Introduction:
This paper focuses on evaluating financial performance of Bellway PLC using financial statements of recent five years, comparing to its proper competitor, Barratt Developments PLC, which both belong to the property industry. It utilizes the horizontal and vertical analysis to evaluate performances via the income statement and balance sheet. Also, in the part of ratio interpretation, four ratio analyses are included in this paper, which are liquidity, long term debt paying ability, profitability and investor analysis. They measure the ability of meeting short-term liability, leverage ability, earning ability and investment ability separately.
Industry information:
Due to the US sub-prime mortgage and financial recession of 2008, UK construction industry faces great challenges. It is hardly to get access to high quality of mortgage. Besides, since the deteriorating economy leads to higher level of unemployment, consumer confidence and expenditure on purchasing houses will be reduced (Bellway, 2009). The declining demand on housing market has an impact on government further policies, which aims to enhance the number of house building (Construction Industry Market Review, 2009). On the other hand, the recession forces the average housing price to become lower. According to Halifax, it fell down by 16.2% at the end of 2008 (Seager, 2009). After the huge decline on price, Nationwide Building Society revealed that there was a 5.9% jump in house price on December 2009 (Osborne, 2009).
After breakout of credit crunch, banks in UK has adopted tighten monetary policy through improving interest rates on loan. As putting high level of constraints, it is difficult to finance mortgages on purchasing a house. According to the research of Osborne (2010), the number of mortgage approvals declined sharply by a half on January 2009. Additionally, during the same periods, the inflation rate arrived at the top of 5.2% on September 2008, and then it declined continuously to 1.1% in this year (guardian, 2010).
Company information:
My target company is Bellway PLC which, after more than 50 years development, has become the 4th largest house builder in the United Kingdom. The number of homes being built is greater than 100,000 till now. The major business activities in Bellway Group refer to land acquisition, finance, planning, architecture, design, build management, marketing and customer service (Bellway plc, 2010). The company occupies a leader position of trading on private markets and takes full advantage of lands which are disused or abandoned to build homes including apartment blocks. It also provides mortgage loans and housing insurance as firm’s financial services (Yahoo finance, 2010). It is available for Bellway to have competitive advantages in property industry.
Barratt Developments PLC, as a benchmark company, is one of the largest house-builders through Britain and over 300,000 homes has been built and sold. The main areas of Barratt Group in operating are from apartments and family homes to urban regeneration schemes (Barratt Developments, 2009). After further development, it becomes a leader in urban regeneration, social housing, design and innovation, trying to satisfy the market demand. Therefore, Bellway and Barratt Developments are both in the same industry and have similar firm size, financial position as well as major operating activities. It is reasonable to make comparison between them.
Vertical analysis:
In the vertical analysis, the base amounts of the income statement and balance sheet are net sales and total assets respectively. Each single item could be explained as the percentage of base amounts selected from the same year.
Income statement:
Cost of goods sold increased steadily with stable increase in sales during first three years; thereafter more significant increase occurs in cost of every one pound of sales because the financial deterioration drives higher costs. Therefore, gross profit shows stable declines and then it becomes more severe accordingly.
There has a stable growth in interest expenses, resulting from more deferred payments. Referring to Bellway’s annual report (2009), there have certain differences between land purchasing and the required payment, which need to be charged interests as an expense.
Other income increases stably, which mainly refers to interests from financial assets. This increase is consistent with the rise of investments made by Bellway. Combining with discussed above, increased interest expenses occupy one pound of net sales are beyond the increased other income; therefore, income before taxes declines.
Taxes related to operations decline stably before 2008. Thereafter, it experiences a significant drop, which can be explained by the changing UK corporate tax rate. According to Bellway’s annual report (2008), the tax rate change from 30% to 28% will be taken effect from April, 2008. Overall, net income shows a decline trend correspondingly, especially significant after the financial depression in 2008.
Balance sheet:
Cash has a fluctuation trend during recent five years，which reflects unstable usage of cash in activities of Bellway. Gross receivables have a stable increase from 1.77% in 2006 to 3.82% in 2009. Receivables are closely linked to fair value of initial recognition and anticipated receipt date. On one hand, the rising percentage can be partly explained by company’s loose credit policies, such as offering allowances to purchase goods or services later. On the other hand, it is partly justified that most of the financial assets have not past their maturity date (Bellway, 2009). Therefore, total current assets rise slightly in previous 4 years but decline in 2009, because it is mainly affected by significantly decreased cash from 2008 to 2009.
Fixed assets experience a stable decline trend these five years. As disclosed in annual report of Bellway (2009), the decline is mainly due to the fact that millions cost of land and property are deducted and categorized as inventory. In addition, the accumulated depreciation on property, equipment and plant is based on straight-line depreciation method, which can be justified this steady change. Comparing declined fixed assets, a stable growth can be noticed on investment. Accounting to firm’s policy that investment is recognized as cost less depreciation charges and the latter falls slowly as illustrated in cash flow statement (Bellway, 2009). As a result, it is obvious to see a rise in investments. Besides, other non-operating assets, such as other financial assets and deferred tax assets also play an important role in raising the value. Thus, total long-term assets increase obviously in 2009 after previous four years decreases.
