Tweedie plc has had consistent revenues in recent years from operational activities but had to dispose of its overseas operations in 2010 to streamline the company. The company appears to be financially sound, though investors may have observed that the company does not promise high earnings in the future as evidenced by the lower than industry P/E ratio. The stable revenues generated by the company could confirm to investors that there is low risk in investing in the company but such investors should not expect higher than average returns, but investors should be wary of economic conditions as Tweedie plc was negatively affected by the 2007-2009 global financial crisis. Investment on a long-term basis however could be recommended.
Tweedie plc is a medium-priced enterprise that operates a chain of hotels in the UK. The company has been on a low growth trajectory since 2006, with directors of the company moving to dispose of their overseas hotels in a bid to streamline the company in 2010. This report will seek to offer guidance on any investment opportunities in Tweedie plc, with emphasis drawn on the financial analysis of the company. The horizontal analysis will be used to portray the performance of the company over three years of analysis while benchmarking and vertical analysis will help illustrate the financial position and competitiveness of Tweedie plc (Weygandt et al. 2008, p. 207).
It should be noted that some limitations on the use of ratio analysis in the development of this report have been discussed. The purpose of the limitations section is to provide the reader with a more comprehensive view of the analysis conducted and thereby aid the reader in making informed decisions. Conclusions made are from the findings in the case study and recommendations made are from the view of the researcher and should therefore be treated as so.
Cash and Profit
Cash accounting differs significantly from accrual accounting. Cash accounting assumes that expenses and revenues are earned the moment cash is received or spent while accrual accounting relates revenues and expenses the moment they are incurred. Analysis of the profitability of the company is drawn from its operational activities, while cash balances could reflect other activities that Tweedie plc is involved in, including financing and investing activities. Activities such as the revaluation of assets and depreciation affect the profitability of a company but rarely affect cash balances, thereby causing a variation between cash flow and profits. The company disposed of its overseas hotels as directors look to concentrate on a few operations.
Tweedie plc has a relatively healthy positive operating profit but has realized negative cash inflows from operating activities. This could be as a result of its policy of extending credit terms to some of its customers in the company’s promotional activities. The result of increasing accounts receivables, coupled with the high tax payment has restricted the amount of cash recoverable from operational activities. The sale of overseas operations has contributed the most in strengthening the cash position of Tweedie plc.
In the company’s financing activities, Tweedie managed to issue additional shares but refrained from paying dividends to its shareholders in the fiscal year 2010. The net effect of the decision is an £850,000 increase in retained earnings. By failing to declare and distribute dividends, directors could be in the view of investing further in the UK, which gives the company a positive future outlook (Shim & Siegel 2008, p. 43).
Analysis of Tweedie Plc
Tweedie plc has a higher gross profit margin than Bilton plc. This could be as a result of high prices charged to customers or a combination of variations in prices and costs, whereby the margin widens (Wild & Bernstein 1998, p. 67). The same cannot be said of the operating profit margin, whereby Bilton plc has a higher ratio. A possible reason for this could be that Tweedie plc has higher operating costs, and therefore been unable to convert its higher gross margins into more profits. Gross margins have been declining in recent years which could be due to declining prices in the market, or implementation policies aimed at increasing customers such as discounts and lowering prices.
The net profit margin could be explained by the use of the operating ratio. For the year ended 31 March 2010, Tweedie plc has an operating ratio of 93.78 percent, indicating that 93.78 percent of sales have been used up by the cost of goods sold and operating expenses, while the rest is left to cover interest, tax, dividends and retained earnings needed for future investing purposes. A high operating ratio is unfavorable because it leaves little money to meet other obligations of the company.
The return on assets (ROA) ratio provides insight into how effectively the company is utilizing funds supplied by creditors and shareholders. Net profit after taxes excludes the cost of debt, or interest, which leads to an understatement of earnings generated by the pool of funds if interest is not included in the net profit after taxes figure. In this case, the current ROA is 8 percent, indicating there is a return of 8 percent on all financial resources invested in Tweedie’s assets.
Tweedie plc has a higher ROCE (return on capital employed) in comparison with Bilton plc, a competitor in the same industry within the UK. ROCE illustrates how effective management of the company is utilizing funds entrusted to it (Sharpe, Alexander & Bailey 2008, p. 570), while the comparison with a similar company demonstrates the performance of Tweedie plc. Tweedie plc and Bilton plc have accumulated almost sizeable revenues, though the latter company has higher capital employed levels to match the almost similar revenues. Tweedie plc has had a higher ROCE ratio since 2006, at over 7 percent. Bilton plc on the other hand has a ROCE averaging 4.4 percent, meaning that investors are best suited to invest in Tweedie plc. Tweedie plc’s higher ratio indicates funds are being used more efficiently, which could add to the company’s relative strength in attracting funds in the future.
The average trade receivable days of Tweedie plc are 15 days, as per 2010. The average collection period is slightly longer than that of its competitor Bilton plc. While this exposes Tweedie plc to more bad credit risk, the collection period is in line with the company’s policy of extending credit terms to attract more customers. This move could add to the company’s competitive strengths since the strategy may enhance the level of sales and improve the profitability of Tweedie plc.
|Acid test ratio||0.7:1||0.9:1||0.8:1||0.6:1||3.2:1|
As from the table above, Tweedie plc could be viewed as attempting to match its current assets and its current liabilities. The current ratio represents a margin of safety from creditors, while too high the ratio may represent idle assets. The 1-to-1 current ratio of Tweedie plc could be considered satisfactory though a refined measure of the firm’s liquidity, in this case the acid test ratio, could provide further analysis of the company’s financial position. The acid test, or quick ratio, establishes the relationship between significantly liquid assets and current liabilities.
