Download Operating profitability

1
Lecture 4
Historical profitability analysis
• Valuation models based on forecasts of
net dividends (or theoretically equivalent
forecasts), but
• Such forecasts must be consistent with
our beliefs about future profitability
2
Historical profitability analysis
Purpose:
• To find ratios useful for forecasting future
profitability
Forecasts:
• Sales forecast
• Different kinds of ratios
• Which ratios?
3
Historical profitability analysis
• Operating profitability
–
–
Sales and OI for each segment
NOA for the company as a whole
• Financial performance
–
which together with financial leverage determine
• Total profitability
4
Operating profitability
For each segment (and the company as a whole) we will
determine
• Rate of sales growth (Sgr)
• Core operating profit margin (cPM)
For the company as a whole we will determine
• Asset turnover (ATO)
• Core return on net operating assets (cRNOA)
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Operating profitability
NCC – Construction Sweden
Net sales
2005 2006
19 354 22 098
Rate of sales growth (Sgr)
Sgr06  Sales06 / Sales05  1  22098 / 19354  1  14,2%
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Operating profitability
NCC – Construction Sweden
2005
Net sales
Core operating income
2006
22 098
1 236
Core operating profit margin (cPM)
cOI 06
1236
cPM 06 

 5,6%
Sales 06 22098
7
Operating profitability
Two quasi-segments
• Discontinued operations
• Other and eliminations
8
Operating profitability
NCC – Group total
2005
Net sales
Core operating income
Net operating assets
2006
55 876
2 385
7 322
Asset turnover (ATO)
Sales 06 55876
ATO06 

 7,6
NOA05
7322
9
Operating profitability
Technical issue:
for all flow/stock and stock/flow ratios, e.g.
-
ATO = Sales / NOA
cRNOA = cOI / NOA
Use beginning-of-period stock values (not
average values)
10
Operating profitability
NCC – Group total
2005
Net sales
Core operating income
Net operating assets
2006
55 876
2 385
7 322
Core return on net operating assets (cRNOA)
cOI 06
2385
cRNOA06 

 32,6%
NOA05 7322
11
Operating profitability
du Pont formula
cRNOA
cOI / NOA
cPM
ATO
cOI / Sales
Sales / NOA
12
Operating profitability
NCC – Group total
2005
Net sales
Core operating income
Net operating assets
2006
55 876
2 385
7 322
du Pont formula
cOI 06
cOI 06 Sales 06
cRNOA06 


 cPM 06  ATO06
NOA05 Sales 06 NOA05
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Operating profitability
The company as a whole
• Calculate
–
–
–
–
Sales growth (Sgr)
Core operating profit margin (cPM)
Asset turnover (ATO)
Core return on net operating assets (cRNOA)
• Compare with the corresponding ratios for the
industry
–
Convert industry ATO and RNOA to measures with
goodwill
14
Operating profitability
• Include unusual items to calculate
–
Operating profit margin (before tax) (PM)
–
Return on net operating assets (before
tax) (RNOA) (final measure of
operating profitability)
15
Financial performance
• Core borrowing cost (cBC)
• Core return on financial assets (cRFA)
–
determine together with the relationship between financial
liabilities (FL) and financial assets (FA)
• Core net borrowing cost (cNBC), or
• Core return on net financial assets (cRNFA)
–
Add unusual net borrowing cost to arrive at
• Net borrowing cost (NBC), or
• Return on net financial assets (RNFA)
16
Financial performance
Core borrowing cost (cBC)
2005
Core financial expense (before tax) (cFE)
Financial liabilities (FL)
Core borrowing cost (before tax) (cBC)
2006
245
3 153
7,8%
cFE06 245
cBC 06 

 7,8%
FL05 3153
17
Financial performance
Core return on financial assets
2005
Core financial income (before tax) (cFI)
Financial assets (FA)
Core return on financial assets (before tax) (cRFA)
2006
108
2 710
4,0%
cFI 06
108
cRFA06 

