Operational Strategy And Financial Analysis
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Introduction
This report is made to evaluate the performance of Associated British Foods or ABF Plc. This is a leading food products manufacturing and distribution company in the United Kingdom (Abf.co.uk, 2021). For assessing the performance and position of the company here in this report, the calculated cost of capital and ratios of past years analyse them to understand the actual position company holds in the market. The later part of this report has a conclusion and recommendations that summarise the findings and recommendations given to mitigate the company’s weakness.
Calculation of cost of equity by CAPM
| Beta | 0.466391725 | |
| E(rm) daily | 0.037% | |
| E(rm) yearly | 14.601% | |
| E(rABF.L) daily | -0.098% | |
| E(rABF.L) yearly | -30.206% | |
| rf | 0.9585% | CAPM (Capital Assets Pricing Model) |
| E(R ABF.L) | 7.321% | Cost of equity = risk free rate + beta( market risk premium) |
| MRP(market risk premium) | 13.642% | Market risk premium = (expected yearly return of market – yearly risk-free rate) |
Table 1: cost of equity
Source: Author
The cost of equity of ABF is 7.321%, this Means Company has to pay £7.321 for extra £100 equity financing.
Calculation of Cost of Debt of ABF plc.
| 2016 | 2017 | 2018 | 2019 | 2020 | |
| Interest Expense | £ 190.00 | £ 161.00 | £ 153.00 | £ 144.00 | £ 204.00 |
| Long Term Debt | £ 627.00 | £ 599.00 | £ 346.00 | £ 348.00 | £ 318.00 |
| cost of debt pre-tax | 30.303% | 26.878% | 44.220% | 41.379% | 64.151% |
| cost of debt after tax | 21.212% | 18.815% | 30.954% | 28.966% | 44.906% |
| The average cost of debt pre-tax | 41.386% | ||||
| The average cost of debt after tax | 28.970% | ||||
Table 2: cost of debt of ABF plc.
Source: Author
The cost of debt of the company is 41.39% while not considering tax adjustment. If tax is calculated on it then the cost of debt will be 28.97%. These costs of debt indicate that the company has to pay this extra amount for debt financing (Nugraha, Puspitasari and Amalia, 2020).
Cost of Capital or WACC
WACC stands for the weighted average cost of capital. This is a weighted average of the cost of debt and cost of equity. The calculation of WACC is in below table
| Average Equity (E) | £ 8,763.80 |
| Average Debt (D) | £ 447.60 |
| Average capital (V) | £ 9,211.40 |
| E/V | 95.14% |
| D/V | 4.86% |
| Re(cost of equity) | 7.32% |
| Cost of debt | 41.39% |
| Tax rate | 30.00% |
| WACC | 8.37% |
Table 3: WACC of ABF plc.
Source: Author
From the above WACC table, it can see that company ABF has the cost of capital financing is 8.37%, which is the combined cost of debt and equity.
Risk assessment
| Type of risk | Impact on the business | Strategies to mitigate risk |
| Liquidity risk due to high current assets in total assets holding. | Low operating leverage | For increasing the operating leverage of the company, the management should increase the fixed assets in its balance sheet. |
| Market risk | Reducing the sales growth | The food industry is one of the most competitive markets. A new player entered every day and local stores are another competitor. To mitigate this risk company should focus on branding its products by enhancing quality and marketing. |
| Capital financing risk | Low financial leverage | The cost of debt for the company is very high that is why the company has very less financial leverage and debt in its capital. The option of financing from debt is very costly and the company should work on this and have to look for another source of debt. |
| Pandemic risk | May stopped business operation. | There is no mitigation process but the company should make a reserve fund to overcome this type of situation in the future. |
Table 4: Risk assessment of ABF plc
Financial performance and financial position analysis
For assessing the shareholders’ investment decision important to assess the financial performance and financial position of a company (Google.com, (2021). The performance of a company can be assessed y various tools such as vertical analysis, horizontal analysis and ratio analysis. Here for better understanding, the performance and position use ratio, as analysing tool. The better financial performance and position will help investors to motivate hold their investment in this company.
Hand Hygiene Compliance with Infection Control Perceived by Health Professionals
Profitability
The profitability of the company is the capacity of earning or the how much amount or percentage earned by from revenue, capital employed and equity capital. There are many ratios that help to assess the profitability of the company, discussed below
Operating profit margin
The operating profit margin of the company is the earning capacity of the business or the profit of the operation of the company. High operating profit is good for the company as a high operating profit margin gives a high return to the shareholders. The below table shows the last five years’ operating margin of ABF plc.
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| (million) | (million) | (million) | (million) | (million) | ||
| Net Profit before interest and tax | £ 1,040.00 | £ 1,267.00 | £ 1,284.00 | £ 1,300.00 | £ 891.00 | |
| sales | £ 13,399.00 | £ 15,357.00 | £ 15,574.00 | £ 15,824.00 | £ 13,937.00 | |
| Operating Profit margin | 7.76% | 8.25% | 8.24% | 8.22% | 6.39% | |
Table 5: operating profit margin
Source: Author
From the above table, it can see that company has an average operating margin in the last few years the operating margin of the company stands lower than the 10%, the operating profit margin of the company is not good. Compare to the industry average, the company holds around the same operating profit margin (Higgins, Robert 2018).
