Challenges and opportunities of Kingsgate Consolidated and ability to create shareholder value
The challenges the company will face for the near future is the weak economy in general as well as the exceedingly globalized situation on our planet is how to defend their existing market share from other multinational entities while at the same time dealing with major technological upheavals. The recommended action for the company to go global to take advantage of the cheap labour that everybody else is taking advantage of. They should move all business processes that can be done on countries with a lower labour cost like the customer service aspect and sales functions. Instead of waiting for the competitors to take the initiative, Kingsgate Consolidated needs to take the lead.
Beginning with the largest sector which shares the prime chunk of influence and not easy to avoid is Political sway. This factor includes Government Intervention, Tax Policy, Labour Laws, Trade Restriction and Tariffs, which considerably affect the company’s performance. Political stability and law and order situation in country is of utmost importance and Australia, is considered as rather secured in this regard. Law and Order situation and prevailing legislature provides legal safety, which is critical for investors and stakeholders to know.
There has been a phenomenal increase and the company should look to the future by making sure that some of inefficiencies of the operations are ironed out in order to help them achieve improved things in terms of their business vision and mission. In addition to this another factor of concern for the company should be the amount of debt that it has taken up, although manageable at these levels of profit making, it will be very hard to sustain once the company has a bad patch. It would be advisable that the company use sources of financing other than direct debt to grow organically rather than on steroids. However in line with the positive future outlook of the company, it will be a worthwhile investment since it is expected that share prices are low right now, but it’s just a matter of time before Kingsgate Consolidated Ltd kicks off well resulting in a upsurge in share prices (Correia, Flynn and Uliana, 2007).
Activity-based costing contribution to shareholder wealth
The cost factors play an important role in pricing and its influence in pricing varies with the circumstances. In some pricing decisions, costs play only a secondary or tertiary role. On the other hand, the impact of the cost factors is great in some pricing decision. For example, in a mining industry, they become the primary determinant of price. This means the use of activity-based costing is very necessary for Kingsgate because the gold will be sold at a profit thus increasing the shareholders value. This is because cost acts like an indication of profitability rather than a pricing tool. Whenever a standardized product competes in an established market with other products serving the same purpose, price is established by the competitive market through the law of supply and demand and is relatively unaffected by the costs of individual suppliers (Palepu, Healy and Bernard, 2010). Instead of providing a pricing tool, costs in this case serve primarily to indicate the profitability with which a product might participate in an established market at the current or predicted future market price. Alternatively, if the costs of a product prohibit it from being sold in the competitive market at a satisfactory profit, management is asked to discontinue the production of the product or discover ways to produce and market it less expensively (Gallagher and Andrew, 2007). Thus, Activity-based costing being a comprehensive and fully integrated system of cost management that tries to allocate costs efficiently helps to solve this problem for Kingsgate Consolidated Ltd. The activity-based costing is to divide a company’s operation into specific activities, grouping them similarly to the primary support activity categories. Within each category, Kingsgate Consolidated Ltd performs a number of activities that may represent cost drivers. Each activity in the mining industry incurs costs and ties up time and assets. Activity-based costing analysis requires managers to assign costs and assets to each activity, thereby providing a very different way of viewing costs than traditional cost accounting methods would produce. Identification of how different activities influence costs can help in modifying the planning of factory layouts and improved efforts in the design process in order to decrease potential costs of production. Proper analysis of activities is believed to assist in better performance evaluation. At higher management levels, the activities can be aggregated to coincide with responsibility centres. Managers are the ones who would be accountable for the costs of the activities associated within the scope of their responsibility (Brigham and Houston, 2008).
Based on the above discussion Kingsgate should adopt the ABC method to remain profitable and add shareholders value.
Market valuation of Kingsgate Consolidated Ltd
In calculating the shareholders value of the company, the future cash flows are estimated using the seven drivers of shareholders value model. These values have been estimated using historical data as provided in the appendix. These drivers have summarised as shown below:
Cost of equity- The required rate of return of the company will be calculated using capital asset pricing model (Moles, Parrino and Kidwell, 2011).
The formula for capital asset pricing model is:
- rj = required return on a security
- rf = risk-free rate of return
- ßj = beta coefficient for the security
- rm = required return on the market portfolio
In this case, the risk free rate is a 10-year treasury rate, which is 4.26% while the market premium always stands at 7% with a few adjustments and the beta of the company is 1.0. However in this case we shall use 7% as the market premium (
–
) and the beta of 1.0
r=
+β (
– 
) = 4.26%+1.0 x 7%=11.26%
The required rate of return for the company equity as calculated above is 11.26%. The value of the shares of the company is 316.053 million and value of bonds of the company is 23.912 million (Kingsgate Consolidated Limited, 2011).
