Investment Opportunities In Reliance Communications Limited And TPG Telecom Limited: A Comparative Analysis Essay.

This assessment task is a written report and analysis of the financial performance of two selected listed companies on the ASX in order to provide financial and investment advice to a wealthy investor. This assignment requires your group to undertake a comprehensive examination of a firm’s financial performance based on update financial statements of the chosen companies.

The report would concentrate from the viewpoint of a foreign investor intending to make investment in the Australian market. Hence, the organisations chosen for meeting the purpose of this paper constitute of Reliance Communications Limited and TPG Telecom Limited. The primary part of this report is to provide an overview of the two above-stated organisations with special emphasis on their comparative advantages. The next part would deal with evaluating and comparing the liquidity and profitability positions of the two organisations for the last three years through extraction of information from the disclosed annual reports. The third section would lay stress on assessing the stock price movement of the two companies so that the stock price volatility could be ascertained by contrasting the same with the index values in the past three years. Moreover, the weighted average cost of capital of these organisations has been computed as well for better analysis of their capital structure. Finally, by considering all the above-stated aspects, the report would shed light on preparing a recommendation letter to the client about the future prospects of investment in the two organisations.  

Reliance Communications Limited:

The organisation is involved in providing enterprise voice, video, data, and IT infrastructure solutions to enterprises and OTTs in India and other global nations. It has been established in 2004 and it operates a telecommunication network providing services to enterprise and retail customers including national and international long-distance connectivity, fixed-line services, enterprise solutions and broadband services. With the help of its subsidiary, GCX, the organisation provides a variety of products and services to the enterprise customers so that they could develop, manage and connect international data networks (Reliance Communications 2019).

TPG Telecom Limited:

The organisation provides telecommunication services to the small and medium-sized enterprises, residential users, big corporate organisations, government and wholesale customers in Australia and other global nations. In addition, it offers fibre optic and Ethernet broadband access, NBM, ADSL2+, internet protocol television, telephony services, SIM only mobile plans and different solutions related to business networking. Along with this, the organisation provides different bundle plans including internet products, POP3 and internet message throughout protocol mail accounts, phone cards and others. In August 2018, the planned merger between TPG Telecom Limited and Vodafone Hutchison Australia where the former would have 49.9% of the stake in the merged organisation would definitely add to its financial performance (Tpg.com.au 2019).

Before undertaking any investment decision, it is always necessary to analyse the liquidity and profitability position of an organisation (Banerjee 2015). The same is applicable for both Reliance Communications Limited and TPG Telecom Limited, which could be analysed with the help of liquidity ratios and profitability ratios. The detailed evaluation of these ratios for the two organisations is undernoted:

Liquidity and Profitability Analysis

The liquidity positions of Reliance Communications Limited and TPG Telecom Limited have been analysed with the help of two ratios, which include current ratio and quick ratio. The detailed calculation of these two ratios is presented as follows:

With the help of current ratio, it becomes possible to identify the ability of an organisation in settling off its current dues with the available short-term asset base (Baños-Caballero, García-Teruel and Martínez-Solano 2014). In case of Reliance Communications Limited, the current ratio has declined from 0.72 in 2016 to 0.61 in 2017, which has increased again to 0.95 in 2018. On the other hand, for TPG Telecom Limited, the ratio has fallen from 0.70 in 2016 to 0.37 in 2017, which has declined again to 0.26 in 2018. However, it is noteworthy to mention that the current ratio of both the organisations is below the ideal level of 2 (Barr and McClellan 2018). The increase in spectrum liability in 2018 has been the main reason of declining current ratio for TPG Telecom, while the increase in assets held for sales has improved the current ratio of Reliance in 2018.

Quick ratio is another liquidity ratio deemed to be superior over current ratio due to the exclusion of inventories and prepaid expenses (Beatty and Liao 2014). The trend of quick ratio for both the organisations is observed to follow the same pattern like quick ratio. However, the ratio for Reliance is closer to the ideal standard of 1, which is not the case in case of TPG Telecom (Bekaert and Hodrick 2017). This is because Reliance did not have any prepaid expenses and it has kept its inventory according to market demand.

