Financial Management
PART 1: Finance in the News
Article 1- ASX: Australian share market posts biggest fall of the year
By business reporter Michael Janda, February 3, 2016
Brief summary
The article is about the biggest fall in the Australian share market where shares of most listed companies have fallen across the board. The article notes that the market value of shares in the Australian share market fell by more than $34 billion in a single day. That fall is the biggest recorded so far in 2016. The fall pushed total losses on the Australian share market to around $130 billion so far recorded in the year. Some of the key indicators that fell as a consequence included the Australian dollar that fell to 70.2 US cents and ASX 200 index which fell to 4,877 representing a 2.33 per cent fall. The article notes that this is the worst fall for the Australian Stock Exchange’s ASX 200 index since September of 2015. Some notable shares of individual companies that fell alarmingly were share of the National Australia Bank which fell by 5.5% and the shares of BHP Billiton which fell by 4% from the previous day’s closing stock price(ALAJBEG, BUBAS and SONJE, (2012; pp. 53-72.).
The article isolates National Australia Bank as one of the biggest drags on the market as the value of its shares fell by 5.5 per cent. A spin-off of the bank’s troubled UK operations is blamed for the fall in value of the bank’s share price on the market. The share price for the bank closed at their lowest in three years at $26.36 per share. A fall in credit rating for BHP Billiton the previous day is assumed to have led to the fall in shares for the resources and energy giant (BISEN and PANDEY 2013, pp. 792-799). The renewed slump in oil prices which saw Brent fall by 5 percent to $US32.60 and West Texas crude fall below $US32.60 is also blamed for the fall in BHP Billiton’s shares. In fact all gas and oil companies listed on the Australian stock exchange saw their stock prices fall as well. Another factor that is generally blamed for the fall in share prices across the board is the general slump in commodity prices that is affecting the overall Australian economy. Australia has recorded the fourth worst trade balance in history due to the general slump in commodity prices. The trade deficit of $3.5 in the Australian economy exceeded forecasts by economists by a whopping $1.2 billion. A 16 percent fall in iron ore and mineral exports and an 8 percent fall in coal sales have largely been behind the fall in commodity prices generally. The stock price for most banks and retailers listed on the stock market were affected by the hit to national income and the prospect of weakening housing market(BISEN and PANDEY 2013, pp. 792-799).
Analysis of the financial issue and relevant financial theory
The financial issue is whether the various factors that impacted on the performance of some of the listed companies and the general condition of the Australian economy really contributed to the fall in share prices or it was just a random act. According to the article various factors did contribute to the fall in share price of some of the companies such as BHP Billiton and several other oil and gas companies due to the general slump in oil prices. The article also points the slump in commodity prices and widening trade deficit as some of the other factors that affected the share price of most of the listed companies(ALAJBEG, BUBAS and SONJE, (2012; pp. 53-72.).
The future prospects of a market are unbiased as it represents the combined beliefs of all investors in the market according to efficient market hypothesis. This efficient market hypothesis theory does seem to apply fully in this article. It appears that investors in the Australian Stock Exchange have all the information about the general economy, individual performance and future prospects of all listed companies and use that to make sell or buy decisions(ALAJBEG, BUBAS and SONJE, (2012; pp. 53-72.).
According to the efficient market hypothesis, the only way an investor can obtain higher returns is by obtaining riskier investments as the information that is already known makes it impossible to exceed the overall market. There is material information in the Australian Stock Exchange that affects share prices which is in line with efficient market hypothesis. It is impossible to purchase undervalued stocks or sell their shares at inflated prices in the Australian Stock Exchange as stocks are traded at fair value which is in line with efficient market hypothesis(ALAJBEG, BUBAS and SONJE, (2012; pp. 53-72.).
(http://www.abc.net.au/news/2016-02-03/asx-australian-shares-fall-early/7135858?section=business)
Article 2- Yahoo to sack 15 per cent of staff and reorganize business
By Bridget Brennan ; February 3, 2016
Brief summary
Internet giant, Yahoo has announced plans to reorganize its business after it reported a loss of $4.3 billion in the last three months of 2015. Some of the strategies identified include sacking of 15 percent of its staff and cutting costs by about $400 million. The company also intends to offload its core search and email business to a strategic investor. Yahoo’s success was at its highest in 1990’s when it ran directory and search engines which were very successful worldwide. Later, the company added social media sites, Tumblr, Flickr, dozens of gaming, sports, news and lifestyle offshoots. The business model that the company adopted faced challenges at implementation which was compounded by intense competitive rivalry from other players in the industry. Notable Silicon Valley heavy hitters Google and Facebook have eclipsed yahoo in the market. Even though Yahoo, is a pioneer tech company in the Silicon Valley it is facing very aggressive competitors and its business model is simply not working. Even though the company still has a future to pursue, the shape of that future is yet to be revealed. The company’s sustainable revenue stream is from a huge collection of sites and services. However, these revenue streams have stagnated. One of the strategic initiatives that the company seems to be considering is breaking Yahoo into smaller business units. The new CEO Ms Mayer has introduced mobile video and social media as new revenue streams that could turnaround the company’s fortunes(MAROYI. and POLL 2012, pp. 9279-9292). All is not gloom and doom for the company after all as reports indicate that the company could be the third largest mobile advertising player in the world. Even though Ms Mayer is upbeat about the prospect of turning around the company, investors are jittery as six CEOs have tried and failed in the past. Analysts point to the challenge of finding a suitable buyer for the company even if a decision to sell is arrived at eventually. Even as shareholders explore the idea of selling the company, Yahoo is simplifying the company by narrowing its focus on a few areas where it has competitive advantage(MAROYI. and POLL 2012, pp. 9279-9292).
