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Financial Reporting Coursework Analysis of the 2011 and 2012 Financial Statements of Vodafone and EE

Introduction and Background In this report, we aim to analyse and juxtapose the 2012 and 2011 annual financial reports of Vodafone and EE, with specific emphasis on the comparison of the two company’s financial ratios, in respect to both each other and their own previous year’s annual reports. Vodafone The Vodafone network was the first cellular network to be launched in the UK, and was responsible for the UK’s first mobile phone call in 1985. By 1987, Vodafone was recognised as the largest mobile network in the world1. To this day, it operates in over 30 countries and has partner networks in over 50 more2, taking pride in itself in being an industry leader in regards to its expansion into new ventures and technological developments, such as pioneering the introduction of 3G and also its various joint enterprises with Apple. Throughout the life span of Vodafone, the company has been through many mergers; starting as part of Racal Telecoms plc in 1982, but demerging from Racal in 1991. Vodafone acquired Mannesmann AG in 2000, almost doubling the size of the Vodafone group, making it the world’s largest mobile telecoms company. Vodafone underwent a major expansion in 2009, spreading into emerging economies thus reinforcing its position as one of the global front runners in the mobile networking industry. EE Everything Everywhere Limited (EE) is a mobile network operator and internet service provider. The company is a 50:50 joint venture between Deutsche Telekom and Orange S.A, which occurred in 2010, when network giants T-Mobile and Orange merged together to form EE, making what is now the largest telecommunications company in the UK. As of October 30th 2012, EE became the first company in the UK to offer 4G coverage, and aims to cover 98% of the country by 2014. It the overall biggest and fastest mobile network in the UK currently supporting 28 million customers, providing the best standard network coverage presently available, reaching 99.8% of the UK.

1 http://www.vodafone.co.uk/about-us/company-history/ 2 http://www.vodafone.com/content/index/about/about-us.html

Comparison between Vodafone and EE at a Glance At first appearance, the newly merged EE seems to be following in the footsteps of the highly established Vodafone, whose strong foundations arose from its domination of the UK mobile industry in the 90s. Although in terms of size Vodafone is largest mobile company in the world, and therefore colossal in comparison to EE; EEs UK derived revenue is in fact higher than that of Vodafone, indicating that it is in a strong position for future financial growth and possible overseas expansion. This might be reflected in the financial statements, with ratios displaying high levels of growth for EE, however, it is important to note that they may still be recovering from the costs of their merger.

Profitability ratios The profitability ratios are used to measure and asses the businesses ability to generate a profit in respect to its costs. Ratio Gross Profit 2012 Gross Profit 2011 Net Profit 2012 Net Profit 2011 ROCE 2012 ROCE 2011 ROE 2012 ROE 2011

EE Percentage 30.60% 32.28% -2.55% -1.02% -2.19% -0.79% -1.85% -0.92%

Vodafone Percentage 32.04% 32.84% 24.10% 12.20% 9.68% 4.51% 8.96% 8.99%

Gross Profit Margin The gross profit margin from both companies is similar and shows relative levels of decline between 2011 and 2012. EE had revenue of £6.6bn in 2012 whereas Vodafone had £46.4bn however they still both maintained a gross profit margin of around 30% for that year, an approximate 2% decrease on 2011’s figures; this could indicate that the decline is due to a natural increase in costs for the mobile networking sector. The similarity in gross profit percentage may suggest that the variable costs of both companies are very similar; however, you might expect Vodafone’s purchases to be comparably cheaper than EE’s due to Vodafone’s relative size and consequent economy of scale factors. Net Profit Margin The net profit margin for both companies indicates hugely differing profitability. EE’s net profit has fallen by 150% from -1.02% to -2.55% in 2012, whereas Vodafone’s net profit boasts an increase of 97.5%, growing from 12.20% to 24.10% in 2012. Initially, it appears that Vodafone may have had a very profitable year, growing significantly or becoming much more cost effective. However, upon further analysis, the financial statements reveal that Vodafone’s impairment loss expense dropped from £6.15bn to £4.05bn, whilst “other income and expenses” had risen from a -£72m expense in 2011, to a £3.70bn income in 2012. This means meaning that their relative revenue had actually only risen by 2.2%.

