British Gas Plc (BG), is an integrated oil and gas company with investments spreading in 27 different countries, i.e. USA, Brazil Nigeria, Tunisia, Egypt, UK, Oman, Norway, Kazakhstan and India, and has a recently expanded to Australia.
In analysing the performance of BG, several measurements have been performed on the company's 2008 financial statements. The computed performance ratios were then compared with the one of the company's major competitor, ENI SpA (ENI). The analysis was r extended further to the company's cash flow statement.
Key Findings
Leading Competitor
ENI has been considered BG's competitor on the premise that it also specialises in the exploration and production of oil and natural gas. ENI also operates globally, with operations spanning in 70 countries. Both companies operate in close markets, i.e. in Europe, Africa, Middle East and North America. Finally, as both companies are based in Europe, this close geographical proximity, leads to careful scrutiny on each other's performance.
Performance, Efficiency, Liquidity and Gearing
Profitability Ratios:
Profitability ratios are a measure of the business' performance. These ratios help managers in examining the firm's profitability, by comparing its present to past performance and further to its competitors'.
Return on Ordinary Shareholders' Funds (ROSF)
This ratio measures profit available to shareholders with the owners' stake in the business. A higher ROSF percentage indicates that more profit is available for shareholders.
BG has a ROSF of 24.45% in 2008; this indicates a return on shareholders' funds of 24.45 pence per pound, while the figure is nearly the same in previous year with ROSF of 24.47%. On the other hand, ENI has a ROSF of 19.70%; which tells us that an investment on BG is more attractive compared to ENI as the resources of BG are better utilized to maximize earnings for shareholders.
Return of capital employed (ROCE)
ROCE compares inputs i.e. long-term capital employed in the business and the output of the business in the form of profit before interest and taxes. In other words, the ROCE ratio is an indicator of how well a company is utilising the capital employed to generate profit.
ROCE should normally be higher than the rate that the company borrows at; otherwise any increase in borrowings will reduce shareholders' earnings.
ROCE ratios for BG were 36.99% and 33.67 for 2008 and 2007 respectively; and ENI SpA's ration for 2008 was 30.83% . This means for every £100 invested in BG, it gave a profit of £36.99 and £33.67 in the two years respectively. Alternatively, ENI made a profit of €30.83 (approximately £29.35) for every €100 invested. Therefore, it means that BG has utilised its invested capital well better than ENI.
Net Profit Margin
This ratio is regarded as one of the most effective measurement of operational performance. In detail, it shows the proportion of the profit gained after all costs (including cost of sales, administration costs, selling and distribution costs and so on that all occur before interest payment and taxes) over the generated sales.
In 2008, the net profit margin ratio for BG was 43.51% and was 36.65% in year 2007. This raise means that for £1 sales generated, the profit earned before interest and tax by BG has risen from 36.65 pence to 43.51pence from 2007 to 2008. In other words, it shows us an 18.72% increase in profit before tax and interest for BG in those years. Meanwhile, the net profit margin for ENI SpA in 2008 was 17.80%, which says that there was a 17.80 Euro cents gained (approximately 16.95 pence) for every Euro of sale. Thus, BG has performed a more profitable operation than its competitor within these years.
Gross Profit Margin
Similar to the previous ratio, the gross profit margin ratio shows the proportion of gross profit (profit right after variable costs or costs of sales) over the sales earned.
There was an increase from 34.35% to 41.69% of gross profit margin for BG from 2007 to 2008, while its competitor had a percentage of 17.24% in 2008. As the same as previous case, this indicates a better performance from BG in comparison to ENI.
The difference between net profit margin and Gross profit margin is that gross profit is sales less cost of sales, which is before indirect expenses. Hence, the gross profit margin is usually higher than the net profit margin. However, in this case, BG had an extra finance income of £229 mil (£276 mil of other incomes minus finance costs of £205 mil and plus income from joint ventures and associates of £158m) adding up to net profit before interest and tax, which led to a higher value of net profit margin than gross profit margin.
Efficiency Ratios:
These ratios measure the efficiency with which a firm uses and controls its assets and liabilities.
