J D Wetherspoon and Scottish & Southern Electricity Plc Case Study

Question: Describe about the Finance Corporate Financial Decision Making of J D Wetherspoon and Scottish Southern Electricity Plc? Answer: Aims and Objectives This aim is to compare the financial management policies and financial performance of two companies- J D Wetherspoon and Scottish Southern Electricity Plc. It connects different financial theories with the financial management policies of both companies. After discussing the financial management policies, suggestions for corporate decision making will be given for Next plc. In addition, the method of stock market prices of both companies will be clarified. Business Strategy Next Plc is interested in investing in J D Wetherspoon or SSE Plc. The financial performance of both companies has been analyzed by reviewing the financial statements of both companies. The business strategies, financial statements served as a major tool for analyzing the financial performance of both companies. The decision to invest in a particular company is based on its financial performance (Ang and Liu, 2003). Different tools have been used in order to conduct financial analysis of both companies such as, financial comparability. Financial comparability is significant to make decisions (Bertoneche and Knight, 2001).Financial Ratios; capital structure has been used for better view of the company position in the market. With these approaches, a clear market as well as financial position of both companies has been identified. These tools have clarified the effective distribution of financial resources in order to maximized share holder value. Financial statement is very important to comparability of financial statement(Borland, 2000). Porters five forces model and PESTEL have also been used in order to define impact of industry factors such as bargaining power of suppliers and buyers on financial aspects such as revenues, profits and cost of goods sold mentioned in the financial statements(Bossaerts, 2009). Validity of data To analyse the financial performance of all the companies, reliable data has been stored from the financial statements. This will include risk- beta, sources of finance, gearing, liquidity, investment ratios, working capital, efficiency ratios and capital structure. Source: Markets.Ft In 2013, due to weather related incidents, SSE electricity production was affected and this was the reason behind decreased sales and net income in 2012. In 2013, SSE made investment in its new 460 megawatt (MW) gas-fired power station at Great Island, County Wexford. Later on, the issues were resolved and SSE preformed better which helped the company in gaining effective return from the investment(Guo, 2010). On the other hand, the decision of the company to freeze the prices for household electricity has helped them to gain right value and which supported in generating effective return. On the other hand, the return from assets shows that SSE Plc generated effective net income from their total assets. Further, it can be explained that assets of SSE Plc is capable of generating revenue which ensures that in future that company can be able to gain better and effective return from their valuable assets(Kramer, 2012). Apart from that, the return on equity of the company reveals that co mpany generated effective from the investment made by the shareholders which shows that SSE Plc is ahead of Wetherspoon in providing better return to their stakeholders(Lie, 2001). Source: Markets. FT The dividend yield of the SSE Plc shows that company is able to gain handsome cash flow from the investment made in the equity. Therefore, it can be understood that SSE Plc earns effective dividend every year in context to their share value. Thus, company is able to provide better return to the shareholders and provide sustainable energy in large quantity(Lusardi, 2012). On the other hand, the dividend growth rate is increasing with a rate of 5.19% which suggests that company is able to generate better return from the equity position. Apart from that, it can be mentioned that company is able to satisfy their internal requirements for capital. The main financial management goal of SSE business is to deliver continued real growth in the dividend which payable to shareholders. It aims to regularly improve its full year dividends(MANISHA B, 2012). In 2013, SSE was able to pay a final dividend amounting to 59.0p per share. It increased the full year dividend by 5.1% to 84.2p. The increase in dividends can be results of the increased net income due to purchase of electricity generation assets in Ireland which cost 289.8m in 2012. Source: Markets.Ft From the above figure, it can be analysed that SSE Plc has made nit significant growth in their earnings per share over the last five years. Since 2011, the company has seriously faced considerable decline in their earning per share due to increasing huge amount of investment in the hydroelectric energy and green energy in order to develop sustainable energy(Margolis and Walsh, 2001). Moreover, in 2014 the earning per share declined in spite of increase in 2013. The reason is certain decline in the sale and effective competition from other energy providing companies (Mulford and Comiskey, 2005). Policies for Sources of Finance It can be analyzed that capital structure of a