In 2012, Vodafone’s other income was £3.7bn; this was due to a one off sale of 44% shares in SFR for £3.419bn and a sale of 24.4% shares in Polkomtel for £296m. These large cash injections may have had a ‘window-dressing’ effect on overall net profit, manipulating it to appear higher, due to nonrevenue related incomes. Therefore, in order to see the change in profit, without any distortion from one off cash injections, we used Vodafone’s 2011 costs alongside its 2012 revenues, in order to calculate a relative operating profit figure for 2012. This illustrated that comparatively, Vodafone would have made a 5.11% lower operating profit in 2012 than that of 2011. EE’s decline in net profit margin is due to its decrease in revenues in 2012. This could be attributable to its net loss of 32,000 customers in its fourth quarter, which the Telegraph suggests may have been due to pressurising existing pay-as-you-go customers to upgrade to the more expensive 4G packages. (1) Return on Capital Employed (ROCE) Vodafone’s ROCE increased from 4.51% in 2011 to 9.68% in 2012. Again, this figure may have been distorted by the large income from disposal of shares. Comparatively, EE’s ROCE in 2011 is -0.79% and -2.19% in 2012. This is dramatically different to Vodafone’s ROCE, implying that Vodafone has higher revenue in relation to their capital, meaning that they are more efficient in the application of capital employed. EE’s ROCE in contrast, suggests that they are becoming less efficient in the use of their capital, and may be struggling to effectively manage their capital investments in order to turn a profit. This could be a consequence of the 2010 merger between Orange and T-Mobile, which would have presented the company with significant additional administration costs; this in aggregation with lower 2012 revenues, and the capital introduced to fund the merger costs, may be responsible for the worsening ROCE. Sofia check!

Return on Equity (ROE) EE’s ROE has reduced by 0.93% from -0.92% in 2011 to -1.85% in 2012. This shows that EE is making a loss as opposed to the growth that might be expected of a fledgling company with such high expectations, especially given that it had such an advantageous start to the year due to its exclusive rights to release 4G in the UK before any other network. Although this venture has gained them a large number of new contracts, it has had an overall adverse effect, losing them existing customers due to the exorbitant costs to customers associated with 4G plans as aforementioned.

The ‘window-dressing’ of Vodafone’s income statement is made all the more apparent by its ROE. Although its net profit margin implies significant increase in profitability and connected growth, there has in fact been a slight decline in Vodafone’s ROE by 0.06% from 2011 to 2012.

Efficiency Ratio’s Ratio Stock Turnover 2012 Stock Turnover 2011 asset turnover 2012 asset turnover 2011 debtor days 2012 debtor days 2011 creditor days 2012 creditor days 2011

EE

Vodafone 9.89 10.04 0.52 0.54 65 68 168 162

5.62 6.36 0.40 0.37 84 74 176 174

Days Days Times Times Days Days Days Days

Debtor and Creditor Payment Period EEs creditor days for both 2011 and 2012 are 162 and 168 days respectively, whilst Vodafone’s are 174 and 176 days. Whilst it is often considered favourable to have a longer creditor payment period, the figures suggest that both EE and Vodafone may not be efficient in managing its payments to creditors; delayed payments may deter potential creditors from entering into contracts with the company, thus limiting EE’s prospective suppliers. This hypothetical payment management issue is also reflected in EE’s debtor days 68 days in 2011 and 65 in 2012 and Vodafone’s, who had debtor days of 74 and 84 days. It is preferable for companies to have the shortest debtor day periods possible, as collecting money quickly is advantageous for the liquidity of a company.

Asset Turnover Asset turnover indicates that both EE and Vodafone have vast amounts of assets in relation to revenues and a low rate of efficiency in terms of revenue produced per asset owned. As they both seem to have fairly similar asset turnovers for both years, where EE is slightly higher this could be the industry norm and thus may not be a cause for concern. Finally as EE and Vodafone’s asset turnovers are growing this does indicate that both companies are becoming more efficient in the use of their assets.

