BAFN200: Principles of Finance FACULTY OF LAW AND BUSINESS

Finance and Accounting Business Data Analysis

Prerequisites: ACCT100 Principles of Accounting, STAT102 Business Data Analysis

It is your responsibility as a student to ensure that you have the prerequisites for a particular unit. You may not enrol in this unit if you have previously passed, or are currently enrolled in, any unit identified as incompatible with this unit. If you do not meet these requirements, then you must see your Course Coordinator.

Description: This unit provides students with an opportunity to develop an understanding of concepts, techniques, and practices that are needed to make financial decisions in a competitive business environment. Students will gain knowledge of the major issues in business finance and the models and theories that have been developed to help us understand how the financial world works. The focus of the unit is on common investment and financing decisions and related financial concepts such as the time- value of money and valuation of different types of securities. The nature of investment decisions will be addressed, including topics such as capital budgeting, portfolio theory and the capital asset pricing model. Having considered how businesses invest their funds, students will learn how those funds are financed and their costs, including the cost of capital, capital structure decisions, dividend policy and current assets management.

ASSIGNMENT 2:

Blackmores’ stock has risen a staggering 1268 per cent over the past ten years (2005-2015). For eight of those years, the stock went practically nowhere, and then rose tenfold in the space of two.

1. Examine the share price history and history of traded volumes over the past five years, identifying the main causes of changes in the share price during this period. Based on its stock price, do you think Blackmores has performed well over the past ten years?
2. Calculate the market capitalisation of Blackmores. Do you think Blackmores’ stock is under- priced or over-priced? Answer this question with reference to capital asset pricing model (CAPM), and justify your answer. How do you estimate the future price of Blackmores’ stock? Is this the best time to buy or sell Blackmores’ shares? Why?
3. What is Blackmores’ cost of capital? What does cost of capital mean for Blackmores?
4. Describe and comment on the working capital strategy of Blackmores for the past 5 years? What major factors would they have considered in determining their working capital strategy?
5. Examine the dividends paid by Blackmores over the past five years and describe the firm’s

dividend policy. Does their dividend policy make sense? Discuss.

Executive Summary

The report investigates the reasons for the rise in Blackmore’s’ stock of 1268 % over the past ten years (2005-2015). This is done by an analysis and examination of the share price and trading volume history over the past five years with identification of the main causes of changes followed by a discussion and comment on the company performance over this period. Calculation of the market capitalisation of Blackmore’s with a comment on the stock overpricing and under pricing with reference to capital asset pricing model (CAPM) is followed.

Discussion on the estimatation of the future price of Blackmore’s’ stock and advise to buy or sell Blackmore’s’ share is followed by the calculation of the cost of capital and its analysis.

Discussion and comment on the working capital strategy of the company for the past 5 years is followed by an analysis and examination of the dividends paid by Blackmore’s over the past five years and a comment on its dividend policy.

Introduction

Blackmore’s is an Australia based company involved in the development and marketing of health products like vitamins, herbals and minerals and other nutritional supplements. The Company is fast making its presence felt in Asia and China as well. The Company offers products for wide ranging health issues like arthritis, brain diseases; children's health; immunity; digestion; energy; eye care , heart care , men care; skin care , stress and teen care; weight management, and women’s health.

Blackmore’s’ stock has risen a staggering 1268 % over the past ten years (2005-2015). For eight of those years, the stock went practically nowhere, and then rose tenfold in the space of two. The discussion that follows investigates the issue in detail.

Discussion and analysis

Methodology

The methodology used for the investigation is factual based on the annual reports of the company. These reports are analyzed using the technique of statistical graph analysis and ratio analysis wherever necessary. The data sources used for the report are cited wherever they have been used and combine the writers theoretical knowledge on the subject. The assumptions are mentioned clearly wherever applicable.

1 Analysis of change in share price

The main causes of changes in the share price during this period can be attributed to the following

