Financial Analysis of Cavco Industries INC.

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Introduction

The Economy of US

The US economy has experienced growth in the GDP from 2006 to date, apart from a brief disruption due to the global economic meltdown in 2009. Generally, the performance of the economy has remained predictable, especially in the manufacturing industry due to constant and ever increasing demand for their products. This is summarized in the table below.

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Current 2006
GDP $15,094,000,000, $13,314,500,000
Inflation 2.7% 3.2%
Unemployment 7.7% 4.6%
Interest rate 0.5% 4.6%

As indicated in the table, it is apparent that the GDP of US increased from $13.314 billion in 2006 to $15.094 billion in 2011. Moreover, the rate of Inflation declined significantly from 3.2% in 2006 to 2.7% in 2011. However, a significant decline in inflation did not translate into reduced unemployment. Rather, the rate of unemployment increased to 7.7% in 2011from from 4.6% in 2006. In addition, the rates of interest reduced to 0.5% in 2011 from 4.6% in 2006. The monetary circulation stimulation policy adopted by the government in 2010 facilitated the reduction of the interest rates. The US economy indicated an economy experiencing an upward growth trend since 2006 as indicated in the graph below.

GDP in current prices

In the year 2011, the value added prices increased by 2.1%. In the general manufacturing industry, the construction industry was one of the largest contributors to the acceleration of the value added to prices. The annual GDP growth in the last five years has improved the standard of the manufactured home industry. In summary, the manufacturing industry shared of the total GDP of the US is currently at 11.5%.

The Manufactured Houses Industry

Industry Characteristics

CAVCO Incorporation operates in the Manufactured Houses industry. It is a segment of the construction industry. Specifically, the incorporation designs and builds fitting structures in homes, cabins, commercial building, and park model homes. The industry is dominated by consumers interested in fitting services for their homes, commercial buildings, and other recreational homes. These customers have customized fitting needs that must be met with standardized designs of the construction engineers. Specifically, “the manufactured housing wholesale shipments of HUD code homes accounted for an estimated 11 % of all new single-family housing starts and 15% of all new single-family homes sold” (Cavco Industries Incorporation 12).

Over the past decade, the industry has registered steady growth and the same is projected in the future especially with the projected decline in the global recession. The key players in this industry include engineering firms, construction resource consultants, and suppliers. However, the industry has to cope with commodity prices rebound due to inflation in vital materials such as steel. Thus, the current economic feasibility positioning largely depends on the primary drivers of the industry who are the emerging economic regions of India, China, Africa, Brazil, and Middle East.

Sales Characteristics

In the recent past, the industry has experienced increases in sales and revenue. This was as a result of the expansion of the business and opening of new stores. The increase in sales was influenced by improvement of services and establishment of new market niche in the recreational home services. The incorporation’s net sales increased to $443.1 million in 2012 from &171. 8 million. This represents a 157.9% increase in sales.

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Sources and Uses of Funds

The sources of funding for this incorporation are debt funding and funds from shareholders. In addition, the incorporation resorts to other short term financing plans such as expansion loans. The production, administration, and distribution channels take the largest part of the funds. In addition, the incorporation does allocate funds for advertisement and research as a strategy meant to improve on the quality of their services.

Causes of Changes in Industry Prospects

The manufactured homes industry is expected to grow rapidly in the future as demand for low cost manufactured homes expands. Therefore, the incorporation is expected to further expand its revenues and sales due to the newly created market for green affordable houses in its line of production. Specifically, the demand for low cost housing in America will be a major survival point of the incorporation that has spread its areas of operation to capture the wants of customers in this segment.

Cavco Industries Incorporation

Background and History

Cavco Industries Incorporation was founded in 2003 to replace the Cavco entities that have been in operation since 1965. The incorporation has its headquarters in Arizona, Phoenix. The incorporation has been active in the design and production of factory-built homes that are distributed primarily through the incorporation owned and independent retailers across the United States of America. At present, the incorporation is number two in the production of factory-build homes in the market of the United States. Moreover, the incorporation is the leading manufacturer of the park home models, commercial structures’ inbuilt systems, and vacation and recreational cabins, and modular homes. Besides the manufacturing industry, the incorporation operates a mortgage subsidiary that offers mortgage services to customers interested in purchasing the factory-build homes. In addition, the insurance branch of the incorporation offers casualty and property insurance to customers who buy the factory-built homes.

Organization of Management

The executive management of Cavco Industries Incorporation is made up of five senior personnel. The total number of employees of the organization is more than 1000 personnel in their group of companies. All the employees of the incorporation work in the departments of construction, mortgage services, and insurance subsidiary of the incorporation. This team offers services in construction, consultation, installation, service delivery, and site inspection services. The company has vast facilities and qualified personnel for its segments. Among the three segments of the company, the most active are the factory-built home construction department. Indicated below is the list of the top management team at the Cavco Industries Incorporation.

Name Position
1 Mr. William C. Boor Senior Vice President
Global Ferroalloys
Cliffs Natural Resources Inc.
2 Mr. Steven G. Bunger Chairman, President & Chief Executive Officer
Mobile Mini, Inc., Executive Vice President and Secretary
3 Mr. David A. Greenblatt Consultant
Eagle Materials Inc.
4 Jack Hanna Principal
Jack Hanna Productions
5 Joseph H. Stegmayer Chairman, President & Chief Executive Officer Cavco Industries, Inc.

