Capital structure analysis is the process of assessing the components of a company’s capital structure, which includes the assessment of debt and equity funding. The purpose of evaluating a company’s debt and equity is to establish the company’s quality and riskiness in order to assist an investor in making a choice. For the efficient operation of an organization and the protection of investor money, an ideal combination of debt and equity sources of financing is critical. The report’s goal is to examine the risk profile, capital structure, and payout policy of three firms, each of which is listed on the FTSE 100, FTSE 250, and FTSE Smallcap indexes. Airtel Africa Plc (FTSE 100), Halfords Group Plc (FTSE Small cap index), and Byggmax Group AB were the three firms considered for the investigation (FTSE 250 index). The risk profile analysis of the firms is presented in the first section of the report, which is based on five years of share price data. The intercept and beta of the stocks were calculated by regressing the monthly returns of the stocks against the FTSE All Share index returns for the same time. The Jensen alpha of the stocks was determined for each stock, and the findings were presented in detail. The second section of the research examines the capital structure of all firms who use CAPM to calculate their cost of equity. Using market data, the cost of debt was estimated, and a final Weighted Average Cost of Capital was determined. The report’s last section details the firms’ distribution policies over the last three years, using accounting terms such as payout ratio and dividend per share. The technique of dividend payout was examined, and the benefits and drawbacks of the method of cash return were reviewed.
An investment portfolio manager can use a variety of methodologies to measure a company’s efficacy and the expected return on its shares to aid in decision-making. The Jensen Alpha is one such measure which calculates the excess return earned by an investment portfolio or a stock over and above the expected return suggested by the Capital Asset Pricing Model. It is one of the measures to assess the risk adjusted performance of a stock and the excess returns in the measure is represented by α (alpha). The measure is suitable to analyze the risk inherent in a stock as it takes into consideration the volatility in the stock with respect to the movements in the market.
Five years of monthly stock price data for each stock and the FTSE all share index, which will be used as a proxy for benchmark, were collected to compute the Jensen Alpha of the stocks chosen for study and recommendation. To determine the stock’s beta and intercept, the returns were regressed against the returns calculated for the FTSE All Share index. The risk-free rate of return was calculated using the yield on 5-year Treasury bonds as a proxy. The beta and intercept obtained were then entered into the Jensen Alpha formula to calculate the excess return gained by each stock over and above the risk-free rate of return.
Systematic risk can be referred to those risks which is inherent in the functioning of a stock market and is applicable to all the sectors, industries and individual stocks in the market. This is also called the market risk or undiversifiable risk as it affects every Part of the stock market irrespective of the type of company, sector, industry or financials. This risk cannot be diversified by means of adopting different strategies and investing in specific stocks. On the other hand, unsystematic risk refers to the risk which is industry or stock specific and is also called specific risk or diversifiable risk. They are the type of risks which are unplanned, sudden and can cause widespread disruption in the working of the specific stock. These risks can be diversified by investing into stocks which represents different industry and sectors. The combination of both systematic and unsystematic risk is called as total risk of a stock. The Jensen Alpha analysis of each stock, as well as a recommendation based on the analysis of systematic and unsystematic risks, are included in the following section:
The regression analysis for the company’s stock return with the market return is shared below in the table:
The monthly Jensen Alpha of the stock was calculated to be equal to 4.04 percent which suggests that the stock has provided excess returns as expected by the CAPM model of estimating cost of equity. The annual excess return provided by the stock over and above the CAPM returns was equal to 3.70 percent. The portion of risk that is represented by market specific factors is equal to 3.28 percent where as the unsystematic of firm specific risk is around 96.72 percent of the total risk. Based on the study of the data, it can be stated that the stock has done very well in terms of return generation, providing returns that are significantly higher than the projected return. Unsystematic risks outnumber systematic risks, which is a positive thing because unsystematic risks are firm-specific hazards that may be addressed by effective risk management practices and cautious monitoring.
The above table presents the beta and intercept values based on the stock returns and market returns. The Jensen Alpha monthly returns of 1.02 percent and yearly returns of 2.10 percent indicate that the stock of Halfords Group has generated super normal results. This might be read as the shares of Halfords Group Plc generating returns above and beyond those predicted by the Capital Asset Pricing Model. In comparison to Airtel Africa Plc, Halfords Group Plc’s stock has a higher R-squared of roughly 17.74 percent, indicating that it has more systematic hazards than unsystematic risks. When compared to Airtel Africa Plc, the unsystematic risk element of the stock was about 82.26 percent, indicating that the stock is less impacted by firm specific variables. If market forces go against the stock, the larger percentage of systematic risk might make things tough for the company’s management to handle. Hence, despite the stock being an outperformer which is represented by the positive Jensen’s alpha value, the systematic risk makes the stock risky to invest into.
The stock of this firm has a monthly alpha of roughly 1.30 percent, while the annual Jensen alpha of the stock was around 1.74 percent. During the five-year research period, the stock outperformed the market. The market contributes around 11.17 percent of overall risk, whereas stock Particular factors represent 88.83 percent of total risk. Byggmax Group plc’s risk is more difficult to diversify than that of Airtel Africa Plc’s stock because the stock has a greater proportion of systematic risk. However, as compared to Halfords Group Plc, the amount of systematic risk is quite low, which improves the stock’s chances on a comparative basis.
