An analysis and evaluation of the business and financial performance of Fresnillo Plc over the period 1st January 2015 to 31st December 2017
PART 1 – Project Objectives and overall research approach
1.1 Reasons for Choosing the topic and organization
With a passion for Finance and a desire for wealth creation through investing in profitable ventures, I have always tried to appraise and analyse the performance stocks (company’s) on the stock exchange to see which might be profitable. I therefor chose this topic because it would help me to develop the ability to better analyse companies performances, and also to further my career in finance. Over the course of my ACCA studies, I have been required to evaluate the financial performance (performing ratio analysis) of organizations, prepare and interpret financial statements (F5, F7, and F9), and to perform business analysis. I therefor seek to apply this knowledge in a real life situation hence this topic seems ideal.
Mankind has for several centuries, depended on the vast wealth of resources beneath the planet’s surface; from agriculture which was the major activity of early man to mining (the extraction of valuable minerals from the earth).
Mining has been a major contributor the global economy. A study published in 2013 found that the global gold industry’s contribution to the world’s economy was more than 150 countries worldwide, as this sector alone produced more than $171 billions (Cecilia Jamasmie, 2015). According to Mark Cutifani, CEO of AngloGold Ashanti (2012), “mining directly or indirectly drives more than 45% of the world’s gross domestic product” (GDP) (Martin Creamer, 2012). This growing importance of the mining industry to the global economy was a key driver to my selection of this sector.
I also happen to work in the forestry sector that also deals with the extraction of natural resources, this proximity to nature also contributed to my choice of industry
I chose Fresnillo Plc because it is one of the largest silver producers in the world. The London-listed company operates several silver and gold mines in Mexico. Despite a drop in Mexican silver production in 2014, the country still remained the highest silver producer worldwide, with Fresnillo at its fore front. The company is resilient and has a targeted production output of more than 65 million ounces of silver by 2018 (Investing News Network, 2015).
1.2 Research aims and objectives
- Analyze and evaluate the financial performance of Fresnillo Plc for the 3 years ended 31st December 2017
- Identify the factors that have impacted the business and financial performance of Fresnillo over these years
These objectives would be achieved by providing answers to the following questions: - What has been the financial performance of Fresnillo Plc over the 3 years ending 31st December 2017, in comparison to Tahoe Resources Inc.?
- How has the strengths, weaknesses, opportunities, and threats to Fresnillo, affected their performance (both financial and nonfinancial) over the 3 year period?
- How has Political, Economic, Social, and Technological factors affected the performance (financial and nonfinancial) of Fresnillo?
1.3 Framework for RAP
The report analyses the financial performance of Fresnillo Plc for the 3 years ending 31st December 2017. This is facilitated by the use of ratios such as: profitability, liquidity, gearing, and investor ratios.
In order to better evaluate the performance of Fresnillo, their performance is benchmarked against that of Tahoe Resources Inc.
The report then goes further to analyse the impact of the business environment on the performance of Fresnillo, by using the SWOT framework to examining its strengths, weaknesses, opportunities, and threats. It also uses the PEST model to assess the impact of political, economic, social, and technological factors on Fresnillo Plc.
PART 2 – Information gathering and accounting/business techniques
2.1 Sources of information
Information is vital to every research project, and given the ambiguity in the nature of information it is essential to ensure that information collected is relevant and appropriate for any given research, analysis etc. There are 2 main information sources: primary and secondary sources.
2.1.1 Primary source
Primary sources are first-hand documents that provide direct evidence on a subject matter. They Library of Congress refer to them as the “raw materials of History” (Sotheby’s Institute of Art, n.d.). Examples include; interviews, letters, artefacts, journals and witness statements.
2.1.2 Secondary source
Secondary sources are interpretations and evaluations of primary sources. They are not evidence but rather commentary on and discussion of evidence (Sotheby’s Institute of art, n.d.). In other words this could be articles, or discuss on someone else’s original research.
2.2 Methods of Information Gathering
For the purpose of this report, I used only secondary sources of information. This information has been collected from various mediums, including:
2.2.1 Text Books
These were a great source of knowledge as they improved my understanding of various theories for example SWOT, PEST, which helped me to perform better analysis. I also did a review of financial ratios, understanding each ratio and their significance. Some of the books I used were ACCA course books (BPP F7, F9, P3), Finance and Accounting in business 2nd edition (Bob Ryan, 2004).
