Discuss about the Analysis of Capital Structure and Policy.
This report presents an analysis of capital structure, dividend policy and the trend in share price of Retail Food Group Limited, a company listed on the Australian Stock Exchange. Retail Food Group Limited operates through various franchises in Australia in the retail food sector. The primary business of the company includes coffee roasting and wholesale of coffee. The company was founded in the year 1989 and since then it has grown manifold to hold at present 2500 outlets with 12 brands spread in 83 territories across Australia (RFG, 2018).
The main purpose of the report is find out whether the company’s capital structure is optimal or not and whether or not the company is a worthy investment choice for the investors. For this purpose, the analysis has been extended on the data for a period of 5 years.
The capital structure of a company comprises the component of capital such as equity, preferred capital, and debt. Every company needs money to finance its assets and this financing need is accomplished by raising money from equity and debt (Grabowski, Nunes, and Harrington, 2017). Thus, equity and debt are the two major components of the capital structure of the company. The equity and debt differs in terms of risk and return characteristics and it is therefore necessary for a company to maintain proper balance between these two. The overall return of a company is increased when the company utilizes an optimal capital structure. An optimal capital structure is one which comprises the debt and equity in the adequate proportions. Ideally when the company has debt and equity in the ratio of 2:1, it is considered that it has optimal capital structure (Grabowski, Nunes, and Harrington, 2017). However, this is not the rigid requirement, a company with debt more than 2/3rd or less than 2/3rd could also be said to have optimal capital structure having regards to the type of industry in which it operates.
In relation to Retail Food Group, the capital structure over the period of 5 years has been analyzed as under:
|
Capital Structure: Retail Food Group |
|||||
|
AUD Million |
|||||
|
2013 |
2014 |
2015 |
2016 |
2017 |
|
|
Debt |
109 |
71 |
208 |
207 |
246 |
|
Equity |
240 |
310 |
404 |
434 |
465 |
|
Debt to Equity |
45.42% |
22.90% |
51.49% |
47.70% |
52.90% |
It could be observed that the debt equity ratio of the company has been fluctuating over the period of 5 years. In the year 2013, the ratio was 45.42% and it reduced to 22.90% in the year 2014. This shows that the company relied more on the equity and repaid the debt owed in the year 2013. However, in the next year, the ratio again rose to 51.49% and finally it stands at 52.90% in the year 2017. Therefore, presently the company uses debt amounting to 52.90% of total equity which seems to be low looking at the ideal ratio. According to ideal ratio, the company can use debt amounting to 200% of the total equity. Thus, there is scope of raising more debt. The increase in debt would reduce of cost of capital and enhance wealth of the shareholders. Further, the company’s profitability is increasing rapidly which implies that the company has good capacity to repay its debt. The net profit of the company in the year 2013 was AUD 32 Million which increased to AUD 62 million in the year 2017 (Morning Star, 2018). Thus, it could be inferred that the company has not been able to maintain an optimal capital structure (Grabowski, Nunes, and Harrington, 2017).
The analysis of dividend paid by the company is essential from the view point of the investors. The investors look for dividend payout and consider the companies paying good dividend as attractive for investment. There are various policies in respect of dividend payment that a company may follow (Little, 2012). A company may follow constant dividend amount policy wherein the company pays a constant amount of dividend per share each year. Further, a company may also follow variable dividend policies wherein the company pays dividend as a certain percentage of its earnings. Moreover, a company may also use a combination of constant and variable dividend payout (Little, 2012). In the case of Retail Food Group, the dividend payments over the period of past 5 years have been analyzed as under:
|
Dividend History: Retail Food Group |
|||||
|
2013 |
2014 |
2015 |
2016 |
2017 |
|
|
Dividend per share (cents) |
0.28 |
0.31 |
0.33 |
0.39 |
0.43 |
|
Growth rate |
10.71% |
6.45% |
18.18% |
10.26% |
It could be observed that the company’s dividend payments are changing each year which implies that the company is following variable dividend policy (Little, 2012). In the year 2013, the company a dividend of 0.28 cents which increased to 0.31 cents in the next year. Currently, in the year 2017, the company paid a dividend of 0.43 cents. The chart presented above shows the growth in the dividend payout each year. In the year 2014, the dividend increased by 10.71%. However, the growth rate in the year 2015 remained low at 6.45% due to reduced earnings. The company again increased the dividend payout in the year 2016 by 18.18%. Thus, it could be observed that the company has been keen towards increasing the dividend payout.