Products

The incorporation has series of manufacturing lines that designs and produces factory-built homes and passes them to distributors who sell the manufactured homes across the world. Cavco incorporation’s “brand names in the industry: Cavco Homes, Fleetwood Homes, Palm Harbor Homes and Nationwide Homes. The incorporation’s insurance group, Standard Casualty, offers a wide range of insurance products for manufactured home owners and its finance subsidiary, CountryPlace Mortgage, offers a variety of home buyer financing options” (Cavco Industries Incorporation 13).

It is factual that the incorporation sells their products in their brand name Cavco Inc. In 2003, the incorporation changed their brand name from Cavco entities to Cavco Industries Incorporation. The manufactured-homes brand has the unique design feature. The most iconic and selling products in the Cavco market are the low cost factory-built homes. The homes are “precision built in controlled indoor environments using comprehensive construction systems and processes where each home is assembled in stages under strict supervision” (Cavco Industries Incorporation 12).

The mortgage services of the incorporation have been modified to suit the demand of high end and low end income customers who want quality services. Besides, the mortgage plans have been made very flexible to suit the volatile property market demands (Eugene and Michael 34). In addition, the insurance services offered by the incorporation are customized to capture the unique economic climate in the property industry.

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Market and Distribution Channels

The incorporation sells its products both in the states market and across the world. The foreign markets include Canada, Japan, Latin America, and Mexico among others. The large amount of net sales emanates from the US market. This was followed by sales in Canada and Mexico. The largest users of the incorporation products are individual customers and incorporations in the recreational service industry. The net sales of the incorporation increased from $171, 234,000 in 2011 to $443,100,567 in 2012.

Cavco Industries Incorporation sells its mortgage, insurance, and factory-built products mainly though international distributors, local distributors, independent distributors, and incorporation contracted distributors. Further, the incorporation sells the products directly to low income and high income customers and franchising distributors. For instance, the incorporation has over 10,000 retail stores in the local market of the United States of America and beyond the borders. For the international market, the incorporation has a sales office in Mexico.

The use of one sales center to connect to other foreign markets does reduce the risks of supply chain disruption. Thus, in the event that the incorporation loses the Mexico sales center, marketing and sales responsibility will be transferred to other international regions. The incorporation will sell its products directly to customers and the independent distributors spread in its foreign markets. The only marketing risks that the incorporation faces are exchange rate fluctuations in the international markets, change of customer preferences, and reduced demand as a result of economic fluctuations and barriers to trade (Cavco Industries Incorporation 12).

As a matter of fact, their performance records and recommendations from several satisfied clients has always been a strong point in furthering expansion capacity. The incorporation has an active marketing team and a bank of competent professionals. To remain competitive in the dynamic market, the incorporation has managed to stand out in quality and competitive price structure (Eugene and Michael 34). The incorporation is divided into three segments with each segment operating independently but is simultaneous to one another. In addition, marketing is mainly controlled by a series of recommendations from their customers.

Competition

The manufactured homes industry in which the Cavco Incorporation operates in is characterized by stiff competition. Cavco Industries Incorporation faces stiff competition from three top companies in America dealing with factory-built homes. The three main competitors of Cavco include “Clayton Homes, Inc., Champion Home Builders, Inc., and Skyline Corporation since they possess substantially greater financial, manufacturing, distribution and marketing resources” (Cavco Industries Incorporation 8). However, Cavco Industries Incorporation has a greater competitive advantage than its competitors because it offers high quality factory-built homes for low income clients in addition to attractive mortgage and insurance packages.

Competition is mainly influenced by company positioning and intensity of projects competed against quality as recommended by clients. Due to high quality in service delivery, coupled with competitive pricing, Cavco Industries Incorporation has managed to survive the competition and is indisputably one of the leaders of this industry. Since the company has diversified its operation, it has managed to survive and remain profitable in the dynamic industry. In addition, it offers an outstanding after sales customer sales, discounts on mortgages, and competitive warranty that its competitors cannot provide. The incorporation depends on “the ability to engineer designs in-house to accommodate virtually any customer request” (Cavco Industries Incorporation 9). In addition, the incorporation’s fleet has ensured reliability in product delivery and response to customer demands.

Production Facilities

The main production facilities of the Cavco Incorporation are based in “Millersburg and Woodburn, Oregon; Nampa, Idaho; Riverside, California; Phoenix and Goodyear, Arizona; Austin, Fort Worth, Seguin and Waco, Texas; Lafayette, Tennessee; Martinsville and Rocky Mount, Virginia; Douglas, Georgia; and Plant City, Florida” (Cavco Industries Incorporation 14 ). In addition, the incorporation has made use of independent suppliers based in foreign countries such as Japan and Mexico to expand and eat into new markets. Reflectively, these manufacturing plants are strategically located across the market in the US to ensure that each unit cost of production results into maximum gain.

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However, despite these expansionary and strategic market positioning policies, the incorporation has continued to face unpredictability in the market response, especially in international markets that have penetration barriers and volatile currency. For instance, its operations in Mexico have continued to decline following economic instability in the country.

