Financial management focuses on the equity, debt and ratios of an organization in order to evaluate the performance, financial position and other financial facts about the business. Financial management involves a proper planning directing, organizing and controlling the financial activities such as utilization and procurement of organization’s funds. Procurement of funds and management of funds are the primary activity in the financial management (Gibson, 2011). In case of management of funds, the assets and the resources of the business is managed to ensure the adequate and regular supply of funds, to ensure the utilization of optimal funds of the business etc.
In this report, the study has been done on Woolworths limited and BHP Billiton limited to identify the performance of both the companies in the market in order to invest in the company. The capital structure, WACC, intrinsic value etc. of both the companies has been determined to measure the overall performance of the business so that the better investment decision could be made.
Woolworths limited is an Australian company which operates its operation under the Australian retail industry. The main area of operations of the company is Australia and New Zealand market. This company is recognized as the second largest Australian company in terms of revenue generation. In the year of 2018, 205000 people are working in the company in order to meet the mission, vision and strategic objectives of the business (Home (b) (a), 2018).
BHP Billiton:
BHP Billiton limited is an Australian company which operates its operation under the Australian mining industry. The main products and operations of the company are in mining, metals, petroleum etc. The main area of operations of the company is worldwide. This company is recognized as the largest mining company in terms of market capitalization (Home (a), 2018). In the year of 2018, 62,000 people are working in the company in order to meet the mission, vision and strategic objectives of the business.
Capital structure is a position of funds of an organization. It evaluates the long term debt and total equity of the business against the total available capital of the business. Evaluation on the capital structure level of the business is crucial for the investors as it defines about the total associated risk with the business (Higgins, 2012). In this report, the capital structure of BHP Billiton and Woolworths limited has been identified to measure the associated risk with the companies.
In case of Woolworths, it has been found that the capital structure of the company has been changed a lot in last 5 years. At initial stage, the debt equity proportion of the company was 0.62:0.38 which has been led to 0.73:0.27 (Annual report, 2018). It represents that the company has improved the equity level to fund the resources of the business which has reduced the risk of the business. Mainly, the capital structure level of the business has been changed because of the industry factors and the need of the business to set an optimal capital structure. Through evaluation on the retail industry, it has been found that the changes are quite similar to the industry and these changes have taken by the business because of the market demand. Woolworths is following the trade off theory in order to manage the tax shield of the business through improving the funds through debt and equity funds (Lemmon & Zender, 2010).
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Calculation of capital structure of Woolworths limited |
|||||
|
|
2014 |
2015 |
2016 |
2017 |
2018 |
|
Total ordinary share |
10252500 |
10834200 |
8470600 |
9526000 |
10481000 |
|
Total long term debt |
6394500 |
5334000 |
6038900 |
4565600 |
3881000 |
|
Total |
16647000 |
16168200 |
14509500 |
14091600 |
14362000 |
|
Ordinary share proportion |
61.59% |
67.01% |
58.38% |
67.60% |
72.98% |
|
Long term debt proportion |
38.41% |
32.99% |
41.62% |
32.40% |
27.02% |
(Morningstar, 2018)
Further, in case of BHP Billiton, the calculations represents that various changes have occurred into the capital structure position of BHP as well. But these changes are not huge and represent that almost similar proportion of equity and debt is managed by the company so that the associated risk and cost level of the business could be managed. The current debt and equity proportion of the business is 0.57:0.43 (Morningstar, 2018). Through evaluation on the mining industry, it has been found that the debt and equity level of industry has also not been changed a lot. BHP is following the trade off theory in order to manage the tax shield of the business through improving the funds through debt and equity funds (Frank & Goyal, 2009).
