Calculating Financial Ratios And Valuation Concepts - JB Hi-Fi Essay.

1.Explain how corporations are financed, the needs of their stakeholders and the calculation of dividend returns to various types of shareholders.

2. Calculate a company’s working capital, profitability and market performance ratios using its annual report.

3. Assess the company’s performance using the results of the financial ratios calculated to make an investment recommendation.

4. Explain key valuation concepts and the valuation process. 

Earning Quality

1. JB Hi – Fi is the largest home entertainment retailer from Australia. They are well known for wide range, biggest brands and low prices. Consumers can purchase LCD, LED, OLED, HD TVs, iPads, headphones, Wireless speakers, home theatres and mobile phones from their shops (Jbhifi.com.au 2018).

Earnings are the profit amount produced by the company during particular period of time generally quarter or year. Earnings are used for determining the share price of the company as earning trend of the company indicates that whether the company will be successful and profitable in the long run or not. It can also be used for comparing the performance of the company over the past periods (Vogel 2014). EBIT or earnings before interest and tax is used for measuring the profit of the company and it includes all the revenues and expenses except the charges for interest and taxes.

From the annual report of JB Hi-Fi it can be identified that the profit for the last 5 years are as follows –

• FY 2013 – $ 177.8 million
• FY 2014 – $ 191.1 million
• FY 2015 – $ 200.9 million
• FY 2016 – $ 221.2 million
• FY 2017 – $ 290.5 million

From the above it can be identified that over the last 5 years the EBIT of the company was in increasing trend and has been increased from $ 177.8 million to $ 290.5 million. Major reason behind increasing trend of EBIT for the company was the increasing trend of sales over the last 5 years. Apart from sales revenue the company received significant amount of income in 2017 from other sources. Further, it is found that out of total sales revenue of $ 5,628 million in 2017, $ 4,148.6 million were generated from JB Australia, $ 221 million were generated from JB New Zealand and $ 1,258.4 million were generated from TGG (The Goog Guys).  As the increasing trend of EBIT over the past 5 years were due to increasing trends of sales rather than the artificial profits generated through accounting anomalies the earning quality of the company is good (Bruce-Twum and Mensah 2015).

The corporate tax rate applicable for the company is 30% for the year ended 2017. However, the income tax expenses of the company for the year ended 2017 amounted to $ 86.8 million whereas the amount of profit before tax was $ 259.2 million (Fazzini 2018). Hence the effective tax rate was $ 86.8 million / $ 259.2 million = 33.5%. There is change between the effective tax rate and applicable tax rate as there is various adjustments to the profit before taxes like previous year adjustments.

Gearing ratio that measures the borrowed funds of the company as compared to its equity indicating that the borrowed funds of the company is 1.9 times of shareholder’s equity. Hence, the company is highly leveraged. On the other hand, the profitability ratios of the company are indicating that the company has strong profitability position if the net profit, gross profit and interest coverage ratio is considered (Robinson et al. 2015).

• Earnings per share

EPS is the major financial metric used for indicating the company’s profitability. EPS is calculated through dividing the entity’s net income by total number of the outstanding shares. It is used by the market participants for measuring the profitability of the entity before purchasing the company’s share. For JB Hi-Fi it is found that the amount of net income is $ 172.4 million (excluding non-controlling interest) whereas weighted average number of outstanding shares is 110.47 million.

Effective Tax Rate

Ex – issue price is the deemed value that is immediately attributed to the share of the company after taking place of any issue transaction. It is computed as follows –

Ex – issue price = Market value of shares prior issue + amount received from issue

Number of shares outstanding after issue

Ex – issue price = $ 2784,692,387 / 114,421,403 = $ 24.34

Share dilution = Market price ex-issue / MP cum issue

= 24.34 / 26.82 = 0.9074

Adjusted EPS = Net earnings / WANOS * dilution factor

= 172.4 / 110.47 * 0.9074 = 1.4

• Price / earnings ratio

Price earnings ratio is used for measuring the amount of dollar the investor can expect from the investment. PER is calculated as follows –

PER = current market price per share / EPS

PER = $ 23.37/ $ 1.4 = 16.69

• Using PER for valuing JBH

PER is price that the investor is willing to pay for $ 1 of the company’s profit or earning. As per the above calculation the PER for JB Hi-Fi is 16.69 that indicate that better performance can be estimated from the company. However, this is the simplistic way to view PER as it does not take into consideration the growth prospects of the company. A company with high PER indicates its long term sustainability.

