Carillion PLC Management finance coursework PDF

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CARILLION INVETSMENT REPORT

Jonny Guy B423633

CONTENTS PAGE

0. Executive Summary………………………………………………………………………………….1 1. Introduction……………………………………………………………………………….………………1 2.0 Overview of the company’s current situation…………………………………………2 2.1 Chairman’s statement……………………………………………………………………….3 2.2 Porters 5 forces analysis……………………………………………………………….….4 3.0 Calculation of ratios …………………………………………………………………………….…6 4.0 Analysis of ratio calculations…………………………………………………………………10 5.0 Conclusions……………………………………………………………………………………………16 5.1 Recommendations……………………………………………………………………………16 5.2 Limitations…………………………………………………………………………………………16 5.3 Foreseeability……………………………………………………………………………………16 Appendix 1 – Chairman’s statement……………………………………………………………………18 Appendix 2 – Balance Sheet…………………………………………………………………………………20 Appendix 3 – Income statement…………………………………………………………………………22

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0. EXECUTIVE SUMMA RY

This report has been commissioned by a hotel chain looking at alternative business ventures to invest in. As Carillion PLC is now a defunct company this report examines the 2015 & 2016 financial data to analyse potential investment at this time, and to see if failure could have been foreseen. It achieves this by firstly reviewing director’s statements, before completing a porters 5 forces study. Following this it undertakes financial overview of the performance of the company and series of ratio analysis.

1.0 INTRODUCTION & COM PANY BACKGROUND Carillion PLC is has been trading in various forms for 115 years. Founded after a demerger from Tarmac in 1999 which itself had been founded in 1903. The company was a constituent of the London FTSE 250 sock exchange, and a multinational, operating in the middle east, Canada and Europe. Carillion was involved in the facilities management and services sector. The company rapidly expanded over the 15 after incorporation, mainly through in-organic growth by purchasing smaller construction and facilities management companies. This growth made Carillion the 2nd largest contractor in the UK. On the 15 January 2018 Carillion was placed into compulsory liquidation after experiencing severe financial difficulties throughout 2017. Several profit warnings preceded carillons demise with 2017’s half year losses totalling £1.1bn. A recapitalisation plan was to be implemented in early 2018, but by this point the company’s share price had fallen over 200% and was now trading at just 14p (See figure 1) valuing the Carillion at just £73m. With the company unable to secure the level of emergency funding required, it was placed into liquidation. It was estimated that Carillion had just £29m in the bank before its collapse.

Figure 1: Carillion’s share price since incorporation 2

Carillion’s previous directors are currently being investigated by the UK financial conduct authority. The investigation is focusing on the preparation and approval of Carillion’s financial reports from 2014 onward, thus including the 2015 & 2016 accounts analysed. The temporary CEO Keith Cochrane, believe the business had accepted too many projects which had turned out unprofitable, its management structure and internal organisation was seen as being overly complex and lacking in sufficient regard to contract risk assessment and overly optimistic assumptions. Carillion owed an estimate £1bn to suppliers and subcontractor putting many of the smaller supply chain businesses in danger of liquidation.

2.OVERVI EW OF THE COMP ANY’S C URRENT SITUAT ION

2.1 Chairman’s statement and director’s reports (Appendix A) Financial • • • • • •

2016 was the first period of revenue growth for 5 years Recent growth driven by organic growth following a period of takeovers Revenue and profit figures have increased substantially Net borrowing has increase supposedly due to the adverse effects on exchange rates because of the EU referendum Key target to reduce the groups net borrowing over short to medium term £1.5bn of potential funding available showing good liquidity

Work winning: • • • • •

Probable orders in 2016 £4.6bn a large increase on 2015 (£3.7bn) Increasing trend towards framework contracts with clients New large high-quality infrastructure orders such as HS2 in order book. Rigorous contract selectivity and risk profiling in order to manage future risks Build long term partnerships with customers and suppliers

Dividends • •

1% increase in dividends from 2015 to 2016 Shares have a progressive dividend policy, which aims to increase the dividend broadly in line with earnings per share

Board changes 3

• •

New finance director (internal appointment) following retirement of previous finance director Board and management has remained stable for a number of years

Strategy • • • • • •

Grow the strong position we have in several key markets Reduce exposure to markets where trading conditions are challenging Develop Brexit action plan to monitor potential risks and opportunities Sustainability and health and safety seen as fundamental. Target to increase technology to help reduce costs. Maintain strong construction capability and remain leader in Health and safety and sustainability. Improve customer satisfaction, deliver profitable growth. Evaluate and identify all risks, suggesting that they require a responsible risk appetite and overall management review of risk.