Therefore, by considering all the aspects, the liquidity position of Reliance Communications Limited is deemed to be superior over TPG Telcom Limited.

The profitability positions of Reliance Communications Limited and TPG Telecom Limited have been analysed with the help of three ratios, which include operating margin, net margin and return on capital employed (ROCE). The detailed calculation of these two ratios is presented as follows:

Operating margin signifies the percentage of profit that an organisation has after deduction of all its relevant expenses excluding finance costs and income tax expense (Bhalla 2014). In case of Reliance Communications Limited, the operating margin has declined from 4.09% in 2016 to 2.87% in 2018, while the ratio for TPG Telecom has fallen from 24.08% in 2016 to 23.97% in 2018 after experiencing an increase to 25.45% in 2017. This implies that TPG Telecom has earned more revenue than Reliance over the years, which has assisted the organisation in covering up its fixed costs effectively.

Stock Price Performance

Net margin implies the proportion of profit that an organisation earns after it has settled all its expenses including direct costs, indirect costs, interest expense and tax expense (Brigham et al. 2016). In terms of this ratio, the net margin is deemed to be fluctuating for Reliance, while the trend is increasing for TPG Telecom Limited owing to increased revenue over the years.

Return on capital employed (ROCE) is a valuable method to compare profitability across the organisations depending on the amount of capital used (Henderson et al. 2015). The ratio is found to be significantly lower for Reliance Communications Limited, while in case of TPG Telecom Limited, the ratio has increased from 15.50% in 2016 to 19.96% in 2018. This implies that TPG Telecom has managed to generate increased returns on its employed capital, which would assist in maximising the wealth of the shareholders.

Therefore, in terms of profitability, TPG Telecom Limited is deemed to enjoy competitive supremacy over Reliance Communications Limited in the telecommunications industry.

From the above figure, the movements in share prices of Reliance Communications Limited and All Ordinaries Index could be observed from 2016 to 2018. The analysis clearly signifies that there has been decline in stock price performance of Reliance during the period. In addition, the stock price of Reliance has failed to complement the rise in stock price of the All Ordinaries Index, in which negative relationship could be observed between the stock price and the index price. The decline in share price of Reliance denotes an unfavourable trend, which would decline eventually in future and hence, the return on investment of the investors would be minimised in future. The correlation between the stock price of Reliance Communications Limited and All Ordinaries Index is relatively negative which is obtained at the level of -0.766.

By carefully analysing the above figure, it could be observed that the stock price of TPG Telecom Limited has declined relatively in comparison to the share price movement of the All Ordinaries Index. This implies that the stock price of the organisation has failed to complement the change in price of the All Ordinaries Index, which denotes all the issues in existing demand among the potential investors. Hence, the contrast between the stock price of TPG Telecom Limited and All Ordinaries Index indicates a low probability of future increments in stock value on the part of the organisation. In addition to this, the correlation between the share price of TPG Telecom and the index is found to be negative at the level of -0.586.

Weighted Average Cost of Capital (WACC) Analysis

The above computation helps in relative representation of the weighted average cost of capital (WACC) of Reliance Communications Limited from 2016 to 2018. The changes in the values could be observed in the WACC of the organisation, which has declined from 8.64% in 2016 from 6.58% in 2018. Such pertinent decrease in the cost of capital is mainly due to the rise in weight of equity over the three-year period. The composition of the capital structure of the organisation has modified in the fiscal year of the three-year period, in which the depth exposure has increased from 62.94% in 2016 to 83.35% in 2018. On the other hand, the equity exposure has declined from 37.06% in 2016 to 16.65% in 2018. Based on the valuation, it could be observed that the cost of equity is relatively high; however, there has been decline in the composition of equity weights. Hence, Reliance uses debt capital in order to support its debt exposure by minimising the equity exposure due to which the cash outflows of the organisation have increased. In this context, Bryce (2017) mentioned that WACC assists the organisations to undertake sound decisions about investments and choose projects, which provides increased return from their capital cost.