Operating return on equity
The operating return of the equity is the percentage of operating profit on the equity of the company. This ratio shows the earning on equity capital. Here in below table show the last five-year operating return on equity.
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| (million) | (million) | (million) | (million) | (million) | ||
| Net Profit before interest and tax | £ 1,040.00 | £ 1,267.00 | £ 1,284.00 | £ 1,300.00 | £ 891.00 | |
| Shareholder’s Fund | £ 7,122.00 | £ 8,412.00 | £ 9,296.00 | £ 9,550.00 | £ 9,439.00 | |
| Operating return on equity (ROE) | 14.60% | 15.06% | 13.81% | 13.61% | 9.44% | |
Table 6: Operating return on equity
Source: Author
From the above table, it can say that the return on equity of the company is average but more than the time value of money. The table also indicates the trend of return on equity is downward which a great concern within the company is (Brealey, Myers and Allen 2019). Understand it better showing this in the below graph.
better showing this in the below graph
Figure 1: operating return on equity
Source: Author
Return on capital employed
The return of the capital employed is the profit earning capacity of the total capital or money operationalised this time. A high return on capital means the company has a high earning capacity. Last five years’ return on capital employed shown in the below table
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| Net Profit before interest and tax | £ 1,040.00 | £ 1,267.00 | £ 1,284.00 | £ 1,300.00 | £ 891.00 | |
| Total Assets | £ 11,376.00 | £ 12,810.00 | £ 13,692.00 | £ 13,760.00 | £ 16,669.00 | |
| Current Liabilities | £ 3,145.00 | £ 3,153.00 | £ 3,248.00 | £ 3,068.00 | £ 3,153.00 | |
| Capital Employed | £ 8,231.00 | £ 9,657.00 | £ 10,444.00 | £ 10,692.00 | £ 13,516.00 | |
| Operating return on capital employed (ROCE) | 12.64% | 13.12% | 12.29% | 12.16% | 6.59% | |
Table 7: Operating return on capital employed
Source: Author
In the above table, the return on capital employed trends is downward indicating the decreasing profitability of the business. The return in 2020 is worsted. From 12.64% to 6.59 % that is not a good sign for the investor (Akakpo et al., 2019). This downward can be shown in below graph
Figure 2: Return on capital employed
Source: Author
From the above profitability ratios analysis, it can say that the company has an average profitability rate and the trend of the profitability of the company is downward.
Short-term liquidity
Short-term liquidity is the value of excess current assets the company have after paid off the entire current obligation. The excess assets is also called as working capital. The working capital or the short-term liquidity is assessed from current ratio and quick ratio.
Current ratio
Current ratio is the ratio between current assets and current liabilities of the company. The ideal current ratio is to maintain by business world is 1.2 to 2. Here the company have a current ratio of 1.82 in 2020 and the ratio was in 2016 1.41. From the below table it can say that company seriously maintain its short-term liquidity over the period. In addition, the trends of increasing short-term liquidity is upward (Finance.yahoo.com, 2021). The current ratio of companies showing in the below table
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| (million) | (million) | (million) | (million) | (million) | ||
| Current assets | £ 4,437.00 | £ 5,190.00 | £ 5,285.00 | £ 5,596.00 | £ 5,753.00 | |
| Current liabilities | £ 3,145.00 | £ 3,153.00 | £ 3,248.00 | £ 3,068.00 | £ 3,153.00 | |
| Current ratio | 1.41 | 1.65 | 1.63 | 1.82 | 1.82 | |
Table 8: Current ratio
Source: Author
Quick ratio
The dependency of the company’s inventory on working capital management can be known from the quick ratio. The quick ratio of four consecutive years of ABF indicates the company efficiently managed its dependency on inventories (bev.berkeley.edu, 2021). The quick ratio trend of ABF showing in the below graph
Figure3: Quick ratio
Source: Author
The changes of factor that is why quick ratio changes showing in the below table
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| (million) | (million) | (million) | (million) | (million) | ||
| Current assets | £ 4,437.00 | £ 5,190.00 | £ 5,285.00 | £ 5,596.00 | £ 5,753.00 | |
| Current liabilities | £ 3,145.00 | £ 3,153.00 | £ 3,248.00 | £ 3,068.00 | £ 3,153.00 | |
| Inventories | £ 2,119.00 | £ 2,191.00 | £ 2,271.00 | £ 2,470.00 | £ 2,222.00 | |
| Quick ratio or acid test ratio | 0.74 | 0.95 | 0.93 | 1.02 | 1.12 | |
Table 9: Quick ratio
Source: Author
Fixed assets to total assets ratio
The long-term liquidity of the company, assess from the ratio of fixed assets to total assets or operating leverage. The higher percentages of operating leverage are good for the company’s long term sustainability. If any company has huge liquidity in its assets then there is a chance of dissolution. Here the ratio of fixed assets and short-term assets is reduced every year, which is not a good sign for the long term (Cloyne et al., 2018). The changing total assets and fixed assets showing below table for a better understanding of the changes
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| Profitability | (million) | (million) | (million) | (million) | (million) | |
| Fixed assets | £ 6,939.00 | £ 7,620.00 | £ 8,407.00 | £ 8,164.00 | £ 10,916.00 | |
| Total assets | £ 11,376.00 | £ 12,810.00 | £ 13,692.00 | £ 13,760.00 | £ 16,669.00 | |
| Operating leverage | 61.00% | 59.48% | 61.40% | 59.33% | 65.49% | |
Table 10: Fixed assets to total assets
Source: Author
Debt to equity ratio
The capital distribution or the source of the financing played a vital role in net profit calculation. High debt means high interest that reduced the net profit other hands the cost of equity share is very high compared to the debt (Brusov et al., 2018). Hence, a balance in financing is needed.