There have been tremendous fluctuations in the share price of Retail Food Group over the period of 5 years as shown in the chart presented below. In the year 2013, the stock was trading at around AUD 4. It showed a rapid growth in the year 2013 and 2014 reaching record at the end of 2014 to near about AUD 8. However, the year 2015 did not go in favor of the company. At the beginning of the year 2015, the stock started falling down and till the mid of 2015, it reached again to the previous levels of AUD 4.
However, in the year 2016, the stock again showed good signals with recovery. The stock started rising in the beginning of year 2016 and it reached to the levels of AUD 7 approximately till the mid of 2016. After reaching to the peak level, it again started falling down in the year 2017 and now it is trading at miserably low level of AUD 0.81.
The fundamental analysis of stock applying the dividend discount model is presented below:
|
Share price: Dividend Discount Model |
|
|
Dividend |
0.43 |
|
Growth rate |
10.26% |
|
Cost of Equity (Ke) |
13.77% |
|
Price |
13.4934 |
The fair value of shares as arrived at applying the dividend discount model is works out to be AUD 13.49. The current price prevailing on the stock exchange is AUD 0.81. Thus, the actual price is lower than the fair price which implies that the stock is undervalued (Thomas, 2014). Further, the analysis of dividend and earnings of the company also shows that the stock has capacity to create wealth for the shareholders. However, recently it has been observed to be going to a record low.
The efficient market hypothesis states that the prices of stocks are not affected by the flow of information in the market. However, the recent collapse of the stock of Retail Food Group shows that efficient hypothesis market is not true (Thomas, 2014). The stock of Retail Food Group fell sharply down to lowest level of 10 years. There has been announcement from the company to shut down its 200 stores by the end of 2019 (Chau, 2018). This news in the market has creates chaos among the investors causing reduction in the stock’s price.
The results of fundamental analysis show that the company’s financial performance has been good. It earned a profit of AUD 62 million in the year 2017 which is up from the last year’s profits of AUD 53 million. Further, the company has been paying attractive dividends over the past years which also support attractiveness of the company’s stock. However, the capital structure of the company has not been optimal. If the company changes its capital structure a little by increasing the portion of debt, the earnings of the company might further improve in the future years. Apart from these observations, the results of dividend discount model shows that the company’s stock is underpriced. Thus, if we go based on the fundamental analysis purely, the stock of the company appears worth investing (Thomas, 2014).
However, the company has been seen to be facing big problems with its franchise system recently. There are various franchises which are not happy with the functioning of the company and they are considering disassociating themselves with the company. It is important to take note that the major earnings of the company are dependent upon the franchise system. If the franchise system fails, the company might incur huge losses. There are apprehensions in the market that the franchise network of the company will be broken in future and due to these apprehensions, the stock has fallen down to a record level (Chau, 2018).
Thus, overall it could be inferred that the company is good for investment but considering the current situation company facing problems, the investors are advised to refrain from investing in the company.
Conclusion
The report provides a succinct discussion on the financial performance of Retail Food Group and its attractiveness for the investors. The financial performance of the company seems to be good, but the company is struggling with its franchise system which is key to the company’s success.
References
Chau, D. 2018. Retail Food Group stocks hit 10-year low on $88m loss and 200 stores to be closed. [Online]. Available at: https://www.abc.net.au/news/2018-03-05/retail-food-group-shares-plunge-on-store-closures/9509156 [Accessed on: May 21, 2018].
Grabowski, R.J., Nunes, C., and Harrington, J.P. 2017. 2017 Valuation Handbook – U.S. Guide to Cost of Capital. John Wiley & Sons.
Little, K. 2012. Teach Yourself Investing In 24 Easy Lessons, 2e. Penguin.
Morning Star. 2018. Retail Food Group Ltd. [Online]. Available at: RFG https://financials.morningstar.com/income-statement/is.html?t=RFG®ion=aus&culture=en-US&platform=sal [Accessed on: May 21, 2018].
RFG. 2018. Welcome to RFG (Retail Food Group). [Online]. Available at: https://rfg.com.au/about/ [Accessed on: May 21, 2018].
Thomas, S. 2014. Security Analysis and Portfolio Management. PHI Learning Pvt. Ltd.
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