company is shaped by the sources of finance used. Therefore the capital structure and sources of finance are related. Each source of finance has its own cost for example, debt, equity, retained earnings. It can be observed that since past five years, Wetherspoons financial policy for capital structure has focused on debt as a major part of the capital structure. This has major effects on the net income. Using more debt will drive the company to make interest payments that can significantly effect net income. Due to high financial influence, Wetherspoon will be considered more risky that will disappoint the investors to invest in this particular company(Stutzer, 2000). SSE Plc is an important company in UK that delivers electricity services in Ireland and UK. In accordance with International Accounting Standards, SSE Plc prepares its financial statements such as Income Statement, Balance Sheet and Cash Flow Statement. Risk: beta Analysis This is the heart of this coursework so please elaborate it and explain with refrences The beta is useful in measuring the risk associated with the individual stock in relative to the entire risk of the stock market. Moreover, if the price of the stock experiences movements higher than stock market then it can tend to beta value of more than one (Brooks, Krebs and Paulsen, 2014). On other hand, if the movements of the price of the stock are lower than the fluctuations of market then the beta value can be lower than one. Apart from that being said, if the value of the stock is trending along with the movement of market then the beta value can be close about one (MoneyWorks4me, 2015). Beta of Next Plc is 0.68. Wetherspoons beta is 0.77 as compared to beta of SSE Plc which is 0.25. This implies that Next Plc is reasonably risk-averse company. Wetherspoon is more risky and subjected to slight instability than Next Plc. SSE Plc is least risky as the beta is only 0.25. Beta theory states that companies having beta more than 1 are considered as highly risky companies(Ang and Liu, 2003). All three companies possess a low degree of risk as beta is less than 1. It can be viewed that beta value of both J D Wetherspoon and Scottish Southern Electricity is less than one but the value of SSE is far than expected beta value of one. Therefore, SSE Plc is encircled with less risky aspects in comparison to Wetherspoon Plc. However, both the company can ensure effective return to the Next Plc. On the other hand, it can be considered that both Wetherspoon and SSE is less volatile stock. Therefore, the stock price of Next Plc will not recoil up and down in comparison to market movement. Thus, company can ensure effective return with engaging less risk (Alzer, 2014). Analysis of data- Analysis of Financial Ratios The financial management policy of Wetherspoon includes collecting and review of all types of budgets. The BODs are responsible for Expenditure management and Income(Bertoneche and Knight, 2001). In Wetherspoon, the financial managers are involved in developing income statements and budgeted cash flows that provide them idea for future fundsuse . The BOD holds the authority to prepare budget in obedience with departmental managers and the CEO(Borland, 2000). The Board may apply a budget planning on annual basis and can review actual expenses as compared to expected financial outcomes. Operating profit Ratio Operating profit of Wetherspoon has a fluctuating trend over the past five years. It has decreased to 7.1 in 2013 due to increased cost of trained staff, new additions in menu and expense for improved customers services. Comparatively, SSE Operating profit has been changing considerably over the last five years(Bossaerts, 2009). Currently, it has increased to 2.8% due to reduced expenditures in the energy operations and increased sales due to high demand of energy services. Source: Markets.Ft The net income ratio of Wetherspoon has been fluctuating since past five years. It has increased due to reduced expenses and lower amount of tax charged. SSE Plc has a highly fluctuating trend and it has increased due to lower prices and high demand of goods and services. Investment Ratio Earnings Per share, Payout ratio Source: Markets.Ft The earnings per share are almost similar in all accounted five years. Therefore, company is able to improve their return from investment and provide better return to the stakeholders(CAO and LERNER, 2008). Moreover, company can be able to sustain their market share in order to earn effective income and provide service to the customers. On the other hand, it can be understand that earning per share of Wetherspoon is higher than Scottish Southern Electricity. Therefore, Wetherspoon shareholders earns better return from investment in comparison to shareholders of SSE Plc. Moreover, it can be predicted that Wetherspoon in future can be able to increase their return from investment that will help in providing better return to shareholders and increasing profit(Castre n, Fitzpatrick and Sydow, 2006). Earnings Per share are significant for investors as they can regulate the earnings that they will receive on each share. Wetherspoons EPS has been increasing due to increase in net income of the company. Earnings per share determine the companys ability to generate cash flows in future. It is calculated by dividing the net income with the number of