General Position and Business Environment of the Company Industry
Graphic Packaging Holding is an American company that has specialized in packaging various products. The firm operates in the United States, Canada, Europe, Asia Pacific, Central, and South America. Graphic Packaging Holding operates in an industry that is not crowded with competitors. However, it faces major operational issues of sustainability and innovation. Shortage of raw materials is also a potential issue. The company has managed steady financial growth despite problems in the economies within which it operates.
The growth is attributable to the dependency of other companies on its products to package their own. The major method of growth has been by mergers and acquisitions. This report compares the company’s financial ratios with industry statistics. The company performs comparatively well in its industry. It also has good growth prospects as portrayed by the financial statements and ratio analysis. The paper concludes that it is worthy to invest in Graphic Packaging Holding.
Company Risks
Financial Risk
Market value of the firm’s equity represents how high or low market participants rate a company’s shares. It is useful in computing the weighted cost of capital. The market value of the firm’s debt represents how high or low market participants rate a company’s long-term loans. It is useful in computing the weighted cost of capital because it enables analysts to compute the proportion of a company’s capital constituted of loans. To deal with this risk, the company should establish an elaborate accounting department that computes the WACC and looks into its implication in the investments of the company. The company should also look into ways of reducing debt and increasing equity since the latter is riskier.
Liquidity Risk (WACC)
The Weighted Average Cost of Capital is computed by substituting the relevant figures into the formula. We assume the market value of equity and debt to be the values presented in the 2012 financial statements. The Value of debt excludes short-term borrowing. The Cost of debt and equity values is readily available. Since tax is incorporated in computing the cost of debt, we ignore the final part of the WACC formula.
WACC= (E/V) Re + (D/V) Rd *(1-t)
Where:
E- Market Value of Equity
D-Market Value of Debt
V- Total Value of capital
Re- Cost of Equity
Rd- Cost of Debt
For Graphic Packaging:-
E-974,000
D- 2,883,100
V-3,857,100
Re- 24.84 %
Rd -5.2 %
WACC = (974,000/3,857,100)*24.84% + (2,883,100/3,857,100)* 5.2%
WACC = 6.27% + 3.88%
WACC = 10.15%
To reduce liquidity risk, the company should find ways of enhancing capital growth through equity as opposed to debt. The company can also enhance liquidity through streamlining operations, which will increase efficiency. Hence, working capital needs will reduce. Lastly, the company’s relationship with banks can help to curb liquidity risk, as the company will have access to quick capital.
Market Risk
The figure for Per Share Market Value of the Firm is determined by the market in which a firm’s securities trade. In the case of Graphic Packaging, it is the New York Stock Exchange. This figure indicates how the investors value a company’s securities. Graphic Packaging has a Per Share Market Value of $7.42. This figure changes frequently due to market activity. Market risk is determined by:
Expected Rate of Return on a Security
It is the result of the CAPM formula. It represents the compensation expected by shareholders for investing in certain shares. It is composed of the risk-free rate, asset beta and expected market returns. In this case, shareholders of Graphic Packaging would expect the returns for their investment of $ 974,000.
Risk-Free Rate
Risk-free rate is the expected return on security with no inherent risk such as a government bond. Government bonds are taken as the proxy for risk-free securities because the risk of default in payment is very low unlike corporate bonds, which are prone to default depending on the company’s financial status.
Beta Coefficient
Beta is a measure of the riskiness of security. It is determined by the business risks facing a company and its environment of operation. Graphic Packaging operates in an environment that is prone to change. The beta coefficient incorporates such risks. Any beta coefficient higher than one indicates that the security in question is riskier than the market. Conversely, coefficients lower than one indicates securities less risky than the market.
Expected Return on the Market
Every stock market has an average return it is expected to produce in a year. This return depends on the portfolio of securities in the market. In the case of Graphic packaging, the expected return on the New York Stock Exchange where it is listed is used in the CAPM formula.
Market Risk Premium
The market risk premium represents the difference between the risk-free rate and the expected rate of return on the market. It represents the amount an investor expects to be compensated for putting funds into that particular securities exchange
Market risk is tricky to deal with because most of the factors that constitute it are not within the control of the company. Industry players, government and the competitive environment at large are some of the factors that determine market risk. The least a company can do is to establish a good relationship with the determiners of these risks to ensure the company is safe. For example, it would be unwise to engage in unfair competitive practices.
Tax Risk
Tax risk refers to the risk a government exposes a company to and other intricacies associated with tax evasion, tax differences in different countries, and tax levels. A company’s operations and goals should be to maximize shareholder value. Hence, minimal risk is a contributor towards that goal. In this case, a company should operate in a country with the least tax percentages and favorable tax regimes with incentives. Additionally, a company should pay tax to curb the reputational risk associated with tax evasion.