• Blackmore’s has been a reputed and well-managed company and the perceived future growth rates for the stock have pushed up the prices.
• The changes in markets sentiments could be reason in as in February 2007, the stock was at $21 with a 67% rise due to the positive market expectations. In February 2014, it was still priced at $21 even though the revenue and operating earnings increased during this period. The investors’ expectations bore fruit during this period with rise in earnings per share at 13% a year over the last five years. However, past performance is not always replicated in the future.
• The share has basically been on arising spree since February 2015 due to the investors’ expectations of its rosy future. The sharp rise occurred around August 2015; with the announcement of the annual financial results; a net profit of $46.6 million, rising 83% from the previous year, a 36% rise in sales to $471.6 million. Earnings per share increased 81% with a dividend of 135 cents per share. The Australian vitamins division reported increase in sales of 43% to $317 million and earnings before interest and tax (EBIT) increase of 88%.
• Debt gearing reduced from 34% to 5%.
• Dividends for 2015 were 203 cents per share, higher by 60% compared to last year. A greater than 100 % payout ratio is one of the most important factors which have caused the rise in the share price and trading volumes as revealed form the perusal of the last five year trading history of the company.
• An increase in sales revenue of $535 million for the 12 month period ending September 2015, compared to $326 million for the 12 month period ending September 2013 implies a 64% increase in revenue and a 157% increase in net profit attributed to the operating leverage in manufacturing vitamins.
• Hopeful investor expectations for the future growth of the reputed stock and its strategic expansion strategy to Asia accounting for 30% of global sales. Free trade agreement of Australia with China implies reduction of import tariffs and great business from China. (Mywealth, 2016) (Intelligent Investor, 2016)

Monthly share prices and volumes for past 5 years

(In AUD)

(Au.finance.yahoo.com, 2016)

Based on its stock price, Blackmore’s has performed well over the past 10 years; as revealed by the opening price chart graphed above ; the price has been steady from July 2010 to February 2015 after which it has taken for a sharp rise due to reasons explained above. Maintaining steady prices over these 5 years is a sign of good performance for a company listed on the stock exchange.

Stock prices rise and fall due to reasons like earning expectations, product launches, acquisitions , change in regulations , legal suits , change in management , dividends , interest rates , state of the economy and global trade and most importantly the investor sentiments . Given this fact, the price of the share remained steady indicating the company’s capability to report positive on all the points enumerated. Never was a major fall reported during this period. This implied steady profit and growth rates for the company as well as earnings for the investors in the form of dividends. (Learn How to Invest and Make Money Online, 2016)

2 Market capitalization and CAPM pricing

Market capitalizationfor thecompany has been calculated by multiplying the marketvalue of the company's outstanding shares as on 31 June 2015 by the current stock price.

17,224*$ 161= $ 4 27, 73,064 (Tradingeconomics.com, 2016)

Determination of the pricing of the shares using CAPM model

A beta less than the market beta of 1 implies that the stock returns and prices vary to a lesser extent and are stable compared to the market. Blackmore’s stock is a defensive stock against the market rather than aggressive. So if the market rises by 10%, the stock with beta 0.16 will raise by 1.6 %

The return on equity was 35% for the year ending June 31 2015 compared to the CAPM rate of return of 4.81 %. So the stock is highly overpriced. The investors’ expectations are far higher than the CAPM rate which also accounts for the systematic as well as the unsystematic risk associated with the security. This implies that the stock currently in riding high on investor expectations rather than the CAPM backing and may find its way backwards any time soon. So, it makes sense based on the above analysis to sell the stock currently and cash on the gains that are available.

The future price of the stock can be estimated by using the rate of return calculated by the CAPM model. This rate can be used to discount the future cash flows to their present value and arrive at the shares fair value. Where the value so obtained is higher than the market , the stock would be underpriced. However, where this value is lower than the market the stock would be overpriced. It would make more sense to sell the stock based on the above premises.

3 Cost of capital

Estimation of the after-tax Weighted Average Cost of Capital for the company

Tax rate adjustment ( 1- 32.4 = 67.6)

The cost of capital for the company is basically comprised of the cost of equity as calculated using the CAPM model for calculating the required or expected rate of return by the shareholders of the company and the after tax cost of the debt component for the company’s interest bearing liabilities.

The cost of capital is hit by the operating expenses, profitability rate, credit worthiness, and goodwill and reputation of the company. These components directly affect the investor’s outlook of the risk premium expected from the company. The cost of debt has been arrived by adjusting the tax expense rate for the interest bearing debt for the tax effect, using the company rate of tax of 32. 4% for the current year as available in its current financial report The cost of equity is arrived at on the basis of the CAPM model. The company’s overall cost of capital is arrived at using the weighted average of these costs. This cost of capital is fit to use for discounting the future cash flows of the company and for the estimation of the net present value of all the future endeavours of the company.