• Dividend per share

Dividend per share is the aggregate of dividends issued by the company for each ordinary outstanding share. It is calculated through dividing the total amount of dividends including the interim dividends over the particular period of time (Wahlen, Baginski and Bradshaw 2014). Hence, for JB Hi Fi dividend per share will be as follows –

DPS = Dividends paid during the year / No. of shares (Fong and Ong 2016)

DPS = 191.1 / 114.42 = 1.7

Pre-tax dividend yield = pre tax dividend per share / market price per share

= ((191.1/70%)/114.42) / 23.37 = 0.1 or 10%

• After tax dividend yield for superannuation fund

Dividend payout ratio = 65% of net profit

Therefore, dividend = $ 172.4 million * 65% = $ 112.06

After superannuation tax = 112.06 * (1-0.15) = $ 95.251

Dividend yield = ($ 95.251/114.42) / 23.37 = 0.035 = 3.5% (Harris, Hartzmark and Solomon 2015)

• Dividend cover

Dividend cover = net income / dividend paid during the year

Dividend cover = 172.4 / 191.1 = 0.9

• NTA per share

It is calculated through dividing the net tangible asset of the company by the number of shares outstanding. Here, net tangible assets mean total tangible assets of the company reduced by total liabilities. It is calculated as follows –

Equity attributable to owners = $ 853.5 million

Intangible assets = $ 1026.6 million

Deferred tax assets = Nil

Adjusted equity = $ 853.5 – 1.026.6 – Nil = -$ 173.1 million

Number of shares outstanding = 111.7 million

NTA per share = - $ 173.1 / 111.7 = -$ 1.55 per share

Hence, NTA per share is in negative or shareholder does not have any tangible asset per share as the liabilities are more than the tangible assets of the company.

From the above calculation it is identified that the NTA per share of the company is - $ 1.55 per share. Hence, the company was not able to provide positive net asset per share as the amount of intangible asset was more than the amount of equity attributed to the shareholder (Heikal, Khaddafi and Ummah 2014). On the other hand, the current share price of the company is $ 23.3. However, as the company’s intangible asset is more than equity and tangible asset is not sufficient to cover up the payment to equity share holders, it will eventually have an adverse impact on the market price of the share.

• Cash flow per share

Financial Gearing Profitability Ratio

Cash flow per share = cash flow from operation / WANOS

Cash flow per share = $ 190.6 million / 110.47 = $ 1.73

• Cash flow per share and earnings per share – reason of difference
• Cash flow per share considers the cash flow generated by the company on per share basis whereas earning per share considers the income generated on per share basis
• Cash flow per share is computed after adjusting the depreciation, amortization and other non-cash expenses like intangibles and deferred tax (Griffin 2015).
• Earnings per share simply consider the outstanding number of shares while cash flow per share considers weighted average number of outstanding shares.

The financial evaluation of JBH has relevantly indicated the improvements in the current financial performance of the company over the period of five years. The revenue of the organisation has increased adequately over the period of five years, which is directly indicating their capability to attain higher profit in future. Moreover, the dividend pay-out ratio the company is mainly at the levels of 65%, which directly indicates the high value of dividend pay-out that is been conducted by the company. This high value of dividendpay-outratio and rising profits of the organisation would eventually allow investors to raise the level of income from investment.

