Question:
Discuss About The Engineering IMI Begins Restructuring Swiss?
IMI PLC is a engineering company with headquarters in Birmingham. It was formerly known as Imperial Metals Industries due in the 1990’s, the company disposed the metal founding and metal smelting businesses. The company currently has three major divisions namely critical engineering, hydroponic engineering and precision engineering. Only a small portion of the revenues of the company is derived from UK (about 5%) while Europe, Emerging Markets and US account for more than 85% of the company’s revenues. The products and services of the companies particularly deal with fluid control in various industrial applications found useful in oil & gas, power, actuation along with petrochemicals. The company embarked on a decade long transformation process which enabled the company to divest the non-core beverage and business intelligence businesses and hence focus solely on the core businesses (IMI, 2016). The objective of the given report is to carry a critical analysis of the financials of the company in order from the perspective of making an investment.
The ongoing time for the industry is challenging primarily on account of fall in crude oil prices which has resulted in major projects being postponed indefinitely. The traction from the petrochemical industry continues to be lacklustre. Besides, the decline in prices of crude oil has also adversely impacted the economics of shale extraction. Further, the growth in the power industry in the USA in 2016 was quite lacklustre, however, the demand in this sector from emerging sector continues to be robust (IMI, 2017). It is quite possible that in the near to medium term, the crude oil prices could stabilise at moderately higher levels which would be positive for the industry and especially for iMI.
The primary financial analysis tool that has been deployed is ratio analysis which tends to focus on performance of the company in various aspects thus considers not only profitability but also capital structure, liquidity along with market performance. A time period of 5 years has been considered for the ratio analysis.
The profitability ratios for the company over the last five years is summarised in the table indicated below (IMI, 2013; 2014; 2015; 2016; 2017).
According to Damadoran (2008), the profitability margins are significantly as the businesses with higher profit margins tend to command higher P/E which creates wealth for the shareholders. Additionally, consistency is also essential. The gross profit of the company has continued to stay within 42% to 46%. It is critical to note that considering that majority of the revenues of the company are derived from outside UK in foreign currency, hence there are fluctuations in revenue owing to foreign exchange translations. Further, in 2014, the company sold the beverage business along with business intelligence to Berkshire Hathway in a bid to focus on the current engineering business. Further, in FY2015 and FY2016, the respective gross margins were lower on account of lower revenues (IMI, 2016; 2017).
From FY2014, there has been a decreasing trend with regards to net profits which is attributed to lowering operating profits considering the nature of the business where economies of scale are clearly visible. Additional, in the recent years, there has been an increase in the interest costs as the amount of long term debt has increased especially in 2015 and 2016. The ROA and ROE tend to be higher for 2015 on account of a reduction of both total assets and equity due to sale of beverage and business intelligence business. Further, in the next two, there has been an increase in the total asset base and shareholders’ equity coupled with lower profits which have led to worsening of ROA and ROE (IMI, 2016; 2017).
The efficiency ratios for the company over the last five years are summarised in the table indicated below (IMI, 2013; 2014; 2015; 2016; 2017).
The asset turnover reflects the ability of the business to derive sales from the existing assets (Christensen et. al, 2013) . In terms of asset turnover, there has been a drop in 2015 which may be attributed to the increase in assets particularly on accounting of increase in intangible assets due to acquisition. For FY 2013, there was a significant decrease in the revenue owing to a decrease in the oil prices which adversely impacted business. The asset turnover seems to have stabilised in the current year and going forward on account of ambitious geographical and product portfolio expansion, the company expects to grow the topline in a challenging industry environment (IMI, 2017).
The inventory turnover represents the ability of the business to convert the inventory into sales (Brealey, Myers and Allen, 2008). The inventory turnover for the business has declined in the given period which may be attributed to mainly two reasons. One is the adverse industry environment especially for oil and gas along with petrochemicals. The other reason may be change in the business as in 2014, the business transformation for the company ended where it exited all retail businesses which typically have a higher inventory turnaround (IMI, 2017).
The receivables turnover ideally should be high so as to ensure that the outstanding receivables are converted into actual cash in the least possible amount of time (Brigham and Ehrhardt, 2013). The receivables turnover has seen a decline which may be attributed to the change in business mix and also due to the difficult times that the oil& gas coupled with petrochemicals is facing in the last couple of years as a result of which the credit period may have been extended by the company thus leading to higher financing needs (IMI, 2017).
The liquidity ratios for the company over the last five years are summarised in the table indicated below (IMI, 2013; 2014; 2015; 2016; 2017).
The liquidity ratios are indicative of the short term liquidity of the company. There is a declining trend in terms of current ratio and the quick ratio also is following a similar trend. There is an improvement in 2014 on account of significant decrease in short term debt by about £ 78 million. Further, in 2015 there is a decrease in the current ratio on account of higher short term while in 2016 there is an increase in the payables leading to lower liquidity ratios (IMI, 2014; 2015; 2016; 2017). Despite the declining trend, considering the industry average value of current ratio at 1.4, the current values are not a matter of concern.
