Question 2: Company analysis, risk and returns (15 marks total) You will be allocated an ASX listed company to study for this part of the assignment and part of Assignment 2. You can find your allocated company in ‘View Grades’ on the unit site. Assume that a stock advisor’s report dated 30 June 2014 recommends buying shares in your allocated company. Your task is to analyse the company with a view to understanding its financial performance and, with the benefit of hindsight, determining whether or not the recommendation to buy was a good one in the short-term. I recommend that you use DatAnalysis for your company financial data collection because most of the needed information is available there. 6 Bond yield and index data can be found at websites suggested in the Web Links section of the unit’s MySCU site. Before you start analysing the financial data, do some background research on the company (e.g. industry, size, products, customers, geography of operations etc.). This background will help you contextualise your financial analysis. Your analysis should cover the following:
(a) Evaluate Statement of Cash Flows data for financial years ending 30 June 2013 and 30 June 2014. Do not include the statement of cash flows in your assignment answer. Evaluate the data, rather than just repeating it. (1.5 marks)
(b) Evaluate the company’s free cash flow and return on invested capital for the 2013 and 2014 financial years ending 30 June. Assume that the company’s cost of capital (WACC) is the same as the expected rate of return (cost of equity) you calculate in part (d) iii) below.7 (1.5 marks).
(c) Provide a summary ratio analysis (5 marks). Start your ratio analysis with an (extended) DuPont analysis based on the financial years ending 30 June 2013 and 2014. Doing the analysis for two years will give you a comparison over time. The DuPont model allows us to decompose return on equity, an important overall indicator of firm performance, into its three drivers: expense control, asset utilisation and debt utilisation. The DuPont model provides a very useful starting point in analysing a company’s financials because it provides structure to initial analysis. This saves time and helps avoid the potential confusion that can occur when faced with an overwhelming number of ratios. With DuPont analysis, you see the big picture first and then focus your attention on areas of strength and weakness.
Use a table to present the figures and then evaluate these with a view to teasing out the strengths and weaknesses of the company by explaining changes in return on equity (or, if no change has occurred, how the return on equity has been achieved). Further judicious ratio analysis to add depth to your analysis is appropriate but you should demonstrate that this extra analysis logically flows from your initial analysis. Simply calculating and discussing all possible ratios without any clear justification is not the purpose of this exercise and will be viewed negatively by your marker. Instead, be concise, logical and purposeful. Interpret the figures with the context of the company in mind and draw on your findings in parts (a) and (b) if relevant. Do the analysis first, consider it carefully, jot down the important conclusions and then write it up. Limit the summary (including table) to one A4 page.
(d) Analyse the market returns for the company’s shares from the end of their financial year (30 June 2014) to 27 February 2015 (the last trading day in February 2015). The following gives you a step-by-step guide to doing this analysis:
i) Calculate the monthly percentage returns for the company’s shares during the period. (To keep it simple, ignore dividends for this analysis and use adjusted monthly closing prices.) Then calculate the average monthly percentage return and standard deviation of returns and, using the procedure described in your text, annualise the returns and standard deviation. (Assume that the shares are held for the entire period so that no capital gain is realised during the period and consequently there is no reinvestment and compounding.) (2.5 marks)
ii) Repeat the process in i) for the same period but this time for the market as a whole, e, using the All Ordinaries price index as a proxy. (0.5 marks)
iii) Calculate the expected return on the company’s shares at the end of their 2014 financial year. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.4% and use the company’s current beta (thus assuming it has not changed since the financial year end). (1.5 mark) iv) Using the figures you have calculated, evaluate the risk and return of the company in comparison with the market actuals and the expected return. (2.5 marks) In writing up part (d) of the assignment, as in part c above, use a table to present the figures and then evaluate them. Limit your answer to one A4 page.