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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Stabilization V diversification

Stabilization V diversification

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1Stabilization V diversification Empty Stabilization V diversification Sun May 26, 2013 9:48 pm


Global Moderator
Ceylon FT discusses with Dr. Kennedy D. Gunawardana, Professor of Accounting Information Systems and Chairman of Board of Management Studies Faculty of Graduate Studies, University of Sri Jayawardenepura, the past five years financial performance of Softlogic Holdings (Pvt) Ltd, using ratio analysis technique.

Q: What are the trend analysis findings of SH PLC?

A: Trend analysis is one of the tools for the analysis of a company's monetary statements for the investment process. Investors use this analysis tool a lot in order to determine the financial position of the business.
Trend analysis of Softlogic Holdings is being carried for, Revenue, Cost of Sales and for Profit before Tax.

Q: What is the revenue position of SH ?
A: In 2008 Softlogic Holdings has recorded a Revenue of Rs 6,844 million, hence there has been slight down turn in revenue in 2009 and 2010 where percentage increase compared 2008 is 82% and 71% respectively. In 2010 it has recovered and has recorded revenue Rs 10,788 million which is a158% increase from 2008. In 2012 it has recorded the highest revenue of Rs 21,908 million which is an increase of 103% from 2011 and 320% increase from 2008. This increase is primarily due to healthcare sector of Softlogic Holdings.

Q: What was the cost of sales behaviour pattern?

A: Cost of sales also has a similar pattern where, in 2009 and 2010 a decline in sales, but has picked up in 2011 & 2012 where 2012 has recorded the highest amount which is Rs 14,639Mn.

Q: What does the profit before tax indicate?

A: Profit before tax has grown from Rs 43million to Rs 1,613million in 2012 which is a 3748% increase compared to 2008. This may be due to the fact that Softlogic Holdings entering into health care sector.

Q: What technique was used to analyze liquidity position of the company?

A: Liquidity is the amount of capital that is available for investment and spending, Most of the capital is credit rather than cash. That does because most of the large financial institutions and group of companies like Softlogic do most investments prefer using borrowed money. Liquidity is characterized by high level of trading activity. Assets that can be easily brought or sold are known as liquid assets.

Liquidity of a company can be ascertained by the following ratio's techniques,
a) Current ratio
b) Acid test ratio
c) Total asset turnover ratio
d) Day sales in inventory & Day sales uncollected ratios
e) Merchandise Turnover ratio
a) Current Ratio

The current ratio is mainly used to give an idea of the company's ability to pay back its short term liabilities (debt & payables) with its short term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations.

As per Fig. 3 Softlogic Holdings (SH) was unable reach at least current ratio of 1, from 2008 to 2012. On 2012 they reached 0.74 but, it is also not healthy mark. A ratio under 01 suggests that the company would be unable to pay off its obligations if they come due at a specific point. This shows the company is not in good financial health, but it does not really mean that it will go bankrupt as there are ways to access financing, yet it is not a good sign for the company.

Low values for the current ratio indicate that the company has difficulty meeting current obligations; however, an investor should also take note of the company's operating cash flow in order to get better sense of liquidity.

Common acceptable current ratio is 2; it is a comfortable financial position for a company. Acceptable current ratios vary from industry to industry. For most of the industrial companies, 1.5 may be an acceptable current ratio.

b) Acid Test Ratio
The term 'Acid test ratio' is also known as 'Quick Ratio'. The most basic definition of Acid test ratio is that, "it measures current (short term) liquidity and position of the company".

This ratio highlights the liquidity of the company.

Fig. 4 shows Softlogic holdings (SH) acid test ratio from 2008 to 2012. It is important to note in neither year Softlogic holdings has unable to gain a mark of 01 for acid test ratio, for the whole period under consideration it is below 01 and only in 2012 they have reached the highest of 0.581, which is also not a healthy position.

Normally if the acid test ratio is less than 01, then it is said that such a company is not stable and may face difficulty in paying off their debts (short term). In order to clear the short term debts they probably would need to sell some of their assets, but since Softlogic Holdings is a highly diversified company this may not be the case.

c) Total asset turnover ratio
Asset turnover measures a firm's efficiency using its assets in generating sales or revenue, higher the number the better.

In analysing Softlogic Holdings, assets turnover ratio, only in 2008 they have recorded their best mark up by registering value of 1.15, rather than 2008, it is a gradual decline in the asset turnover ratio till 2011 and little bit of gain in 2012.

Normally companies with low profit margins tend to have high asset turnover, while companies with high profit margins have low asset turnover ratio such as Softlogic.

d) Day sales in Inventory & Day sales uncollected Day sale in inventory (DSI)
Financial measure of a company's performance that gives investors an idea to decide how long it takes a company to turn its inventory (including goods that are work in progress) in to sales. Generally, the lower the (shorter) DSI the better, but it is important to note that the average DSI varies from one industry to another.