Sales to capital employed
This ratio examines how effectively the assets of the business are generating sales revenue. In other words, it is used to measure how much sales are generated for each pound's worth invested in this business. A higher asset turnover ratio is preferred to a lower one. In BG's case from 2007 to 2008, the ratio went down from 0.72 to 0.68. Conversely, ENI seemed to use its assets more effectively with a rate of 1.33 in 2008 which indicate a double value compared to BG's.
Sales per employee
A higher sales-per-employee ratio indicates that the company has the ability to operate with a low overhead cost, and therefore can earn more with less number of employees. Nonetheless, comparisons must be made with similar type of businesses i.e. sales per employee of a retailer is much lower compared to the sales made per employee by a manufacturing company.
During the two years 2007 and 2008, it showed a dramatic boost of £0.65mil in the business' sales-per-employee from £1.68mil to £2.33mil despite the effect of the economic recession and an increase of nearly 500 employees. The reason for this is less likely to be any internal factors within the business' operational system but tends to be other economic influences such as the huge raise in oil price (refer to cash flow statement session). At the lower position, ENI SpA had €1.37mil sales-per-employee in 2008. However, ENI SpA had a total of 78,880 employees in 2008 (about 15 times more than BG's), which was 3,018 employees more than the previous year.
Liquidity Ratios:
Current ratio
This ratio is used to measure whether or not the business has enough resource to pay its debts in next 12 months. Generally, the higher the current ratio, the better it is. Moreover, this ratio is acceptable at the rate of 2:1; however, it can vary from industry to industry.
In 2008, we examine that both ENI SpA and BG group's ratio were basically at the same level of 1.05 times. This ratio is lower than the common standard ratio of 2:1; nevertheless, with the continuous consumptions of oil and power from customers or the high level of necessity of product in the economies, the ratio is believed to be acceptable.
Besides, it is not a good sign to see the figure of BG went down from 1.30 times to 1.06 times within 2007 and 2008.
Acid test ratio
The ratio is used to measure the ability of the business to use its cash or quick assets to immediately distinguish or retire its current liability. Commonly, the quick ratio should be no less than 1:1 and like current ratio, the higher the ratio, the better it is. Unlike the current ratio, the quick ratio excludes the inventories from the current assets, as they made not be equivalent to liquid cash.
In both BG and its competitor's cases, the results from the tables in 2008 are less than 1:1 (0.97 and 0.88 respectively). However, like the previous case, BG seemed to have better position. Furthermore, BG had a healthy number of 1.21:1 in 2007.
Gearing Ratio:
Gearing Ratio gives the relationship between long term liabilities and capital employed. This simply means for example if a company is borrowing from a bank in order to fund a project, it has to pay interest on borrowing whether or not the investment is successful. Hence, this means there is a risk associated with the borrowing. This is measured using the gearing ratio.
BG has a gearing of 30.39% and 36.06% in FY 08 and FY07 respectively in contrast with ENI of 40.29%. It can be inferred that over the two year time period the amount of borrowings of BG has reduced which means the company has lowered is risk with respect to interest rate fluctuations. However, ENI has a comparatively high gearing ratio of 40.29% implying that ENI's borrowings are higher in comparison with the capital employed.
Cash flow Statement
It should be noted that even though the income statement is a reflection of the company's profitability, it however has some limitations, as it records some none cash items eg depreciation. The ability of the firm to take care of its obligations or paying declared dividends is depended upon the cash position of the firm, thus cash is the life line of business. The cash flow statement is a summary of the cash receipts (cash inflows) and payments (cash outflows) over the period concerned. Therefore, it will ignore all transactions that do not directly affect cash receipts and payments such as depreciation, write-off on bad debts and loss credits.
The cash flow statement consists of three main segments, thus cash from operating activities, cash from investment activities and cash from financing activities.
Cash flows from operating activities
This is the net cash inflows and outflows from the business operations, i.e. cash raised from sales less cost of sales, interest paid, and tax and dividends paid, thus earnings before interest and taxes (EBIT) plus depreciation minus taxes.
The BG group's cash flow statement reflects an increase of 70% in the cash from operating activities from £3,691million in 2007 to £6,274million in 2008. The business experienced a growth of 3% in exploration and production, which was attributed to contribution from the Buzzard in the UK and new production in India and Trinidad. More importantly, it should be noted that this jump had the main contribution of the bound in oil & gas prices during the 2008 financial year.