Tweedie plc, from 2006 to 2009, has averaged a quick ratio that is lower than the conventional 1-to-1 ratio which may not necessarily imply bad liquidity position. The low acid test ratio could be as a result of Tweedie’s policy of paying current obligations on time. Being a firm that provides hospitality services, the small variation between the Tweedie’s current ratio and its acid test ratio could be due to low investment in inventories. Tweedie plc is more liquid than Bilton plc in terms of both the current ratio and quick test ratio, and is therefore in a more comfortable position in paying its debt. In 2010, Tweedie plc had significantly high current and acid test ratios which could be as a result of the sale of overseas operations in 2010, thereby causing a large increase in the bank balance.
Tweedie plc has been decreasing its use of debt in recent years, as evidenced by the steady decline in the company’s gearing ratio from 8.3 percent in 2006 to 7.6 percent in 2008. The ratio is expected to decline further in subsequent years, especially after the issue of additional shares, to 6.29 percent in 2010. This could indicate that either the current investment opportunities have high risks, which would be reflected by high interest rates, or that Tweedie plc has identified a long term investment opportunity that does not justify the use of debt. Creditors of the company are likely to be satisfied by the capital structure of Tweedie plc since the high proportion of equity presents a larger cushion of safety for them. Shareholders of the company are likely to expect low returns from the company as a result of low gearing.
Tweedie plc has an EPS (earnings per share) figure of 0.1953 pence in fiscal year, as compared with an EPS of 0.0333 pence in 2009. This indicates that the company’s earning power on a per share basis in the period under review. This has been explained by the sale of overseas operations in 2010, thus the higher EPS levels may not significantly be sustainable, at least in the short term. The subsequent price-earnings ratio in 2010 is 8.986 which are lower than the typical industry ratio of 12. This result deems that investors have low expectations about the growth of the company’s future earnings. Tweedie’s revenues have only increased marginally over the 2006-2008 period. The company’s earnings were affected by the global recession, which resulted in a decline of revenues (Fridson & Álvarez, 2002).
Limitations of ratio analysis
Although ratio analysis is a widely used technique for evaluating the financial position and performance of a company, there are certain problems that arise from the use of ratios, as discussed in this section. One limitation is that complications arise when deciding on the proper basis for comparison. In the case study, the comparison is rendered difficult because of the differences in situations and information provided on Tweedie plc and Bilton plc. Details provided for Bilton plc relate to years 2009 and 2010 while comparison data on Tweedie plc relates to years 2006, 2007 and 2008.
A second limitation is that interpretation of financial ratios is subjective, based on the analysts experience (Fridson & Alvarez 2002, p. 14). The user or analyst of such information determines the meaning of such ratios. For example, one analyst could Tweedie plc a low credit rating because it has a low current ratio. Another analyst could be in the view that Tweedie plc is utilizing its resources more efficiently. The third limitation is that while it’s important to analyze company information based on a comparison with a similar company in the same industry, difficulties arise when choosing an alternate company for comparison purposes. This is because no two companies are alike, in terms of resources, structure and policies used. In the case study, Tweedie plc has a policy of not revaluing its properties while Bilton plc revalues its properties. This would cause Bilton plc to report higher profits should the value in its properties appreciate, while Tweedie plc would not report such gains in property values.
Conclusions and Recommendations
Tweedie plc appears to have a strong operation in the UK, with revenues being consistent over the years in focus. The company has a better performance level than its competitor, Bilton plc, with revenues growing at slow rate from 2006 levels but the company’s revenues were negatively impacted by the recent global recession. The company may bounce back with positive earnings, depending on the UK economy. A larger hotel company may acquire Tweedie plc if it wants to expand operations. The investment opportunity is of significantly low risk while potential returns are low. Effective management and restructuring of Tweedie plc may be needed on acquisition so as to derive more positive results.
Operating ratio = Cost of goods sold + operating expenses/sales
2010: 10,768,000+180,000+212,000/11,900,000= 0.9378
Return on assets =Net profit taxes+interest/total assets
Current ratio = Current assets/current liabilities
Acid test ratio =Current assets-inventory/current liabilities
Gearing ratio =Non-current liabilities/shareholdersequity+non-current liabilities
2010:900,000/13,405,000+900,000*100% = 6.29%
2009:900,000/11,305,000+900,000*100% = 7.37%
Earnings per share (EPS) =Profitafter interest∧tax/outstanding ordinary shares
2010:1,250,000/6,400,000= 0.1953 pence
2009:200,000/6,000,000= 0.0333 pence
Price/earnings ratio (P/E) =Priceper share/EPS
Fridson, M.S. & Álvarez, 2002. Financial statement analysis: a practitioner’s guide, 3rd edn. New Jersey: John Wiley and Sons.
Sharpe, W.S., Alexander, G.J. & Bailey, J.V., 2008. Investments, 6th edn. New York: Prentice Hall.
Shim, J.K. & Siegel, J.G., 2008. Financial Management, 3rd edn. New York: Barron’s Educational Series.
Weygandt, J. J. et al. 2008. Hospitality Financial Accounting, 2nd edn. New Jersey: John Wiley and Sons.
Wild, J. J. & Bernstein, L. A., 1998. Financial statement analysis: theory, application, and interpretation. New York: Irwin/McGraw-Hill.