In Fig. 6 it has the SH's ability to turn its Inventory in to sales, only in 2008 it has shown the least period i.e. of nearly 58 days, rather than that it shows quite considerable period in excess of two months and especially in 2011 it has risen to more than 117 days and it has reduced in 2012 to 86 days. Therefore it shows that in an emergency situation SH needs time to convert its inventory in to cash/sales.

Q: What were the findings on day sales uncollected analysis of SH?

A: This is a specific measurement procedure whereby it is determined by a company how many days it typically takes for the collection of their average accounts receivable. A high average day's sales uncollected mark can be a sign of ineffective accounts payable procedure.

Fig. 6 shows SH's behaviour of Days sales uncollected. In 2008 it had a reasonable short period, but since that it has risen to more than two months and in 2010 itself has risen to 113 days. SH has a problem of recovering its accounts receivables in a short period of time.

e) Merchandise Turnover ratio
The merchandise turnover ratio is also called as the Inventory Turnover Ratio, tells business owners how efficiently their company moves products. In general, a high merchandise turnover ratio is preferable to a low one, but each has its pros and cons. Analyzing the Merchandise turnover ratio helps business owners determine liquidity, highlight top selling products, pin point poorly performing items, and create a plan of action to increase product movement.

Fig. 7 shows SH's merchandise turnover ratio from 2008 to 2012, In 2008 SH have enjoyed fairly high merchandise ratio of 6.31, but since then it has declined to 4.24 in 2010 and an increase from 2011 to 2012.

Q: What is the solvency position of SH?

A: Solvency is the ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a company also needs liquidity to thrive. Liquidity is a company's ability to meet its short-term obligations. A company that is insolvent must enter bankruptcy; a company that lacks liquidity can also be forced to enter bankruptcy even if it is solvent.

Investors can use ratios to analyze a company's solvency. The debt equity ratio, times interest earned ratios show a company's debt as well to how much extent it can pay its interest on debt.

a) Debt Ratio
Debt ratio is a ratio that indicates the proportion of a company's debt to its total assets. It shows how much the company relies on debt to finance assets. The debt ratio gives uses a quick measure of the amount of debt that the company has on its balance sheets compared to its assets. The higher the ratio, the greater the risk associated with the firm's operation. A low debt ratio indicates conservative financing with an opportunity to borrow in the future at no significant risk.

The optimal debt ratio is determined same proportion of liabilities and equity as a debt to equity ratio, if the debt ratio is less than 0.5, then most of the company's assets are financed through equity, if the ratio is greater than 0.5, then most of the company's assets are financed through debt.

Maximum normal value is 0.6 – 0.7, but varies to the type of industry.

Fig. 8 shows SH's Debt ratio and Equity ratio profile, hence it can be note that SH has above normal Debt ratio, which means SH's assets are financed by Debt.

On further investigation, it can be noted that SH has a very high Debt/Equity ratio, which generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.

b) Times Interest Earned
This is a metric used to measure a company's ability meet is debt obligations. It is calculated by taking the company's Earnings Before Interest and Taxes (EBIT) and dividing it by the total interest payable on bonds and other contractual debt (finance cost). It is usually quoted as a ratio and indicates how many times a company can cover its interest charges on a pretax basis. Failing to meet these obligations could force a company into bankruptcy.

However, ensuring interest payments debt holders and preventing bankruptcy depends mainly on a company's ability to sustain earnings. A high ratio can indicate that a company has an undesirable lack of debt or is paying down too much debt with earnings that could be for other projects.

Fig. 9 shows SH's ability pays its interest payments. Throughout 2008 to 2012, SH has maintained minimum ratio of 1.07(2008) to maximum of 2.22 times in 2011. This shows that SH's earnings are barely enough to pay its interest payments. This may be the case that SH's highly diversification in Health care field where SH acquiring Asiri Hospitals through heavy borrowings.

Q: What are the indications of profitability ratios of SH?
A: Most of these ratios, having a higher value from previous period is indicative that the company is doing good.

Ratios are,
a) Profit Margin
A ratio of profitability calculated as a net income divided by revenue, or net profits divided by sales. It measures how much out of every Rupee of sales a company actually keeps earnings.

Looking at the earnings of a company often does not tell the entire story. Increased earnings are good, but an increase does not mean that the profit margin of a company is improving. For instance, if a company has costs that have increased at a greater rate than sales, it leads to a lower profit margin. This is an indication that costs need to be under better control.

Fig. 10 shows the profitability profile of SHs profitability from 2008 to 2012. In 2008, SH have recorded a 0.67% loss and had gradually worked towards profitability in 2009, where it has recorded a 1.23% profit. SH has never been able to gain a healthy profit more than 10%, where there maximum profit gain is in 2011 which is 9% nose-dived to 4.66% in 2012. This may be the fact, SH being a highly diversified group and few members of the group may be incurring losses.

b) Gross Margin
A financial metric used to assess a company's financial health by revealing the proportion of money left over from revenues after accounting for the cost of goods sold/cost of sales. Gross profit margin serves as the source for paying additional expenses and future savings.

