Introduction
An analysis of financial performance of Liberty International Plc has been carried out for a period of three years. The basic financial tools used for this analysis are financial ratios. The analysis has been made from the point of assessing performances on account of liquidity, profitability, activity efficiency, and investors’ interests. The performance of Liberty International Plc as assessed has also been compared with performance of Brixton Plc for the year 2007, a competitor of Liberty International Plc.
Liberty International Plc was once part of Liberty Life association of Africa. The company’s main business is to develop shopping centers, offices, and other retail properties and earn rental income from letting out such developed properties. The financial performance of the company is assessed as under with the help of financial ratios calculated in the appendix.
Company Overview
The company was founded in 1980. It operates as Real Estate Investment Trust in UK. Liberty International is a property development company. The company develops, owns, and manages shopping centers. The company also provides managerial services for Group’s commercial and retail property portfolio. It is UK’s third largest listed company and one of FTSE 100 companies. The company has interests in 14 UK regional shopping centers.
Industry Overview
Liberty International Plc operates in the real estate industry in UK. The industry is in dire state at present. As per Wall Street Journal Press ‘As the gloom in real estate market continuous to spread , European property companies are rushing to raise capital as a last resort to remain liquid and keep from busting debt covenants. The latest and perhaps most dramatic evidence of the trend is a round of capital increases in UK.’(Smart Brief)1 Accordingly, rumors are rife that Liberty International might raise capital from market.
Liquidity Analysis
Liquidity refers to the ability of a firm to meet its obligations in the short run. Liquidity ratios are generally based on the relationship between current assets (the sources for meeting short term obligations) and current liabilities. The liquidity ratios that are considered for this analysis are current ratio and quick ratio.
‘Current ratio, one of the most commonly cited financial ratios, measures firm’s ability to measure its short term obligations. Generally the higher the current ratio, the more liquid the firm is considered to be.’(Lawrence J Gitman, page 58)2 A current ratio of 2:1 is considered most suitable for all types of firms but its accepted variability also differs from industry to industry.
“The quick (acid test) ratio is similar to current ratio except that it excludes inventory, which is generally the least liquid current asset. A quick ratio of 1:1 is recommended or greater is occasionally recommended, but as with the current ratio, what value is acceptable depends largely on the industry.” (Lawrence J Gitman, page 59)3. Simply the quick ratio is that part of current ratio that includes current assets quickly convertible into cash. In order to assess the liquidity position of Liberty International Plc these ratios calculated in the appendix are as under:
Current Ratio:
- 0.77:1 (2007)
- 1.30:1 (2006)
- 0.69:1 (2005)
Quick Ratio:
- 0.68:1 (2007)
- 1.18:1 (2006)
- 0.36:1 (2005)
The above figures show a fluctuating trend for both current ratios and quick ratios. In 2006 these ratios increased when compared with 2005, and then nosedived in 2007 to bottom level. It is important to state the for calculating the quick ratio for three years current assets represented under the heading ‘ Trading Property’ have been considered equivalent to inventory, and thus not considered for the calculations of quick ratio for all the three years under consideration.
The ratios calculated above reveal that the liquidity position of Liberty has been fluctuating over a period of three years. Current ratio and quick ratio of 0.69 and 0.36 in 2005 declares a very fragile liquid position of the firm. The firm would have faced a liquid crunch in that year and found it difficult to meet its current obligations as those became due.
However, the liquidity position improved a lot in the year 2006 for the company when current ratio and quick ratio rose to some respectable figures of 1.30 and 1.18. It appears that the liquidity position in 2006 improved mainly because of rise in trade and other receivables and cash balances.
The situation again worsened in 2007 when borrowing under current lease rose from £43.5m to enormous £152.3. That made all the position reversed to almost 2005 level of liquidity when current ratio and quick ratio came down to 0.77 and 0.36 respectively. In 2007 the company was facing big short term solvency problems making it difficult to meet its short term liquidity.
