Equity and Fixed income investments in the market - Free Essay Example

Sample details Pages: 16 Words: 4829 Downloads: 2 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? The Equity Fixed Income Investment basically deals with analysis of company stock, what are investment opportunities in the company. This report undertakes an in-depth study on financial analysis .Numerous studies point out to the fact that financial analysis help investors, company to have a clear idea about their investment options. Financial Analysis Refer to an assessment of the viability stability and profitability of a business or project. This project is used for owner, investor Creditors, Shareholders, Bankers etc. For an outsider user the detail in the financial statements indicates only raw data or raw material. This Raw material needs to re-organised, processed converted into easy to understand form. Don’t waste time! Our writers will create an original "Equity and Fixed income investments in the market" essay for you Create order Kingfisher plc is Europes leading home improvement retail group and the third largest in the world, with over 830 stores in eight countries in Europe and Asia. Its main retail brands are BQ, Castorama, Brico Dpt and Screwfix. Kingfisher also has a 50% joint venture business in Turkey with Ko Group, and a 21% interest in, and strategic alliance with Hornbach, Germanys leading large format DIY retailer. This report is also analysis of nature of Retail industry of Europe and what is the industry life cycle of the of retail industry. RESEARCH METHODOLOGY As the process of analysis Equity Fixed Income investment is a thought provoking process, it is totally based on the secondary data that is being obtained from the audited balance sheet of the division and then this data is being processed using various techniques of analysis. Research methodology describes the research procedure. KINGFISHER PLC Kingfisher plc is a United Kingdom-based home improvement retailer. The Company, together with its subsidiaries, joint ventures and associates, supplies home improvement products and services through a network of retail stores and other channels, located mainly in the United Kingdom, continental Europe and China. As of January 30, 2010, the Company operated over 830 stores in eight countries in Europe and Asia. Its main retail brands are BQ, Castorama, Brico Depot and Screwfix. Kingfishers portfolio of own brands includes the Colours range of decorative products, and MacAllister and Performance Power power tools. Kingfisher also has a 50% joint venture business in Turkey under the name Koctas, Yapi Marketleri Ticaret A.S., and a 21% interest in, and strategic alliance with Hornbach Holding A.G., a do-it-yourself (DIY) retailer operating in Germany. The Companys geographic segments are France, UK Ireland and Other International. Kingfisher plc is Europes leading home improvement retail group and the third largest in the world, with over 830 stores in eight countries in Europe and Asia. Its main retail brands are BQ, Castorama, Brico Dpt and Screwfix. Kingfisher also has a 50% joint venture business in Turkey with Ko Group, and a 21% interest in, and strategic alliance with Hornbach, Germanys leading large format DIY retailer. OVERVIEW OF RETAIL INDUSTRY The UK retail market is set to increase in size by 15% over the next five years, taking its value to just over 312bn (UK Retail Futures 2011: Sector Summary, Datamonitor). However this represents a slowing down of annual growth and with operating costs and the cost of credit set to raise, the retail sector faces challenging times. Companies who cannot compete against shrinking margins will suffer. The electrical sector is currently the best performer, with a predicted growth of 24% (UK Retail Futures 2011: Sector Summary, Datamonitor), while the home sector retailers face a tough period as falling house prices make people more cautious about moving home. Consumer debt, rising interest rates, inflation, house prices and job security all affect how much people shop, and the current economic climate indicates that consumer spending will slow down. Customer confidence is a key issue: if people feel optimistic about their situation, they will spend more. If they are nervous about their own financial security, they will spend less. The retail industry employs over 3 million people (data collected March 08). This equates to 11% of the total UK workforce (UK Retail Futures 2011: Sector Summary, Datamonitor). Almost 8% of the Gross Domestic Product (GDP) of the UK is generated by the retail sector. UK retail sales were approximately 265 billion in 2007, which is larger than the combined economies of Denmark and Portugal (UK Retail Futures 2011: Sector Summary, Datamonitor). ÂÂ   STRATEGIC GROUP ANALYSIS Kingfisher being at the first rank in the retail sector being highest profit gainer and sales has many