Promotional Activities

Since its establishment in 2003, the incorporation has been in the forefront of offering discounts, after sales services, friendly mortgage, and customized insurance packages that are tailored towards attracting and maintaining customer loyalty. Specifically, in the year 2011, the incorporation established the 2% mortgage discount to customers who pay their mortgage on time. In addition, the incorporation has spent millions of dollars in the research services department aimed at the creation of modern facilities in line with customer preferences. Through investment in new building technology, the incorporation has been able to design green houses that come with free services such as underground solar heating, wind fans, and efficient climate control roofing. Moreover, the incorporation spent substantial amounts of money in the advertisement and other promotional campaigns.

Acquisitions

The initial Cavco Entities Incorporation was formed in 1965. Due to the need for diversification and sustainable trade, the incorporation rebranded to Cavco Industries I Incorporation in the year 2003. Since then, the incorporation has been able to establish three independent business activities that include the mortgage subsidiary, insurance subsidiary, and the factory-built homes subsidiary. These subsidiaries offer support services to each other. During the 2011 fiscal year, the incorporation, through its Palm Harbor Homes subsidiary, acquired the Fleetwood Homes to purchase the incorporation in totality and its distribution chain. The “aggregate gross purchase price was $83.9 million and is exclusive of transaction costs, specified liabilities assumed and post-closing adjustments. Approximately $45.3 million of the purchase price was used to retire the Debtor-In-Possession (“DIP”) loan previously made by Fleetwood Homes to Palm Harbor Florida” (Cavco Industries Incorporation 12).

As a result of this acquisition, the incorporation acquired 49 locations of retail operation, 5 idle manufacturing houses, and all the trade marks. Reflectively, it is apparent that Cavco Industries Incorporation has expanded its scope of operations through a series of acquisitions, rebranding and adaptation of expansionary business policies. Through acquisitions, the company has been able to diversify its product. Secondly, the group has been able to expand the market share. Currently, it has presence in all continents. Further, the asset base and competitive edge of the group have enormously improved. This is because the assets of the acquired businesses are brought into the books of account of the group. Finally, the strategy enabled the group to spread risks that arise from international trade. As a result of these acquisitions, the incorporation has managed offer different services that meet the customer preferences and market demand.

From the above acquisitions analysis of Cavco, we can deduce that acquisition strategy enables companies to strengthen their market position. Further, it enables an entity to increase asset base, enhance competitive advantage, diversify its products, spread operational risks, and explore new markets. Therefore, a strategy is necessary for growth and success of the business. Strategies help in improving the profitability of the company and hence the shareholder return (Eugene and Michael 34). However, a parent company has to be strategic during acquisition as was in the case of Cavco Incorporation. It should consider acquiring companies that would have a long term impact on the company.

Notes to Consolidated Financial Statements

Notes to consolidated financial statements gives detailed explanation of the values reported in the income statement, cash flow statement, statement of changes in equity, and the balance sheet statement. Further, the notes give details or explanation of the information that were not included in the financial statements. The financial statements of Cavco Industries Inc. are accompanied by 26 notes. The first note gives information on the significant accounting policies used in preparing the financial statements. The first policy is the principle of consolidation. The financial statements of the company are prepared after consolidating operations of its two subsidiaries. The second key principle is revenue recognition. The note further goes ahead and explains other principles that guide reporting of figures in the financial statements. The second note gives information on the restricted cash. In 2012, the total amount reported was $6,784 up from $436. The increase was contributed by customer payment to be remitted to third parties ($3,643) and cash related to securitized loans ($2,128). The third note gives information on investments. The company has five investments in securities and treasury notes. The total fair value of the securities amounted to $14,202 as of 2012. The fourth note gives workings for the inventories reported in the statement of the financial position. The class of inventory are raw materials, work in progress and finished goods and others. The total inventory in 2012 amounted to $62,246 up from $16,036 in 2011 (Cavco Industries Incorporation 56).

The fifth note gives information on consumer loans receivable. These loans are held for various activities such as investment, sale and construction. The total loan receivables amounted to $119,299. The sixth note gives information on inventory finance receivable and allowance for loan loss. This amounted to $24,681 in 2012 up from $17,759 in 2011. The seventh note gives a summary of depreciation schedule for plant, property and equipment. The net balance of property plant and equipment increased from $35,993 in 2011 to $50,064 in 2012. Note eight shows workings for goodwill and other intangible assets. As at 2012, the gross value amounted to $84,240 while the gross value amounted to $68,859. Note nine gives a list of items that make up the accrued liabilities reported in 2011 and 2012. Some of the items that make up the accrued liabilities are salaries, wages and benefits, customer deposits, accrues taxes, accrued insurance and estimated warranties. The total accrued liabilities in 2012 amounted to $58,495. This was up from $26,245 in 2011. The tenth note gives information on the estimated cost of warranties for home owners. This amounted to $9,456 in 2012 up from $9,371 in 2011 (Cavco Industries Incorporation 66).