The higher the percentage, the more the business retains of each Rupee of sales, which means more money is left over for other operating expenses and net profit.

A low gross margin ratio means that the business generates low level of revenue to pay for operating expenses and net profit.

Gross Margin = [Net Sales (Revenue) – Cost of sales] / Net sale (Revenue)

Now let analyze SH's Gross margin ratios from 2008 to 2012, in 2008 they have recorded the lowest margin of 19.94%, and gradually with increase business they reached 33.18% in 2012, which can be considered as a fairly good percentage.

c) Return on Total Assets (RoTA)
This ratio measures a company's earnings before/after interest and taxes against its total net assets. The ratio is considered and indicator of how efficiently a company is using its assets to generate earnings before/after contractual obligations must be paid.

In SH analysis, here it is being considered the Net Profit after taxes, That is after meeting the contractual obligations payment.

Fig. 12 shows SH's behaviour of generating earnings from total assets, in 2008 it shows a negative percentage of 0.78 which not a good sign for the company. But since 2009 they have worked their way forward by achieving +ve percentages and in 2011 they have recorded the highest percentage of 5.36% which is very good sign for the group. But in 2012 it has come to half, which means further acquisitions by SH.

d) Return on Equity
The amount of net income returned as a percentage of shareholders equity is called as the Return on Equity (RoE). RoE measures a company's profitability by revealing how much profit a company generates with the money shareholders have invested.

Fig. 13 shows the SH's RoE ratios, for the years 2008 and 2009 it is not available. As we discussed in RoTA, year 2011 has recorded highest, hence in 2011 RoE also high with a percentage of 27. This means in 2011 SH has utilized its assets, as well as shareholders equity to generate income to a maximum.

e) Basic Earnings per Share
This is a valuation ratio of a company's current share price compared to it's per share earnings.

Fig. 14 shows SH's basic earnings per share from 2008 to 2012. In 2008 it has recorded a negative figure of 9.45, which is bad picture for the SH as well for the shareholders. But it has increased in 2009 healthily to 13.75, but there onwards except 2011 it never has reached 1, which is not good for the company.

Basically investors are expecting higher earnings growth; therefore, it may be a disadvantage to Softlogic to attract investors, if the price earnings ratio is not improved in the future.

In efficient market, the share price should reflect a firm's future value creation potential, greater value creation can indicate greater future dividends from the company. Higher earnings per share should reflect greater expected future gains because of perceived growth opportunities and some competitive advantages and lesser risk, but at the same time it indicates that the share price is relatively more expensive.

f) Book value per common share
A measure used by owners of common shares in a firm to determine the level of safety associated with each individual share after all debts are paid accordingly.

Book Value per Share = Total Equity / Total Outstanding Shares

Should the company decide to dissolve, the book value per common share indicates the Dollar value remaining for common shareholders after all assets are liquidated and all debtors are paid.

Fig. 15 shows SH's book value per common share from 2008 to 2012, it is notable that in 2008 and 2009, there is high book value per common share. From time to time SH has increased its number of shares by share issues to the market to gain capital, this has led to the reduction of book value per common share from 2009 onwards.

Q: How would you describe the economic status of SH?

A: Market value ratios evaluate the economic status of a company in the wider marketplace. Market value ratios include price earnings ratio, dividend yield ratio an so forth. Market value ratios are pertinent to the publicly traded firm. If rest of the company's ratios are good, then the market value ratios should reflect that and stock price of the company should be high. Market value ratios measure different ways of looking at the relative value of a company's stock.

In 2008 SH has recorded the worst price earnings ratio (in which year company is at a loss), since it is a negative figure not entered in fig. 16. But 2010 and 2012 it has recorded good values. Even though SH has recorded good values on price earnings ratio rest of the other ratios are not healthy as discussed earlier.

Dividend Yield
A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for stock.

Dividend yield = Annual dividends per share / Price per share

During the past few years (That is 2008 to 2011) SH has not paid any dividends to its shareholders. But for the first time in the history of the company, it has paid dividend of 0.13 per share and recorded a dividend yield of 1.16% in 2012, which is a good achievement for the company.

Q: What are your concluding remarks on SH?

A: Softlogic Holdings with its diversification runs the risk of being faced with poor performing investments and uncertainties attached to making an investment that may not yield the expected returns, entering healthcare sector and financial sector may be a plus factor for the group, which are profitable businesses.

Softlogic Holdings has done most of their investments through heavy borrowings, which is evident from debt ratio and other relevant ratios. Further SH is working on negative working capital, which means they do not generate enough earnings from their current assets.

Therefore, SH needs to maintain sustainability in income generation to meets its contractual debt payments and survive liquidity problems.

In 2010, 2011 SH has done huge investments for acquisitions and expansion to the group. It is worthwhile to look into SH's future strategy, whether they go for further expansion of the group or tries to stabilize the current status and achieve financial growth.

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