2.2.2 Annual Reports
The annual reports contain the yearly overview of an organisation, the financial statements and financial highlights. This provides a view of the organisation from the perspective of the directors and was therefore an important tool that assisted in my analysis. I used the annual reports for both Fresnillo Plc and the benchmark Tahoe Resources Inc.
2.2.3 The Internet
The internet was a great source providing access to a vast range of information. This was made possible through the use of search engines such as Google, yahoo, Bing search amongst others. This gave me access to books, articles, journals, documents, newsletters, business channels, and websites which provided a lot of data.
2.3 Limitations to information gathering
One of the major problems I faced was being able to acquire relevant information. With the internet being one of my major sources of information, there was the risk of some of this information being inaccurate. Getting specific information pertaining to Fresnillo was challenging.
It was not possible to get financial statements in excel format therefore I had to extract them from the annual statements which were in pdf formats, which then required further adjustments, making it more susceptible to errors.
Another major limitation was that I was not able to gain access to certain business journal data bases which required premium subscriptions such as Financial Times, and BNamericas.
2.4 Ethical Issues
I have tried to respect the norms of research ethics, above all which is the tendency of just copying someone else’s work to pass of as mine plagiarism. I had to therefore discipline myself and conduct my own research and where ever I used the work of someone else, I made sure this was properly referenced. I had to remain objective whilst performing my analysis to ensure that the results of the companies were presented without any bias.
2.5 Accounting and Business Techniques
In the report, I used the SWOT and PEST models to analyse the impact of the business environment (macro environment) on the business and financial performance of Fresnillo Plc. The most part of the financial performance was however carried out using ratio analysis, in which case a benchmark, Tahoe Resources Inc. was used.
2.5.1 SWOT Analysis
SWOT is an effective tool in reviewing strategy, position and direction of a company or business proposition, by analysing their Strengths, Weaknesses, Opportunities, and Threats (Businessballs, n.d.).
SWOT analysis enables organisations to develop an awareness of the factors that may affect strategic planning and decision-making by analysing the internal and external factors affecting these organisations (Chawda Surendra, 2015).
- Strengths: characteristics of a business that give it a competitive advantage
- Weaknesses: characteristics of the business that place the business or project at a disadvantage relative to others
- Opportunities: external/environmental factors that the business could exploit to its advantage e.g. customer trends, technological advances
- Threats: external factors that could damage an organisations productivity, profitability or growth
Limitations
The analysis relies on the ideas of the individuals who are involved in the process and as such, whether or not the analysis is effective depends entirely upon the intuition, creativity, dynamism, and information gathered by these participants. Failure therefore to identify certain strengths, weaknesses, opportunities, and threats, could seriously hamper the overall success of the organisation.
The analysis enables an organization to generate lists of concerns regarding the organization. A problem is however eminent where some organizations end their planning process at the level of the list generated, without moving beyond to discuss how the identified problems can be resolved, or activities which could be implemented to enable them attain their objectives (Steven Symes, n.d.).
2.5.2 PEST Analysis
PEST analyses how the Political, Economic, Social, and Technological factors of the macro-environment affect an organisation. Usually these factors are beyond the organisation’s control and may either create new opportunities for the organisation to exploit, or threats to be addressed (NetMBA, n.d.). In a broader sense, it also takes into account the Environmental, and Legal aspects of the macro-environment, to come up with the more complete PESTEL.
- Political: this relates to government policies and changes in legislation that impact the economy. It also looks at the political climate of a nation
- Economic: this considers how economic factors such as exchange rates economic growth, demand and supply, inflation and recession may impact an organization
- Social: takes into consideration social trends, demographics, culture, fashion trends, and how these may impact an organization
- Technology: innovations in technology and their impact both positive and negative on an organization.
Limitations
As an analytic tool, the PEST framework focuses solely on the external macro environment and thus may not be value adding to an organization if taken solely on its merits. For PEST to be an effective tool it must therefore be used alongside other models which focus on the internal condition of the organization.
Due to the dynamic nature of the external macro-environment, and the vastness of information required for such analysis, it may be difficult to predict how such external factors which are constantly and rapidly changing may affect the organisation in the long run.
2.5.3 Ratio Analysis
“Ratio analysis is a quantitative analysis of information contained in a company’s financial statements. It is used to evaluate various aspects of a company’s operating and financial performance such as its efficiency, liquidity, profitability and solvency” (INVESTOPEDIA, n.d.).