The eleventh note gives the items that make up the debt obligations. The total debt obligation amounted to $96,025 in 2012 and $36,000 in 2011. Note twelve gives information on the net premium on reinsurance. Reinsurance enables the company to write a larger risk and maintain losses within capital resources. The total net premium written in 2012 amounted to $9,031. Note thirteen gives information on income taxes and provision. The total income tax provision in 2012 amounted to $2,499. The fourteenth note gives information on commitments and contingencies. The balance of future contingent liabilities increased from $597 in 2011 to $819 in 2012. These are liabilities that arise from normal operations of the business. Further, note fifteen gives the difference between the net income and total comprehensive income. The total comprehensive income increased from $4,072 in 2011 to $29,844 in 2012. The sixteenth note gives workings for stock based compensations. These are restricted stock awarded to certain employees for exemplary work. The aggregate intrinsic value of the shares that can be exercised in 2012 amounted to $168,775. Note seventeen gives calculations of basic and diluted earnings per share. Note eighteen gives information on fair value measurements of various assets. Note nineteen gives information on employee benefit plan. The company maintains a self funded group medical plan. It is administered by third party administration. The medical plan compensates employees up to $200,000. The twentieth note gives information on debtor – in – possession note receivable. They arise for agreements entered into with Palm Harbor Florida. It is a DIP revolving credit agreement and a security agreement. The company agreed to provide up to $55.0 million for a debtor in possession of credit facility. Note twenty one gives a summary of the various accounting entries and documentations for the acquisition of Palm Harbor Homes, Inc. The total net assets acquired amounted to $83,900.

Note twenty two gives explanation on the redeemable non controlling interest. Note twenty three gave information on convertible note payable. The note indicates that the convertible notes increased by $22.0 million. This was as a result of the acquisition of Fleetwood Homes. Note twenty four gives information on related party transaction. The major related party transaction was with Third Avenue Management LLC which owns about 13.0% of Cavco Industries Inc. Note twenty five gives information on the results of each business segment. The financial statement is broken down based on the business segments. Finally, note twenty six gives a summary of unaudited quarterly financial data for the year ended March 31, 2012 and 2011 (Cavco Industries Incorporation 77).

Trends in Growth and Variability and Historical Financial Statements

The four key financial statements presented by the company are income statements, statement of changes in equity, balance sheet and cash flow statement. This section gives the trend the performance of the company with values picked from the four key statements. Further, it will also give information on the performance of the shares. The tables below summarize the trend of Calvo Industries Inc. for the three years between 2010 and 2012.

Trend and historical information for income statement values

Some of items in the income statement that will be discussed are net sales, gross profit, selling, general and administration expenses, and net income. The table below summarizes the values of these items reported between 2010 and 2012.

Item 2010 2011 2012
1 Net sales 115,612.00 171,827.00 443,066.00
Percentage change 48.62% 157.86%
2 Gross profit 10,697.00 24,278.00 95,945.00
Percentage change 126.96% 295.19%
3 Selling, general and administration expenses 16,718.00 21,345.00 79,800.00
Percentage change 27.68% 273.86%
4 Net income (3,793.00) 4,072.00 29,728.00
Percentage change 207.36% 630.06%

From the table net sales increased from $115,612 in 2010 to $171,827 to 2011. It is a 48% increase. It further increased by 157.86% in 2012 to $443,066. Gross profit similarly increased from $10,697 in 2010 to $24,278 in 2011. This was a 126.96% increase. It further increased to $95,945. This was a 295.19% increase. Further, selling, general and administration expenses increased from $16,718.00 in 2010 to $21,345 in 2011. This was an increase of 27.68%. It further increased to $79,800. This was an increase of 273.86%. Finally, the net income increased from ($3,793) in 2010 to $4,072 in 2011. This was a 207.36% increase. If further increased to $29,728 in 2012. This was a 630.06% increase. It is clear that the company has recorded a tremendous increase in performance from 2010 to 2012. This can be attributed an increase in the number of properties from 10 to about 30. Further, the company made a major acquisition of Fleetwood Homes in 2012. The company brought in net assets amounting to $83,900. Further, it is clear that the company is in a position to manage the cost of production and the cost of operating the business so as to earn profit. The graph below shows the trend of the various values between 2010 and 2012.

Trend of values

Trend in earnings per share and number of shares

Earnings per share denotes the net income that is attributed to the common shareholders. The table below summarizes the trend of earnings per common share and the weighted number of outstanding shares for the three years.

Item 2010 2011 2012
1 Earnings per common share (diluted) (0.52) 0.41 2.19
Percentage change 178.85% 434.15%
2 Weighted average number of outstanding shares (diluted) 6,516,572.00 6,859,457.00 6,949,077.00
Percentage change 5.26% 1.31%

From the table, the diluted earnings per share increased from ($0.52) in 2010 to $0.41 in 2012. This was a 178.85% increase. It further increased to $2.19. This was a 434.15% increase. The weighted average number of outstanding shares increased by 5.26% from 2010 to 2011. It further increased by 1.31% in 2012. The increase in earnings per common share can be attributed to increases in net income reported above. It is worth mentioning that the company did not pay any dividends during the three years. The trend of earnings per share takes the same trend as net income as shown in the graph below.

