made between the bond’s yield and yield of the available benchmark for the given period. The yield delivered by the benchmark bond is free from default or credit risk and are also known as risk free rate of return. Credit spread is the difference between the yields provided by the benchmark bond and the non benchmark bond. Credit spread is thus can be treated as compensation provided to the investors for taking such a high level of risk. Thus, the credit spread is involved so as to determine whether appropriate compensation is provided or not against the risk involved (Fabozzi, 2001).

There are several kind of risk associated with issuing a bond.

  • Financial Risk: As bonds are debt instruments, it is the duty of the issuer to repay the amount after the maturity. If the issuer is running short of money, still he has to repay the maturity amount as it is enforceable under law.
  • Refinancing Risk: Another risk associated with issuing bonds is refinancing risk. When the issuer of the bonds repays the mature bonds, it is definite that he will require new capital to finance assignment help the business operations. So he will have to again search for the investors. In such situations, he may face interest rate risk also.
  • Large Bullet Payment: As it is the property of bullet payment that they are repaid on maturity only. So at the time of their maturity, the issuer has to repay a huge sum of amount. So it may be possible that at the time of maturity he is short of liquidity (Veronesi, 2010).

On the other hand, various types of cost are associated with issuing a bullet bond. To maintain the data of all the investor is very tedious work as compare to maintain a file of loan taken from any bank. It requires more human resources and thus increases administration cost. In addition to this, other types of cost associated with issuing bonds are legal cost that is incurred so as to prepare contracts etc. Moreover, at the time of issuing bonds, underwriting is also done, thus cost of underwriting is also associated with issuing bonds. Apart from this, other cost associated with these is promotional cost, printing cost, etc (Chen, Liao and Tsai, 2010).

E: Callable and Putt-able Bonds

Callable bonds are those in which the issuer of the bond has the right to call the bonds anytime from the financier at a price which is agreed at the time of issuing bonds. The amount which the issuer will repay to the investor will be more as compared to the principle amount put by them at the time of issuing the bond. In other words it can be said that the issuer of the callable bonds has right, but not obligation to buy back them from their holder at a pre decided price. Most of the time, the call price will be at premium to the issued price, thus providing issuer with an option for which the company pays higher coupon rate (Tawatnuntachai and Yaman, 2008).

On the other hand, a putt-able bond is a kind of bond which an investor can sell back to the issuer before its maturity date at a price which is decided at the time of issuing the bond. In other words, it can be said that holder of the putt-able bond has right but not obligation to demand prepayment. Thus, this type of bond can be exercised at on or before the maturity date (Chang, Tseng and Chang, 2010).

From the company’s perceptive, it is benefitted from callable bonds. It is so because; the callable bond provides an opportunity to the company or the issuer to refinance the debt when the interest rate falls. On the other hand, this feature of callable bond act as drawback for the investors as their invested amount is not appreciated as desired due to fall in interest rate.

Pricing of callable ad putt-able bonds are somewhat different from that of straight bonds. In case of callable bonds, pricing is calculated by subtracting the price of the call option from the price of the straight bond (Nowman and Sorwar, 2001).

Price of callable bond = price of straight bond – price of call option

From the above formula it can be said that price of straight bond will always be higher than that of callable bonds as callable bonds does valuation addition to the company or an issuer. On the other hand, yield on the straight bond is lower than the yield on the callable bond.

In case of putt-able bonds, it price is calculated by adding the price of the put option to the price of straight bond.

Price of putt-able bond = price of straight bond + price of put option

The above formula suggests that price of straight bond is always low than the price of putt-able bond as instead of adding value to the holder, it adds value to the investors. Moreover, yield on the straight bond is always more as compared to yield on the putt-able bond (Chang and Krueger, 2011).

CONCLUSION

To analyze the security of a company, best way available to an investor is to evaluate the performance of the organization. So, to determine the performance of any firm, it is must to carry out financial analysis and fundamental analysis. In the above study, various aspects of United Utility were studied. It helped in understanding the operations and activities of the company. Further, financial analysis of the company suggests that it is the market leader in its sector and will continue to do well. The last part of the report tells about some of the options available to the company in raising finance. It describes different types of bonds that a company can issue and further tells which type of bond benefits a company or an investor.

REFERENCES

  • Ahrendsen, B. L. and Katchova, A. L. 2012. Financial ratio analysis using ARMS data. Agricultural Finance Review. 72(2). pp.262–272.
  • Altman, E., 2012. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The Journal of Finance. 23(4). pp.589-609.
  • Bertoneche, M., 2001. 2 – Review of financial statements 2: The income statement and the statement of cash flows. Financial Performance. 46-73.
  • Brigham, E. F. and Houston, J. F., 2009. Fundamentals of Financial Management. 12th ed. Cengage Learning.
  • Chandra, P., 2008. Investment Analysis. 3rd ed. Tata McGraw-Hill Education.
  • Chang, C. E. and Krueger, T. M. 2011. Does index investing work in bonds?. Managerial Finance. 37(5) pp.451-464.
 
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