|
Calculation of capital structure of BHP Billiton |
|||||
|
|
2014 |
2015 |
2016 |
2017 |
2018 |
|
Total ordinary share |
79143000 |
64768000 |
54290000 |
57258000 |
55592000 |
|
Total long term debt |
54206000 |
46959000 |
52323000 |
48382000 |
42412000 |
|
Total |
133349000 |
111727000 |
106613000 |
105640000 |
98004000 |
|
Ordinary share proportion |
59.35% |
57.97% |
50.92% |
54.20% |
56.72% |
|
Long term debt proportion |
40.65% |
42.03% |
49.08% |
45.80% |
43.28% |
(Morningstar, 2018)
WACC:
After the evaluation on the capital structure level of the business, WACC of the companies have been calculated to identify the total associated cost of the business. WACC represents the total cost of debt, equity and other sources of funds which must be paid by the company against the total investment and borrowings in the business.
The WACC calculations of Woolworths represents that the total cost of debt of the business is 2.80% and the 8.35% is the total cost of equity of the business. Further, the debt and capital ratio of the business is 0.27:0.73. It leads to the conclusion that the total cost of capital of Woolworths limited is 6.85% (Morningstar, 2018). Company has to pay 6.85% to the debt holders and equity holders from the profit to maintain the resources in the business.
Further, the study has been done on BHP Billiton and it has been found that the total cost of debt of the business is 1.75% and the 10.62% is the total cost of equity of the business. Further, the debt and capital ratio of the business is 0.43:0.57 (Morningstar, 2018). It leads to the conclusion that the total cost of capital of BHP Billion is 6.78%. Company has to pay 6.78% to the debt holders and equity holders from the profit to maintain the resources in the business.
It represents that the cost of BHP is lower than the Woolworths and the associated risk of BHP is higher than Woolworths. The difference in the total cost is not much higher and it has taken place because of lower cost of debt of the business.
In order to calculate the WACC, cost of debt, cost of equity, cost of preference share and cost of other sources are required to be determined. The cost of debt, cost of preference share etc are tax free for the business and thus it is determined after deducting the taxation % from the total cost (Brigham & Daves, 2012). If the tax rate of the country would be reduced or eliminated than the total cost of debt or preference share would be improved and it would lead to the higher weighted average cost of capital in the business.
The impact of taxation on WACC could be recognized through the below equation:
The formula of WACC is as follows:
1 – T x D V x r d + P V x r p + E V x r e
But if the taxation factor is eliminated from the business than the formula of WACC would be as follows:
D V x r d + P V x r p + E V x r (Chandra, 2011)
It defines that the elimination of taxation directly eliminated the fact which helps the business to reduce the total cost of the business and thus the total cost of the business get increased.
In case of Woolworths and BHP Billiton, the tax rate has been eliminated to identify the impact of taxation rate on WACC level of the business and it has been determined that the weighted average cost of capital of Woolworths and BHP Billiton has been improved from 6.85% to 7.17% and 6.78% to 7.10% because of the improvement in the cost of debt level of the business.
Valuation analysis:
It is quite important for the investors and the financial analyst to recognize the intrinsic value of the business. Intrinsic value stands for the fair value of the stock of an organization. In valuation analysis, the important factors of an organization are considered to recognize the fair value of the stock.
The valuation analysis study on both the companies has been done in the attached spreadsheet.
In case of Woolworths limited, in order to recognize the intrinsic value of the business, the dividend growth model and PE valuation model has been applied on the company so that it could be measured that whether the investment into the company would offer the return to the investors or not. The dividend growth model explains that the intrinsic value of the company is $ 57.05 on the basis of the dividend growth rate model whereas the P/E valuation model explains that the intrinsic value of the company is $ 39.58. The market value of the stock is $ 29.98 which explains that the stock price of the company is undervalued in the market and the investment into the company would offer huge return to the investors (Yahoo finance (b), 2018). This is the right time to purchase the stock of Woolworths limited.