Earnings per common share

Trend and historical information for balance sheet items

The key balance sheet items that will be discussed are total assets, total long term liabilities and total equity. The table below summarizes the historical information of the balance sheet values for the company.

Item 2010 2011 2012
1 Total assets 232,342.00 269,719.00 437,334.00
Percentage change 16.09% 62.14%
2 Total long term liabilities 54,272.00 53,310.00 183,486.00
Percentage change -1.77% 244.19%
3 Total equity 145,776.00 150,669.00 168,343.00
Percentage change 3.36% 11.73%

From the table, total assets increase by 16.09% from 2010 to 2011 and by 62.14% in 2012. Total long term liabilities declined by 1.77% from 2011 to 2012. It increased by 244.19% in 2012. Finally, total equity increased by 3.36% from 2010 to 2011. It further increased by 11.73% in 2012. The large increases from 2011 to 2012 is attributed to acquisition made in 2012 and expansion of the scale of operation. The graph below shows the trend of the balance sheet values.

Trend of values

Ratio Analysis

The reported financial statements of the company do not give an in depth analysis of the strengths and weaknesses of the company. Therefore, it is necessary to carry out an in depth analysis of the financial analysis of the financial statements so as to have a better view of the company. Further, analysis of the company helps in making informed decision. Ratio analysis breaks down the financial data into various components for better understanding of the financial strengths and weaknesses of the company. Ratio analysis will focus on the profitability, liquidity, efficiency, and the gearing level of the company from 2010 to 2012 (McLaney and Atrill 96).

Profitability ratios

Profitability ratios give an indication of the earning capacity of an entity. The ratios measure the effectiveness of a company in meeting the profit objectives both in the long run and short run. The ratios show how well a company employs its resources to generate returns. Commonly used profitability ratios comprise of gross profit margin, operating profit margin, net profit margin, the return on asset ratio, and the return on equity. The table below summarizes profitability ratios for Cavco Industries Inc. for the period under review.

Profitability ratios 2010 2011 2012
1 Gross profit 9.25% 14.13% 21.65%
2 Net profit -3.28% 2.37% 6.71%
3 Return on assets -1.63% 1.51% 6.80%
4 Return on equity -2.60% 2.70% 17.66%

From the calculations above, it is evident that the profitability ratios increased over the period under review. For instance gross profit margin increased from 9.25% in 2010 to 14.13% in 2011. It further increased to 21.65% in 2012. Similarly, net profit increased from (3.28%) in 2010 to 2.37% in 2011. It further increased to 6.71%. The two ratios show the ability of the management of the organization to manage the cost of sales and cost of operation so as to generate sales. The industry net profit margin is 3.8%. This implies that the net profit margin of the company for the first two years is lower than the industry average. However, in 2012 the net profit margin for the company exceeds the industry average. Despite the acquisition, the company has shown increasing ability to manage the costs so as to generate sales. Return on assets shows the ability of the organization to generate revenue from the assets of the company. The return on assets increased from (1.63%) in 2010 to 1.51% in 2011. It further increased to 6.80% in 2012. The industry statistics for return on equity is 7.9% (ABC News Network 1). The company’s ratios for the three years did not meet the industry average. This shows the increasing ability of the organization to generate sales from the assets of the company. Finally, return on equity shows the ability of the management to generate revenues from shareholders’ fund. The ratio increased from (2.60%) in 2010 to 2.70% in 2011. It further increased to 17.66% in 2012. The management of the company has been successful in ensuring success in increasing the revenue generated from shareholders fund. Generally, profitability of the company has increased over the three years. It is a good indication to any third party willing to engage with the company. The graph below shows the trend of the ratios for the three years.

Profitability ratios

Liquidity ratios

Liquidity ratios show the ability of an organization to maintain positive cash flow while satisfying immediate obligations, that is, the availability of cash to pay current debt. The common ratios used to analyze liquidity are current and quick ratio. It is necessary to maintain optimal liquidity ratios since either low of very high ratios are not favorable. The table below summarizes the liquidity ratios for the Corporation.

Liquidity ratios 2010 2011 2012
1 Current ratio 3.50 2.24 1.98
2 Quick ratio 3.01 1.99 1.25

Current ratios for all the years are greater one. This implies that the organization is able to meet current obligations using current assets. The current ratio declined from 3.50 in 2010 to 2.24 in 2011. It further declined to 1.98 in 2012. The company’s current ratios are high especially in 2010. It implies that the company had a very high liquidity and that most assets were held in the form of cash instead of revenue generating assets. Similarly, the quick ratio declined from 3.01in 2010 to 1.99 in 2011. It further declined to 1.25 in 2012. Generally, a company needs to maintain the current ratio between 1.5 to 2.0 and quick ratio between 1.0 to 1.5. Very high ratios are not suitable. The fact that the ratios are declining is a good indication but they should not decline to values lower than industry averages. The graph below shows the trend of the liquidity for the three years.

Liquidity ratios

Solvency ratio

Solvency ratios measure the ability of the company to repay the long term debts. A commonly used ratio that is used to measure solvency of a company is the times interest earned ratio. The table below shows the times interest earned ratio for the company.