Total current liabilities can be explained by two key factors. On one side, there is a reasonable fluctuation in accounts payable, of which the main part is land payables. This fluctuation can be derived from the fact that land payables could be impacted by the fluctuated carrying value of the land for collateral (Bellway, 2009). On the other side, after a slight growth from 2005 in short-term loans, there appears a drop from 2007, even short-term loans becomes zero in 2009. With the occurrence of credit crunch in 2008, the property market has been impaired. The central bank and most commercial banks tighten the monetary policy and increase the interest rate and limitation on bank loans, in order to minimize the credit risk (Osborne, 2010). Consequently, the total current liabilities experience the same trend correspondingly.
Long-term debt, including preference shares and bank loans, comprises the most essential proportion of non-current liabilities. It has a significant fluctuation and experiences a huge decline after financial crisis. Other long-term liability is retirement benefit obligations, which form a “U” shape and reach the bottom in 2007. Because there always has a gap between assets and obligations contributed to the schemes, when obligations are larger than assets and when there is little contribution from employers, other liabilities will go up in 2008 and 2009 (Bellway, 2009). As a result, total long-term liabilities fluctuate relatively.
Common equity has a significant fluctuation while there is a greater jump in 2009, which is consistent with the information that the firm raises new funds through issuing new ordinary shares (Bellway, 2009).
Horizontal analysis:
In horizontal analysis, each amount will be compared with a selected base year, which is year 2005.
Income statement:
Net sales have a trend of fluctuation from 2005 to 2009. After three years stable increases, net sales decline in 2008 and 2009, partly due to the reduction of sales price considering the current housing market condition, and partly due to that homes sold quantity dropped 33% in year 2009 (Bellway, 2009).
Cost of goods sold experiences the same trend with net sales, as which suggests that the falling sales number could reduce expenditure. Additionally, because the cost is also related to inflation rate, which fell to 3.7% in 2009 comparing with 3.9% in 2008, the cost of goods sold decreases reasonably (Bellway, 2009). Therefore, it led to a decline in gross profit in 2009.
Interest expense suggests a fluctuated trend but not severe. It increased and then began to decrease from 2007 to 2009. From total liabilities of the firm, the lower level of bank loans could reduce the interest rate exposure.
There has an obvious fluctuation in other income, which comprises the interest income from bank deposits and financial assets. The frequent change of interest rates results in the fluctuation of available income. In year 2009, the estimated interest rate will go up 1%, so that there is a slight increase in other income (Bellway, 2009). Besides, investment item in balance sheet jumps during these periods, which also brings about large number of other income.
In terms of taxes related to operations, it shows a trend of fluctuation. Taxes increased smoothly until 2007, and then decreased significantly in recent two years. The reason can partly due to the decline of net sales and partly due to the corporation tax rate, which changes to 28% from April 2008 comparing to 30% before (Bellway, 2009).
Therefore, from the analysis above, the trend of net income of Bellway is fluctuating. After three years’ steady increase, the net income declined severely from 2008. The financial crisis plays a critical role in explaining the decline. Since expenditures far outweigh net sales, net income in 2009 becomes negative.
Balance sheet
There exists a severe fluctuation of cash from 2005 to 2009. Cash reached the top at 164.53% in 2008, but it dropped heavily to 65.04% in 2009. The reason firstly can be attributed to serious change of interest rates charged, which fell to 0.22% in 2009 comparing to 3.69% in 2008 (Bellway, 2009). Secondly, the increase in long-term loan in 2008 could illustrate the rise in cash; conversely, the decline on loan thereafter lowers the cash. Finally, there is a positive relation between investment and cash. Investment grows heavily in 2009, requiring more cash to be spent, so that cash declines significantly.
Considering gross receivables, it experiences a stable fluctuation. Comparing with previous increase, there was a decline in 2009, which mainly results from the credit crunch. The firm gave little permission of sales on credit in order to enhance their risk management. Another possibility is that the decline of net sales also reduces gross receivables. Therefore, total current assets show a fluctuation because cash and receivables both change over years
In terms of tangible assets, there shows a stable decline from 100% in 2005 to 46.79% in 2009. On one hand, the accumulated depreciation and impairment losses have to be deducted over these years. On the other hand, Bellway sold parts of tangible assets to get access to funds for further growth of investment (Bellway, 2009). When refers to investment, which has a significant increase because of less depreciation being charged and the lower land price. Thus, the total long-term assets have an increase trend the same with investment, which takes up the largest part.
Accounts payable fluctuated steadily over these periods. After slow growth to reach 120.31% until 2007, accounts payable started to fall to 89.99% and 77.75% in 2008 and 2009 respectively. The fall might results from the decline of being offered to purchase on credit from suppliers, because of the financial crisis and credit risks.
Combining with long-term debt and common equity, both of them have a reasonable fluctuating trend. It is clear to find out that long-term debt declined but common equity had a growth from 2005 to 2007. It represents that the major financing method is issuing common equity. However, after 2008 financial crisis breaks out, both debt and common equity declined in 2009. The long-term debt decrease more severe from 115% to 39%; while common equity only show a smooth decrease from 129% to 124%. Thus, even if facing the financial deterioration, Bellway still relies more on issuing common equity to finance.