Stock Turnover In an industry such as this it is expected that the stock turnover will be very high as mobile phones are considered a necessity and the market is vastly diverse in choice and price range, presenting it as an option for many people to buy. Both companies have a very high stock turnover; however Vodafone’s is almost double EE’s in both years. This could be attributable to the fact that Vodafone is worldwide and has a significantly higher customer base than that of EE which is only operating in the UK; likewise EE holds almost twice the stock as a percentage of their relative revenue than Vodafone. This could be because EE have obtained exclusive rights to the release of 4G technology in the UK. This could be why EE are holding a higher proportional stock level in comparison to Vodafone.

Liquidity Ratios Test and date Current Test Ratio 2012 Current Test Ratio 2011 Acid Test Ratio 2012 Acid Test Ratio 2011

EE 0.94 0.63 0.88 0.58

Vodafone 0.83 0.63 0.81 0.61

Ratio :1 :1 :1 :1

Acid Test Ratio EE and Vodafone both have a less than 1:1 current ratio. This indicates they are unable to pay their short term liabilities with the short term assets. However both companies have a growing acid test ratio which indicates they are growing in terms of their assets or are receiving better credit terms from their suppliers. In respect to the above and the industry these two companies operate in it can be said that the acid test ratio is more relevant than the current test ratio. This is because this industry is primarily service based and holds little stock in relation to revenues produced.

Current Test Ratio These companies are in a primarily service based industry; the current and acid test ratios are very similar as the companies do not hold much stock. Both EE and Vodafone’s current test ratio in 2011 is 0.63:1 which is relatively lower than the preferred ratio of 1.5:1 to 2:1. However, both companies

increased their ratio to 0.94:1 for EE and 0.83:1 for Vodafone which may suggest that they are increasing their assets or decreasing their liabilities in order to control their liquidity.

Shareholder’s Ratios Ratio EPS 2012 EPS 2011 Dividend Yield 2012 Dividend Yield 2011 Dividend Cover 2012 Dividend Cover 2011

EE -17.32 -9.43

-0.26 -0.12

Vodafone 13.82 15.02 5.44% 5.82% 1.01 1.64

p p

:1 :1

Earnings per Share This is considered to be the most important ratio that can be calculated from the financial statements as the higher the earnings, the more reliable the company is to invest money into as they have a strong financial position. Vodafone’s EPS has slightly declined which could be due to the fact that their profit after tax has fallen from 7.87bn to 7bn. This slight fall has caused the earnings per share figure to go from 15.02p to 13.82p and this may influence shareholder’s future decisions on investment within the company.

Dividend Yield Investors commonly use this ratio to analyse and consider the company’s past dividend yield ratio to decide whether or not to invest in the company or not. Vodafone’s dividend yield figure fell slightly from 5.82% to 5.44%, this may suggest that the company’s earning capacity is falling slightly. On the other hand, it seems that Vodafone is a well known established company with a stable dividend distribution history meaning that this company is more reliable and a less risky company to invest in. http://www.investopedia.com/ask/answers/05/negativeeps.asp

Dividend Cover Vodafone’s dividend cover has fallen from 1.64 to 1.01 which means they could only cover their dividends one time over in 2012. This could be worrying for potential and current investors as if the dividend cover gets much worse in 2013 they will not be able to pay out through the year’s profits. This could affect the company as current shareholders may decide to sell their shares now and this could also deter potential investors as well because of the high risk of losing their dividend pay-out. Likewise EE has a negative dividend cover from the formula which basically means they did not pay out their dividend in the last two years from their profits. They did however pay their dividends via their reserves though will reduce their capital base.

The loss after tax for the year ended 31 December 2012 was £191 million (year ended 31 December 2011: £104 million) on revenues of £6,657 million (year ended 31 December 2011: £6,784 million) and has been deducted from reserves. Detailed results for the year are shown in the Consolidated income statement on page 13.