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| (million) | (million) | (million) | (million) | (million) | ||
| Long term loans | £ 627.00 | £ 599.00 | £ 346.00 | £ 348.00 | £ 318.00 | |
| Total equity | £ 7,122.00 | £ 8,412.00 | £ 9,296.00 | £ 9,550.00 | £ 9,439.00 | |
| Debt/equity ratio (financial leverage) | 8.80% | 7.12% | 3.72% | 3.64% | 3.37% | |
Table 11: debt to equity ratio
Source: Author
The yearly financing data showing in the below table to get an idea about the source of financing
Managerial performance
In an organisation, management efficiency plays a vital role in an organisation’s growth. The exact measurement of efficiency is not possible but from some ratios, it is possible to draw an efficiency line (Smerichevskyi, Kryvoviaziuk and Raicheva, 2018).
Assets turnover ratio
The efficiency of assets management is measured from this ratio. The impact of assets in the company’s turnover assesses by this ratio. The trends of assets turnover ratio shown in the below graph
Figure: Assets turn over
Source: Author
The trends of the asset turnover indicate that the company has poor assets management efficiency and the trends show that efficiency is not constant (Smerichevskyi, Kryvoviaziuk and Raicheva, 2018). The changes in assets and sales showing below table
| Financial Performance of ABF plc. | Year | |||||
| 2016 | 2017 | 2018 | 2019 | 2020 | ||
| (million) | (million) | (million) | (million) | (million) | ||
| sales | £ 13,399.00 | £ 15,357.00 | £ 15,574.00 | £ 15,824.00 | £ 13,937.00 | |
| Asets | £ 11,376.00 | £ 12,810.00 | £ 13,692.00 | £ 13,760.00 | £ 16,669.00 | |
| Assets turnover | 1.18 | 1.20 | 1.14 | 1.15 | 0.84 | |
Table 12: Assets turnover ratio
Source: Author
Inventory turnover
Another managerial ratio is the inventory turnover ratio. The efficiency of managing inventory is assessed from this ratio. The high inventory turnover ratio is best for any organisation. The trends of inventory turnover ratio showing in the below table
Figure: Inventory turnover
Source: Author
From the above graph, it can be seen that the trends of inventory efficiency are uplifted which indicates the company has an increasing trend in the efficiency of inventory management (
Global Financial Data, 2021).
Debt collected period
The debt collected period is the capacity for handling credit sales. High debt collected period indicates highly efficient credit management. The company ABF decreasing its efficiency in credit sales management (Xu, Liu and Li, 2019). The trends of debt collected period is shown in the below graph.
Figure: debt collected period
Source: Author
The above trends show that the company interestingly increases its credit sales management efficiency, which is why in four years debt collected period increases from 28.11 days to 26.77 days.
Recommendations
In the above financial performance and risk analysis, it is found that the company has many weak areas. The overall financial performance of the company is very poor except for the working capital management. The profitability of the company is should be the primary focus area as the profit margin is very low. The second focus area should be managerial efficiency. The management efficiency of the company is worst and it can see in the ratio analysis. The company should drive training or new recruitment for increasing its management efficiency (Armour and Enriques, 2018). The liquidity of the long-term is very high that may affect negatively the market. The company also should work on this. They should focus on increasing fixed assets and manage the existing assets to increase sales of the company. the company also have a huge cost of capital the average cost of capital is much higher than the market, company also focus here on refinancing its capital (Cohen, 2005). The structure of the financial position does not help the company to increase its earnings. The company should restructure its balance sheet. For long-term existence, the company have to increase its fixed assets. The market performance of the company is high but this also indicates that the market price of a share is very volatile; the company also work on share price stability (Arnold and Lewis, 2019).
Conclusion
From the above analysis, it can conclude that the company ABF has performed extraordinarily in the share market even the company has a poor financial performance also the risk of the company is considered high as the WACC is around 8.37%. The company also suffers a loss in recent past years in 2017 and 2018. The recovery rate of the company is also not so good. From this factor, it can say that company is not a good option for an investor. However, if anyone wants a high return in short term then his is the best company.
Reference list
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