outstanding shares. Investors use this ratio to measure the value of a stock (Stickney, et al, 2009). Due to decreased tax expense, EPS has increased. In addition, the company has been taking effective measures to improve its net income such as improving product and advertising. The financial management policy of SSE focuses on involving an independent evaluator in order to prepare a Financial Statements for the Special Purpose(Estrada, 2005). This is considered as an important effort to provide financial discovery to the interested investors.. The policy involves that members at the annual general meeting accept the auditor. SSE EPS has been changing over the five year period. EPS has increased to 0.45 due to decreased tax expense and increased net income. But, due to increased amount of shareholders company has reduced i ts payout ratio so that each investor can receive return(Fridson and Alvarez, 2011). Source: Markets.Ft Dividends per share of Wetherspoon have been constant over the past five years. This means that shareholders have not received increased returns on their investment. It is evident that payout ratio is 35.78% which means that majority of the portion of net income is being retained by Wetherspoon. The financial policy of Wetherspoon has been able to provide receivable income for the year 2013, amounting to 469.46. This is due to increase in the sales of Wetherspoon. Sales have been increased due to new pubs and expansion programmes in UK. SSE receivable income has been experiencing a fluctuating incline over the past five years. It has decreased due to improper credit management policies of SSE. Managers have to focus and develop appropriate and effective credit management policies in order to increase the receivable income . This would imply that company can be prevented from the bad debts and receive the promised amount form the customers(Kramer, 2012). Fixed Assets Turnover This ratio determines the capability of the company to efficiently use its non-current assets in generating sales volume. A higher fixed asset turnover ratio is favourable for the company and vice versa (Warren, et al, 2013). There is an increasing pattern in FATO of Wetherspoon. It has improved to 1.36 due to effective human resources capital and training provided to the employee workforce. SSE Plc has a fluctuating trend of FATO since the past five years. It has decreased to 2.98 due to inefficient employees and high cost of the operations. Asset Turnover Source: Markets.Ft Asset turnover means the ability of the company to generate or maximize sales by efficiently utilizing its total assets.Wetherspoon Asset Turnover ratio has been increasing over past five years. The reasons for this can be spotedto efficient allocation of resources, effective employee work, training provided to employees and proper cost management techniques. On the other hand , the asset turnover of SSE Plc has been changing since past five years(Lie, 2001). It has decreased to 1.41 in 2013 due to slight increase in sales and ineffective approaches taken by the management in utilizing the resources. The financial management policy of Wetherspoon focuses on developing purchase orders while buying fixed assets. It is important to get approval of the CEO or in his/her absence the authorization of Purchase manager. Wetherspoon's has defined Fraud as the motivation of financial managers, internal auditors or external auditors to mislead the financial statements. Wetherspoon's has clearly defined that any activity such as misappropriation of assets of company by auditors or authorized person will be considered as a fraudulent activity. Recommendation - Wetherspoon or SSE Plc One of the most important business for creativities is the calculation of an appropriate rate of return for invested capital or cost of capital (Galiniene and Butvilas, 2010).In the profitability ratios such as Gross Margin, Net Profit and Operating Profit, Wetherspoon is performing better than SSE Plc. In Liquidity ratios, SSEs performance has decreased and Wetherspoon is able to improve its management of funds. However, SSE Plc has higher liquidity ratios such as Current ratio and acid test ratio as compared to Wetherspoon. Gearing ratios suggest that SSE is a less risky company as compared to Wetherspoon due to low financial weight and its capital structure combines major portion of equity. Efficiency ratios determine that SSE Plc has a strong capability to sell its list faster thanWetherspoon, however SSE;s receivable amount is depends on the customers. Increasing fixed asset turnover and asset turnover suggests that SSE Plc is able to generate more sales revenue using its total assets compared to Wetherspoon. Comparisons Analysis Risk analysis It is recommended that Next Plc should invest in SSE Plc due to lower risk: beta which is 0.25 as compared to Whetherspoon beta: 0.77. Investment analysis It is advised to the CEO of Next Plc to purchase shares of SSE Plc due to improved financial ratios of EPS, Dividends and Net Profit ratio. The Dividend per share (DPS) of SSE- 0.90 is higher than DPS of Wetherspoon- 0.12. Also, the Earning per share (EPS) of SSE- 0.5 is greater than EPS of Wetherspoon- 0.38. This implies that Next Plc should make investment of shares in SSE Plc because SSE Plc is performing better than Wetherspoon in Investment ratios. This has