Capital Structure Ratios Test and date Gearing 2012 Gearing 2011

EE 32.73% 31.45%

Vodafone 32.32% 29.47%

Gearing Ratios A gearing of less than 50% is generally recommended. Though there is a significant size difference in these companies, they both maintain an almost identical gearing in 2012; though it can be seen that Vodafone has risen by 2.85% from 2011 but EE has only risen by 1.28%. The reason for Vodafone having increased their gearing further than EE could be because Vodafone, being a bigger company can secure a bigger loan against their assets and vice versa, as EE are in their second year of financial losses; banks are less inclined to loan them money because they will be considered a higher risk investment.

2233 Conclusion   

Difficulty as EE only has 2 years worth of statements EE appears to be less profitable could be because of merger costs Difficult to compare the two companies as they differ greatly in size and length of time established

STILL NEED TO INCLUDE:      

TREND ANALYSIS QUALITATIVE ANALYSIS OF FINANCIAL STATEMENTS CONCLUSION APPENDIX WITH DETAILED CALCULATIONS AND DESCRIPTIONS OF RATIOS, ANNUAL REPORTS AND NUMBERS USED IN TREND ANALYSIS BIBLIOGRAPHY NEEDS DOING BUT WE CAN DO THAT TOMORROW. COMPLETION OF ‘TIDYING UP’ DOCUMENT BUT I’LL DO THAT

Appendices

Bibliography http://www.vodafone.com/content/annualreport/annual_report13/downloads/vodafone_annual_re port_2013 https://explore-orange-live-orangedigital.s3.amazonaws.com/2013/02/19/EE_Accts_YE_2012__Final_signed.pdf.pdf

Rushton, K.(February 19th 2013) EE loses customers despite 4G headstart. Retrieved 10th December 2013 from the Telegraph website: http://www.telegraph.co.uk/finance/9881306/EE-loses-customersdespite-4G-headstart.html

http://www.mirror.co.uk/money/city-news/mobile-firm-everything-everywhere-loses-87898

Appendix Table of formulas:

Ratio Formulas The gross profit margin is the profit before fixed costs expressed as a percentage of revenue.

Gross profit margin =

Gross profit Revenue(turnover)

*100

The Net profit margin is the profit after total costs, expressed as a percentage of revenue.

Net profit margin =

Net profit Revenue(turnover)

*100

Return on Capital Employed (ROCE) compares a company’s capital introduced in relation to the revenue of the company, measuring both the profitability and efficiency of the company.

Return on capital employed (ROCE) =

Operating profit Shareholders equity + long term liabilities

*100

Return on Equity is the rate of return on shareholders’ equity, effectively showing how well a company uses investment funds to generate earnings growth. For high growth companies you would expect a higher ROE and vice versa.

Return on equity =

Profit after taxation Shareholders’ equity

*100

Current test ratio shows a company’s ability to pay their current liabilities with their current assets.

Current Ratio =

Current assets Current liabilities

The acid test ratio shows a company’s ability to pay their current liabilities with their current assets minus inventory, therefore a ratio of 1:1 or greater shows a company is able to pay their current liabilities without being dependant on the sale of inventory.

Acid Test =

Current assets - inventory Current liabilities

Asset turnover is a business’s assets expressed as a ratio of revenue and this is one of the key efficiency ratios.

Asset turnover =

Revenue Net assets

Inventory turnover shows how many days it takes a company to sell its entire stock holding in a set period, usually a year.

Inventory turnover =

Inventory Cost of sales

*365

Measures the average length of time it takes the credit customers to pay.

Debtor days =

Trade receivables Revenue

*365

Measures the average length of time it takes to pay your credit suppliers

Creditor days =

Trade payables Cost of sales

*365

Measures the extent to which a company’s long term loans have been provided by lenders.

Gearing ratio =

Non-current liabilities Capital employed

*100

Measure of the number of times the interest payment can be covered by profits.

Interest cover =

Operating profit Interest charges

Measures the number of times that an ordinary dividend can be paid by attributable profits.

Dividend cover

Profit after tax Dividends paid

=

The likely percentage of capital returns that an investor will receive in dividends per share.

Dividends per ordinary share Market price per ordinary share

*100

Dividend yield =

EPS is a ratio that shows how much potential return an investor could gain per share invested in the company.

Earnings per share =

Profit after tax and preference dividends Weighted average number of ordinary shares...