2010 2011 2012
Times Interest Earned 0 0 2.22

From the table above, the company incurred interest expense in 2012 only. This emerged from the acquisition made in 2012 of Fleetwood company. The ratio shows that the company is in a position to pay with ease the interest expense using earnings before interest expense and taxes. High times interest earned ratio is favorable.

Leverage ratios

A company’s leverage is explained by the amount of debt financing it holds. The ratios are vital since they show the investor the extent of exposure of equity financing. A commonly used ratio is the debt to equity ratio. A high leverage ratio is not favorable since it scares away capital providers. It is because high ratios imply an increase in interest expense. This reduces the income attributable to to shareholders. On the other hand, very low ratios are not favorable since it shows that the management of the company are not willing to exploit the potentials of the company. The table below shows the debt to equity ratio for the company for the three years of review.

2010 2011 2012
Total debt to equity ratio 0.59 0.79 1.60

From the table, the total debt to equity ratio increased from 0.59 in 2010 to 0.79 in 2011. It further increased to 1.60 in 2012. The leverage level of the company is quite low though it is increasing. Considering that the nature of the business is capital intensive, it would be expected that the ratio would be higher than what the company attained. Further, the ratios for the three years is lower than the industry average which currently stands at 18.5. A low debt to equity ratio implies that the company has a low amount of debt financing in relation to equity financing. This implies that the company has not exploited its full potential. It implies that there is room for growth in the company. Increasing debt to equity ratio shows that the company has started to exploit its potentials. However, caution should be taken so that the ratios are maintained within optimal level. The graph below shows the trend of the debt to equity ratio for the three years.

Leverage ratios

Efficiency ratio

Efficiency ratios focus on the internal operations of the company. These ratios show the level of activity in a company, that is, how well a company manages resources to generate sales. Commonly used turnover ratios are fixed asset turnover ratios, asset turnover ratios, stock turnover ratios, debtor collection period, and creditor payment period. A summary of the turnover ratios is shown in the table below.

Efficiency ratios 2010 2011 2012
Fixed asset turnover 3.07 4.77 8.85
Total asset turnover 0.49 0.63 1.01
Stock turnover 6.66 9.20 5.57
Debtor collection period 29.76 13.96 12.25

The efficiency ratios for the company has been increasing over time as shown in the table above. The fixed asset turnover increased from 3.07 in 2010 to 4.77 in 2012. It further increased to 8.85 in 2012. Similarly, the total asset turnover increased from 0.49 in 2010 to 0.63 in 2011. It further increased to 1.01 in 2012. The fixed assets and total asset turnover measure the amount of sales generated from each unit of fixed asset and total assets respectively. Increasing ratios are favorable since they show increasing utilization of assets in the company to generate sales. The stock turnover ratio increased from 6.66 in 2010 to 9.20 in 2011.However, it declined to 5.57 in 2012. The stock turnover ratios measure the rate at which stock is turned to sales. A high stock turnover ratio is favorable since it shows that less money is tied in less productive assets. The decline in the stock turnover ratio reported in 2012 is attributed to the acquisition of Fleet wood corporation. The company acquired inventory worth $47,229. This contributed to a large amount of closing stock in 2012. Finally, the debtors collection period declined from 29.76 days in 2010 to 13.96 days in 2011. It further declined to 12.25 days in 2012. The debtors collection period shows the efficiency of the company in collecting debts of the company. An increasing number collection day shows a decline in efficiency in collecting debts of the company. A decreasing number of collection days, as in the case of Cavco industries Inc., are favorable. Efficiency is attained when the company collects debts in lesser number of days. The graph below shows the trend of efficiency ratios over the three years.

Efficiency ratio

Summary of ratio analysis

From the ratio analysis above, it is evident that the company’s liquidity position is favorable, that is, they are able to meet current obligations using current assets. Further, profitability of the company is relatively high and it shows that the company is attractive enough to invest in. Further, the efficiency of the company in using resources has increased over time. Also, the company’s leverage is favorable though extremely conservative. Finally, the solvency of the company is favorable. The substantial increase in performance of the company can be attributed to the major acquisition that took place in 2012.

Analysis

Pro – forma financial statements

This section gives an estimation of the initial – pro forma statements of the company for two years these are, 2013 and 2014. Pro – forma income statement and summarized pro – forma balance sheet will be prepared as shown in appendix one. From the financial analysis above, it is evident that the financial position of the company improved significantly with values increasing by more than 100%. However, this massive increase is not attainable in the future because the increase was generated by the acquisition that took place. Therefore, conservative rates will be used to grow the financial statements of the company. All items will grow by 20% both in 2013 and 2014. Based on the assumptions, the net income will be $18,284.40 in 2013 and $21,941.28. While the total assets will be $524,800.80 in 2013 and $629,760.96 in 2014.

Capital structure, funding analysis and valuation

Analyzing the capital structure of a company is of utmost importance because it determines the rate at which a company grows. Further, it also dictates the amount of working capital that is available for the company. The capital structure shows the amount of various ways of funding that the company uses. The management of the company needs to maintain an optimal mix of various sources of funds because the mix has an impact on the profitability, cash flows and amount attributed to shareholders. The capital structure that a company decides to use depends on the market the company operates in (Holmes and Sugden 179). The table below shows the current capital mix of the company for the year 2012.