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Analysis of the financial issue and relevant financial theory
The financial issue in this article is about making wrong investment decisions. After the company’s initial success from its directory and search engines, the company added other business lines namely social media sites, Tumblr, Flickr, dozens of gaming, sports, news and lifestyle offshoots which were not received well in the market. The company’s business model did not work in later years as it did in the 1990s(MAROYI. and POLL 2012, pp. 9279-9292). This was due to bad decisions made at investment stage. The company did not use effective capital investment decisions as stipulated in finance theory(MAROYI. and POLL 2012, pp. 9279-9292). There are various capital investment decision making techniques that the company could have used to make the right decisions on which additional projects to implement. Some of the most commonly used capital investment decision making techniques include net present value technique, internal rate of return, and payback period and profitability index among others. For example, if the company had used net present value to decide whether to invest in Tumblr, it would have first determined the future cash flows from Tumblr and then discounted them to their present values using the company’s weighted cost of capital. Its only after the present value of future cash flows exceeded the initial investment that the company would have invested in the project(MAROYI. and POLL 2012, pp. 9279-9292). Internal rate of return technique involves investing in only those projects whose internal rate of return is higher than the company’s cost of capital. Payback period is a technique which demands that a company chooses only those projects with the shortest payback period. Had the company used the various capital investment decision making techniques available in finance theory perhaps it would still be profitable(MAROYI. and POLL 2012, pp. 9279-9292).
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http://www.abc.net.au/news/2016-02-03/yahoo-to-sack-15-per-cent-of-staff/7137166?section=business
PART 2: Real-World Analysis
a)
The best way to analyze Santos’ short term liquidity through various ratios such as current ratio, acid test ratio, debt-equity ratio and cash ratio
i) Current ratio
The formula for determining Santo’s current ratio is as follows:-
? In 2014=> $2,065million/$1,946 million=1.06.
? In 2013=> $2,078 million/$1,726million=1.20
Current ratio measures the short term liquidity of a company. It measures the ability of a company to pay its short term obligation with its liquid assets (current assets). From the foregoing analysis, Santos current ratio fell from 1.20 in 2013 to 1.06 in 2014 which means that the company’s liquidity position got worse. The ideal current ratio is 2:1 which means that for every one dollar that the company is owed it has 2 dollars to pay off.
ii) The next liquidity ratio is quick ratio (Acid-Test Ratio)
The next liquidity ratio is quick ratio. The formula for determining quick ratio is as shown below.
=total current assets- (less inventory +prepaid expenses)/current liabilities
In 2014 => $2,065 million- ($443 million +$91 million)/$1,946 million=0.79
In 2013=>$2,013 million- ($419 million +$202 million)/$1,726 million=0.81
This ratio measures a company’s ability to pay off its current liabilities using its most liquid assets. The company’s position worsened from 2013 to 2014. A 1:1 ratio is the most ideal since the company holds a dollar for every dollar held(MAROYI. and POLL 2012, pp. 9279-9292)
b)
A convertible bond is a debt instrument whereby a holder can convert the bond into either equity or cash at a given agreed point in time. The bondholder can decide to convert the bond into a specified number of shares of common stock of the company that has issued the convertible bond or the bond holder can also decide to convert the bond into cash. It is called a hybrid security because it has a feature of shares of common stock and also debt features(MAROYI. and POLL 2012, pp. 9279-9292)
c)
The company is using retained earnings, borrowings and issue of ordinary shares to finance its operations. In 2013 the company had retained earnings of $3420 million but in 2014 retained earnings decreased to$2,166 million. The company also took loans of $ 2,167 million and issued common stock of $10 million in 2014. The company is therefore using indirect sources of financing such as retained earnings and also external sources of financing. The reason why the company may prefer indirect sources of financing is because of the falling crude oil prices as fewer and fewer investors are noted (MAROYI. and POLL 2012, pp. 9279-9292)
d)
Total liabilities went up to $ 10,212 million in 2014 from $ 12,932 million in 2013. Most of the interest bearing loans were borrowed through Santas Finance Limited. Interest bearing loans also went up from $ 5,582 million in 2013 $7,925 million in 2014. The reason for this increase could have been the fact that the company was building its capacity to do more business in 2015 when petroleum and gas prices go up. The company could have taken higher debt to meet liquidity demands (KARANOVIC, BARESA and BOGDAN 2010, pp. 55-66)
.