2.2 Porters 5 forces analysis

Although porters 5 forces relate to market conditions to determine the industry’s strengths and weaknesses the model can help to understand Carillion’s vulnerabilities and competitiveness in the market:

Threat of new entry

Supplier Power

Competitive Rivalry

Threat of substitution

Figure 2: Porters 5 forces 4

Buyer Power

Threat of new entrants New entrants may find it hard to enter the construction market because of established players like Carillion who have specialist knowledge. In the construction industry generally, the barriers to entry (in terms of costs and complexity) are high; moreover, the margins in construction are small compared to other industries. It may therefore take some time before a new entrant can achieve profitability, exposing it to liquidity risks. Even if new contractors did enter the market they wouldn’t be able complete the scale of project that Carillion deliveries (such as HS2). Additionally, Carillion is used on several framework agreement in both the public and private sectors this means Carillion is guaranteed a level of future work and would make it hard for new entrants to win contracts. The construction market is considered a mature market, and this makes it unlikely for new business to enter.

Buyer Power This specifically deals with the ability customers have, to drive prices down. It is affected by how many buyers or customers a company has and how significant each customer is. Carillion’s clients comprise of both public and private organisations, however since the financial crash, demand from both sectors has weakened. Massive cost pressures from buyers mean construction is all about small margins especially in public sector projects, where they have to demonstrate they are achieving value for money. Additionally, construction prices aren’t set by the contractor, instead these will be negotiated between the client and contractor, giving the client purchasing power. When selecting a contractor there is minimal differential between competitors as they all offer the same service often utilising the same subcontractors to do the actual work. This means buyers can easy switch to one of Carillion’s rivals for their next project. However, Carillion has formed good relationships with clients and has regular repeat business, this should help it to successfully tender and win jobs in the future.

Threat of substitution At present there is not current a substitute for Carillion’s product/ service as there is no viable alternatives to infrastructure and buildings. As a result, CARILLION is safe from this kind of pressure.

Supplier power This force addresses how easily suppliers can increase the price of goods and services. It is affected by the number of suppliers of a good or service. For Carillion the term suppliers imply a range of partners and stakeholders encompassing raw material suppliers, subcontractors, and planning bodies. All these stakeholders are suppliers in the sense that 5

they provide either goods or services, without which Carillion cannot carry out its business. There are many suppliers in the construction industry with little to differentiate between so substitution is easy. This means suppliers compete for work, in order to be competitive and win tenders keeping their price as low.

Competitive rivalry Construction is a heavily contested market, with many large-scale contractors competing for the same jobs. As a result, despite Carillion’s good reputation within the market, the intense competitive rivalry drives prices down and decreases Carillion’s overall profitability. This in part is a reason why construction companies profit margins are comparatively low compared to other industries.

3.0 RA TIO CALCU LATIO NS (I NCOME S TATEMENT AN D BALANC E SHEET : AP PENDIX B & C)

Ratios

Company Accounts Calculations 2016

Trend/ Notes

2015

Liquidity Ratios

Current Ratio = Current assets / Current Liabilities

Acid Test = (Current assets – Inventory) / Current Liabilities

Current Assets = £2,269.8m

Current Assets = £1,813.1m

Current Liabilities = £2,217.4m

Current Liabilities = £1,771.6m

2,269.8/ 2,217.4 = 1.02

1,813.1/ 1,771.6 = 1.02

Current Assets = £2,269.8m

Current Assets = £1,813.1m

Inventory = £78.8m

Inventory = £64.3m

Current Liabilities = £2,217.4m

Current Liabilities = £1,771.6m

(2,269.8 – 78.8) / 2,217.4 = 0.99

(1,813.1 – 64.3) / 1,771.6 = 0.98

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Unchanged

Unchanged

Profitability Ratios

Return on Equity = (Profit before tax x 100) / Shareholder Funds

Profit before tax = £146.7m

Profit before tax = £155.1m

Shareholder Funds = £701.2m

Shareholder Funds = £993.5m

(146.7 x 100) / 701.2 = 20.92%

(155.1 x 100) / 993.5 = 15.60%

Return of capital employed = (Profit before interest and tax x 100) / Long term capital (Equity + Noncurrent liabilities)

