Essay: Analysis of the financial situation

1.Introduction

1.1 Topic chosen and its context

In my Research and Analysis Project the topic chosen by me is AN ANALYSIS OF THE FINANCIAL SITUATION OF YOUR CHOICE OF ORGANISATION. To select the organisation of your choice for my thesis was a difficult and interesting job for me as I myself had to choose it and then to analyse its financial situation. Moreover, The Company had to be in such a line business with which I was familiar. Therefore in this report, I will be analysing the financial situation of Lucky Cement Limited. Identification and analysis of the factors effecting the financial situation of Lucky Cement is the core area of my thesis. Apropos to display the true picture both financial and non-financial factors have been considered. Here, I will be particularly concerned with the financial situation of Lucky Cement for financial year 2007 (FY’07). However, last four years (FY’03 to FY’06) and one year ahead (FY’08) have also been considered to disclose the company’s financial situation at a glance and for comparison purposes. The company will also be evaluated against its competitorsand cement sector in Pakistan.

“Ratio Analysis” will mainly be used for financial analysis. Risk analysis will describe its financial risk elements and their management’s policies to deal with those risks. “SWOT Analysis” will be a key to determine its current internal strength. Competitive analysis has been used to view the company against its competitors.

1.2 Reasons for selection

The selection of this topic and organisation is based on the following reasons:

Area of prime interest: Analysing the financial situation of a company is interesting and I always find my interest in gaining depth knowledge about the financial situation of cement conglomerates.

Consisting wide information: Cement industry is one of the largest industries in the Pakistan and its broadness leads the knowledge to be available and collect easily.

Link to my studies & profession: Our ACCA study is heavily based and circle around the companies, its performance and financial situations. This topic makes me confident to analyse through what i have learned from my ACCA studies. Moreover, my profession was also based around the financial data of companies that also helped me to do my best.

The Company: Lucky Cement Limited is the largest, most modern and growing cement company in Pakistan.

1.3 Aims and objectives

The aims and objectives of this report are to:

• Evaluate the financial performance and position of the company.
• Highlight the stake of the company in the industry.
• Compare the company’s results with its competitors and industry average, and Its total contribution to the industry.
• Use ratio analysis to structure the solvency, liquidity, capital, cash and debt position of Lucky Cement.
• Use SWOT analysis to analyse the strengths and weaknesses of the business, and comparing them with opportunities and threats in the environment.
• Conclude about the current situation and prospects of Lucky’s financial position and performance based on my analysis for the users this report.

2.Information Gathering

Wide-ranging information was available due to the topic and choice of the organisation. Because not all information is always relevant, and irrelevant information makes confusion with the objectives, therefore only relevant information was compiled and analysed accordingly.

2.1 Sources used and reasons for their use:

A number of sources were available to gather appropriate and valuable information. However these sources are summarised in two broad headings ‘Primary sources’ and ‘Secondary sources’

a) Primary Sources:

An interview was conducted with Mr. Muhammad Abid Ganatra – Director Finance & CompanySecretary in Lucky Cement. The primary purpose of this interview was to understand the Directors Report and to assess how the business is seeking financial resources to finance its activities. After this interview, I had a clearer perspective of how the company is financing its current operations and how it plans to cope with ever increasing demand of resources. I also got some information regarding Lucky’s national and international markets. The request for documents such as Company profile and Annual financial accounts for year ended 2003-2007 was made.

Another interview was conducted with Mr. Tajamal Rashid – Chief Financial Officer & Company Secretary in First National Equities Limited. The purpose of this interview was to seek information regarding competitive positions to know about the market place of Lucky Cement. Mr. Tajamal Rashid is highly experienced personnel and has good knowledge of the Pakistan Cement Industry. For this reason, I also got some information about Lucky’s major competitors, its current and future perspective and information about The Pakistan Cement Industry at glance.

Prior to the all meetings a layout and structure of the meeting and questions to be asked were sent via an email in order to reduce the confliction of time management and misunderstanding about the meeting. I also took my working diary with me to write down key verbal information.

b) Secondary Sources:

These consisted of the following:

• Audited Accounts: Annual audited accounts of Lucky Cement proved to be valuable source of reliable and accurate data regarding its financial situation. Data for ratio analysis was primarily withdrawn from these accounts.
• Articles: Consulting articles such as business articles from newspapers, and business magazines were valuable source of information for my project.
• Electronic Research: Internet through World Wide Web proved to be the most powerful tool of gathering and analysing information. Information about Lucky’s competitors and current trend in domestic and international markets were also scrutinized through this source.
• Text Books: Consulting Foulks Lynch and BPP textbooks for ACCA were also valuable supporting material, to give guidance for adopting appropriate analysis tools.
• ACCA Magazines: ACCA Student Accountants helped me throughout the research and made me confident in my findings. These proved not only giving me techniques of report writing but also a source of gathering base knowledge about analysis of financial situation. Although to the point information was tuff to be gathered from these.
• Analyst’s Reports: Some Analysts’ Reports were used to make my research more valuable through their findings and recommendations.