better effects for the investors (Next Plc Group) in the form of increased return on their investments. This means that it is favourable for Next Plc to invest in SSE Plc so that in case if SSE Plc bankrupts, Next Plc will be able to hold a higher amount of money on its shares(MANISHA B, 2012). Capital structure SSE Plc has low debt to equity ratio and low financial debt as compared to Wetherspoon. This implies that Next Plc should invest in SSE Plc. Thus, by the above financial analysis, it is suggested that Next Plc should invest in SSE due to attractive investment, gearing, investment and liquidity ratios. Share Value Analysis- fair value According to Baker and Powell 2009, valuation represents an important process that aims at linking the returns and risks in order to estimate the value of a financial asset or a company. Financial asset can be a bond, preferred share or common share. Between the different types of value, market value is advertised as a vital one. From the view of corporate finance, Market value or current value indicates the price that owner of the financial asset is likely to receive from selling that asset in the stock market. The market value mainly originated from the demand and supply of that asset. Market value is compared with the central value that is also called as Fundamental value (Whaley, 2007). This represents a measure of imaginary value of financial assets. It is difficult to predict the actual estimated value of financial assets because prices are required in order to calculate the value of assets. Critical values are calculated by the investors and shareholders in order to decide whe ther to sell or purchase a financial asset with its current market price or the opportunity cost should take into account .Opportunity cost mean the value of the next-highest-valued alternative use of that resource (Econlib.org, 2014). However, the capital markets cannot be counted as a type of perfectly efficient markets because current share prices and estimated values are likely to differ for financial assets. It is important for corporate managers and financial managers to know the process for estimating value of shares and bonds. This will help in defining if market is correctly playing its role in pricing the financial assets.. Investors are likely to purchase the asset when the estimated value is greater than the current market price. According to Koller, et al (2010), markets are likely to reflect central values and prices that are in line with the basic value of achieving returns on growth and capital. This suggests that managers should concentrate on developing core value as it is the most essential aspect of the markets in the long run. Calculation of Share value As the current stock price is lesser than the core value of stock, this suggests that share price of Wetherspoon is undervalued. It can be observed that the trend of cash flows is stable and investors are likely to get returns if they buy shares of Wetherspoon. Hence, shares of J D WetherspoonPlc represent a fair value.. In 2012, SSE Plc. achieved negative cash flows and positive cash flows were achieved in the next years. The trend of cash flows is highly fluctuating. This means that investors will suffer through losses if they invest in SSE Plc because core value of shares is less than market price. Alternative investment Portfolio Theory The portfolio theory is effective for the investors to understand the nature of risk, return and management of portfolio. Moreover, the theory explores that portfolio diversification can be useful in decreasing the investment risk (Barracchini and Addessi, 2012). On the other hand, Next Plc can use it as an investment decision method. The investors can be able to calculate the required or expected amount of return that they can generate via investing in the particular portfolio or shares. Apart from that, it has been said that portfolio theory holds a view that when the numbers of uncorrelated assets are put together in the portfolio then it can ensure improved return and risk can be controlled (Athanassakos, 2012). Therefore, it can maximize the expected return of the portfolio for an adjusted sum of portfolio risk. However, in order to gain higher return from the investment, the industries or investor has to choose the right proportion of different assets as it can make sure an eff ective return (Barracchini and Addessi, 2012). On the other hand, in order to engage low risk and beneficial return, the company may have to try to acknowledge the risk that is associated with each stock such as JD Wetherspoon Plc and Scottish Southern Electricity. Further, if the Next Plc wants to earn better return then the company may need to take risk more than average. Therefore, when market turn in favour of the company then it can ensure expected return (Gyorfi and Walk, 2012). Apart from that, if the portfolio lies on the efficient frontier point then the company can make decision to make an investment in that portfolio. Therefore, higher expected return can be acknowledged for a specified rank of risk. Thus, the company has to concentrate on that stock or portfolios that are more inclined towards the efficient frontier (Hugonnier, 2012). Next Plcs Profit after tax has increased in 2013 to 473.1 as compared to 427.4. This suggests that Next Plc is in a position to invest in SSE