Profit before tax = £146.7m

Profit before tax = £155.1m

Interest = (£60.4m)

Interest = (£60.33m)

Equity = £701.2m

Equity = £993.5m

Minority Interest = £28.8m

Minority Interest = £23.1m

Non-current liabilities = £1,485.8m

Non-current liabilities = £1,081.3m

(146.7 + 60.4) / (701.1 + 28.8 + 1,1485.8) = 0.093 = 9.3%

(155.1 + 60.33) / (993.5 + 23.1 + 1,081.3) = 0.103 = 10.3%

Net profit (after tax)= £129.5m

Net profit (after tax)= £139.4m

Revenue = £4,394.9m

Revenue = £3,950.7m

(129.5 / 4,394.9) x 100 = 2.95%

(139.5 / 3,950.7) x 100 = 3.53%

Operating profit = £181.9m

Operating profit = £209.4m

Revenue = £4,394.9m

Revenue = £3,950.7m

(181.9 / 4,394.9) x 100 = 4.14%

(209.4 / 3,950.7) x 100 = 5.30%

Net Profit Margin (After tax) = (Net profit / Revenue) x 100

Operating Profit Margin = (Operating profit / turnover) x 100

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Increasing

Decreasing

Decreasing

Decreasing

Gross Profit Margin = (Gross Profit / Turnover) x 100

Gross Profit = £350.7m

Gross profit = £340.9m

Revenue = £4,394.9m

Revenue = £3,950.7m

(350.7 / 4,394.9) x 100 = 7.98%

(340.9 / 3,950.7) x 100 = 8.63%

Trade debtors = £1,664m

Trade debtors = £1,270.8m

Revenue = £4,394.9m

Revenue = £3,950.7m

(1,664 / 4,394.9) x 365 =

(1,270.8 / 3,950.7) x 365 = 117.41 Days

Decreasing

Efficiency Ratios

Debtor Days = (Trade debtors / Revenue) x 365

138.2 Days

Creditor Days = (Trade creditors / Cost of sales) x 365

Trade creditors = £2,090.1m

Trade creditors = £1,714.3m

Revenue = £4,044.2m

Revenue = £3,609.8m

(2,090.1 / 4,044.2) x 365

(1,714.3 / 3,609.8) x 365

=188.6 Days

= 173.3 Days

Long term loans = £592.0m

Long term loans = £598.5m

Equity = £701.1m

Equity = £993.5m

Minority interest = £28.8m

Minority interest = £23.1m

592 / (701.1 + 28.8 + 592.0)

598.5 / (993.5 + 23.1 + 598.5)

Increasing

Increasing

Funding Ratios

Balance sheet gearing = Long term loans (over 1 year) / (Total equity + loans)

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Increasing

= 44.8%

= 37.1%

Ordinary Dividend Cover = Earnings per share / Dividend per share

Earnings per share = 28.9p

Earnings per share = 30.9p

Dividend per share = 18.35p

Dividend per share = 17.85p

28.9 / 18.35 = 1.57

30.9 / 17.85 = 1.73

Interest Cover = Profit before interest and tax / Interest

Profit before tax = £146.7m

Profit before tax = £155.1m

Interest = £60.4m

Interest = £60.3m

(146.7 + 60.4) / 60.4 = 3.43

(155.1 + 60.3) / 60.3 = 3.57

Total dividend = £78.9m

Total dividend = £76.8m

Number of shares issued = 430.2

Number of shares issued = 430.2

78.9 / 430.2 = 18.35p

76.8 / 430.2 = 17.85p

Profit after tax = £129.5m

Profit after tax = £139.4m

Minority interest = £5.3m

Minority interest = £6.6m

Number of shares issued = 430.2

Number of shares issued = 430.2

(129.5 – 5.3) / 430.2 = 28.9p

(139.4 – 6.6) / 430.2 = 30.9p

Decreasing

Decreasing

Investment Ratios

Dividend Per share = Total dividend / Number of shares issued

Earnings per share = Profit after tax / Number of shares issued

Additional Ratios

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Increasing

Decreasing

Gearing including all long-term liabilities = Long term liabilities / (Total equity + Long term liabilities)