Based on the above research, it is recommended to invest in Airtel Africa Plc’s stock since it gives the most alpha compared to other companies and has a greater degree of firm specific risks that can be diversified. An investor’s worry about the high amount of diversifiable risk can be mitigated by strengthening management or operational procedures and implementing efficient management practices. The stock of Halfords Plc is preferred above the stock of Byggmax Group Plc because it provides a bigger proportion of excess returns while having a lower degree of diversifiable risk, which influences the stock’s preferences.
The capital structure of a firm refers to the combination of debt and equity forms of funding employed by the organization. Equity capital may be obtained by the selling of a company’s stock, which provides the stockholders the right to claim the company’s assets, future cash flows, and profits. Debt capital is available in the form of bonds or loans, and it offers several advantages over equity capital.
A bond or bill is a financial product in which a lender lends money for a longer period of time and receives monthly interest charges, with the principal returned when the bond matures. Bonds, bills, and banknotes are examples of debt that a business might create to obtain funds for a variety of objectives (Brigo, Garcia and Pede 2015). These securities pay creditors semi-annual or yearly interest costs, which are a cost to the corporation. The interest paid by the company on the debt it has borrowed is tax deductible, lessening the company’s tax burden. The firm may better control their spending and estimate future transactions since interest expenditures can be simply computed over time. A corporation, on the other hand, sells its shares in the market through an initial public offering (IPO). Unlike debt funding, money received through equity does not have to be paid back. This allows the company to prolong the time horizon of a project where it is investing money. Unlike debt funding, the company is not required to pay a recurrent expense in the form of interest.
The weighted average cost of capital (WACC) is the estimated average rate of return on a company’s borrowing. That is, how much money does the company get back for every dollar it invests. The WACC calculation takes into account the expenses of both debt and equity, which are weighted depending on the company’s proportional usage of both. The WACC is a rate necessary to satisfy the objectives of the stakeholders who give money that is used by a firm internally to assess growth prospects through merger or startup. The following section contains the details about the calculations of different components of WACC:
The CAPM model, which is a standard way of calculating the cost of capital, was used to determine the cost of equity. The CAPM takes into account the systematic risk of the stock and is used to price risky assets across the globe by various investors (Zhang 2017). The formula for CAPM can be demonstrated as below:
Ke = Rf + b (Rm – Rf)
Where, Rf represents the risk-free rate of return represented by the five-year treasury bond issued by the UK government. Beta coefficient captures the systematic risks of the stock which is captured by the volatility in the movement of stock price with respect to the market. The (Rm – Rf) is called the risk premium which refers to the excess return provided by the market over and above the risk-free rate of return. The cost of equity calculated for each stock is represented in the table below:
|
Airtel Africa Plc |
Halfords Group Plc |
Byggmax Group Plc |
|
5.23% |
10.06% |
7.89% |
The cost of debt of a company comprise of two components; the interest rate calculated based on the interest expense of the company and net debt of the company, and the default risk premium based on the assessment of synthetic credit rating. The synthetic credit rating was assessed based on the interest coverage ratio of the company and was judged according to the scale represented in figure 1 of appendix. The tax rate of the companies was determined by the tax expense of the company with respect to the Profit before tax of the company in the latest annual report published by each firm. To arrive at the after-tax cost of debt the pre-tax cost of debt was adjusted by the tax rate. The after-tax cost of debt of the company is represented in the table below:
|
Airtel Africa Plc |
Halfords Group Plc |
Byggmax Group Plc |
|
5.68% |
5.02% |
3.55% |
For the calculations of the weighted average cost of capital, the market cap value of each stock was ascertained and the book value of debt was taken from the latest annual reports of each company (Frank and Shen 2016). The book value of debt was taken from the annual reports of the respective stocks to avoid complications in the calculation of WACC. The cost of equity and cost of debt was adjusted with the weights of equity and debt respectively for each company and the final Weighted Average Cost of Capital was determined. The following table represents the WACC of each company:
|
Airtel Africa Plc |
Halfords Group Plc |
Byggmax Group Plc |
|
5.41% |
8.04% |
5.89% |
With a weighted average cost of capital of 8.04 percent, Halfords Group Plc has the highest. The firm is 60% funded by equity capital and 40% financed by loan capital, with a cost of equity of 10.06 percent, which is the highest among all other companies in comparison. The high costs of equity were related to the level of sensitivity in the stock’s value in relation to market fluctuations, which was indicated by the stock’s beta of 1.76. Due to a healthy interest coverage ratio the synthetic credit rating of the company was AAA resulting in the lowest default spread. Byggmax Group AB has the second highest WACC with a value of 5.89 percent. The stock’s beta was about 1.31, which was a key factor in the stock’s high cost of equity of 7.89 percent. The corporation was financed with a 56 percent equity capital and a 44 percent loan capital ratio. The shares of Airtel Africa Plc, with a WACC value of 5.41 percent, has the lowest WACC. The stock’s beta is less than one, indicating significant diversification advantages. Due to a reduced interest coverage ratio, the business is 60% funded by equity capital and 40% financed by borrowed capital, with a default spread of 2%. Based on the cost of capital for all three firms, investing in Airtel Africa Plc is advised since the company has access to a lower source of funding owing to the stock price’s resistant properties in respect to market movement.