Source of funds Amount (000’) Proportion
1 Total debt 54,272.00 27.13%
2 Total equity 145,776.00 72.87%
Total 200,048.00 100%

The current capital structure of the company comprises of debt and equity financing. The total debt amounts to $54,272. It is equivalent to 27.13% while the total equity amounts to $145,776. It is equivalent to 72.87% of the capital structure. Therefore, it is evident that equity financing is greater than debt financing. Capital structure can be presented in a pie chart as shown below.

Cost of debt and cost equity

Cost of debt and cost equity

Determination of optimal capital structure is a vital decision on financing options to use. Optimal level of debt is the level at which the cost of capital is minimized. It is the level beyond which a firm should not borrow. Further, as debt increases, equity becomes riskier and the cost of equity will definitely increase. The optimal debt ratio depends on a number of factors. These are the tax rate, the pre – tax returns on firm, variances in earnings and default spread. Computation of optimal debt will be based on the Damodaran model thus the amount of debt has an effect on the capital structure of the firm. The weighted average costs of capital approach will be used to calculate the optimal debt. Based on this approach, the cost of debt is determined by a number of factors these are, the rate at which the company can borrow long term today (risk free and a default spread) and the tax rate. The cost of debt is not similar to the interest rate at which a company obtains debt. The cost of debt is computed as shown below.

Cost of debt = (risk free rate + default spread) (1 – t)

Risk free rate = 6%

Default spread = 0.4

Tax rate = 30% (corporate tax in the US is 34%)

Substitute the values

(6% + 0.4)0.66 = 4.224%

The cost of debt is 4.224%. It is based on the risk free rate of 6% and the default spread is 0.4%. Determination of the optimal amount of debt majorly depends on the objective the firm. Use of debt is cheap and it reduces the weighted average cost of capital. However, increasing the amount of debt increases the amount of weighted average cost of capital as gearing, financial risk, and beta equity goes up. If the Group’s objective is to maximize shareholders’ wealth, then the company must reduce the amount of debt thus reducing beta equity. Further, the amount of debt is inversely related to its risk.

Cost of equity denotes the of return shareholders require for their investment. Equity is a significant component of the capital structure. It is worth noting that the amount debt in the capital structure has an impact on the cost of equity. High amount of debt increases risk of equity thus increasing the risk premium that shareholders will require for their investment. Cost of equity is computed using the formula shown below.

Cost of equity = risk free rate + Beta * Risk premium

Risk free rate shows the rate of interest that does not have default risk, no reinvestment risk and are in the same currency. Beta measures the market risk in which the group operates in. Beat depends on the type of business, operating leverage and financial leverage. Finally, risk premium shows the premium for the average risk of investment.

Cost of equity = 6% + 1.37 * 5.82% = 13.9734%

The calculations above shows that the cost of equity is 13.9734%. The market risk premium for the industry is 5.82%. The risk premium and the beta factor are relatively high due to the nature of the industry in which the company operates. Computation of the weighted average cost of capital is shown below.

The weighted average cost of the capital = cost of equity * proportion equity the capital structure + cost of debt * proportion debt in the capital structure.

Weighted average cost of capital = 13.9734% * 72.87% + 4.224% * 27.13% = 11.3046%

The calculations above can be summarized as shown in the table below.

Source of funds Amount Proportion Cost of capital
1 Total debt 54,272.00 27.13% 4.224%
2 Total equity 145,776.00 72.87% 13.9734%
Total 200,048.00 WACC 11.3%

The company should maintain a capital mix that will maximize shareholders’ wealth. Debt offers a cheap source of financing though it reduces shareholders’ wealth. The optimal level of debt in the capital structure should not be more 50% of the total amount of debt.

Value of debt and equity

The value of debt can be indicated by the interest rate for the US treasury bonds. The rate is 4.23%. The cost of debt is equal to its intrinsic value. Valuation of equity shows the value of a company based on the current assets and its position in the market. The valuation is of significance to potential shareholders and debt providers so as to know how the shares of the company performs in the market. There are a number of models that can be used to value equity of the company, these are, price earnings ratio, dividend discount model, and dividend growth model. Valuation of equity will be carried out using a price earning ratio. It is a ratio of market value per share and earnings per share. Using this valuation model, the value of equity is £25.13. The current share price is $45.64. It is evident that the company’s shares is been trading at a price greater than the intrinsic value of the shares. The graph below shows the chart for daily share prices for the past one year plotted against the intrinsic value.

Value of debt and equity

Dividend Policy

Dividends have not been paid for the past five years. This can be attributed to the growth stage of the company. Based on the dividend growth model, the company is in a position to pay dividend after reaching maturity stage. Currently, the company is focusing on growth. Management is concerned with increasing sales.

