The present report is developed for carrying out an in-depth analysis into the financial performance of a selected company listed on ASX. The analysis is carried out for the purpose of providing financial assistance to wealthy investors by guiding their decision-making process. The analysis is undertaken in respect of the financial reports disclosed by the selected company on the ASX. The company selected for the analysis purpose is Wesfarmers Pty Ltd, a supermarket giant in Australia. In this context, the report includes providing a brief description of the company and its ownership-governance structure. This is followed by carrying out examination of its difference performance ratios for gaining an analysis of its financial performance in depth. The report also provides a description of the significant factors influencing the share price of the company. Also, it carries out the calculation regarding the beta values and the expected rates of return using the CAPM model. The report also carries out calculation in relation to the weighted average cost of capital of the company and debt ratios for examining the improvement achieved in relation to maintaining a preferred optimal capital structure. Lastly, the report provides discussion in relation to dividend policy and recommendation to the investors in relation to the overall analysis carried out.
Wesfarmers is recognized as a leading retail company of Australia listed on ASX established in the year 1914. The company carries out diverse business operations including supermarkets, liquor, hotels, convenience stores, home improvement, office supplies and department stores. The company is also having industrial divisions for carrying out businesses in chemicals, energy, fertilizers, and coal and safety products. The company actively provides its products and services across Australia and New Zealand. It is also attributed to one of the major organization in Australia involved in providing employment to large number of people and thus is an important contributor of economic growth and development of the country. The company has achieved a dominant position with the retail sector of Australia by providing satisfactory return to shareholders. The major objective of the company is to effectively meet the demands and expectations of the customers by providing them high quality products and services. The high brand value of the company is attained on the basis of integrity and honesty maintained in carrying out its business activities. Also, their strong corporate governance policy is responsible for carrying out its business activities in an ethical manner by proper management of its community and environmental impact (Wesfarmers: About Us, 2018).
Major Substantial Shareholders
Wesfarmers at present is having a shareholder base of approximately 530,000 and detailed information regarding the issued capital to its largest shareholders is presented in its annual report as follows:
(Annual Report 2017: Wesfarmers)
As depicted above, the major shareholder of the company having about 21.25% share is HSBC Custody Nominee (Australia) Limited. As the major shareholder of the company is not a part of the Board team or management personnel, the firm is a non-family company. The shareholders having more than 5% issued capital is JP Morgan Nominees Australia Limited (12.29%) and Citicorp Nominees Pty Limited (5.77%).
Major People Involved in Firm Governance
The Chairman
Michael Chaney is the Chairman of the Group since the year 2015 and possesses the qualifications of BSc, MBA and FTSE (Annual Report 2017: Wesfarmers).
|
Name OF Board Members |
Designation |
|
Rob Scott |
|
|
Anthony Gianotti |
Chief Financial Officer |
|
Maya vanden Driesen |
Group General Counsel |
|
John Durkan |
Managing Director |
|
Michael Scheider |
Managing Director |
|
Guy Russo |
|
|
Ian Bailey |
Managing Director |
|
David Baxby |
Managing Director |
|
Linda Kenyon |
Company Secretary |
|
Jenny Bryant |
Chief Human Resources Officer |
|
Alan Carpenter |
Executive General Manager |
|
Edward Bostock |
Managing Director |
(Annual Report 2017: Wesfarmers)
CEO
Rob Scott is appointed as Chief Executive Officer of the company in the year 2017 and also serves the position of Managing Director from the year 2017.
Also, the top twenty shareholders of Wesfarmers having issued capital more than 20% and 5% are the individual business corporations and thus the main people involves in its governance are not the substantial shareholders.
In this section ratio analysis of Wesfarmers has been done for last two years. Below are main financial ratios that are calculated in each category.