From above ratios it is assessed that liquidity wise the company is not performing well. Fluctuations in current and quick ratios show unhealthy liquidity position of the company, as it makes the company very fragile from short term solvency point of view. The company needs concrete measures to improve its liquidity.
The competitor of Liberty, Brixton Plc is also suffering liquidity problems. Its current ratio for 2007 is poor 0.40:1, which is the same as its quick ratio, as there are no inventories involved in its current assets. Just like Liberty Brixton also requires immediate measures to solve its liquidity problems.
Profitability
Profitability performance of Liberty International Plc is assessed on the basis of three ratios, namely gross profit Margin, net profit margin, and return on capital employed.
These ratios calculated for Liberty International Plc in the appendix are as under:
Gross Profit Margin:
- 65.14% (2007)
- 60.51% (2006)
- 69.09% (2005)
Net Profit Margin:
- 9.05% (2007)
- 164.83% (2006)
- 195.85% (2005)
Return on capital employed:
- 0.57% (2007)
- 10.60% (2006)
- 11.67% (2005)
Gross profit margin dipped in 2006 when compared to 2005 and in 2007 retained the level of 2005 again. Net profit margins have showed dramatically high trend till 2006 and then dashed to pathetically poor figure. The same is the case with the trend of Return on capital employed.
Gross profit margin ratio is the ‘percentage of sales left after subtracting the cost of goods sold from sales. It indicates the percentage of sales availability to operating expenses.’(Donald D Taylor and Jeanne Smalling Archer, page 171)4
In fact gross profit indicates the trading efficiency of the firm. Liberty International Plc is not a manufacturing or trading company. Its main revenue is from rental income. Therefore in case of Liberty International Plc gross profit is taken as net rental income remaining after deducting rental expenses from gross rental income.
Net profit margin has been specially defined for the purpose of this analysis. Net profit margin is taken as earning before interest and taxes (EBIT). In fact for the purpose of this analysis operation profits (EBIT) are treated as net profits of the company.
Return on capital employed is ‘a very common measure of profitability both for external assessment of companies’ performance and for internal assessment of the efficiency of the management. It measures the return on total capital employed of the business regardless of how it is financed.’(Michael Broadbent and John Cullen, page 57)5 It is very important to point out here is that for calculating the return on capital employed for Liberty International Plc the net profit as defined above, i.e., EBIT is considered as per requirements.
It will be observed that the company has attained mixed bag so far as gross profit margins or net rental income is concerned. Its margin of 69.09% in 2005 came down to 60.51% in 2006, mainly due to increase in rental expenses even though rental income also increased in this period. In fact rental income increased in 2006 by 14.52% when compared with 2005; but rental expenses increased in 2006 by 13.09%. Though the ratio of increase in rental income as compared to ratio of increase in rental expenses is slightly better, but it has affected the gross margin by a reduction of 8.59%. The company should have controlled its direct rental expenses to maintain the gross margins at 2005 level. In 2007 gross profit again rose to 65.14%
Net profit margins of Liberty International Plc over three years are presenting an astonishing picture. It is rare to hear net margins exceeding the gross revenue. This has happened for Liberty International Plc. The reason is method of valuation adopted by the company. The company has valued its assets at fair value. This has resulted in increasing the income by ‘gain on revaluation’ of assets. Along with this the company has earned gains on sales of investment properties. Both these factors have contributed a total gain of £565.5 m in 2005, which figure in itself is more than the company’s total revenue from it main business of earning rental revenue. The gross rental revenue in 2005 was only £434.3 m as compared to gains from revaluation and sale of investment property of £565.5m. This has resulted into an astonishing net profit margin ratio of 195.85%.
The same result was more or less repeated in 2006 when the gains from revaluation and sale of investment property were £ 586.5m and rental income gross revenue was £562.8m. The result is again a net profit margin of 164.83%. These results are because the company has adopted fair value basis for evaluating its assets at the balance sheet following IFRS.