competitors. The competitors of Woolworth (previous name for kingfisher) are deemed as follows:- Discounters:-those stores which have or offer stock particularly at lower prices have this unique selling point. These would Wilkinsons, asda-walmart and poundstrecher. Supermarkets:-these are the stores that used to sell predominantly only food items have now expanded their range towards other items like home decor, toiletries etc. These are basically termed as substantial non-food categories. E.g. Tesco, Sainsbury etc Departmental stores: these are the kind of stores which sell a range of items usually non-food, divides its goods into distinct areas of the stoppers known as departments. In UK this category includes MS, Debenhams, and house of Frazer etc. Catalogue stores:-in this kind of store the retailer has a large storing space which is dominantly dedicated to storing space rather than selling space. Very few goods (at times) are on display and customers select their goods from a catalogue. They select their choice of product before actually seeing it. Argos and next are most well-known in UK related to the examples of this kind of store. Specialist stores:-those who are concentrated on a specific part of product or subject in a store which corresponds on parts of Woolworth range. Foe e.g. mothers care and early learning centres for childrens clothes, BQ, home base and focus DIY for DIY products. Competition is relatively very high which has lead to ignoring or blurring of retail sector differences between the categories. Many companies are diversifying into new sectors which have for many years now had a fierce competition or are aiming high market penetration for their existing product. A good example is the supermarkets. MICHAEL PORTERS FIVE FORCES AS APPLIED BY KINGFISHER PLC As it can be seen in the above figure this is a diagram of Michael porters five force model. The explanations for these can be seen in brief as below. Rivalry:- Traditionally it is believed that rivalry drives profits to zero. But in todays advanced age rivalry is taken up in a positive attitude and it is termed as competitive advantage. In case of kingfisher PLC it had 3 major rivals focus (DIY), Homebase LTD and wolseley. Rivalry tends to be more if there are more competitors and vies versa. In case of the retail sector when barriers to leaving an industry are high, competitors tend to exhibit greater rivalry. Rivalry among kingfisher and the other retailers decreased when the buyers had high switching costs. Threat of substitutes:- In the retail sector Substitute product can be referred to as other products in the industry which could replace the existing industries product. A threat from the substitutes is known to occur when a products demand is affected by the price change in the substitute product. A products price elasticity is affected by the substitute product. In case of kingfisher PLC its substitute was mark and spencers which took the place of kingfisher in 1968 as Britains leading retailer both in terms of profit and sales. As more substitutes enter the market, demand becomes more elastic since the buyer has more alternatives or choices. The threat from a substitute comes from a product engendered outside the industry. Bargaining power of buyers:- The buying power of customers decides the kind of impact that a company has had on the markets. Especially when it comes to the retail sector the buyer is considered as the kingpin case of kingfisher PLC staff turnover led to consumer dissatisfaction. This led to decreasing profits for the industry. When the buyers side is strong he is close to what an economist calls as a monopsony. monopsony refers to a situation where there are many suppliers and just one buyer. When such a situation occurs the buyer decides the price. In reality monopsony can hardly be seen but frequently there is some asymmetry between a producing industry and buyers. Bargaining power of suppliers:- An industry which is involved in production requires certain raw material like labour, components and certain other supplies. The suppliers of kingfisher PLC were the manufacturers themselves. At the beginning the manufacturers were reluctant to give supplies to them but later on they felt that the direct supply decision that was taken was right. This requirement of raw materials leads to a buyer-supplier relationship. This kind of relation is between the industry and the firm which provides the raw material to create the finished goods. If the suppliers are powerful then it can produce an influence on the producing industry. Suppliers are powerful if the customers are concentrated, significant cost to switch suppliers etc and they are termed to be weak if there are many competitive suppliers, concentrated purchasers and if customers are weak. Kingfisher had also helped some suppliers to grow. By early 1960s duttons was one of the major suppliers to