(Annual report 2017: Wesfarmers)
(Brigham and Michael, 2013)
Graph representing the monthly share price of Wesfarmers and All Ordinaries
(Yahoo Finance, 2018: ALL ORDINARIES (^AORD) and (Yahoo Finance, 2018: Wesfarmers Limited (WES.AX))
On the basis of above graph it can be said that there is positive correlation between the price movement of share price of Wesfarmers and Index price of All Ordinaries. It means when the index price of all ordinaries goes up the share price of Wesfarmers all goes up. It is interesting to know here that the exact correlation in the share price of Wesfarmers and index price of All Ordinaries. On the basis of calculation it has been found that there is positive correlation of 0.86 between share price and index price. It clearly indicates that share price of Wesfarmers will move 0.86 bases point when the index price moves by 1 bases point. So there is positive correlation between Wesfarmers and All Ordinaries index (Damodaran, 2011).
Standard Deviation is regarded as the best measure to test the volatility in the stock returns. But only standard deviation cannot provide the answer by how much any stock is volatile. For this purpose there is need to calculate the coefficient of variation. If coefficient of variation is greater than 1, it means very high variances as compared to coefficient of variation less than 1. On the basis of calculation it has been found that both Wesfarmers and All Ordinaries have coefficient of variation more than 1 that clearly indicates that there is relatively high variation. So it can be concluded that both Wesfarmers stock and All Ordinaries index are highly volatile but all ordinaries is more volatile than Wesfarmers (Davies and Crawford, 2011).
The following financial and business publications can be cited in the context of significant announcements influencing the share price of the company:
Demerging Coles
Wesfarmers at present is emphasizing to demerge Coles into a distinct ASX-listed company and would only retain its minor ownership in it up to 20%. The main objective of the company behind this decision is to provide new shares for investment purpose to its shareholders. Coles is presently having a good potential growth with adequate cash generation and strong earnings. Thus, it would provide an opportunity to shareholders for investing in two companies having different investment positions (Intention to Demerge Coles – Briefing Presentation, 2018).
Wesfarmers as per the Australia Tax Office (ATO) is subjected to make a capital return of about $1 fully paid share to the shareholders. The managing director of Group in this context has stated that the strong cash position of the company and low level of debt is responsible for its return of capital to the shareholders. Thus, the company has made announcements regarding its strong ability for making acquisitions or investing in expanding in its present business portfolio. The capital return to shareholders is expected to increase the net debt to equity ratio of the company by about 62 per cent and thus meeting its target range of 50-75 per cent (Wesfarmers Limited: Investor Centre, 2018).
Change of Directors’ Interest
Wesfarmers Ltd as per the section 205G of the Corporations Act has issued changes in director’s interests in securities and contracts. The indirect interest of Robert Geoffrey Scott, director of Wesfarmers Ltd, includes being a beneficiary of the shares as per the trust deed and rules as per the Wesfarmers Long Term Incentive Plan (WLTIP). The direct interest of the director in relation to securities includes granting performance rights for acquiring fully paid ordinary share based on its performance measured by criteria’s of ROE. There is also change in director’s interest in relation to contract as provided by the ASX announcements of the company (Wesfarmers Limited: Investor Centre, 2018).
Opportunities of Existing Growth
Wesfarmers aims at providing higher return to shareholders by maintaining a strong portfolio of cash generating businesses having higher growth prospects. This includes positive growth prediction in relation to its subsidiaries of Bunnings, Target, Industrials, Officeworks and others after its demerger with Coles. Bunnings is expected to maintain its strong position as a leading retailer for home improvement and living products. Also, the potential pipelines of its products and reinvestment strategy in past stores is directed towards sustaining its present growth. Target present financial performance is also very strong to drive its future growth in general merchandise and apparel retailer section. The high operational expertise maintained by its industrial business section also predicts its good opportunity of potential growth. The office works is also recognized as leading retailer for providing office products and solutions and is also expected to drive its present growth through merchandise investments (Wesfarmers Limited 2018 Third Quarter Retail Sales Results, 2018).
Change in management
Wesfarmers has also made important announcements in relation to changes in its leadership succession besides financial performance. The company has announced the takeover of Rob Scott from Richard Goyder as managing director in the year 2017. Also, there is disclosure of information in the media in relation to quantum of executive remuneration at Wesfarmers (Wesfarmers: Media, 2017).
Estimation of calculated beta of the chosen company
In order to find the beta of Wesfarmers, the pre calculated beta on Reuters has been taken. The beta of Wesfarmers as provided on Reuters is 0.85 (Reuters, 2018).