e)
On asset management, the first ratio is inventory turnover. The ratio improved from 6.11 in 2013 to 6.54 in 2015. This implied that the company was able to turn around its inventory faster than in 2013. This explains why the turnover was higher in 2014 as compared to 2013. The asset turnover ratio fell from 0.053 in 2013 to 0.051 in 2014. This shows that the company was in not effective in 2015(BISEN and PANDEY 2013, pp. 792-799). The debt to equity ratio was 1.02 in 2013 and 1.37 in 2014. This shows that shareholders increased their stake in the company. Equity multiplier shows that the company was more able to generate higher returns for shareholders in 2014 than in 2013. Net asset value per share fell in 2014 as compared to 2013. The fall was caused by a fall in net assets in 2014. The net profit margin shows that the company made profits in 2013 which totally fell in 2014 as the company made losses in 2014.However, the gross profit margin improved in 2014 as compared to 2014(ARAK and MARTIN 2005, pp. 44-50)
f)
The yield in Santos hybrid convertible bonds fell in 2014-15 mainly due to general outlook of the economy and the fall in crude oil prices. The bonds became less marketable as investors became reluctant to trade in the bonds as prices plummeted in the international market. (KOH, 2012) Hybrid securities are essentially securities that can be converted in to a number of shares of the common stock of the issuing company. If the company’s core business does not have a favorable outlook investors tend to wait and see. The company also made a loss in 2014 which also had an impact on the bonds(ARAK and MARTIN 2005, pp. 44-50)
.
g)
The formula for calculating holding period return is as follows:
Holding Period Return = Income + (End of Period Value – Initial Value) / Initial Value
=4%+(5%-4.5%)/4.5%=4.11%
2.
To determine the price of Rio Tinto we use Capital Asset Pricing Model which is used to price securities with a high risk. Capital asset pricing model describes the relationship that exists between required rate of return and the market risk of a stock (TEPLOVA and SHUTOVA 2011). The formula is as follows
In this case rf =3%, rm=15%, Beta is 1
Ra=3%+1(15%-3%)=15%
By using Gordon growth model we can get the stock value as follows.
D-dividend per share
k- Required return rate
G-Growth rate
=$2,166/(15%-12%)=72,200
(KOH 2012)
References
ALAJBEG, D., PHD., BUBAS, Z., PHD. and SONJE, V., M.B.A., (2012). The efficient market
hypothesis: problems with interpretations of empirical tests. Financial Theory and Practice, 36(1), pp. 53-72.
ARAK, M. and MARTIN, L.A., (2005). Convertible Bonds: How Much Equity, How Much
Debt? Financial Analysts Journal, 61(2), pp. 44-50.
BISEN, V. and PANDEY, M.,( 2013). Testing Efficient Market Hypothesis (EMH) in Current
Indian Stock Market. Journal of Commerce and Management Thought, 4(4), pp. 792-799.
KARANOVIC, G., BARESA, S. and BOGDAN, S., (2010). TECHNIQUES FOR MANAGING
PROJECTS RISK IN CAPITAL BUDGETING PROCESS. UTMS Journal of Economics,1(2), pp. 55-66.
KOH, J., (2012). CAPM and irrational market: Theories and empirical studies, The University
of Texas – Pan American.
MAROYI, V. and POLL,HUIBRECHT MARGARETHA VAN DE R, (2012). A survey of
capital budgeting techniques used by listed mining companies in South Africa.African Journal of Business Management, 6(32), pp. 9279-9292.
NASEER, M. and BIN TARIQ, Y., (2015). The Efficient Market Hypothesis: A Critical Review
of the Literature. IUP Journal of Financial Risk Management, 12(4), pp. 48-63.
TEPLOVA, T. and SHUTOVA, E., (2011). A HIGHER MOMENT DOWNSIDE
FRAMEWORK FOR CONDITIONAL AND UNCONDITIONAL CAPM IN THE RUSSIAN STOCK MARKET.Eurasian Economic Review, 1(2), pp. 157-178.
http://www.abc.net.au/news/2016-02-03/asx-australian-shares-fall-early/7135858?section=business