The computations made in the above table have direct effect on WACC of TPG Telecom Limited. Therefore, the computation is carried out for three-year period, which has increased from 9.67% in 2016 to 11.10% in 2017; however, it has declined again to 10.12% in 2018. The debt combination after witnessing sharp increase in 2017 has fallen again in 2018 due to which fluctuating trend could be observed in the cost of capital of the organisation. Owing to this, fluctuations could be observed in debt weight and equity weight of the organisation over the years, which have direct effect on the cost of capital. If the cost of capital increases, the financial ability of the organisation is minimised when it comes to the acquisition of additional investment projects. As commented by Hoyle, Schaefer and Doupnik (2015), the calculation of WACC enables the investors in identifying the minimum required rate of return, which the organisation has to accomplish for ensuring sustainable progress.

Debt to equity ratio helps in gauging the financial leverage of an organisation by comparing the total debt to total equity (Vernimmen et al. 2014). A debt to equity ratio of 1 is considered to be stable for any organisation. In this case, the ratio has remained above 1 for Reliance Communications Limited, while in case of TPG Telecom Limited; the ratio has remained below 1 after 2016. This implies that TPG Telecom is raising majority of funds through equity in order to minimise its overall financial leverage.

Conclusion and Recommendation

Interest cover ratio helps in analysing the ability of an organisation to clear off its interest expense with the help of operating income (Weygandt, Kimmel and Kieso 2015). In case of Reliance, the interest cover ratio has been 0.18 in 2016; however, the ratio is found to be nil in the next two years, since it has not incurred interest expense in the next two years. On the other hand, the ratio is deemed to be favourable for TPG Telecom Limited, since it is well above the ideal standard of 1 (Wang 2014).

Therefore, in terms of capital structure, the policy of TPG Telecom Limited is observed to be more suitable in comparison to Reliance Communications Limited.

After critical analysis of the entire financial performance, stock price performance, capital structure and WACC position of both Reliance Communications Limited and TPG Telecom Limited, the latter is considered to be a viable option for the investor. The global telecommunications industry is making progress, which would assist the investors to generate increased level of income for the investor. The main reason that TPG Telecom Limited is chosen is due to improved financial performance in terms of profitability and capital structure; the only exception is liquidity, as it is struggling to settle its short-term obligations with the short-term asset base available. However, in other aspects, TPG Telecom Limited is observed to be in a better position than Reliance Communications Limited.

This would assist in undertaking the investment decision of choosing an effective investment alternative, which would maximise the overall return of the concerned investor. Although the share price performance is declining for both the organisations, TPG Telecom Limited has experienced a slight increase its share price in 2018, which is a positive sign for the investor. In addition, the capital structure policy of the organisation is found to be effective, as it could adequately support it finance costs with the help of operating profit. This implies that the investor would be able to obtain to earn increased returns in future along with minimising the investment risk of the organisation. Hence, choosing TPG Telecom Limited would be an added benefit for the investor, since it would raise the pertinent returns related to the portfolio of investment.

Conclusion:

Based on the above discussion, it could be stated that the financial performance of TPG Telecom Limited is superior over Reliance Communications Limited in terms of capital structure and profitability with the only exception observed in liquidity. Even though the share price performance of both the organisations is observed to have negative relationship with the All Ordinaries Index, the performance still seems to be better for TPG Telecom Limited. Therefore, by considering all these aspects, the concerned investor is recommended to invest in the shares of TPG Telecom Limited, as it has experienced a slight increase in its share price in the final quarter of 2018. Therefore, by investing in the shares of TPG Telecom Limited, the investor would be able to maximise their overall return on investment.

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