Formula of CAPM model: Risk Free rate of return + Beta * Market risk premium
|
Required Rate of Return of Wesfarmers |
|
|
Risk Free rate of Return (Given) |
4% |
|
Market risk premium (Given) |
6% |
|
Beta of company (Reuters) |
0.85 |
|
Required Rate of Return |
9.10% |
(Krantz, 2016)
Conservative investment mean an investment strategy that lay emphasis on the preservation of capital and minimization of risk through developing and maintaining the diversified and balance portfolio that has low risk. The examples of conservative investment are corporate bonds, government bonds, blue chip stock and large cap stock that pay the dividend regularly. On the basis of news published on financial review website, Wesfarmers is the consistent blue chip company as it is providing regular returns to their shareholders in form of dividends and increase in share prices. So it can be said that Wesfarmers is a good option for investors to choose it as conservative investment.
WACC of Wesfarmers
Formula of WACC: E/ (E + D)*Cost of Equity + D/ (E + D)*Cost of Debt*(1 – Tax Rate)
Points for the calculation of WACC:
|
Calculation of WACC |
|||||
|
Capital |
Amount |
Weights |
Rate BT |
Rate AT |
Weighted Cost |
|
(in million $) |
Tax Rate 30% |
||||
|
Debt Part |
5413 |
9.58% |
3.64% |
2.55% |
0.24% |
|
Equity Part |
51079 |
90.42% |
9.10% |
9.10% |
8.23% |
|
Total |
56492 |
100.00% |
|||
|
WACC |
8.23% |
(Madura, 2014)
Implication of higher WACC
Weighted average cost of capital is used to calculate the expected costs of all the financial sources that have been used by the company to finance the assets. In case management of Wesfarmers want to take the prospective investment projects than it has to take extra finance from either debt capital or equity capital. So there is requirement to pay $ 0.0823 for every extra dollar Wesfarmers takes from market. In case WACC is higher than its actual return it indicates that company its losing its value and it is certain that there has been more efficient returns elsewhere in market (Merritt, 2018).
Part 8: Capital Structure of Wesfarmers
Optimal Capital Structure
Capital Structure means mix of debt and equity sources of finance and optimal capital structure is best balance of debt and equity capital. As cost of debt of Wesfarmers is much lower than its calculated cost of equity that indicates that Wesfarmers must depend upon debt capital as compared to equity capital. The debt ratio indicates the proportion of debt used by the company to finance the assets. The debt ratio of Wesfarmers was 0.14 in year 2016 and it was reduced to 0.10 in year 2017. It can be said that Wesfarmers is mainly dependent upon the equity capital as the major source of capital. So it can be said that company has not maintaining the optimal capital structure and it does seems to be stable in last two years (Moles and Kidwekk, 2011).
Impact on the gearing ratio
In order to adjust the gearing ratio management at Wesfarmers has decided in year 2017 to repay the borrowings of $ 1994 million and has also there has been increase in borrowing by $ 220 million. There has not been change in equity capital as no buy back and issue of equity capital has been taken place. So it can be said that company has decreased its gearing ratio in year 2017 as compared to year 201. Director report does not provide any clue of any adjustment made for gearing ratio (Ross, Jaffe and Kakani, 2008).
|
Wesfarmers Dividend information |
|||
|
Items |
2015 |
2016 |
2017 |
|
EPS |
$ 2.16 |
$ 0.36 |
$ 2.54 |
|
DPS |
$ 2.04 |
$ 2.02 |
$ 1.98 |
|
Dividend Payout Ratio |
94.4% |
562.0% |
78.0% |
Wesfarmers Limited can be stated to be following a constant dividend policy as reflected from its EPS and DPS ratios calculated for the financial period between the years 2015-2017. As reflected from the EPS of the company calculated for the period between the years 2015-2017, the company has experienced wide fluctuations in its earnings per share while maintaining a constant base of DPS. Thus, despite the company has been realizing lower earnings it has managed to pay its shareholders a const dividend as per its strategic aim of creating larger value for the shareholders (Arnold, 2013).