In case of BHP Billiton, in order to recognize the intrinsic value of the business, the same valuation model has been applied on the company so that it could be measured that whether the investment into the company would offer the return to the investors or not. The dividend growth model explains that the intrinsic value of the company is $ 38.09 on the basis of the dividend growth rate model whereas the P/E valuation model explains that the intrinsic value of the company is $ 45.88. The market value of the stock is $ 33.01 which explains that the stock price of the company is undervalued in the market and the investment into the company would offer huge return to the investors (Yahoo finance (a), 2018). This is the right time to purchase the stock of BHP Billiton.
On the basis of the study, I found that P/E valuation model is more reliable as it directly focuses on the earnings of the business. Through the evaluation, it has been concluded that the performance of both the comapny is better, however, Woolworths limited is performing better than BHP Billiton in terms of the associated risk and the return from the business.
Other factors:
If the other factors of the business such as the projects, market position, demand of the products, industry growth rate etc of the companies are measured than it could manipulate the decisions. As the BHP’s growth rate is quite better than the Woolworths limited and the market performance and competitive level of BHP is also better in the market (Haney, 2009). An investor is required to evaluate on all the related factors in order to measure the overall performance and position of the business.
Standard risk:
Risk of an organization could be calculated through various measurement bases such as probability distribution, standard risk and coefficient of variation. All of these methods take the concern on different factors to determine the performance of the stock. Through the study on all the factors, it has been determined that the standard deviation method is one of the best and common method to measure the performance.
Beta level represents about the volatility in the stock price of an organization. Beta of Woolworths and BHP Billiton has been calculated through regression model to measure that how much the stock price gets fluctuated against the index price. On the basis of the study it has been found that the volatility level of Woolworths and BHP is 0.96 and 1.34 which explains that the Woolworths fluctuations are lower than market index and the fluctuations in the BHP stock is higher than the market index. It represents that the portfolio of both the stock would be better as it would compensate the associated risk of the investment.
Conclusion
On the basis of the study, it is recommended to the investors to invest in the stock of Woolworths to get higher return and increase the market value of stock as the associated risk with the Woolworths stock are quite average and the return from the stock are higher. Along with that, the valuation method also explains that the intrinsic value of the stock is higher than the market value of the company.
References:
Annual report. (2018). Woolworths limited. (online). Retrieved from: https://www.wesfarmers.com.au/util/news-media/article/2018/08/14/wesfarmers-2018-full-year-results
Brigham, E., & Daves, P. (2012). Intermediate financial management. Nelson Education.
Chandra, P. (2011). Financial management. Tata McGraw-Hill Education.
Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: which factors are reliably important?. Financial management, 38(1), 1-37.
Gibson, C. H. (2011). Financial reporting and analysis. South-Western Cengage Learning.
Haney, L. H. (2009). Business Organization and Combination. BiblioBazaar, LLC.
Higgins, R. C. (2012). Analysis for financial management. McGraw-Hill/Irwin.
Home (A). (2018). BHP Billiton limited. (online). Retrieved from https://www.bhp.com/
Home (B). (2018). Woolworths limited. (online). Retrieved from: https://www.woolworthsgroup.com.au/
Lemmon, M. L., & Zender, J. F. (2010). Debt capacity and tests of capital structure theories. Journal of Financial and Quantitative Analysis, 45(5), 1161-1187.
Morningstar. (2018). BHP Billiton limited. (online). Retrieved from https://financials.morningstar.com/income-statement/is.html?t=0P000000NF&culture=en&ops=clear
Morningstar. (2018). Woolworths limited. (online). Retrieved from: https://financials.morningstar.com/cash-flow/cf.html?t=WOW®ion=aus&culture=en-US
Yahoo Finance (A). (2018). BHP Billiton limited. (online). Retrieved from: https://au.finance.yahoo.com/quote/BHP.AX/history?p=BHP.AX&.tdata-src=fin-srch-v1
Yahoo Finance (B). (2018). Woolworths limited. (online). Retrieved from: https://au.finance.yahoo.com/quote/WOW.AX/history?period1=1372617000&period2=1530297000&interval=div%7Csplit&filter=div&frequency=1mo
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