The solvency ratios for the company over the last five years are summarised in the table indicated below (IMI, 2013; 2014; 2015; 2016; 2017).
The solvency ratio tend to capture the capital structure of the firm along with the ability to service long term debt (Damodaran, 2010). It is evident that the balance sheet of the company is getting increasingly leveraged which is apparent from the respective increase in 2015 and 2016. This is on account of increasing long term debt which the company is aiming to use to fund the expansion into new geographies and also develop new products for the market. Further, considering the nature of the industry, the debt equity ratio should not pose any concern (IMI, 2017).
On account of the increasing interest burden coupled with lower operating profit, the interest coverage ratio has been adversely impacted in the recent years. However, despite the fall, it remains quite healthy and does not pose much risk of interest default with regards to outstanding loans. Also, it is noteworthy that majority of the debt is long term which is essentially for expanding the business and only a very small amount of loan has been taken as working capital which augers well for the company (IMI, 2017).
The market ratios for the company over the last five years are summarised in the table indicated below (Yahoo Finance, 2017)
It is apparent from the table that post restructuring of the business, there has been an improvement in the P/E ratio of the company which augers well for the company. The P/E ratio is typically indicative of the future growth potential associated with the company on account of the renewed focus on the core business (Graham and Smart, 2012). Hence, from an investor perspective, it would be fair to expect that there is expectation that the company would deliver superior returns in comparison to the past. However, considering the industrial engineering sector P/E in excess of 35, the company is still trading at a significant discount (Burman, 2017). This may be on account of difficult ongoing environment and the niche player that the company is coupled with low topline growth and falling profitability margins owing to high raw material cost. However, a positive aspect for the company is that there seems to have been an improvement in the dividend yield which augers well for the shareholders going ahead (Brealey, Myers and Allen, 2008).
It is apparent from the information in the public domain that the company is currently facing significant challenges owing to the low prices of crude oil and the consequent decrease in orders from oil & gas, petrochemicals, automotive etc. This is also reflected in the recent announcement by the company where it cited these conditions and lowered the earnings guidance which also led to a decrease in the share price (Dyer, 2017). However, it is heartening of see that the company is coping up well with the industry challenges by carrying on restricting in the Swiss and the European operations with a bid to lower down costs. This is imperative considering off late the company has faced lower margins on account of rising raw material costs besides muted sales growth (Reuters, 2016).
Another key aspect of the company’s business model is the relative isolation to UK economy considering that 90% of the revenues are sourced from outside UK. In wake of Brexit, this augers well for the company as the impact on business would be quite negligible for the company (Simpson, 2017). Also, the attempt at restructuring the business which essentially ended in 2014 has been viewed positively by various brokerage houses which at the time had expressed positive views about the company. Additionally, the niche specialist engineering sector is expected to be highly in demand going forward as the various industries would focus more on efficiency for competitive advantage over peer group (Burman, 2017).
Also, another factor which has been highlighted frequently is the P/E ratio of the stock which is lower than the sectoral average. However, it needs to be taken into consideration the similarity of IMI with other companies coupled with the potential growth (Burman, 2017). Considering the niche focus area and the current industry environment, in the near term growth would be essentially muted and hence the emphasis for the company would be on maintaining the margins (Jones, 2013). However, considering the cyclical nature of commodities coupled with China’s economy coming back to track, the oil prices may start firming up sooner than expected and hence bring back higher growth prospects for the company which would potentially lead to re-rating of the stock (Burman, 2017).
The corporate governance mechanisms adopted by the company are in line with UK Corporate Governance Code. Further, there is a periodic evaluation of the board which is carried by external and independent conduct and considers various aspects such as effectiveness and independence. There are various standing committees of the board namely Audit Committee, Nominations Committee and the Remuneration Committee. Each of these committees is headed by an independent non-executive director and also the membership of these committees is dominated by non-executive directors, which is in line with the global practices (IMI, 2017).
Additionally, the various roles that are allocated to these committees are also in line with their respective roles. The audit committee besides the audit function is also entrusted with the management of the risk. Besides, the various board composition best practices and norms are also adhered to by the company which help in lowering the agency costs and provide confidence to shareholders about the accuracy of the various disclosures and financial information representation. The reports of the various committees have been highlighted in the annual report so that the key decisions and suggestions of these committees can be known by the investors and other users. Also, the company has no previous history in relation to the violation of corporate norms which augers well for the external stakeholders as it minimises the risk of corporate fraud (Christensen et. al., 2013).
The asset value per share can be determined by dividing the net asset value by the total number of outstanding shares (IMI, 2017).
