Investment Appraisal Report Example

Investment Appraisal Report ExampleRe Investment in Kingfisher PlcFollowing our conversation earlier, I give birth prep ard a report into Kingfisher Plc to foster you with your investment decision. I devour split this report into two sections, to help you analyse the comp some(prenominal)s fiscal management practices and as well to determine what represents a sightly legal injury for the attach tos shargons.As we discussed earlier, when making any investment it is vital to consider the financial management policies and practices of the high society. These include what the keep go with invests in how these investments perform how the company raises funds to invest and how the company treats its moolah. As such(prenominal), the first part of this section leave extend these four sections in turn, and how these preserve the exercise of the company.The second section impart address the fair pass judgment of the theatrical roles of the company. This is because, whilst th e company may perform well, if the contends are purchased for much than a fair economic determine, base on the companys ability to earn, they may non provide a good return to an investor.I desire this report will be of interest to you, please let me know if you redeem any questions ab go forth any aspects.Part A)Financial ManagementInvestmentsKingfishers primary investment all everyplace the ancient five years has been in tangible additions, such as property, plant and equipment, which ad try on do up over fifty percent of entireness assets over the past five years. The majority of the remain assets are composed of thanksgiving, with small amounts devoted to pension plans, financial derivatives and separate intangible assets. This commode be seen in the t qualified belowTable of non current asset set for Kingfisher Group Plc (all in one thousand thousands)Assets200320042005200620072008Property, Plant and Equipment304127813032326532113698Goodwill2652245524632559255 22532 different Assets309146289354380532(Source Kingfisher, 2008)The main trend in the assets of Kingfisher has been a steady rise in the evaluate of property, plant and equipment as well as new(prenominal) assets. The main revision in the other assets is a rise in the aim of post employment benefits deferred tax assets and derivative financial instruments, which were not on the balance canvas in 2003 but arrive at a total value of over 200 gazillion in 2008. In addition, the drop in all values from 2003 to 2004 is a result of the disposal of the Chartwell Land property portfolio, which resulted in a reduction in the value of all asset classes due to the transfer of goodwill associated with the property sold. From 2004 onwards, the company has engaged in a significant expansion program based on organic growth and the opening of new stores. This has by nature additiond the value of the total property, plant and equipment with a small drop in 2007 where the company disposed o f some of its less profitable stores.This balance in assets is largely expected because Kingfisher is a retail group, operating stores such as BQ, Screwfix, Castorama, and Brico Depot. As such, the groups main source of income comes from sales from these stores hence these stores are the most valuable asset the group owns. In addition, the company maintains a diverse portfolio of businesses crossways the UK, France and other countries including the Republic of Ireland, Poland, Italy, Spain, Turkey and China. In order to ascertain in these countries, the group needs to own assets such as stores, offices, and distribution networks. This further increases the percentage of total assets which will be taken up by property, plant and equipment.With regards to the level of goodwill, this became quite high prior to 2003, but has stayed quite constant over the period of the study. This indicates that a significant proportion of the business assets have been purchased for more than their m ass value. This is possibly how the group has managed to obtain such a large portfolio of businesses, and particularly how it has managed to ensure that all of its businesses are in the top trey of the domestic markets. However, over the period of the study, the group has not experienced a significant increase or decrease in the level of goodwill, which implies that it has not significantly stretch outed its portfolio through acquisitions, and the majority of the increase in the value of the total assets has come through organic growth or purchases at close to book value. This is slightly complicated by the groups goodwill policy, which makes an assessment of the ability of acquired businesses to generate cash each year, and amortises the level of goodwill to compensate. As such, it is practicable that the group has invested a significant amount in buying new businesses, and the value of the goodwill from these businesses has since fallen. However, the annual reports mention th at new stores are being opened, not bought, which implies that the groups expansion policy is to open new stores, rather than acquire existing ones from competitors.Investment appraisalInvestment appraisal is generally make on a per project basis, with a company projecting the cashflows, both positive and negative, associated with a project and then calculating whether the net cashflow will be positive or negative, and by how much. This value can be calculated based on either the absolute value of the cashflows, or on the discounted value of the cashflows which takes into account the fact that cashflows occurring in later years will be less valuable due to inflation and other factors (Knott, 2004). However, when considering an investment in Kingfisher, this ruleological analysis is not appropriate, as