Blackmore’s for the current year has a low gearing ratio of 5.1% which increases its reliance on equity financing resulting in low leverage rating for the company. The cost of capital for the company is the cost which the company incur and pays for utilizing the funds of the stakeholders as well as the external finances of the company. (Staff, 2003)

4 Working capital strategy for the past 5 years

Reduction in Non-current liabilities from $74 million to $45 million was achieved by the company by reducing the interest-bearing liabilities that had the effect of decreasing the debt component from $54 million to $7 million, by 87%. This brought about an increase in operational cash flow of $71 million, which was used to pay off the debt and which majorly contributed to the improvement in the working capital for the company.

Working capital strategy of Blackmore’s focuses on maintaining efficient levels of the components of working capital i.e. current assetsandcurrent liabilities, such that the company has just enough cash flow to honour its short-term debt obligations and routine operating expenses. Blackmore’s has majorly improved their earnings through an efficient working capital strategy in the last five years by maintaining favourableratios through management of the two components of working capital. An ideal working capital ratio has contributed to increasing the efficiency ofinventory management,cash management, and accounts receivable and payable management. (Investopedia, 2006)

Relevant ratios

(Financials.morningstar.com, 2016) (Blackmores.com.au, 2016)

The working capital of the company has overall increased from $ 45 million to $ 73 million over the last five years. The fall in the operating working capital turnover from 5.2 in 2011 to 4.75 in 2014 indicates that Blackmore’s’ capacity to generate operating revenue from its operating working capital was low during these years. However, 2015 saw an improved efficiency. This is attributed to the improved operational management and improvement in operating cash flow by 90% compared to previous year. The operating cash flow grew on a year to year basis from (16.38) % to 89.72 % in these five years.

The factors that the company would have considered in determining its working capital strategy include credit policy , growth and expansion strategy to China and Asia , stress on increasing the net cash profit , dividend payments , cash Requirements , revenue generation, current assets requirements , repayment ability , existing cash reserves to name a few.

(Working capital, 2016)

5 Dividend policy in the past five years

The share dividend has increased from 1.63 to 2.16 per share over the last five years. The company follows a liberal dividend policy by distributing a large chunk of its earnings to the stakeholders as reward for the trust, support and confidence in the future prospects of the company put in them. The company declared a final dividend of 135 cents per share (fully franked), making the total dividends for 2015 to 203 cents that is greater than last year by 60%.

Dividend policy of the company includes strategically decisions about the amount of dividendsand the timing of the payments. These decisions are based on factors like better investment opportunities, estimated volatility of future earnings, tax considerations, financial flexibility etc.

An examination of the dividend policy for the last five years clearly points out that the company has been following a dividend policy wherein a high payout is given to shareholders. The company view the debt/equity ratio as a long-term goal and believes in paying off a large chunk of its earnings as dividends. The impact of business cycle fluctuations and other priority payments of the company are accounted for before paying off the dividends. (Investopedia, 2012)

Comment on the propriety of the dividend policy

The dividend policy of the company with a dividend payout ratio of 100% or greater over the last five years is not a very idealistic scenario. Income-oriented investors, may be impressed by such payment but it ought to be remembered that this kind of payment is unsafe and is prone to reduction .Where a company with ample profits distributes modest dividend ; it is affordable in the long run. However, an excessively highpayout ratiois not always affordable and may also imply lost profitable reinvestment opportunities. This makes the dividend payments rarely sustainable implying a warning of dividend cut. Whenever this happens, this may trigger a decline in the share price. The policy may also result in a dwindlingcashposition or an increasingdebt load. Even though the company is a large and established one, distribution of such a large larger percentage of earnings to stockholders may not always be ideal.

Conclusion

A greater than 100 % payout ratio is one of the most important factors which have caused the rise in the share price and trading volumes as revealed form the perusal of the last five year trading history of the company. Based on its stock price, Blackmore’s has performed well over the past ten years; the price has been steady from 2010 to February 2015 after which it has taken for a sharp rise.

The stock currently in riding high on investor expectations rather than the CAPM backing and could find its way backwards any time soon. So it makes sense based on the above analysis to sell the stock currently and cash on the gains that are available. The cost of capital for the company is the cost which the company incur and pays for utilizing the funds of the stakeholders as well as the external finances of the company.

The working capital of the company has overall increased from $ 45 m to $ 73 million over the last five years. The fall in the operating working capital turnover from 5.2 in 2011 to 4.75 in 2014 indicates that Blackmore’s’ capacity to generate operating revenue from its operating working capital was low during these years. The dividend policy of the company with a dividend payout ratio of 100% or greater over the last five years is not a very idealistic scenario. Income-oriented investors, may be impressed by such payment but it ought to be remembered that this kind of payment is unsafe and is porn to reduction.