 4,0%
FA05
2710
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Financial performance
Core net borrowing cost (FL > FA)
2005
Core financial income (before tax) (cFI)
Financial assets (FA)
Core return on financial assets (before tax) (cRFA)
Core financial expense (before tax) (cFE)
Financial liabilities (FL)
Core borrowing cost (before tax) (cBC)
2 710
4,0%
245
3 153
7,8%
Core net financial expense (before tax) (cNFE)
Net financial liabilities (NFL)
Core net borrowing cost (before tax) (cNBC)
2006
108
137
443
30,9%
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Financial performance
Determinants of the core net borrowing cost
cNBC
cNFE / NFL
FL / NFL
FA / NFL
cBC
cRFA
cFE / FL
cFI / FA
FL05
FA05
cNBC 06  cBC 06 
 cRFA06 
NFL05
NFL05
20
Financial performance
Core return on net financial assets (FA > FL)
2005
Core financial income (before tax) (cFI)
Financial assets (FA)
Core return on financial assets (before tax) (cRFA)
Core financial expense (before tax) (cBC)
Financial liabilities (FL)
Core borrowing cost (before tax) (cBC)
5 000
6%
240
3 000
8%
Core net financial income (before tax) (cFI)
Net financial assets (NFA)
Core return on net financial assets (before tax) (cRNFA)
2006
300
60
2 000
3,0%
cNFE06  cNFI 06
 60
cNBC 06 


 3%  cRNFA06
NFL05
 NFA05  2000
21
Financial performance
• Include unusual items to calculate
– Total net borrowing cost
–
Note that a positive sign in the income
statement means a negative unusual net
financial expense, and vice versa
22
Total profitability
Determinants of total profitability
Total
profitability
Financial
leverage
Operating
profitability
Financial
performance
23
Total profitability
2005
Operating income (before tax) (OI)
Net operating assets (NOA)
Net financial expense (before tax) (NFE)
Net financial liabilities (NFL)
Income after financial items (Iafi)
Taxes (T)
Net income (NI)
Total equity (E)
Return on equity (ROE)
ROE 06
NI 06 1708


 24,8%
E05
6879
2006
2 392
7 322
129
443
2 263
-555
1 708
6 879
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Total profitability
2005
Operating income (before tax) (OI)
Net operating assets (NOA)
2006
2 392
7 322
Income after financial items (Iafi)
Taxes (T)
2 263
-555
Effective tax rate
T06
555
tr06 

 24,5%
Iafi06
2263
Return on net operating assets after tax
RNOAat 06  RNOA06  (1  tr06 ) 
OI 06
2392
 (1  tr06 ) 
 (1  0,245)  24,7%
NOA05
7322
25
Total profitability
2005
Net financial expense (before tax) (NFE)
Net financial liabilities (NFL)
2006
129
443
Net borrowing cost after tax (NBCat)
NFE06
129
NBCat 06  NBC 06  (1  tr06 ) 
 (1  tr06 ) 
 (1  0,245)  22,0%
NFL05
443
If the effective tax rate deviates significantly from the marginal tax
rate, a more accurate determination of RNOAat and NBCat must be
made (see Ch. 3, p. 18).
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Total profitability
Net operating assets (NOA)
2005
7 322
Net financial liabilities (NFL)
443
Total equity (E)
6 879
Financial leverage (FLEV)
NFL05 443
FLEV05 

 0,06
E05
6879
2006
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Total profitability
ROE
NI / E
FLEV
NFL / E
RNOA
NBC
OIat / NOA
NFEat / NFL
The leverage formula (with RNOA and NBC after tax)
ROE 06  RNOAat 06  FLEV05  ( RNOAat 06  NBCat06 )
ROE06 = 24,7% + 0,06∙(24,7% – 22,0%) = 24,8%
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Total profitability
Minority interest and minority income
Calculate
• Return on minority income (rMINT)
• Proportion of minority interest (pMINT)