A dividend distribution policy is one of the most important decisions a corporation can make since it determines how much of the firm’s overall profit may be paid to shareholders. When a firm makes a profit and has sufficient cash on hand, it distributes a portion of its profits to its investors to encourage them to purchase the company’s stock (Baker and Weigand 2015). Dividends are divided into two categories: preferred dividends, which are issued to preference shareholders first and have priority in obtaining dividends; and common dividends, which are distributed to ordinary stockholders after the preference stockholders have received their dividends (Booth and Zhou 2017). Dividends might be paid out quarterly, half-yearly, or once a year. Dividend policies can be different types, a few of them are discussed in detail below:
|
AAF.L |
|||
|
2019 |
2020 |
2021 |
|
|
EPS |
0.11 |
0.10 |
0.09 |
|
DPS |
0.03 |
0.04 |
0.03 |
|
Pay-out ratio |
27.27% |
40.00% |
33.33% |
The firm has regularly paid out a portion of its earnings back to its shareholders in the form of dividend which is evident by a payout ratio of around 27 percent, 40 percent and 33 percent in 2019, 2020 and 2021 respectively. The last dividend paid by the company in the year was around 0.03 cents per share. The company has adopted a progressive dividend policy which it claims would help in investing into growth opportunities and would increase the rate of deleveraging by the company. For the year 2021, the corporation plans to increase the dividend by a mid- to high-single-digit percentage from a base of $4 cents per share. The company’s progressive dividend policy will be sustained until it achieves a leverage ratio of less than 2.0x, following which it will review its dividend policy to search for growth prospects (Annual report/AAF.L 2021).
|
HFD.L |
|||
|
2019 |
2020 |
2021 |
|
|
EPS |
0.56 |
0.23 |
0.71 |
|
DPS |
0.19 |
0 |
0.08 |
|
Pay-out ratio |
33.93% |
0.00% |
11.27% |
The company pays out its earnings in the form of dividend back to its shareholders and the current dividend payout ratio of the company in the year is 11.27 percent. The average dividend yield of the company currently is around 3.3 percent which is more than the average market yield of around 2.5 percent. The dividend yield is forecasted to grow by around 3.7 percent in the next three years (Simply Wall| HFD.L 2022). The lower payout ratio of the company ensures that the company would be easily able to cover its dividend payments by the earnings of the company. In order to accommodate the changes in the firm’s capital structure, the company intends to amend its dividend distribution policy. This shows that the company has adopted a residual dividend policy, which allows it to invest the appropriate amount of earnings without being obligated to return cash to shareholders. Due to the consequences of the pandemic in 2020, the company did not pay any dividends, demonstrating the firm’s flexibility by implementing a residual dividend policy (Annual report/HFD.L 2021).
|
BMAX.ST |
|||
|
2019 |
2020 |
2021 |
|
|
EPS |
2.32 |
7.94 |
10.2 |
|
DPS |
0 |
2.75 |
4 |
|
Pay-out ratio |
0.00% |
34.63% |
26.96% |
The corporation has been paying dividends to its shareholders in order to reinvest its profits. Despite having a lengthy history of dividend payments, the corporation has been inconsistent in recent years, with dividend cutbacks and pauses. The company’s dividend payout was approximately KR1.50 in 2012, and it has climbed to around KR4 in 2021, reflecting a compounded annual growth rate of around 10% each year (Annual report/BMAX 2020). The company is following a residual dividend policy as the growth of dividend depends upon the growth o earnings for the company in the future periods (Simply Wall|BMAX 2022). The company’s modest payout strategy assures that it will easily be able to cover its dividends with the amount of revenues generated.
The followings section highlights the difference between the dividends and share repurchase programs as means of returning the earnings back to the shareholders:
Conclusion
The purpose of this research is to look at the risk profile, capital structure, and payout policy of three companies that are Part of the FTSE 100, FTSE 250, and FTSE Smallcap indexes, respectively. The three companies investigated were Airtel Africa Plc (FTSE 100), Halfords Group Plc (FTSE Small cap index), and Byggmax Group AB (FTSE 250 index). The first component of the study presents a risk profile analysis of the companies, which is based on five years of share price data. Based on the excess return earned, the study revealed that Airtel Africa was the top performing stock. The share of systematic risk in overall risk was similarly low, suggesting that the stock has a stronger investment potential than the other two. The research’s second component looks at the capital structure of all companies who utilize CAPM to assess their cost of equity. The cost of debt was assessed using market data, and a final Weighted Average Cost of Capital was calculated. The analysis revealed that Airtel Africa Plc has the lowest rate of WACC which makes it an appropriate choice of investment. In the report’s last Part, accounting metrics such as payout ratio and dividend per share are used to describe the businesses’ distribution practises during the previous three years. The manner of dividend distribution was analysed, as well as the pros and downsides of the cash return approach.
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