Woolworth. Threat of new entrants:- Rivals are not the only people who pose threat to the retail industry. When kingfisher was into action new entrants in their field led to a lot of stress among the kingfisher employees. Even new entrants are a certain kind of threat to the existing industries. According to theory there is free entry and exit of firms in a market. According to that the industries have to keep the profits normal. But in reality the industries work with a high profit and gain a good name which proves to be very unhealthy to the new entrants. These are barriers to entry. Other sources for the barriers to entry are government barriers, patents and proprietors service to restrict entry, asset specificity, organisational economies of scale ETC. LIFECYCLE OF KINGFISHER PLC. Introduction. Kingfisher primarily opened as a subsidiary of F.W.Woolworth and company of the U.S.on July 23 2003, 1909 the subsidiary was incorporated in England as a private limited company, F.W.Woolworth ltd with a share capital of 50,250 pounds. in 1912 the share capital was increased to 1,00,000 pounds. During the first two days of the business 60,000 people visited the shop. Between 1909 and 1919 the shareholders did not receive any dividends and following six years it issued paltry dividends. All this was not due to low profits but because the shareholders wanted to create reserves for the company. After a steady business in the US it opened its branch in Britain. Everything was priced only in pennies. GROWTH. Supplies were being brought directly from the manufacturers. In US they had a problem in making the manufacturers agree that they should supply them the materials directly but in Britain the manufacturers readily agreed and soon they found that the decision taken was right. By 1912 the chain had expanded to 28 shops 26 of which were managed by Britons. Again Woolworth started an Irish subsidiary. At the beginning of World War 1, women replaced men in the stores here. After the war the British subsidiary had become ready for a major expansion. The man who was mainly responsible for the expansion was William.L.stephenson.stephenson started working in the company in 1909 even before the first shop had opened. Later on he became the chairman in 1931.there was a flotation of chain of 444 shops which resulted in an excellent track record of the company. The Woolworth flotation was a success despite it taking place during the great depression. Since its foundation in 1909 the company had ma de considerable profits which increased year after year and continued to do so until the beginning of the Second World War. Maturity. After all the flotation and steady profits Woolworth had reached a settled position in the markets.ste phenson had brought in an important change which was that he had made properties of Woolworth instead of leasing spaces(Stephensons property investment would later prove to be a major contribution to the revival of worldworths successor, kingfisher, during the 1980s).under stephensons management Woolworth had opened many new shops at the rate of one every fortnight this remarkable growth was maintained till world war two. World war two led to a big loss for Woolworth.23 shops were destroyed and 353 were damaged by enemy in action. But again by the end of 1951 the expansion programme had resumed. Decline. Though it was a decline, it was only for a short period. The company faced many ups and downs before it was names as kingfisher PLC in 1989. A visible sign of trouble was seen when Woolworth lost its place as Britains leading retailer and marks and Spencers overtook it both in terms of profits and sales. Despite all of the modernisation programmes Woolworth still possessed a number of small and poorly locate branches with an extremely low rate of turnover and profitability. In 1971, with the profits still not coming into place, Woolworth opened new cash and wraps policy and began to convert 777 shops from conventional behind the counter service to a system of centralised payment in each shop. Despite of that profits failed to recover very strongly as a result of its heavy cost of modernisation and created a prolonged start-up problem with a new distribution centre. Despite recovery in profits, Woolworth had still not solved its problems. Woolworth had now began to reorganise by selling all the unprofitable parts of the business and finally on March 17 1989 woolworth was rechristened as kingfisher PLC. During the 90s kingfisher has made a number of acquisitions in the process becoming a much more diversified retailer. GENERIC STRATEGIES ANALYSIS In the retail sector, specifically related to the kingfishers home improvement business, the industry can maintain a high profitability specially with reference to the porters generic strategies mentioned as below:- Cost leadership:- Kingfisher was ranking first in the retail sector related to the profit and