3. Analysis

3.1 Company History:

Lucky Cement Limited is a project by Yunus Brothers Group (“YB Group”), which is one of the largest business groups in Pakistan. Lucky Cement Limited was incorporated in Pakistan on September 18, 1993 under the Companies Ordinance, 1984. The Company is listed on all the three stock exchanges in Pakistan, (the Lahore, Islamabad and Karachi Stock Exchanges), since 1996.

3.2 Business Profile:

Lucky’s products are comprised of Ordinary Portland Cement (OPC), Sulphate Resistant Cement (SRC) and Slag Cement (SC).Moreover, unlike other companies it has different brands, (regular, star, gold, chairman, SRC), to magnetize different requirements of users.

[http://www.lucky-cement.com/products.asp]

The Company is ISO 9001:2000 certified, for manufacturing and sales of cement by UKAS Quality Management, Pakistan National Accreditation Council and Moody International, and a leading exporter of cement products due to its quality and business strength.

3.3 Sector Overview:

The fiscal year FY’07 was an eventful year for the cement sector of Pakistan. Cement dispatches grew at a record 32% for the period by making dispatches of 24.22mtpa in FY’07 against the last year dispatches of 18.34mtpa. At the same time, however, the industry also suffered from a drastic decline in profitability as the combined industry profits declined by 56% from Rs 12.3 billion in FY’06 to Rs 5.3 billion in FY’07. This decline in profitability despite the impressive growth in sales volume can be explained by a number of factors. The most important factor was the significantly slim retention price by 32% on year-on-year basis, due to severe price was among manufacturers owing to supply overhang observed during most part of the year. Moreover, the rising international prices of coal and oil resulted in a 37% increase in the cost of production for the sector. [Business recorder]

3.4. Ratio Analysis:

The broad categories of ratios, that i have analysed in this report, are as follows.

• Sales and Profitability
• Returns
• Cash flows
• Liquidity and Working capital
• Long-term solvency
• Shareholders’ investment

Profitability:

In FY’07 gross profits of the Lucky Cement registered a growth of 23.32% over the last year because of volumetric growth in sales to 4.64mtpa in FY’07 from 2.2mtpa in FY06 and reduction in cost of production. Whereas the profitability margins in FY’07 were registered lower against the previous three years due to significant decline in cement retention prices because of price war among large cement manufacturers in 2Q’07. The retention price declined 28.7%, to PKRs 128.9 per bag in FY’07 from PKRs 180.9 per bag in FY’06. [Muhammad Faraz, 2007]

After tax profit of Lucky Cement also affected primarily through price fluctuations and then mainly through financial charges, particularly in FY’07 when finance charges were PKRs 863 million against PKRs 83 million in FY’06, representing a significant increase due to charging of financial charges to P&L a/c, which were last year capitalized to operating assets in compliance with the requirements of IAS. Wining a refund claim case of PKRs 538.8 million in Supreme Court against Collector of Central Excise and Sales Tax Peshawar, in FY’07, also affected profit results. [Company Report, 2007]

Company’s highest profitability margin was recorded in FY’04 because of 32.79% growth in sales with reasonable prices and only marginal difference in cost of sales, due to use of coal as a fuel instead furnace oil.

However, as compare to industry averages Lucky Cement showed esteemed results. Gross profit growth of the industry was in negative because as a result of price wars and cost of sales has increased mainly due to rise in coal prices in the domestic and international markets, as most of the companies in the industry are using coal in their processes.

In FY’08 Lucky Cement is expected to be more profitable against current year (FY’07) because the sales of the company are expected to increase. Moreover, company has achieved the opportunity at Pezu Plant to use natural gas by replacing its existing captive power generation facility from furnace oil. This will reduce the cost of power generation, which will ultimately reduce the cost of production, and hence the profitability will come up. (See Appendix II, Ratios Table 1 & Appendix III, Graph 1)

Returns:

The return measured by ROA registered a continued increase from FY’05 to FY’07, following growth in profitability for the preceding periods. However, as the profitability growth in FY’07 was lower than in FY’06, as compare to preceding periods, ROA was also affected by the same trend, but still recorded 122.97% growth against the industry average. Whereas, ROE reveal a marginal decline in current year, from expected results, mainly through the transfer of PKRs 3 billion to reserves that increased the equity against previous years. In FY’08 ROA is expected to grow in the same earlier fashion whereas a marginal decline in ROE is expected due to increase in equity, which is expected to be raised, along with other financing facilities (Global Depository Receipts (GDRs)), for company’s forthcoming expansions at Karachi Project and development expenditure to set up Silos facility at port for further enhancing its exports. (See Appendix II, Ratios Table 2 & Appendix III, Graph 2)

Cash Flows:

Cash flow statement takes the same importance by the users as Profit and Loss Account and Balance Sheet take. It demonstrates the destinations and amounts of cash that is being utilized or earned throughout the period. It also gets attention because it carries the actual transactions that have been taken in cash terms and the Net cash of the period end is the actual ready cash profits.

Cash flows from operating activities have been registered steady growth and grew ranging between 82%-85% in years 2003-2006. Company’s highest cash flows from investing activities was recorded in FY’05 in which the company made PKRs (8.514) million cash outlay for the purposes of fixed capital expenditure and PKRs 0.016 million was gained through their sale proceeds with totalling net cash from investing activities was PKRs (8.498) million. However this amount was 1.4, 8.5 and 33.33 times high against the FY’06, FY’04 and FY’03 respectively. Cash flows from financing activities also increased over the years and the highest cash flows from such activities were registered in FY’06 amounting to PKRs.6.038 million. In FY’07 the overall cash flow performance is a little bit unusual with major changes recorded in financing cash flows and then investing cash flows, however operating cash flows showed a petite change and stood at PKRs 1.850 million against last year’s amounted PKRs 2.724 million. Cash flows from investing activities also reduced from PKRs (6.053) million to PKRs (2.037) million in FY’07. The major change was in financing cash flows which reduced from PKRs 6.038 million to PKRs (0.894) million in FY’07 following with strong reasons of repayment of some long-term loans and cash payment of dividend. Thus In FY’07 Net cash flow was registered with outflow of cash amounted to PKRs (1.081) million against last year’s inflow of cash amounting PKRs 2.709 million.

However based on the company’s past cash flow experience, In FY’08 the company is expected to generate Rs.4.671 million operating cash inflow, Rs. (1.160) million cash outflow from investing activities and Rs. (2.391) million cash outflow from financing activities, reasoning the expected repayment of long term loans in FY’08. Therefore, upcoming FY’08 is expected to generate net cash in the company amounting PKRs.1.120 million. (See Appendix I, Yearwise Statistical Summary, Cash Flows)

Working Capital & Liquidity:

Liquidity prescribes the availability of sufficient funds to meet financial commitments as they fall due. Lack of cash affects the strength of the company, though it is profitable but availability of cash, when needs, is one of important aspects of company’s going concern issue. Generally 1:1 ratio is considered to be safe, though other business conditions apply as well.

Apropos to the ratios calculated, Lucky Cement in this aspect is considered to be week as it has poorer ratio strength than generally accepted and in FY’07 against the industry average. However, in FY’04 Lucky Cement revealed unquestionable results. But with deep analysis of its Balance Sheet we come to know that it always hold sufficient funds to cover its trade payables, wages, daily expenses and taxes as they fall due. With respect to acid test ratio Lucky Cement looks to have sufficient liquid assets (other than stocks) to pay all its short-term obligations as they fall due. Generally this ratio is considered to be safe at 0.8:1 and though Lucky Cement has below this assumed safe limit but its liquidity is taken to be unquestionable based on its other business conditions and strength.

However in forthcoming year no enormous changes are expected to occur in these ratios and are expected to change slightly with trend.

Inventory turnover days of the company are also in effective control and currently almost in line with the industry, though fluctuations appeared in FY’04-06. However, over all the company’s marketing and JIT (Just in Time, for inventories) functionalities combination is ideal that is why after the expansion it still maintained its inventory turnover more or less the same and is expected to remain on the same track. (See Appendix II, Ratios Table 3 & Appendix III, Graph 3)

Solvency:

Solvency prescribes the availability of cash over the longer term to meet financial commitments as they fall due.Leverage is the term used to describe the proportion of total assets financed by equity.

In FY’03 business was highly financed by equity with 89.08% equity and 10.92% debt (long-term) after which debt proportion of the company dramatically increased upto FY’06 and equity proportion decreased with more or less the same ratio. However in FY’07 the trend is seen going reverse and company is now improving its debt position again. In the end of FY’04 the proportion of debt and equity was at the ideal point (dominated by ‘a’ see appendix III, graph 4), and it was the financial year when company registered its ever-highest profitability margins. As compare to industry Lucky’s overall equity and debt position was weak in FY’07.