In the year 2007 when market value of properties fell down dramatically the company had to adjust its valuation according to fair value on balance sheet date. The result was reversal of fortunes. The net profit margins were only 9.05% in 2007. There were losses to the tune £279.10m from revaluation of assets and sale of investment properties. Even though the gross revenue from rental income has shown a rise of 10.87%, the company suffered net profit margin reduction to the tune of 155.75%. All this is because the company has adopted international financial reporting standard for preparing its financial statements and it had to follow the fair market valuation regulation for valuing its properties on valuation date.
Accordingly from net profit margin point of view, the performance is full of dramatic results and astounding when some one observe that net profit margins has increased beyond the gross revenue of the company from its main activities.
Return on capital employed reflects the performance of management in effectively using the capital employed into the assets of the company. The capital has earned a return of 11.67% in 2007 which has come down to 10.60% in 2006, and then nosedived to 0.57% in 2007. The reason for this is the decreasing net profit margin (EBIT) that is taken as the profit for calculating return on capital employed. The company would have shown losses on capital employed during 2007 if the profits after interest and taxes would have been considered for the purpose of calculations of return on capital employed.
Overall the profitability performance appears brilliant in 2005 and 2006 not because of company’s own efforts on its main business activity but because of the adoption international accounting standards seeking valuation of assets at market value and taking the gain on such valuation to income statements. Some reviewer would consider this as the basic limitation in the system of fair valuation, which is receiving a lot of criticism and flaks during the current economic crisis world over. Few analysts treat the fair value method responsible for the present depression causing a lot of economic and social problems. Only because of such adoption of fair value method of valuation under IFRSs the company has suffered sliding results of only 0.57% earning on the total capital employed. It may be noted these results are not due to any bad performance on the rental income earned by the company, which the basic and main activity of the company’s business. The profitability results are demoralizing but worth considering the effects of following international accounting standards on the profitability and in turn market prices of the securities of the company.
The profitability performance of the competitor Brixton Plc is fantastic as compared to Liberty International Plc during the year 2007. Its gross profit margin is 91.70%. The net profit margin (EBIT) is whooping 110.36%. This is due to gains from valuation of properties in 2007.
Activity
Activity is measured the speed with which various assets are converted into sale or cash. That is to say the analysis is about cash inflow and cash outflow. The ratios considered for such an evaluation are stock turnover ratio, trade receivable turnover, and creditor turnover ratio, asset turnover ratio, interest cover ratio, and gearing of capital structure.
Stock turnover ratio “gives an estimate of the average number of days taken to convert the stock into either cash or debtors. The ratio is sometime calculated using closing stock than the average stock and sales rather than cost of sales.” (Peter J Clark, page 93)6. Normally the effects of assessment of stock turnover through this ratio are available only in case of manufacturing and trading companies. Liberty International Plc is neither a trading company nor a manufacturing company. The business of Liberty International Plc relate to rental income from properties. It has other income as gains from trading in investment properties. Accordingly it will not be possible to compute stock turnover ratio in case of Liberty International Plc and no assessment of any performance of the company can be made using this ratio.
Trade receivable turnover is also known as ‘average collection period. “The average collection period or average age of accounts receivable is useful for evaluating credit and collection policies.” (Lawrence J Gitman, page 60)7 This ratio show how fast receivable are converted into cash to enable smoothness of the working capital of the company. As per information available in the financial statements of Liberty International Plc about receivables and treating the rental revenue of the business as sale, the trade receivable turnover is calculated in the annexure is as under:
Trade Receivable Turnover (days):
- 98.91 (2007)
- 73.89 (2006)
- 66.13 (2005)
Trade Receivable Turnover shows a rising trend over the years and that reflects creeping inefficiency in collection of receivables.
From above figures of trade receivable collection period it appears that the performance of Liberty International Plc has deteriorated over the years. Average rental collection period that was 66.13 days in 2005 has increased to 73.89 days in 2006 and then worsened to 98.91 days. Though the rental income is rising year after year but collection period is increasing year after year putting a pressure on its working capital. That is the reason that current ratios and quick ratios of the company are fluctuating and the company is facing fragile liquidity position. The competitor of Liberty, Brixton Plc has trade receivable turnover for 2007 is 120.45 days, and that is very poor performance even as considered to the performance of Liberty International Plc.