Investment Decision

Criteria for evaluating future funding needs

Investment decisions require adequate review before injecting funds into the investments because they require massive capital. Further, the decisions are irreversible. Also, there are competing demands for capital therefore, funds should only be channeled to most viable ventures. There are a number quantitative criteria that can be used to evaluate an investment. The firm’s key goal is to reduce leverage and increase returns. A significant quantitative approach is the net present value approach. It shows the present value of net benefits that a firm expects. It is a superior method of evaluating project because it uses cash flow for the entire project life. Finally, the management can use the internal rate of return to evaluate the project (Eugene and Michael 279)

Discounted Cash flow Assumptions

The company is considering the possibility of acquiring a machine that costs $2,575,000. The average fee per use of the machine is $889 while the variable cost is $91. The company cannot postpone acquisition of the machine. The machine is expected to operate for 5 years thereafter it will be written off. The operating cost per annum is estimated at $10,000. The streams of income expected during the five years and calculation of NPV is summarized in appendix two. Assume the required rate of return is 15%.

Break even analysis

Break even analysis gives the number of units that must be processed with the machine so that the total cost equals to the total revenue earned.

Total revenue (P * Q) = total cost [Variable (C *Q) + fixed cost]

  • 889 * Q = 91* Q + 2,575,000
  • 889Q – 91Q = 2,575,000
  • 798Q = 2,575,000
  • Q = 2,575,000/798 = 3,226.81 units per year

Net present value

The net present value method will involve selection of a rate acceptable to the management or that equals the cost of finance. If the NPV is positive, the decision should be to invest in the project but if negative, the decision should be to avoid the project. From the calculations in appendix two, the net present value of the project is $30,048. Therefore, using the net present value approach, the acquisition of the machine yields a net return amounting to $30,048.

Internal rate of return

IRR is a tool of capital budgeting that give the discount rate that equates the present value of cost to the present value of benefits. Basically, it is the discount rate at which the net present value of the project is zero. Interpolation will be used to estimate the value of IRR. A project is accepted when the internal rate of return is greater that the required rate of return. From the calculations in appendix two, the IRR is 15.5% it is slightly greater than the required rate of return. This implies that the project is viable.

Discounted payback period

The capital decision analysis tool gives the duration of time that the business will take to recover the initial cost of investment. This tool of analysis is significant for ranking of projects or for assessing projects high risk projects. In such projects, the investors require return within a short duration. A project with a shorter payback period is often preferred.

Discounted payback period = Present value of cash inflows / initial investment

The discounted payback period for the project is 4years, 11 months.

Investment Choices

Based on the criteria discussed above, the project is viable and worth investing in. However, it will take the management a period close to the life of the project to recover the cost of the project.

Sensitivity analysis

Sensitivity analysis is carried out to ascertain how profitability of the company changes when certain variables such as the price of the commodity, cost of production or operating expenses changes. It is important to find out the key factors that affect the profitability of the business. Sensitivity analysis helps in assessing how profitability will change in a worst case and a best case scenario. Appendix three shows the workings and the workings for sensitivity analysis.

Conclusion

The nature of a company defines its financial position. Comprehensive analysis of financial performance of a company like Cavco Industries Incorporation may prove complex due to the fact that it operates more than one segment existing independently of the other. As indicated in the above analysis, it is apparent that profitability of this multinational company has remained steady despite slight variances noted across the five year period. Despite a dismal performance in 2010, Cavco Industries Incorporation has exhibited steady capital structure and dividend though earnings per share declined. Reflectively, due to strategic position, the company was in a position to meet its current obligations every year.

From the analysis of profitability, return on equity, return on assets, and efficiency ratios, it is apparent that the performance of this company is predictable and very stable. Thus, creditors and investors are not only safe but are assured of returns on their investments in short and long term. The current capital structure allows for expansion of the business since it is very profitable and operates below the optimal debt level. As indicated in the above financial analysis, Cavco operates in a competitive market that expands steadily. The market is sensitive to inflation and its effect on the foreign currency exchange rates. This is indicated by a dismal performance in 2010 associated with the global depression of the early 2009. From the ratio analysis, it is apparent that the company is in a steady position to benefit from competitive advantage, while at the same time expand without serious difficulties as it has displayed consistence in performance over the years. Despite the low start, the company is in a process of resuming optimal performance as noted in the stability of its returns and capital structure.

As a matter of fact, the steady and lower rates of equity are an indication of stability which in turn is an assurance to creditors and investors of the company’s credit worthiness. Notably, the debt to equity ratio remain low and within the ideal despite slight inconsistence incorporation efficiency in balancing net worth and total sales. At present, the current positioning of the firm can be extrapolated and used to make future forecasting because of consistencies in profitability and operations efficiency. In addition, its current capital structure guarantees potential investors and creditors of high return rates on every investment. Therefore, as reflected in the comprehensive financial analysis, the company is viable and safe to invest in. Besides, it has a stable capital structure that can support expansionary investments with short term and long term positive returns. Incorporation of the market forces analysis in the management of this successful incorporation is directly linked to its consistency, profitability, and efficiency.

Works Cited

ABC News Network 2013, Company Profile. Web.

Cavco Industries Incorporation 2012, Annual Report 2012. PDF file. Web.

Eugene, Brigham, and J. Michael. Financial Management Theory and Practice, USA: South-Western Cengage Learning, 2009. Print.

Holmes, Green, and A. Sugden. Interpreting Company Reports, New York: Harlow, 2008. Print.

McLaney, Evans, and P. Atrill. Financial Accounting for Decision Makers, London: Harlow, 2008. Print.

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