Market capitalisation = Current stock prices x Number of shares issue

Price to equity Ratio = stock price / Earnings per share

Long term liabilities = £1,485.8m

Long term liabilities = £1,081.3m

Equity = £701.1m

Equity = £993.5m

Minority interest = £28.8m

Minority interest = £23.1m

1,485.8 / (701.1 + 28.8 + 1,485.8) = 67.0%

1,081.3 / (993.5 + 23.1 + 1,081.3) = 51.5%

Stock price (31st Dec) = 236.4p

Stock price (31st Dec) = 317.0p

Number of shares issued = 430.2m

Number of shares issued = 430.2m

236.4 x 430.2 = £1.02bn

317 x 430.2 = £1.36bn

Stock price (31st Dec) = 236.4p

Stock Price (31st Dec) = 317.0p

Earnings per share = 28.9p

Earnings per share = 30.9

236.4 / 28.9 = 8.17

317 / 30.9 = 10.3

Increasing

Decreasing

Decreasing

4.0 ANA LYSIS OF RA TIOS

An insight into a firms financial performance can be gained by looking further an examining relationships between various important values in the accounts using ratio analysis. We use internal analysis to compare multiple accounting periods that have been reported using the same accounting methods.

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2.3 Liquidity Ratios (Current Ratio, Acid test) Liquidity ratios are designed to help the user take a view of the ability of the business to meet its short-term debts. These ratios are particularly useful to anyone thinking of lending to the company. This is done by comparing a company’s most liquid assets by its short-term liabilities. The acid test removes inventory, as this is considered by some to be an illiquid asset. Carillion’s current ratio is 1.02 and has remained stagnant over both 2016 & 2015 despite the change in both current assets and current liabilities. This is toward the lower end of what should be expected. Current assets are just above their current liabilities suggesting that although they have the ability to meet short term debts, they might have difficulty doing so. Carillion’s acid test ratio is 0.99 in 2016 & 0.98 in 2015, this is again at the lower end of the scale. With inventories removed Carillion would not have the ability to pay off its short-term debt, and therefor if debts were called in Carillion could be in danger of becoming insolvent. However, it should be noted that it is highly unlikely that current liabilities would be called in at once. For construction companies the acid test ratio may not be as important as while most companies want to shift inventories into cash, construction companies inventory often consists of land, which unlike retail stock has the potential to gain in value. Contractors such as Carillion generally have low volumes of inventory as they are not manufactures or retailers with products to sell. Instead many construction companies are viewed as service providers with the Contractors role to manage sub-contractors further down the supply chain. As a result, the current ratio and the acid test ratio are similar. While the sharpe rise in Carillion’s current liabilities is concerning, there has also been a rise in assets to cover this. Carillion’s liquidity is in a poor position and this could mean lenders will be warry of loaning funds to Carillion and they therefore could struggle to raise capital for new projects.

2.4 Profitability Ratios (ROE, ROCE, NPM, OPM, GPM) Profitability ratios help to assess the performance of the business in terms of how profit and loss relates to certain other figures in the accounts. Different profit margins are used to measure a company’s profitability at various cost levels, including gross margin, operating margin and net profit margin. The margins shrink as additional costs are taken into consideration. The long-term profitability of a company is vital for both the survivability of the company as well as the benefit received by shareholders.

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Net, gross, operating profit margins Gross profit margin shows the profitability of products/ services sold before any other costs of business have been considered. Carillion’s gross profit margin dropped from 2015 (8.63%) to 2016 (7.98%), although their underlying gross profit figure actually increased. This suggests there has been a dip in the profitability of their core business and profit is not of such as high quality as previous. As a result, Carillion now have to complete more work in order to make the same level of profit. Net Profit focusses on profit after all expenses of the business, compared to sales. We can see that in 2015 Carillion had a larger net profit margin of 3.53% compared to 2.95% in 2016. This is allied to a higher amount of net profit in 2015, but the reduction in profit comes despite a massive increase in re...