the company is a continuous operation with no definite start or end point. Indeed, all the new stores the company opens are intended to remain operational for the foreseeable future, hence making it very difficult to calculate their rates of return and net present values. Whilst the company will undoubtedly have an internal method for doing this, perhaps taking the cashflows for the first five years of operations, this method is not detailed in the annual reports. Nor does Kingfisher distinguish details of the exact hails of the investment into stores or their cashflows in the annual reports, thus making it impossible to attempt such an analysis with the available data.As such, it is necessary to analyse the performance of Kingfishers overall business, from the point of view of an investor looking to buy shares. As such, the initial purchase of the shares represents the initial investment, and the return made on these shares can be taken to be the future cashflows for the purposes of the analysis. On this basis, it is necessary to look at the annual returns provided by Kingfisher, as well as the change in the value of the shares (Lumby, 1994).Kingfisher annua l share expense from May 2003 to May 2008DateClosing Price27/05/2003257.2527/05/2004285.527/05/200525926/05/2006235.7525/05/2007252.7527/05/2008138.1(Source Yahoo Finance, 2008)Kingfisher stipend per share from 2003 to 2008 category meshing per share200316.4200417.4200520.8200612.2200711.8200811.7(Source Kingfisher, 2008)As can be seen from these graphs above, Kingfishers share price and net profit per share have both fallen over the period of the study. As such, one share purchased for 257 pence in 2003 would be worth but 138 pence in 2008, and the total dividend earnings per share would be beneficial 90 pence. As such, the total return from an investment of 257 pence would be only 228 pence. This implies that an investment in Kingfisher over the past three years would have performed very poorly, with a return of -12.7% over five years, even without considering discount factors and net present values. Indeed, given that the positive cashflows have occurred after the negative c ashflows, any investment in Kingfisher would have a negative net positive value for any positive discount factor.In addition, the earnings per share have fallen from 2003 to 2008. Within the period of the study, earnings per share rose from 2003 to 2005, before falling sharply between 2005 and 2006 and then rest relatively constant. This fall is specifically mentioned in Kingfishers 2006 annual report as being due to a significant fall in profits from the UK market, which was driven by rising energy costs, higher taxes and pension contributions and consumer confidence has been affected by a weaker ho exploitation market (Kingfisher, 2008). This implies that Kingfishers investments in the UK have performed poorly over the past three years, and indeed the 2008 annual report shows that the UK investments have further weakened against the background of the global opinion crunch. Whilst the credit crunch has affected all markets around the world, Kingfisher specifically points out that the high level of debt in the UK has created even more problems for consumers, who have less money to put down as their debt payments have risen. As such, Kingfishers investments in the UK, which account for around 47% of the groups total revenue, are unlikely to improve their performance in the near future.Sources of fundingKingfisher main sources of fundingAll in millions200320042005200620072008Total long term debt1528744.9828.31255.514321620Total equity446344074387.34320.444214724(Source Kingfisher, 2008)Kingfisher is strongly dependent on equity as a source of funding, with total shareholders equity making up at least three times as much of the funding as long term debt. Short term debt has been excluded from these calculations, partly because short term debt appears to be apply only to settle any cashflow issues, and partly because prior to the 2006 accounts short term debt was not declared separately from trade payables. As such, it would be impossible to compare short te rm debt across the entire period. It is worth point out that the decrease in debt from 2003 to 2004 is largely due to the sale of the Chartwell Land property portfolio mentioned above. The proceeds of this sale were largely used to reduce the level of long term borrowings, thus resulting in a significant drop between 2003 and 2004.However, following this sale, when the debt to equity ratio fell to just 0.17, the amount of debt has risen steadily, to the point where it reached 0.34 in 2008, the same level as in 2003. This rise has been accompanied by a small rise in the level of shareholder equity, but not to the extent that the total asset value has risen as seen in the investments section above. This implies that the store expansion and return programs mentioned throughout the Kingfisher annual reports during the period of the study have been funded largely by debt. This has caused the companys debt to equity ratio to rise quite significantly over the period of the study, which ha s more than doubled the debt to equity ratio.This significant increase in the debt to equity ratio could be a cause for concern, as it potentially places a higher debt burden on the company which must be serviced from profits. As such, if the companys fortunes continue to suffer due to the effects of the credit crunch, the company may have difficulty paying its debts and may suffer liquidity problems. However, in the 2008 financial statements the net finance costs on the debt are just 62 million, whilst the operating profit is 453 million. As such, the company can cover its interest more than seven times from