Cost of debt
The average cost of debt is 7% and
- After tax cost of debt = (1-tax) x Cost of debt
- After tax cost of debt = (1-tax) x 7% = 5.58%
The weighted average cost of capital
Weighted average cost of capital is the average cost of components of capital of capital. The weighted average cost of capital is computed as:
Weighted average cost of capital
The excel import is as shown below;
The future cash flows and their present values are estimated using these drivers is shown are shown in appendix but are summarised below:
This is after assuming that the market is efficient the intrinsic value is $ 11.25.
The efficient markets theory states that the price of commodities reflects all such factors. Surpluses and shortages are thus dealt with accordingly – a surplus would lead to a fall in prices and hence demand would increase and vice versa.
Analysis and discussion – The maturity of the mining industry has already long been a fully matured market and there is indeed very little room for growth. In fact, a sizeable growth of the company will come from its foreign operation expansion. The company can always improve their existing market and customer base and introduce new lines of product but it will not have the dramatic effect expected from fast growing companies. Its competitive advantage is the size of its organization, which produces many economies of scale for the business as well as its diversified operations. The presence on energy as well as other industries helps ensure the company will not be severely affected by any sudden downturn from one of their sources of income (Besley and Brigham, 2007; Sharan, 2008).
The management is adding value to the company in terms of the expansion overseas and entering new markets. The stock price of the company is also very close to its actual intrinsic value. The financial valuation of the company indicates that they are indeed strong and growing at a healthy rate. The residual income is growing at a constant rate despite the negative factors still present. The only downside to their operation is their need for massive capital inputs. They surely will not be as fast in terms of growth and revenue generation unlike technology companies but they are very resilient when it comes to technological changes and economic downturns by the very nature of their businesses as well. In short, they are big and strong but unfortunately, they are also slow in terms of investment growth rate (Kapil, 2011). To provide a rough picture, they are 18% in terms of the actual value they have for investors if we are to compare their calculated present value from the current operating asset size they have. It is not small but it is not big either. They fall in the category of average.
The current stock price of the company is hovering at 6.77 something with an EPS of 0.19 and a P/E of 36.34 only. The return on investment from the company is steady and growing steadily as well with many strong core competencies but not generating income in an explosive manner like well known companies do. The EPS is good when compared to its colleagues in the industry. The PE multiple is also average as well. In short, the company is a solid business but does not belong to the impressive category either as a business or as an investment option. Solid and steady depicts them perfectly.
Conclusion
If we are to take the calculated discounted value of the company at $2.668 Billion and then divide it with the number of shares at 915.8B, we will get the result of $11.25 per share. If we are to compare this value with the current stock price of $ 6.77(Finance.yahoo, 2011), it is not close to the valuation of the business. Hence, we can conclude that the stock price is not indeed reflective of the true business potential of the company.
For any outside investor, the answer to whether or not they should invest in Kingsgate Consolidated Ltd is yes. Although their investment money could certainly find other impressive places that will, more than double their money’s worth, Kingsgate Consolidated Ltd will at least ensure that their investment is in a safer place like any other because of the sound management and solid business strengths it was based upon.
Reference List
Besley, S., & Brigham, E. 2007. Essentials of managerial finance. Mason: Cengage Learning.
Brigham, E. & Houston, J. 2008. Fundamentals of financial management. Florence: Cengage Learning.
Correia, C., Flynn, D. & Uliana, E. 2007. Financial Management. Cape Town: Juta and Company Ltd.
Finance.yahoo, 2011. ‘Financials- Kingsgate Consolidated Limited’. financeyahoo. Web.
Gallagher, T. & Andrew, J. 2007. Financial Management; Principles and Practice. Saint Paul: Freeload Press Inc.
Kapil, S. 2011. Financial Management. New Delhi: Pearson Education India.
Kingsgate Consolidated Limited, 2011. AnnualReport2011. Kingsgate Consolidated Limited. Web.
Moles, P., Parrino, R. & Kidwell, D. 2011. Fundamentals of Corporate Finance. San Francinsco: John Wiley and Sons.
Palepu, K., Healy P. & V. Bernard V., 2010. Business Analysis and Valuation using Financial Statements: Text and cases. New York: Springer.
Sharan, V. 2008. Fundamentals of Financial Management. New Delhi: Pearson Education India.