Net asset value for the company as on December 31, 2016 = £ 583.2 million
Total number of outstanding shares = 269.27 million
Hence, asset value per share = £ 583.2/269.27 = £ 2.17
Compared to the asset value per value, the market value of the share at £ 11.29 is significantly highly which indicates the significant value that the market has given to the business and the future ability to generate profits. It may be stated that the current price is about 5x times the asset value on a per share basis (Damodaran, 2010).
Conclusion
On the basis of the above financial analysis of the company, the various trends associated with various aspects of the financial statements have been discussed. Based on this, it becomes evident that owing to the decade long restructuring program that finished only in 2014, the positive impact of the same is not reflected in the various ratios. This may be attributed to challenging industry environment for the company where the crude oil prices have fallen considerably which has had a negative impact on the demand of the services and products offered by the company. However, a positive aspect for the company is reflected in the form of increasing P/E ratio which represents that the marketing views the restructuring of the business in positive light as it would allow for higher focus on the core businesses and thereby create shareholders’ value in the long term.
An additional factor which needs to be considered is that the current P/E of the stock is significantly lower than the industry average. However, considering the niche business that the company is based in, it is expected that there would be an enhancement of P/E at which the stock would trade in the future especially once the sentiments related to the oil and gas sector improve. Hence, from a medium to long term perspective, the company’s share can be bought and it is expected that there would be outperformance of the index by the stock.
References
Brealey, R, Myers, S and Allen, F (2008), Principles of Corporate Finance, 9th edn., New York: McGraw Hill Publications
Brigham, EF and Ehrhardt, MC (2013). Financial Management: Theory & Practice, 14th edn., New York: South-Western College Publication
Burman, R. (2017), Should You Be Tempted To Buy IMI plc (LSE:IMI) Because Of Its PE Ratio?, Simply Wall Street, [online] Available at https://simplywall.st/news/2017/09/12/should-you-be-tempted-to-buy-imi-plc-lseimi-because-of-its-pe-ratio/ [Accessed September 15, 2017]
Christensen, M, Drew, M, Blanchi, R and Ross, S (2013), Fundamentals of Corporate Finance, 6th edn., New York: McGraw Hill
Damodaran, A. (2008), Corporate Finance, 2nd edn, London: Wiley Publications
Dyer, R.(2017), IMI shares plunge as it warns oil price slump will hit second-half revenue, Proactive Investors, [online] Available at https://www.proactiveinvestors.co.uk/companies/news/181629/imi-shares-plunge-as-it-warns-oil-price-slump-will-hit-second-half-revenue-181629.html [Accessed September 15, 2017]
Graham, J. and Smart, S. (2012), Introduction to corporate finance, 5th edn. Sydney: South-Western Cengage Learning
IMI (2013), Annual Report 2012, IMI Website, [online] Available at https://www.imiplc.com/investors/annual-reports/2012.aspx [Accessed September 15, 2017]
IMI (2014), Annual Report 2013, IMI Website, [online] Available at https://www.imiplc.com/investors/annual-reports/2013.aspx [Accessed September 15, 2017]
IMI (2015), Annual Report 2014, IMI Website, [online] Available at https://www.imiplc.com/investors/annual-reports/2014.aspx [Accessed September 15, 2017]
IMI (2016), Annual Report 2015, IMI Website, [online] Available at https://www.imiplc.com/~/media/Files/I/IMI/annual-reports/IMI-ARA-2015.pdf [Accessed September 15, 2017]
IMI (2017), Annual Report 2016, IMI Website, [online] Available at https://www.imiplc.com/investors/annual-reports/2016.aspx [Accessed September 15, 2017]
Jones, H. (2013), Should I Buy These Shares? IMI plc, Hammerson plc, The Sage Group plc, Meggitt plc And Capita plc, The Motley Fool, [online] Available at https://www.fool.co.uk/investing/2013/08/02/should-i-buy-these-shares-imi-plc-hammerson-plc-the-sage-group-plc-meggitt-plc-and-capita-plc/ [Accessed September 15, 2017]
Reuters (2016), Engineering firm IMI begins restructuring Swiss ops, [online] Available at https://uk.reuters.com/article/uk-imi-restructuring/engineering-firm-imi-begins-restructuring-swiss-ops-idUKKCN0VZ0TM [Accessed September 15, 2017]
Simpson, S. (2017), IMI Plc Working On Self-Improvement Through Still-Challenging Markets, Seeking Alpha, [online] Available at https://seekingalpha.com/article/4077383-imi-plc-working-self-improvement-still-challenging-markets [Accessed September 15, 2017]
Yahoo Finance (2017), IMI Plc, Yahoo Finance, [online] Available at https://finance.yahoo.com/quote/imi.l?ltr=1 [Accessed September 15, 2017]
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