Ratio analysis
Ration analysis mainly focuses on comparing between the target company Bellway and its competitor Barratt Developments in terms of liquidity, profitability, long-term debt-paying ability, and investor analysis.
Liquidity:
Comparing with Barrett Development (6.63), day’s sales in receivables shows that Bellway (27.54) takes longer time in collecting receivables, and the firm has higher probability of failure on collecting receivables. As a result, Bellway holds more risks and has no rapid and effective policy of collecting future receivables.
Accounts receivable turnover and accounts receivable turnover in days show that Bellway spends longer time between selling goods on credit and collecting back money. It results in less cycles and lower turnovers. Therefore, it concludes that Bellway is less active in selling on credit and collecting back receivables than its competitor.
Day’s sales in inventory depict the time taken between purchasing goods and reselling them. Comparing to Barrett Development (486.72), it takes Bellway (666.89) longer time in selling inventory. Consequently, Bellway is not active in selling inventory and has weaker ability of converting inventory into cash easily. Apparently, Inventory of Bellway is lack of liquidity.
Inventory turnover and inventory turnover in days are both much better for its competitor. As Barrett Development has lower day’s sales in inventory, it results in higher turnover and more cycles correspondingly. Thus, ratios about inventory imply that Barrett Development has better liquidity of inventory. The consistency of these ratios also shows that there exists no any lagging time when completing the cycle.
Operating cycle exhibits the time taken from purchasing goods, stalling them, selling them to collecting money from credit sales. Bellway (775.74) has longer operating cycle than its competitor (246.68), because the accounts receivable turnover in days and inventory turnover in days are both higher.
According to working capital, Bellway (1060010) is lack of ability to meet short-term liability using current assets comparing with Barrett Development (2940800). It presents the latter has higher net assets after meeting short-term obligation. Thus, Bellway cannot achieve success on short-term safety.
As can be seen from current ratio, figures show that Bellway (5.31) has enough current assets to cover current liabilities, so that the firm has more safety in current ratio than Barrett Development (4.38).
Acid test suggests firms use current assets excluding inventory to meet short-term obligation. Comparing with its competitor (0.25), acid test shows more risky in Bellway (0.39), but current ratio put it in safer situation. It is Inventory that makes Bellway much safer. Thus, it is obvious for Bellway that inventory plays an essential role in meeting the short-term liabilities.
Furthermore, cash ratio indicates that when excluding the inventory and receivables, Bellway (0.18) has lower ability to meet short-term obligation using current assets than Barrett Development (0.21). Therefore, receivables in Bellway also can enhance the ability to meet short-term liabilities.
Sales to working capital suggest whether firm is successful or not when using working capital to generate sales. Referring to current ratio, although Bellway has enough current assets to meet obligation, current assets could not be utilized efficiently to generate sales than its competitor. In summary, it is quite necessary to keep balance between having enough working capital and using them efficiently.
Long-term debt-paying ability
When it comes to debt ratio, the figure shows the percentage of relying on debts in financing assets. Comparing to the competitor (53.78%), Bellway (28.51%) is not heavily relied on funding by debts, so relative small amounts of debt could be found in its capital structure.
Debt/ Equity are in consistent with debt ratio. It is apparent to see that Barrett Development (116.34%) depends on more debts than Bellway (39.89%), so that the firm has to face more risks in paying interests, although it has more safety in capital structure. Also, debt to tangible net worth reveals the same result, which implies that Bellway has lower probability to finance through debt.
Cash flow/Total debt illustrates the ability of using debts to generate cash. Bellway (50.13%) has more efficiency in using debts in terms of generating cash in the future than Barratt Development (15.03%), even if the latter has more debts in total number.
Profitability
Comparing with Barratt Development, the net profit margin shows that Bellway has more efficiency using sales to generate profit. However, when considering total asset turnover, the figure implies that Bellway (0.45) is worse in using assets to generate sales than its competitor (0.91). It is not efficient in terms of asset utilization.
In terms of sales to fixed assets, Bellway (69.04) has a lower ratio than its competitor (461.66), which indicates the ability of the firm when producing sales by productive assets utilization is worse. The higher fixed asset base could be justified to explain the lower ratio (Gibson, 2009).
Investor analysis
Dividend payout ratio for Bellway and its benchmark firm is 50.85% and 0 respectively. For Bellway, nearly half of the earnings have been paid out to its shareholders. While zero dividend payout represents that all the earnings of Barratt Development has been reinvested for obtaining higher capital gains in 2009, thus, a good return on equity must be provided in order to attract its shareholders. Lower ratio also implies that Barratt Development is a growing firm (Gibson, 2009).
Comparing to its competitor, Bellway has a lower book value per share but a higher earnings per share. The former links to lower historical value and retained earnings, implying that shareholders’ equity to each issuing share is small; while the latter indicates that the proportion of earnings being distributed to each share. Higher EPS could generate more profitability for the firm and increase its share price.
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