Creditors Turnover is also called ‘average payment period’. “The average payment period is a ratio which shows the number of days used to pay creditors. Too many days in the payment period may develop a poor credit relationship with suppliers, and too few days may indicate that funds should be invested for longer time before creditors are paid.”(James E Allen, page 257)8Liberty International Plc is not a manufacturing company or a trading organization. It was tried to calculate creditors’ turnover ratio treating rental expenses as cost of sales, but the results were not worth consideration as the average number of payment days were exceeding even the total number of 365 days in a year. Thus it can be said no evaluation can be made using creditors’ turnover ratio in case of Liberty International Plc.
Asset turnover ‘indicates the efficiency with which the firm uses its assets to generate turnover.’ (Lawrence J Gitman, page 62)9 As Liberty International Plc is earning rent on its properties, assets turnover ratio may not be that important from the point of view of measuring rental income. This is because rental of property is always fixed for the agreed period. The asset turnover ratio of the company is as under
- 0.12 (2007)
- 0.12 (2006)
- 0.15(2005)
Assets turnover has shown a decreasing trend till 2006, and thereafter it remained static. The above ratio reflects a lower turnover of assets in 2006 and 2007 as compared to 2005 in generating the rental income for the company. The comparable asset turnover ratio of competitor for the year 2007 is 0.06 times, which is very poor when compared the performance of Liberty.
Interest Cover Ratio is used “to see how comfortably the company can meet its interest payment.” (Philip Ramsden, page 36)10 It is also called the times interest earned ratio. The ability of Liberty International Plc to meet interest liability is reflected in this ratio as under:
- No cover (2007)
- 4.88 (2006)
- 4.95 (2005)
Interest cover ratio has shown a decreasing trend and it dashed out in 2007.
The company’s EBIT in 2007 is merely £52m against the interest liability of £290.3m. So there is no cover even for single times in 2007. On the other hand EBIT covered the interest liability in 2006 for 4.88 times and in 2005 for 4.95 times. Brixton Plc , the competitor has interest cover ratio of 4.04 time in 2007, which is better when Liberty has no cover for interests payable in 2007.
Gearing of capital structure represents how total assets of the company have been financed. The company is said to be high geared when debt capital is used for more than half of required funds to finance assets. In case of Liberty, the gearing of capital structure is as under:
- 48.66% (2007)
- 45.92% (2006)
- 59.76% (2005)
Capital gearing has shown that company was high geared in 2005 and thereafter a low gearing trend for 2006 and 2007. The company is low geared in later two years. That means the equity holders may not be able to take advantage of trading in equity during the periods of rising profits. The gearing of capital structure of Brixton Plc for 2007 is 37.27%, and accordingly Brixton is also a low geared company.
Investors’ interests
The ratios that reflect the investors’ interest in the company are EPS, P/E ratio, dividend yield, and dividend cover.
Earning per share is “the amount of reported income on per share basis that a firm has available to pay dividends to common shareholders or reinvest in itself.” (David logan Scott, page 121)11 EPS attracts the investors as this is popular ratio closely watched by investors. It is indicator of corporate success. Liberty’s EPS is as under:
- 29.0p (2007)
- 462.1p (2006)
- 114.8p (2005)
Earning per share has a rising trend till 2006 and then down to a comparatively poor figure in 2007.
The company’s EPS has come down heavily in 2007 basically because fall out of valuation losses on adoption of IFRS standards of fair valuation of properties. On the other hand Brixton Plc’s Earning per share in 2007 is 22.1p and that is lower than Liberty International Plc.