However, from the evaluation of the ratios it can be detected that gearing ratio of JBH is mainly at the levels of 1.9, which directly indicates that the company has acquired higher debt in comparison to equity. Nevertheless, the other financial ratio such as interest coverage ratio, gross profit and net profit margin has directly indicated that the performance of the company is adequate, where it can yield higher return for the investors. The interest coverage ratio is mainly at the level of 25.2, which indicates that the interest payment is relevantly 25 time lesser than the operating income of the company. This measure can be detected as a positive sign, which allows the organisation to acquire additional debt to support its operations. The gross profit of the company is mainly at 21.9%, while the net profit is at 3.1%, which direct indicates that the operations of the company have been conducted adequately. The positive attributes of the financial ratio directly indicate that the share price of JBH needs to be purchased, as higher income and growth is anticipated for the organisation.

The qualitative factors of JBH can be detected from different management decision that has been conducted for improving their current operations over the period. In addition, the management has been improving their current operational condition by making certain decisions, which supported them to attain higher revenue over the period. The positive changes in revenue and net income of JBH is mainly initiated by positive decision that has been made by the management, which is allowing them to provide higher dividends in every year. Hence, the positive strategic decision that has been made by the management is optimistically affecting their share price and allowing the investors to gain higher returns from investment.

Major downside of the company is the amount of intangible asset against the amount of tangible asset. It is identified from the annual report of the company for the year ended 30^th June 2017 that the tangible asset of the company are not sufficient to settle down the payment of equity share holders in case the company needs to make payment from the asset. Further, it is identified that owing to insufficient amount of tangible asset the company’s net tangible asset per share is negative that is the shareholder is not provided with positive dollar of asset for each share held by them. it will eventually de-motivate the investors in investing into the company.

PER is price that the investor is willing to pay for $ 1 of the company’s profit or earning. As per the above calculation the PER for JB Hi-Fi is 16.69 that indicate that better performance can be estimated from the company. On the other hand, dividend yield is the ratio of the annual dividend against the share price of the company. It is found that the pre-tax dividend yield of the company is 10% whereas the same for superannuation fund is 3.5%. Hence, both the dividend yield for the company is good that can attract the investors for investing into the company. 

Reference and bibliography

Bruce-Twum, E. and Mensah, C.C., 2015. Financial Statement Analysis.

Fazzini, M., 2018. Financial Statement Analysis. In Business Valuation (pp. 39-76). Palgrave Macmillan, Cham.

Fong, W.M. and Ong, Z.H., 2016. The profitable dividend yield strategy. The Journal of Investment Management.

Griffin, P.A., 2015. Financial Statement Analysis. Finding Alphas: A Quantitative Approach to Building Trading Strategies, pp.119-125.

Harris, L.E., Hartzmark, S.M. and Solomon, D.H., 2015. Juicing the dividend yield: Mutual funds and the demand for dividends. Journal of Financial Economics, 116(3), pp.433-451.

Heikal, M., Khaddafi, M. and Ummah, A., 2014. Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), p.101.

Jbhifi.com.au. 2018. JB Hi-Fi | JB Hi-Fi - Australia's Largest Home Entertainment Retailer. [online] Available at: https://www.jbhifi.com.au/ [Accessed 19 Nov. 2018].

Laitinen, E.K., Lukason, O. and Suvas, A., 2014. Behaviour of financial ratios in firm failure process: an international comparison. International journal of finance and accounting, 3(2), pp.122-131.

Le, H.H. and Viviani, J.L., 2018. Predicting bank failure: An improvement by implementing a machine-learning approach to classical financial ratios. Research in International Business and Finance, 44, pp.16-25.

Misund, B., 2017. Financial ratios and prediction on corporate bankruptcy in the Atlantic salmon industry. Aquaculture Economics & Management, 21(2), pp.241-260.

Robinson, T.R., Henry, E., Pirie, W.L. and Broihahn, M.A., 2015. International financial statement analysis. John Wiley & Sons.

Shaverdi, M., Ramezani, I., Tahmasebi, R. and Rostamy, A.A.A., 2016. Combining fuzzy AHP and fuzzy TOPSIS with financial ratios to design a novel performance evaluation model. International Journal of Fuzzy Systems, 18(2), pp.248-262.

Vogel, H.L., 2014. Entertainment industry economics: A guide for financial analysis. Cambridge University Press.

Wahlen, J., Baginski, S. and Bradshaw, M., 2014. Financial reporting, financial statement analysis and valuation. Nelson Education.