sales. One of the main reasons was their cost leadership. The company that attempts to be the lowest cost producer in the industry can e referred to as those following the cost leadership strategy. Kingfisher was run with the lowest costs but would run highest profits in the events when the competing products are essentially undifferentiated, and selling at a standard market price. Kingfisher placed an emphasis on every activity in the value chain. It must be noted that the company might be a cost leader but that doesnt mean that its products are that of lower prices. In certain instances companies have followed the company charges an average price while following the low cost leadership strategy and reinvest the extra profits into the business (lynch, 2003). The risk of following a cost leadership is that the companies focus on cutting the costs may sometimes affect the vital factors and this mistake may become so dominant that the company may lose vision on why it embarked on this type of a strategy at the first place. Differentiation. When a company makes a certain difference in its product it is often able to charge a premium for its products and services in the market. Generally speaking in the retail sector differentiation would include better service levels to the customers, better product performance, better packaging, and better after sale services etc as related to its competitors. Porter argues that a company following the differentiation strategy would incur further charges resulting in an increase in the cost of production. The high costs would be incurred for the purpose of better advertising features etc. Differentiation brings about many advantages to the firm which makes use of the strategies. Some problematic areas include the difficulty on part of the firm to estimate whether the extra costs can be recovered from the customers by charging a premium cost. Moreover successful differentiation strategy of a firm may attract the competitors to enter the market segment and copy the differentiated product (lynch, 2003). Focus. Porte initially presented focus as one of the three generic strategies but later on recognised the focus as the moderator of the two strategies. Companies follow this strategy by focussing that part or area of the market which has the least amount of competition (Pearson, 1999). Companies can make use of this strategy by concentrating on a specific area of the market and create a product specifically suiting that area of market. This is why the focus strategy is also sometimes referred to as the niche strategy as it focuses on a specific niche in the market. Therefore by employing focus strategy the company can attain competitive advantage. The company can make use of the cost leadership or differentiation approach with regards to the differentiation strategy. In that the company using the cost focus approach would aim for differentiation in its target segment only and not overall the market. This strategy provides the company with the possibility to charge a premium price for superior quality or by offering a small low priced product to a group of buyers. Compound Annual Growth Rate CAGR A compound annual growth rate (CAGR) measures the rate of return for an investmentÂÂ   such as a mutual fund or bondÂÂ   over an investment period, such as 5 or 10 years. The CAGR is also known as smoothed rate of return because it measures the growth of an investment as if it had grown at a steady rate on an annually compounded basis The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered.ÂÂ   This can be written as follows i.e CAGR = ( Dn/Do)1/n -1 Here we know that, Ending valve in Year 2005 i.e Do = 204.8 Beginning valve in Year 2010 i.e Dn =125 n = 5 no. of years We using above formula we get CAGR = (125/204.8)1/5 1 CAGR = -0.0940 CAGR = -9.40% These are some of the common CAGR applications[3]: Calculating and communicating the average returns of investment funds Demonstrating and comparing the performance of investment advisors Comparing the historical returns of stocks with bonds or with a savings account Forecasting future values based on the CAGR of a data series (you find future values by multiplying the last datum of the series by (1 + CAGR) as many times as years required). As every forecasting method, this method has a calculation error associated. Analyzing and communicating the behaviour of different business measures such as sales, market share, costs, customer satisfaction, and performance. Absolute Valuation Models Dividend Discount Model: this model is theoretically one of the most correct valuation models. This model is also known as the GORDON MODEL named after Professor Myron J. Gordon who popularised this model. The model is effective when a company is distributing a significant amount of their earnings as dividend. This model value shares at a discounted value of the future dividends paid because share is