This analysis entails a comparison among figures to come up with a ratio, and then assessing if this ratio indicates a strength or weakness in the organization’s affairs (BPP, 2016).
In my analysis I have used the following ratios:
Profitability: Profitability ratios are a class of financial metrics that are used to assess a business’s ability to generate earnings relative to its associated expenses. For most of these ratios, having a higher value relative to a competitor’s ratio or relative to the same ratio from a previous period indicates that the company is doing well (INVESTOPEDIA, n.d.). In this report the ratios used for Fresnillo plc and Tahoe Resources inc. are;
a) Gross profit margin
b) Operating profit margin
c) Net profit margin
d) Return on capital employed
e) Asset turn over
Liquidity: Liquidity ratio is a measure of how solvent an entity is, and its ability to raise cash or how easily it can convert its assets into cash (My Accounting Course, n.d.). In this report the following ratios are used;
a) Current ratio
b) Quick ratio
Leverage: A leverage ratio measures how much of an entity’s capital is generated in the form of debt (loans), “or assesses the ability of a company to meet its financial obligations” (INVESTOPEDIA, n.d.). The following are used in this report;
a) Gearing ratio
b) Interest cover
Investor ratios: Investor ratios are used to measure the ability of a business to earn an adequate return for the owners of the business (Double Entry Bookkeeping, n.d.). For the purpose of this report, the following will be used;
a) P/E ratio
b) Earnings per share
Limitations
A major limitation of ratio analysis is its historical nature. Ratio analysis is based totally on passed data and as such cannot adequately represent the company’s future performance.
Some ratios are a snapshot at a particular point in time (as at the balance sheet date) of a company’s performance, and as such any unusual spikes or drops at this point may give a false interpretation of the company’s performance.
When using ratios to benchmark other companies, there is the risk that the two companies may not be implementing the same strategies and therefore, conclusions drawn may not be accurate, for example a company focusing on high customer service and the other on a low-cost strategy.
Another major limitation is when using ratios to make comparisons between companies which are implementing different accounting policies.
Ratio analysis is a quantitative measure of performance and as such does not take into account the qualitative aspects of a company’s performance.
PART 3 – Analysis of Financial Performance and Business Environment
Description of business
Fresnillo plc is a holding company which gained listing on the London stock exchange in 2008, thereby becoming the first Mexican listing on the London stock exchange (David Robertson, 2008). Through its subsidiaries, the Company is engaged in the mining and beneficiation of non-ferrous minerals, and the sale of related production. The primary contents of their production include silver, gold, lead and zinc. The Company has six operating mines: Fresnillo, Saucito, Cienega, Herradura, Soledad-Dipolos mine, and Noche Buena which are all located in Mexico. The Company has two development projects, which include Saucito II and San Julian (investing.com, n.d.). Fresnillo seeks to create value for stakeholders by implementing a strategy that focuses on high potential silver and gold projects that can be developed into low cost, world-class mines, investing across metal price cycles, delivering growth through development projects and maximising the potential of existing operations (Fresnillo plc, n.d.). Fresnillo is the world’s largest primary silver producer and Mexico’s second largest gold miner (Cecilia Jamasmie, 2018). They have approximately 1.8 million hectares of surface land, with exploration prospects containing over 2,320 million ounces of attributable silver resources and 38.5 million ounces of gold resources (Fresnillo, 2017 p. 11).
The Benchmark
Tahoe Resources is a leading mid-tier precious metals company headquartered in Reno, Nevada and incorporated under British Columbia law. Tahoe and its subsidiaries directly employ approximately 2,700 people and are led by experienced mining professionals dedicated to the responsible production of precious metals across the Americas. Tahoe owns and operates the world-class Escobal silver mine in Guatemala, the La Arena and Shahuindo gold mines in Peru and the Timmins West and Bell Creek gold mines in Canada. Their stock is traded on both the Toronto Stock Exchange and the New York Stock Exchange (Tahoe Resources, nd).