Company’s Position, Dividend Policy and Performance
Divided policy
Divided policy refers to the procedure used by a company to share its profits with shareholders. There are several types of dividend policies employed by companies. They include:
- Constant Dividend per Share – Such a policy entails issuing a fixed amount of dividend for every share held. It can be a disadvantage to shareholders in times of rising inflation.
- Constant payout ratio – Such a policy requires a company to set the ratio of Dividends to net earnings. This ratio determines the number of dividends to be paid out. Thus, a company pays out only what dividend it can afford.
- Irregular Policy – A Company can fail to have a set dividend policy and instead issue dividends randomly each year. The policy is common in companies that have variable earnings and operate in uncertain environments.
- No dividends – A company can fail to pay out dividends altogether. The no-dividends policy may be adopted in the early years when growth is a priority and all available funds are being channeled towards expansion.
- Unfortunately, information about Graphic Packaging’s dividend policy is not available publicly.
Ratio Analysis
Ratio analysis enables the comparison of various Financial Statement items as percentages of other items. It is meaningful when conducted over a period, in this case, 2010 to 2013. There are four categories of ratios profitability, liquidity, advantage, and activity. Each of the mentioned categories is covered in the analysis.
Efficiency Ratios
Inventory Turnover Ratio
The ITR of 0.15 indicates the rate at which inventory moves. At Graphic Packaging, a rate of 15% is applicable every month. Therefore, the company should have a purchase of 15% of inventory every month.
Receivable Turnover Ratio
The ratio shows what the suppliers expect from a company. In this case, the amount of money the suppliers expect is equivalent to 94% of the inventory at any time. The figure is too big as it may be confused for value whereas the company is in debt.
Solvency Ratios
Debt capital refers to what a company has borrowed to help finance its investments. In the case of Graphic Packaging, for the year 2012, it is the $ 2,253,500 shown on the balance sheet under long-term debt. Debt issuers expect returns in the form of interest, which is the charge to the company for using their funds. Interest is quoted in percentage form.
However, since interest is a deductible expense for taxation purposes, debt reduces the amount of tax a company effectively pays. Therefore, to determine the cost of Graphic Packaging’s debt, we must consider both the interest rate charged by the lenders and the corporate tax rate charged by the government. The formula that connects these two items to give the cost of debt is:
Cost of Debt = YTM * (1-T)
Where:
YTM- Yield to Maturity
T – Corporate Tax Rate
The average YTM of the debt carried by Graphic Packaging is approximately 8%. The corporate tax of its mother company, USA, is approximately 35%. These are the two figures necessary for computing the company’s theoretical cost of debt.
Cost of Debt = 8% * (1-0.35) =8% * 0.65 =5.2%
This means that the debt providers require an approximate return of 5.2% from Graphic Packaging in return for financing their projects.
Debt Ratio
The weighted average cost of capital incorporates both equity and debt capital. Each type is considered depending on its proportion in the total capital mix. Graphic Packaging has significantly more debt than equity. This could be attributed to the high cost of equity.
Profitability Ratios
Gross Profit Margin
A ratio of 0.17 indicates that the profit margin before tax is at 17%, which is reasonable as per industry comparisons. For each dollar of sale, 17 cents is profit.
Net Profit Margin
A ratio of 0.03 indicates that the profit margin before tax is at 3%, which is reasonable as per industry comparisons. For each dollar of sale, 3 cents is net profit.
Return on Investment (ROI)
The ROI of 0.03 is not good enough. It indicates that for every dollar invested in the company, an investor expects a return of 3 cents, which is quite low as per industry and stock market standards.
Return on Equity (ROE)
The cost of equity refers to the returns expected by the owners of a company. Shareholders are the owners of the company and they expect compensation for providing capital. Compensation is usually in the form of dividends. Graphic Packaging shows stockholders’ equity of $ 974,000 on its Statement of Financial Position for the year 2012 (Graphic Packaging Holding Company 2013).
The most acceptable method of determining a company’s cost of equity is the CAPM method. The CAPM method considers several variables in order to arrive at the cost of equity. The variables include Risk-Free Rate, Expected Rate of Return on the security, Beta Coefficient, and Expected Rate of Return on the Market
Earnings per Share (EPS)
The Earnings per Share (EPS) is 0.43. The figure indicates what the shareholders will earn in form of dividends for every share they own.
Summary
Overall Summary Comments on Ratios
This paper has analyzed Graphic Packaging’s operational and financial details. The major operational issues faced by the company are innovation and sustainability. It is evident from the ratio analysis in part one that the company is doing well compared to the industry statistics. Additionally, the ratio analysis on the financials indicates that it will continue to do well. Therefore, I would recommend Graphic Packaging as a worthy company in which to invest.
Reference
Graphic Packaging Holding Company. 2013. Graphic Packaging Holding Company. Web.