However, going with trend, in FY’08 the debt situation of the company is expected to improve more, following some of the debt pre maturity repayment through GDRs issue.

(See Appendix II, Ratios Table 4 & Appendix III, Graph 4)

Interest Coverage:

Lucky’s interest cover ratio was unquestionable in the FY’03 and FY’04 though after that it dramatically declined up to FY’07. However, the ratio is still within the generally acceptable limit. The main reason for this decline was due to continues fluctuations in PBIT and finance costs, that increased over the periods, and particularly in FY’07 when finance costs increased with 941.97% whereas PBIT growth was only 10.69% against the previous periods respectively. However, in FY’07 Lucky’s interest cover is above the industry average and satisfyable. In FY’08 ratio is once again expected to progress due to fall (expected repayments) in debt and increase in PBIT. (See Appendix II, Ratios Table 4 & Appendix III, Graph 5)

Earning Per Share:

Earning per share (EPS) demonstrates the value currently the shareholders derive from their holding of ordinary shares. It also highlights the potential value and performance of the business.

EPS trend in Lucky Cement is highly in favour of its shareholders. EPS grew 13 times from FY’03 to FY’07. However, in FY’07 EPS grew 32% against the last year 2006, in which the expansion came in live. Lucky’s strength in this aspect is also considerable; when it is compared with the industry average Lucky’s EPS is 5 times high than the industry average which is only Rs.1.89 in FY’07. This positive growth is also building the shareholders trust in the company and they might also be willing to invest more, if it is being demanded, as in future expansions are expected and this situation is likely to arise. However, as compare to industry, Lucky’s EPS position is highly progressive and the growth trend is expected to remain in same fashion for the upcoming year 2008.

Net assets per ordinary share of the company also increased over the periods and hence increased the shareholders value. Though there was a trivial change from year 2006 to 2007, with only 2.65% growth was recorded, the overall shareholders investments are safe and are generating more value from time to time. Whereas in FY’08 a marginal decline is expected. Book Value per share also improved with ever-positive trend and expected to be on the same track in future. Overall Lucky’s shareholders value is very sound and is also in a good stake against industry. (See Appendix II, Ratios Table 5 & Appendix III, Graph 6)

3.5. Risk Analysis:

Risk analysis forms the basis for risk management and crisis prevention. Risk management involves adapting the use of existing resources, contingency planning and good use of new resources.[http://www.mindtools.com/pages/article/newTMC_07.htm]

With the tight schedule of words and being specific here I am analyzing only the financial risk of Lucky Cement.

Financial Risk Analysis:

Lucky Cement encounters financial risks like credit risk, mark-up rate risk, liquidity risk and foreign currency risk, through export sales, import of materials & machinery, export financing & refinancing and foreign currency import finance, which are sizeable. These risks are mainly hedged by forward contracts and cross currency swaps. However, the company very effectively manages the risks profile on ongoing basis.

The top of the risks that Lucky Cement concerns the most is markup rate risk and foreign currency risk. The Company has long-term and short-term Rupee based loans at variable rates. Substantial part of the variable rate Rupee loans are hedged against interest rate and cross currency swap risk by instituting fixed interest rate swap arrangements. This protects the Company against any adverse movement in mark-up rates. Rates on short-term finances are also effectively fixed. Foreign currency risk arises mainly due to fluctuation in foreign exchange rates; the Company also has transactional currency exposure. Such exposure arises from sales and purchases of certain materials by the Company in currencies other than rupees. Approximately 34% of the Company’s sales are denominated in currencies other than rupee, while almost 66% of sales are denominated in local currency. The Company is exposed to foreign currency risk due to cross currency swaps on long term finance amounting to US $ 40.047 million (2006: 16.681 million) which is covered because of export proceeds. (Company Report, 2007)

3.6. SWOT Analysis:

3.7. Competitive Analysis:

Total Net Sales:

In terms of individual companies, DG Khan Cement Limited (DGKC) was the long-standing market leader in terms of sales. However through recent expansions, Lucky Cement has been able to lead the market with 95% high sales volume than its major competitor, DGKC, and holding 19.16% market share. With the upcoming expansions of the company this trend is highly considered going continue so far. (See Appendix-IV, Chart-1)

Profitability:

Lucky Cement has comparatively low profit margins than its major competitor, DGKC, due to high interest cost and depreciation as a result of recent expansion. However, high sales volume growth partially offset it and enabled the company to improve its bottom line. (See Appendix-IV, Chart-2)

Returns:

Lucky Cement has the highest return on assets than its comparable peers like, DGKC, Maple Leaf Cement Factory Limited (MLCF), and Pioneer Cement Limited (PIOC). However, Lucky Cement has the second highest return of the industry and comes after Fauji Cement Company Limited (FCCL), which is leading the market in ROA terms that also has the highest ROE in FY’06, in the industry. However Lucky Cement maintained its position and has the highest ROE of the industry in 2007. FCCL’s this lead is due to its small size of balance sheet. (See Appendix-IV, Chart-3)

Earning Per Share:

In current financial year 2007 Lucky Cement had the highest EPS as compare to its peers due to high sales growth and hence profitability, following the recent expansions. Though in FY’06 it had a marginal low EPS than its major competitor, DGKC, in the current year it maintained its position as market leader and expected to be in future. (See Appendix-IV, Chart-4)

Debt to Assets:

Lucky Cement is in high debt as compare to its peers, though there was a marginal difference in debt ratio of Lucky Cement with its competitors MLCC and PIOC but has a 50% high debt ratio as compare to its major competitor, DGKC in 2007. This debt amount includes prior charge capital and is one of the factors for Lucky’s lower profitability. (See Appendix-V, Chart-5)

3.8. Future Outlook:

The Public Sector Development Projects (PSDP) allocation of Rs.520 billion for the financial year 2007-08 with focus on the development work all over the country will lead to a drastic increase in the demand of cement in future. The entry of private investments by reputed international construction companies including Emaar, Nakheel, Al-Ghurair and Meinhardt will also create a sizeable demand of cement in the domestic market and hence Lucky Cement is considered to be in focus in terms of quality and capacity available for timely need, as it is a leader in country’s cement sector.

With the main focus on exports to the regional countries, Lucky Cement has decided to take further lead by adding two additional cement production lines identical to previous ones within the same premises of Karachi Project with annual capacity of 2.5 mtpa. The total capacity of the company after this expansion plan will be 9mtpa. The project would be financed through GDRs issue upto US$150m, to be listed in the London Stock Exchange. This expansion plan is scheduled to come online in 18 months.

To minimize expansion cost, the power requirement for the expansion lines will be met through captive gas based power generation for which additional supply of gas has been arranged from the recently discovered reserves of natural gas at Gurguri area which is around 150 Kilometers from the plant site.

The Company is also setting up silos facility at Port for further enhancing its exports with higher ship loading rates and minimum risk of demurrage.

The registration of Lucky Cement with the Bureau of Indian standard (BIS) is at final stages, as visit of the plant by BIS engineer has been made, which will make the company to explore the market in India as well. (Company Report, 2007)

4. Conclusion:

It is stated, based on the findings; data available; company’s current business and financial situations and trend over the years, that Lucky Cement is a major part of the Pakistan’s Cement Industry which current (FY’07) gross sales is PKRs 16.6 billion that represents PKRs 12.3 billion local sales and PKRs 4.3 billion export sales and enjoying with gross profits amounting PKRs 3,675 million.

In past Lucky Cement has been attractive and profitable all the times that let it to lead today’s market in Pakistan. Though, the company’s highest sales and profitability growth was registered in FY’04, but the company was continuously profitable since last 5 years with getting improve results year-by-year, and remained strong than the market of Pakistan cement sector. The company was standing after its major competitor DGKC in FY’05 with Turnover PKRs. 3,980 Million and gross profits PKRs 1,380 Million.

However, currently Lucky Cement is the market leader following the significant upsurge in FY’06 and FY’07 represented by additional capacity of Line C and D of Pezu Plant Unit II and E of Karachi Plant Unit III, streamed lined in FY’06. Currently in FY07 the company is leading both markets with holding 15.13% Domestic market share and 45.70% in Export market share.

Lucky’s current results expose its future so bright and following its expected expansion plans and its development projects, setting up silos facility at Port for further enhancing its exports, will positively affect the company’s performance. The company’s decision, to use gas in its Pezu Plant is much appreciated as it will reduce its cost with the positive affects on its profitability and will get a ‘Golden Hill’ position in the market, being leader in production capacity, turnover and profitability. Moreover, with exploring market in India its export market share will further increase which will allow the company to contribute more actively and considerably to the international market. Based on my research and findings it is expected that Lucky Cement will move forward with 51.04% Sales growth and 74.01% Gross profit growth and will generate earnings PKR.12.20 per share.

I, Muhammad Faheem Chughtai, conclude based on my all research and findings that Lucky Cement is going concern and will remain for the foreseeable future, and is expected to be profitable, and lead the market for at least upto 3 years.