Plc. Next Plc is highly ethical company and incorporates ethical values that will not be followed if Next Plc purchases shares of Wetherspoon Plc. Adverse effects on Next Plcs reputation can occur if it invests in Wetherspoon Plc. SSE Plc have bad cash flows which indicates that it Next Plc can be significantly affected by investing in SSE Plc. When risks are high, a portfolio theory of Diversification can be sued to minimize risks. Thus, Next Plc can use diversification its portfolio by investing in both companies. It will reduce the risks associated with investments. Diversification will reduce random risk events in a portfolio so that the positive performance of some investments can deactivate the negative performance of other investments. Therefore, diversification will be beneficial if the securities in the portfolio are not perfectly conn ected. This strategy is used so that a portfolio including a variety of investments can generate higher returns and lower risk as compared to a single investment found within the portfolio. Dividend Payment Wetherspoon Dividend Trend SSE Plc Dividend Trend Furthermore, the benefit of investing in SSE is that SSE is committed to increasing dividends per share by at least the rate of inflation. Next Plc can be benefited by this action. The Dividend per share (DPS) of SSE- 0.90 is higher than DPS of Wetherspoon- 0.12. This indicates that SSE Plc can satisfy its shareholders by maximizing their shareholders wealth. Next Plc should invest in WetherspoonPlc due to its improved profitability ratios and because the market value of shares exceeds its core value. As both investment indicate risk , Next plc should reinvest the money to expand their shop in the stores. For example , opening restaurant in the stores can lead them to higher returns and can be a alternative to invest in JD Weatherspoon. Valuation of Shares Net Assets Method for the valuation of shares Value per share= (Net Assets Preference Share Capital) / Number of Equity Shares In order to compute the value of share, the data has been accumulated from the financial statement of both the company, JD Wetherspoon and Scottish Southern Electricity. J D Wetherspoon = (1199668 24560) / 227168 = 5.172 (Jdwetherspoon.co.uk, 2015) Scottish Southern Electricity Plc = (3969 487) / 972 = 3.58 (Sse.com, 2015) It can be understood from the adopted share valuation method that, value per share of JD Wetherspoon is higher than SSE Plc. Therefore, it can suggests that Wetherspoon will earn higher income and return on the net profit whereas SSE PLC will gain slightly lesser but can be able to provide effective return to the shareholders. Dividend Discount Model The DDM will be helpful in assessing the current value of the stock on the basis of dividend growth rate. Current Stock Value = Dividend per Share / (R Discount R Dividend Growth) J D Wetherspoon 0.12/ (0.1578 0) = 0.76 or 76 (Jdwetherspoon.co.uk, 2015) Scottish Southern Electricity = 0.82 / (0.26 0.0297) = 352 (Sse.com, 2015) According to dividend discount model, the stock valuation at present scenario of J D Wetherspoon is lesser than SSE Plc. Therefore, it can be understood that SSE Plc is trading at higher rate as the company is large enterprise in comparison to Wetherspoon and provides large amount of electricity to different sectors. Therefore, the price of share is higher. Ethical Issues of Next Plc Next Plc is highly ethical responsible entity which encloses all their stakeholders and shareholders together which helps the company to build their brand image in the industry. The company continuously improve and develop healthy relationships with employees, suppliers and takes active part in the environment sustainability and also makes charities (Ethicaltrade.org, 2015). It is evident that, Next Plc is an active associate of Ethical Trading Initiative and follows ethical trading standard. The Code of Practice Audit team is effectively involved to engage with suppliers in order to identify any non-compliance causes. Moreover, supplier payment policy is followed by the company. On the other hand, the Next Customer Service is involved with the Directory and Retail consumers so that their issues and doubts can be handled. Apart from that, Next Plc effectively makes contribution in health and safety and environment fields. Moreover, Next Plc adopts transparency factor in their disclos ure of financial position (Nextplc.annualreport2013.com, 2015). Conclusion Financial management policies play essential role in effective financial management of the companies. On the basis of financial ratios, Next Plc should invest in SSE Plc due to improved Earnings per Share, Dividend per Share, liquidity ratios low risk and efficient capital structure. However, SSE Plc has poor cash flows that can significantly affect the dividend payment. In compare, Wetherspoons profitability ratios are better than SSE Plc. Apart from financial ratios, other factors such as stock market functioning, demand and supply and market prices are also significant for making investment decisions. Therefore, the stock market analysis ensures that Next Plc should purchase shares of Whetherspoon because the market value of shares exceeds its core value. This will provide increasing returns to the investors in future as compared to SSE Plc. 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