Analysis of Financial performance
3.1 Ratio Analysis
3.1.1 Returns and Profitability
Revenue Growth
Fresnillo revenue increased by an amazing 31.9% in 2016, this growth was primarily due to an obdurate increase in production output for the year. Annual silver production for the year was a record 50.3 million ounces, 7.1% up from 2015. Fresnillo attributes this increase primarily to the start-up of phase 1 of San Julian mine, higher ore grades at Cienega and an improved contribution from the Silverstream (Kitco News, 2017). Gold output was also up 22.8% from 2015, to a total of 935,300 ounces in 2016 (Cecilia Jamasmie, 2017). Another contributor to this increase in revenue was an increase in metal prices. Global silver prices on an annual basis moved up 9.3% to $17.14 per ounce in 2016 (World Silver Survey, 2017). More specifically, Fresnillo recorded increase in average gold and silver prices of 11%, and 10% respectively in 2016 compared to 2015 (Alliance News, 2017).
Despite a fall in gold output in 2017, Fresnillo still reported an increase in total revenue of 9.9% in 2017 to $2 billion. This increase was precipitated by record silver production, higher zinc volumes, and base metal prices. Silver production increased 16.6% to a record 58.7 million ounces, mainly attributable to the operation of the San Julian mine at full capacity for the first full year (Arathy S Nair, 2018).
Gross Profit Margin, Operating Profit Margin, and Net Profit Margin
Gross profit increased 103.69% in 2016 compared to 2015 (Figure 3 above). This can be attributed primarily to the increase in revenue as mentioned above, and reducing costs. ‘The company reported 8.41% cost deflation in 2016, driven by a weaker PESO compared to the dollar, and lower diesel and electricity costs’ (Sam Williams, 2017). Peso dropped 17% compared to $US in 2016 (Ivana Kottasova, 2016), and with 67% of Fresnillo’s costs being peso based, the company benefited from this fall in currency (Proactiveinvestors, 2016). In 2016, Mexico’s gold mining sector also saw a fall in average cash costs of 5.4%, with Fresnillo recording the lowest cost gold operation at its Cienega mine where cash costs were $-217 per ounce down from $245 per ounce in 2015 (Sam Williams, 2017). Despite their profitability in 2017, growth in Fresnillo profit margins is reducing (Figure 3). Gross profit increased only by 4.91%, due to increasing costs. Cost of sales increased 14.1% from 2016 compared to only a 1.2% increase 2015 – 2016. 2017 saw an increase in cost per tonne of 29.3% which was mainly due to lower volumes of ore being processed, energy cost also increased 22.3%, from $118 million in 2016 to $144 million in 2017(Fresnillo, 2017 pp. 56, 210). This increase could be attributed in part to an increase in base power tariffs, by Mexico’s state power utility (CFE), which recorded an increase in base power prices on a year on year basis of 14.3% in 2017 (Daniel Rodriguez, 2017). Fresnillo also experienced an increase in wages on average of 5.8% (Alex Newman, 2018)
Operating profits also increased 237.49% in 2016 (Figure 3) due to falling expenses. The fall in operating expenses could be attributed to; devaluation of the Mexican peso, decrease in non-recurring engineering and construction services provided by Servicios Industriales Peñoles, S.A.B. de C.V., which reduced administrative expenses by 5.8%, and a 13.6% fall in exploration expenses, as a result of management’s decision to reduce expenditure in volatile market conditions (Fresnillo, 2016 p. 108). In 2017 operating profits are growing at a diminished rate of 4.86% compared to 2016. According to Octavio Alvidrez the chief executive, there was an intensification of exploration activities around mining districts (Marcus Leroux, 2017), this could account for the 16.4% increase in exploration expenses to $141 million from $121 million in 2016. Further expenses were incurred as Fresnillo commenced drilling at the Juanicipio project, in collaboration with the exploration team from MAG Silver corp. This contributed to reduce growth in Fresnillo’s operating margin.
Net profits were at a low of 4.8% in 2015, but with a significant boost in production output and revenue growth, this margin increased by an amazing 512% in 2016, despite tax expense increasing 105%. This trend continues in 2017 with the margin increasing 31.97%, as tax expenses dropped 38.39%. The fall in tax expense was partially due to the deduction of inflationary uplifts of the tax base of assets and liabilities (Fresnillo, 2017). In 2017, Fresnillo’s gross and operating profit margins have both dropped slightly, to 44.21% and 33.88% respectively whereas the net profit margin has increased to 26.79% (figure: 2 above). In addition to the 38.39% fall in tax expense, this increase can also be attributed to the 4.5% spot revaluation of the Mexican peso against the US dollar that resulted in a decrease in Fresnillo’s foreign exchange loss to US$6.4 million as compared to US$18.4 million in 2016 (Fresnillo, 2017).
1.6.2019