profits, which means that this rise in the level of debt is not currently a significant concern. Of course, running counter to this is the fact that the global credit crunch is expected to increase the effective rates of borrowing, which could increase the interest payments as well as reducing the long term levels of consumer spending. As such, it is possible that the credit cr unch will continue to reduce Kingfishers profits whilst increasing the interest cost, thus potentially creating financial troubles in the next few years. This potential issue is compounded by the fact that the company capitalised 1 million of borrowing costs in 2007, and a further 3 million in 2008, which may indicate issues in paying these loans out of profit.The major sources of debt finance for the business at the current time are medium term notes and other fixed term debt, which make up 1,436 million of the debt. These have been placed on markets in the UK, Eurozone and United States and have raised capital at a net cost of between 4.1% and 6.9%. As such, the company has relied on non convertible loans raised on public markets. The majority of the remainder is made up of non secured bank loans. This indicates that, even if the company should encounter financial difficulties, it will not necessarily lose any of its property or have its equity diluted by convertible loans.Treatme nt of profits and dividend policyYear200320042005200620072008Dividend per share (pence)9.59.6510.6510.6510.657.25Earnings per share (pence)16.417.420.812.211.811.7(Source Kingfisher, 2008)From 2003 to 2005, Kingfishers dividend grew by a reasonable amount, although this was not proportional to the increase in earnings per share over the period. This indicates that Kingfisher was using partly using the increase in earnings to boost the dividend, but mainly using it to build up the volume of fill-ins, pay back debt, and expand the company. As a result of this, the company allowed its earnings per share to rise by more than the level of the dividend. Following the decline in the UK market from 2005 to 2006, and the incidental fall in the earnings per share for the company, Kingfisher attempted to maintain its dividend at 10.65 pence per share in spite of the fact that this left very little hold earnings. However, in 2008, following a significant fall in the share price, the dividend yield has also fallen to 7.25 pence in spite of the earnings per share remaining at the same level as in previous years. This implies that the company is now encountering difficulties maintaining its dividend yield at this level, and thus is having to drop its dividend in order to roll further reserves.Unfortunately, there is no detail in the Kingfisher accounts around exactly why this reserve is being built up. However, it is interesting to note that the reserves have now been built up to the 2.2 billion mark, after being maintained at around the 1.9 billion mark for the period from 2005 to 2007. This may indicate that the company feels that the tough business conditions will continue for some time, and hence there may be a need to retain more earnings to help cover interest payments in the future. Another potential explanation is that, as a retail company owning a significant amount of property, plant and equipment Kingfisher has a significant level exposure to the property mark et in both the UK and France. As such, the company may feel that, with the property markets in the UK and France showing signs of helplessness due to the credit crunch, there may soon be a need to revalue the property portfolio in each of these countries. Therefore, the reduced dividend and increase reserve may be an attempt to boost the equity and net asset value of the company in order to protect the value of the company against such a fall.However, the balance sheet tends to reveal a different potential explanation. The rise of 300 million in the value of the reserves of the company has occurred at the same time as a 300 million rise in the value of the inventory held by the company. This could be due to the fact that cost price inflation is significantly boosting the cost of inventory and the price of sales, and hence has increased the value of the inventory held by the company. However, the annual report indicates that cost price inflation for the company was just 4% over the previous year. As such, this cost price inflation is unlikely to have created a 300 million rise in the value of inventory, which is a 20% rise in the total value of inventory. This implies that the rise in the value of the inventory is for another reason, potentially due to a lack of sales or by overbuying of replacement inventory. As such, this does not indicate that the company is making the best use of its profits, nor that it is efficiently pursuing a goal of maximising value for its shareholders.Part B) Fair ValueWhen attempting to assess whether the current share price of Kingfisher Plc represents a fair value for the company, it is necessary to look both as the share price and the market capitalisation which is the total market value of all the shares. This price is determined by the shares traded on a stock market where brokers buy and sell shares on behalf of their clients. For Kingfisher, the stock market is the London Stock Exchange, and Yahoo Finance (2008) quotes the current share price of the company as 128.2 pence. In addition, the 2008 annual report states there are 2,361 million shares outstanding. This gives the company a total market capitalisation of 3.027 million as of the 18th sumptuous.One potential method of calculating the fair value of the company is through the net asset value of the company. This is because, provided the company can sell all its assets and pay off all its