Dear Client,
I am writing this letter to you to provide information relating to financial performance of Wesfarmers Limited. Wesfarmers Limited is having a strong corporate governance structure developed by a competent team of Board members having diverse skills and competencies as reflected from their past experience and qualifications. Also, it is a non-family company which improves accountability and reliability in the financial outcomes provided by the company. The Board members does not have any interest in the shares of the company and carry out their responsibilities in an independent manner. The financial performance ratios of the company calculated over the period of 2016-2017 has indicated that it is having at present a good financial condition. The company liquidity position is strong as it has maintained adequate liquidity to meet its financial obligations. Also, as indicated from its long-term solvency ratios, the company is reducing the proportion of debt in its capital structure which means that there is less financial risk related with the future growth of the company. The company efficiency to realize sales from its asset base is also good indicating its strong potential for future growth. Also, the company as per its strategic mission of creating value for its shareholders is providing a constant dividend despite of reduction in its earning capacity as reflected from the financial outcomes of the EPS and DPS. Also, it can be stated from the weighted average cost of capital calculated for the company that it’s cost of debt is much lower as compared to cost of equity. This indicates that the company is paying its shareholders at a higher rate in comparison to the money lenders. Also, the bets of the company is less than 1 indicating that it is possessing less market risk which further is favorable for the investors.
References
Annual Report 2017. Wesfarmers. [Online]. Available at: https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0 [Accessed on: 21 May, 2018].
Arnold, G., 2013. Corporate financial management. Pearson Higher Ed.
Brigham, F., and Michael C. 2013. Financial management: Theory & practice. Cengage Learning.
Damodaran, A, 2011. Applied corporate finance. John Wiley & sons.
Davies, T. and Crawford, I., 2011. Business accounting and finance. Pearson.
Intention To Demerge Coles – Briefing Presentation. 2018. Wesfarmers Pty Ltd. [Online]. Available at: https://www.wesfarmers.com.au/docs/default-source/asx-announcements/intention-to-demerge-coles—briefing-presentation1971516999c863f7bfccff00000e9025.pdf?sfvrsn=0 [Accessed on: 20 May 2018].
Krantz, M. 2016. Fundamental Analysis for Dummies. John Wiley & Sons.
Madura, J. 2014. Financial Markets and Institutions. Cengage Learning.
Merritt, C. 2018. AZ central. [Online]. Available at: https://yourbusiness.azcentral.com/management-influence-over-wacc-24570.html [Accessed on: 20 May 2018].
Moles, P. and Kidwekk, D. 2011. Corporate finance. John Wiley &sons.
Reuters. 2018. Wesfarmers Ltd (WES.AX). [Online]. Available at: https://www.reuters.com/finance/stocks/overview/WES.AX [Accessed on: 21 May, 2018].
Ross, A., Jaffe, J. and Kakani, R.K. 2008. Corporate Finance. Pearson.
Wesfarmers Limited 2018 Third Quarter Retail Sales Results. 2018. [Online]. Available at: https://www.wesfarmers.com.au/docs/default-source/asx-announcements/2018-third-quarter-retail-sales-results.pdf?sfvrsn=0 [Accessed on: 20 May 2018].
Wesfarmers Limited. 2018. Investor Centre. [Online]. Available at: https://www.wesfarmers.com.au/investor-centre [Accessed on: 20 May 2018].
Wesfarmers: About Us. 2018. [Online]. Available at: https://www.wesfarmers.com.au/who-we-are/who-we-are [Accessed on: 20 May 2018].
Wesfarmers: Media. 2017. [Online]. Available at: https://sustainability.wesfarmers.com.au/our-report/stakeholder-engagement/media/ [Accessed on: 20 May 2018].
Yahoo Finance. 2018. ALL ORDINARIES (^AORD). [Online]. Available at: https://finance.yahoo.com/quote/%5EAORD/history?period1=1459449000&period2=1525113000&interval=1mo&filter=history&frequency=1mo [Accessed on: 21 May, 2018].
Yahoo Finance. 2018. Wesfarmers Limited (WES.AX). [Online]. Available at: https://au.finance.yahoo.com/quote/WES.AX/history?period1=1459449000&period2=1525113000&interval=1mo&filter=history&frequency=1mo [Accessed on: 21 May, 2018].
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