P/E ratio is normally used to assess the value of shares. A P/E ratio indicates how much an investor is willing to pay per pound of earnings of the company. Liberty’s P/E ratio is under:
- 2421.24 (2007)
- 158 (2006)
- 253.64 (2005)
P/E ratio trend is highly fluctuating as the ratio is dependent upon earnings which showed extraordinary results because of gains on valuation of assets as earlier explained in this write up. That is why P/E ratio came down from £ 253.64 in 2005 per share to £158 per share in 2006.As the profits in 2007 were astonishingly high, P/E sharply rose to £2421.24. That means in 2007 investors were ready to pay £2421.24 per pound of earning of Liberty. On the other hand P/E ratio of Brixton being £262.5 per share in 2007, investors were ready to pay £262.5 per pound earning of Brixton. These are certainly not normal results, as the gains on valuation of assets are mainly affecting the earnings of companies.
Dividend yield is considered useful for determining the return in shape of dividend on investments. It tells the percentage return a company pays to shareholders as dividend.
Dividend yield of Liberty is as under:
- 0.05% (2007)
- 0.04% (2006)
- 0.10% (2005)
It shows that dividend yield on shares has dropped from 0.10% in 2007 to 0.04% in 2006, and 0.05% in 2007. As in every other ratio, dividend yield has also reacted sharply in 2006 when it decreased from 0.10% to 0.04%.
On the other hand Brixton Plc has shown a dividend yield of only 0.02% in 2007 on investments in its shares as compared to 0.05% for investments in shares of Liberty.
Dividend cover indicates the number of times the dividend is covered by the earnings of the company. In case of Liberty International Plc this cover for three years is as under:
- No cover (2007)
- 16.05 (2006)
- 4.24 (2005)
Dividend cover has shown rising trend till 2006 and thereafter it dashed out of the scene.
In 2007 the company has losses for the shareholders after taxes, and thus there is no dividend cover. However, in 2005 the dividend cover was 4.24 times which increased tremendously to 16.05 times in 2006 due to gains from valuation of assets. The dividend cover of Brixton Plc for 2007 is 1.79 times, which is better as Liberty has no such dividend cover in 2007.
Conclusion
Liberty International Plc has a very fluctuating liquidity position over the years, and in 2007 the position is very delicate. The company’s short term solvency is in danger because of this fragile liquidity. Profitability wise the company has performed very well in 2005 and 2006 mainly because of gains from valuation of properties following the fair valuation of assets as per application of IFRS. The company has performed unsatisfactorily in 2007 on profitability front because of the fair valuation adoption. That is P/E ratio is very fluctuating over the three years’ period under consideration. Otherwise the rental revenue of the company has been rising in these three years. The company’s trade receivable turnover is high and not satisfactory over the years. Assets turnover is not much of importance considering the nature of business of the company. Liberty is a low geared company as less than half of funds required for financing its assets has come from debt capital. EPS of the company is satisfactory but much lower in 2007 as compared to earlier years. Though Liberty’s dividend yield is better than its competitor in 2007, it has no dividend cover for investors in 2007 as a result of effects on earnings of the deficit from valuation of properties at fair market value as at the date of balance sheet.
Appendix of ratio calculations
Appendix containing ratios of Brixton Plc
Footnotes
- Smart Brief, British REITs stampede to raise capital, The Wall Street Journal. Web.
- Lawrence J Gitman, Lawrence J Gitman, Pearson Education, Eleventh edition, page 58.
- ibid, page 59.
- Donald D Taylor and Jeanne Smalling Archer, Up Against the Wal- Marts, AMACOM Divisional Mgmt. assn, 2005, page 171.
- Michael Broadbent and John Cullen, managing Financial Resources, Butterworth Heinemann, 2003, page 57.
- Peter J Clark, Accounting information for Managers, Cengage Learning, EMEA, 2002, page 93.
- Lawrence J Gitman, Lawrence J Gitman, Pearson Education, Eleventh edition, page 60.
- James E Allen, Nursing Home Administration, Springer Publishing Company, 2008, page 257.
- Lawrence J Gitman, Lawrence J Gitman, Pearson Education, Eleventh edition, page 62.
- Philip Ramsden, The Essentials of management Ratios, Gower Publishing Limited, 1998, page 36.
- David logan Scott, Wall Street Words, Houghton Mifflin Harcourt, 2003, page 121.