liabilities at their book value, it will realise its net asset value in cash. In addition, in theory the shareholders own a share of the net assets of the company equal to their share of the market capitalisation. Therefore, if the market capitalisation of the company was equal to the net asset value of the company, the share price would be at a fair value. For Kingfisher, the net asset value in the 2008 financial statements is 4,724 million. This implies that a fair value for the market capitalisation would also be 4,724 million, which is around 56% higher than the current value of the shares. This would further imply that a fair share price for the company would be 200 pence. However, this method is somewhat flawed because it assumes that all assets can be sold for fair value and all liabilities can be settled at fair value. In reality, the only time when all assets and liabilities will be sold is if the business is wound up under loser or liquidity problems. As such, assets are most likely to be auctioned off by the creditors and shareholders are unlikely to receive a fair value for them. Indeed, assets such as inventory are often sold at less than ten per cent of their market value. As such, this method is likely to be unreliable, particularly for a business with such a large volume of inventory (Lumby, 1994).Another method of calculating the potential fair value of a company is to use the value of net earnings and compare this value to the historical price / earnings ratio to work out what the current fair price should be for the sha res. Based on this method, the average price / earnings ratio of Kingfisher has been 16.18 over the past five year period.Year200320042005200620072008AverageEarnings per share (pence)16.417.420.812.211.811.715.05Share price (pence)257.25285.5259235.75252.75138.1238.0583Price / Earnings Ratio15.6859816.40804612.4519219.3237721.4194911.8034216.1821Applying this to the earnings per share over the past year of 11.7 gives an estimate of the fair value of the share price of 189.33 pence this is 47% higher than the market value of the shares. As such, this also implies that the current market value of the shares is too low. However, valuing the company on this basis is also flawed, in that it assumes that the company will maintain its past performance, and that the past performance of the shares has been efficient. Indeed, for Kingfisher this is arguably even less of a relevant method by which to judge the shares, as Kingfisher is currently suffering significant problems in its main UK mar ket. Therefore, attempting to value the company based on its past valuations assumes that the company is still performing as it did in the past, something which is arguably not the case. In addition, with many predicting that the Kingfishers UK market will continue to shrink, it is possible that the companys ability to generate earnings will be further impaired, and its earnings per share ratio will fall below its average (Lumby, 1994).As such, and given that there is significant irresolution over the future value of Kingfishers assets and liabilities as well as the ability of the company to generate earnings, it is difficult to come up with an analytical method for calculating the fair value of the company. Therefore it is necessary to use the efficient market meditation when attempting to value the company. This hypothesis is based on the view that the market produces the fair value of the shares of the company using all available information. As such, the market should already have priced in the potential for Kingfishers properties to decrease in value and the potential for the company to be unable to make as much money in the future. This is based on the argument that the market as a whole has access to all the information available, and also has experience in reading and judging signals regarding the value of a company. As such, if Kingfisher were currently trading at too high a price, people would sell the shares until the value moved to a fair value. In contrast, were the company currently trading at too cheap a price, participants in the market would buy the shares until the value was driven up to a fair price.As such, the efficient market hypothesis implies that the current fair price for the Kingfisher shares is the price at which they are currently traded on the open market. Therefore, the fair price of the shares is 128.2 pence. However, the efficient market hypothesis is based on markets only being able to act on available information. As such, it is possible that there is a fundamental problem with Kingfisher which will affect the share price but which is not included in the publicly available information. In addition, the market price for the shares can be driven by factors such as investment banks buying up shares, or takeover rumours. Therefore, in the short term the market value of shares may not forge their fair value, as the market may not have all the information or may be being driven by other factors. However, in the long term, the professional analysts who are employed by many of the banks and investment funds which buy and sell shares will be best able to value the shares, and hence the best estimate of the fair value of the shares is their current market value 128.2 pence.ReferencesKingfisher (2008) Kingfisher Plc. http//www.kingfisher.co.uk/ Accessed 16th August 2008.Knott, G. (2004) Financial Management. Palgrave MacMillan.Lumby, S. (1994) Investment Appraisal and financing Decisions. Thomson Learning.Turne r, G. (2008) The Credit Crunch Housing Bubbles, Globalisation and the Worldwide Economic Crisis. Pluto Press.Yahoo Finance (2008) Kingfisher Share Price Chart. http//uk.finance.yahoo.com/q/bc?s=KGF.Lt=5y Accessed 18th August 2008.