worth the present value of all future dividends. This is a procedure of valuing the price of a stock by predicted dividends and discounting them back to present value. The idea behind this is that if the value obtained from the Dividend Discount Model is higher than what the shares are trading at, than the stock is undervalued. Returns derived from the model can be combined with risk data to construct a market line benchmark. Securities that plot along the line are considered fairly priced, the ones below the line are unattractive and the ones above the line are offer more return. The rational of the model lies in the present value rule. Two basic inputs to the model are the expected dividends and the cost of equity. Two Stage model: this model allows for two stages of growth. It states the fact the company goes through ups and downs and a high growth period will lead to face a decline in the growth rate and later the company will have a steady growth face. The initial phase is where the growth rate is not stable and a subsequent steady state where the growth rate is stable and is expected to remain same for a long time. This model allows greater flexibility in the testing of scenario for the investor looking at a firm in its infancy or in a new industry. This works on the assumption that the firm grows at a higher growth rate in the first period, the growth rate will drop at the end of the first period to the stable growth rate and the dividend payout ratio is consistent with the expected growth rate. The Formula: P=nt=1[D0(1+g1)t/(1+ke)t]+t=n+1[Den(1+g2)t-n/(1+ke)t] where: P = intrinsic value D0= expected initial period dividend Den= expected dividend during mature period ke = appropriate discount factor for the investment g1= expected dividend growth rate for initial growth period g2= expected dividend growth rate for mature period There are limitations with this model: Defining the length of the extraordinary growth period. It is difficult to convert qualitative considerations into specific time periods. The assumption that the growth rate is transformed overnight from a higher rate to a lower rate. The focus on dividends can lead to skewed estimates of value for firms that do not pay what they can afford in dividends. It under estimates the value of the firm that accumulates cash and pay little in dividends. Multi stage model: this is an advanced version of the Gordon growth model that determines the equity valuation by utilising an assortment of growth rates. This model incorporates the H-model, the two stage model and the three stage model. The model assumes growth rate which is different every year. It takes three different rates of growth- initial high rate of growth, transition to slower growth and a sustainable steady rate of growth. The present value of each stage is added to derive the intrinsic value of the stock. The main drawback of this model is the assumption that dividends will grow in perpetuity at a constant rate that can be determined at the time of the calculation. This assumption is unrealistic with companies that undergo different stages of growth. High growth: fast growth is early in companys development as it capitalizes on opportunities in new market segments or uses new approach to gain a share in the existing market. With the market expanding new clients may be easy to attract and revenues will grow. Transition: the companys initial growth slows down as the market grab period ends. The overall market might grow at a slower pace or may become more competitive reducing scope for dynamic revenue growth. Maturity: the revenue growth slows down as the market moves closer to the saturation point. It becomes more difficult to attract new clients and the firms have to compete hard on their prices and services to avoid switching to their competitors. Taking into account the different phases of the growth of the companies the multistage dividend model focuses on forecast cash flows for the high growth and transition stage. When the maturity stage is reached we use constant dividend growth projection. The limitations of this model: It remains vulnerable to minor inaccuracies in source data. It is more prone to errors in calculations which are due to poor cash flows which are estimated during high growth phase of a companys development. It is not reliable for companies that are in their early phase of growth as it is difficult for them to accurately forecast the duration of the high growth and the transition stage. FREE CASH FLOW APPROACH: this is the cash that a firm has after has managed to lay out the money required to maintain and expand its asset base. It is mandatory for a firm because it allows a company to pursue opportunity to enhance shareholder value. It is difficult for any company whether small or big to develop products, pay dividends and reduce its debts without cash. FCF is calculated as: This can also be done by taking operating cash flow and subtracting capital expenditures. A firms stock is valued by forecasting free cash flow to firm (FCFF) or free cash flow to equity (FCFE) and by discounting these cash flows back to the present at the required rate of return. These models are used when a firm pays no or little dividends and when free cash flow traces profitability. Free cash flow to firm (FCFF) is the cash available to all the firms investors including bondholders and stockholders, after the firm buys and sells products, provides services, pays the cash operating services and makes short and long term investments. Once the firm is free from meeting all its obligations to its other investors is called Free cash flow to equity (FCFE). Free Cash Flow to Equity (FCFE) = Net Income (Capital Expenditures Depreciation) (Change in Non-cash Working Capital) + (New Debt Issued Debt Repayments) Free Cash Flow to Firm (FCFF) = FCFE and FCFF Two stage models are designed for firms which are expected to grow faster than a stable firm in the initial period and at a stable rate after that. FCFE and FCFE Three stage models are for firms that have three stages of growth an initial stage of high growth, a transitional period when the growth rate declines and the period when the growth rate is stable. RESIDUAL INCOME APPROACH: it is a performance measure that consists of some measure of operating income minus capital used by the unit being evaluated. This model is designed for companies that do not pay dividends. When there is a great uncertainty in estimating the terminal value than this method is appropriate. It is designed to influence managements investment in capital assets, to undertake investments for which the net present value is positive and to let go of those where the net present value is negative. The rate used in calculating the cost of capital is the riskless interest rate in the world of certainty. The Residual income = investment centres profit [investment centres invested capital ÃÆ'Æ’- imputed interest rate] Where, imputed interest rate = firms cost of acquiring investment capital It works on the assumption that: The market value of a company should equal the present value of the future expected dividends. The change in the book value between two dates equals earnings minus dividends in the period t. The book value of equity after infinity equals to zero. Asset Based Model: we will not use this model because our company kingfisher plc does not use natural resources. The Dividend Discount Model (DDM) ( ALL VALUE IN MILLION) All value taken by financial income statement of kingfisher plc Given: D= dividend per share= 3.4p R=discount rate= 10.2759% G= dividend growth rate=0 Po=Price per share =221.5p Do=dividend that year=80 Ke=cost of equity=7.9% g= dividend growth rate=0 The value of single period of DDM as follow as Single period : Vo=Do*(1+g) / (Ke-g) Vo= 80*(1+0) / (7.9%-0) Vo= 1012.658 So value of firm= 1012.658 i.e. DDM The Free Cash Flow to Firm Given: Net Income=385 Tax rate= 31.9% Net Borrowing= -1024 Non cash charges=260 Working capital Investment= -582 Interest rate = 72 Fixed Capital Investment = -87 Cost of Equity=7.9% Equity= 4955 Total Debt= 1530 Cost of Debt= 8.15% FCFF= net income+ non cash charges working capital investment + interest (1-t) fixed capital Investment FCFF= 385+260+582+72(1- 31.9%)+87 FCFF= 385+260+582+ 49.032+87 FCFF= 1363.032 We want value of firm fist find out WACC WACC=Ke*e / e+D+Kd * e / e+D *(1-t) WACC= 0.079*0.7640+0.0815*07640*0681 WACC=0.102759 WACC= 10.2759% Value of firm using FCFF Value of firm= FCFF/ WACC Value of firm=1363.032/0.102759 Value of firm=13264.356 The Free Cash Flow to Equity FCFE= FCFF-interest(1-t)+net borrowing FCFE=1363.032-72(1-31.9%)-1024 FCFE=290 So value of firm using FCFE Value of firm= FCFE/WACC Value of firm= 290/0.102759 Value of firm=2822.137 The Residual Income Model The Residual Income =net income (Ke*equity) The Residual Income =385-7.9%*4955 The Residual Income =385-391.445 The Residual Income=-6.445 So value of firm using The Residual Income model Value of firm =RI/Ke Value of firm= -6.445/0.079 Value of firm= 81.582 ÂÂ   CONCLUSION From the above learning outcome we came to know that the kingfisher PLC has come through various ups and downs in the retail sector. Its strategy of opening various branches and making reserves rather than paying the shareholders their shares has helped the company with all its financial and expansion functions. The employees of kingfisher especially the chairmen of the company have played a very important role in the companys success. It was deemed to be the first most profitable and most selling company. These are main features of the kingfisher PLC that made it the no. 1 company amongst the retail sector. There have been certain ups and down but strategies like opening discount shops or closing down the unused branches has helped the company in many ways.