According to US Energy Information Administration Independent Statistics Analyst, the oil prices steadily increased from $54.67-$85.91 per barrel in January-December 2007. However, from January the industry experienced an exponential increase from $92.93 January 2008 and reaching records highs of $137.22 July 2008. Even though the oil prices steadily declined to $43.12 per barrel the end of the financial period, the company had received a significant increase in revenues during the period.
Natural gas accounts for 71% of the Group's production, and did not suffer severe price decline like the oil prices. As stated in BP publications and report the natural gas prices averaged 10.79 and 12.61 in 2007 and 2008 respectively. Please refer to Appendix 3.
Furthermore, the weaken foreign exchange rate of British Sterling Pounds over the US dollars in 2008 compared to 2007's had a positive impact on the Group's revenue. The reason for this is that the oil and gas are traded in the US dollars in international markets; however, the BG group accounts are prepared in British Sterling Pounds.
Cash flows from investing Activities
This consists of the cash outflows to invest in new ventures and cash inflows from previous investments and disposal of assets. From the firm's cash flow statement, we see that the net cash outflow increased from £1,685m in 2007 to £4,814m in 2008. This was due to reasons stated below:
An investment of £2,061m compared to £497m in the previous year, the Group acquired Queensland Gas Company (QGC) at £2,209m, a major Australian coal seam gas company.
An investment of £2,976m compared to £1,718m in acquisition of property, plant and equipment. Meanwhile, the total development investment on current and future production (on proved properties) was £1,701m in 2008 compared with £1,242m in 2007.
This increase in net cash outflows is a clear reflecting of the company's growth and expansion, thus enhancement of shareholders' wealth. The acquisition of QGC presents an opportunity for the group to supply the Austrian domestic market and also access to the Asia Pacific market.
Cash from financing Activities
This segment includes cash inflows raised through debt/loans or issuance of new shares; and interest receivable, as well as cash outflows as dividend payments, interest payable and borrowing payment. According to the company's cash flow statement, the levels of financing cash flow between the two years 2007 and 2008 were nearly the same of roughly -£650m. Nevertheless, there are some activities which are worth noting.
Though the company has made a considerable investment during the 2008, it has managed to pay dividends of £348 in 2008, compared to £264m in 2007, this reflects a strong cash position of the company. BG also borrowed less and paid more towards the loans during the period (borrowing of £444m in 2007 to £300 in 2008 and payment of £290m in 2007 up to £371m in 2008). Moreover, the firm issued less shares than it acquired during 2008, thus less dilution of existing shares, and this further affirms the strong cash position of the company.
Investing Measurement
Therefore, there are two main interests that prospective investors can take, which are dividend-based ratios including dividend payout ratio, dividend yield ratio and share-based ratios involving earning per share (EPS) ratio and price/earnings ratio (P/E ratio).
The two ratios that evaluate the dividend structure of the firm are dividend payout ratio and dividend yield ratio.
The dividend payout ratio, is calculated as following:
According to our calculations, the figures for 2007 and 2008 are 17.24% and 12.25% respectively. This decrease is not a result of a fall in total dividend payout of the year 2008. In fact, the volume of dividend jumped up by 30% from 2007 to 2008; however, the value of earnings available for dividends went up with much higher proportion. Thus, it led to the fall in dividend payout ratio.
The dividend payout ratio cannot certainly be deemed as bad or good as some investors prefer that a company re-invest its earnings back into the business to generate future growth, in this scenario a low payout ratio is preferred. However some investors seek generous dividends. This also depends on the growth stage of a business; a young or new business may be interested in re-investing to achieve fast growth whereas a matured company would pay out more dividends to its shareholders.
Dividend yield ratio, on the other hand, is said to relate the cash return from a share to its current market value. This can help investors to assess the cash return on their investment in the business.
The ratio is as the below formula:
This ratio is the UK-based ratio with the tax factor being concerned. The reason for it is that in the UK, investors who receive a dividend from a business also receive a tax credit. Moreover, this tax rate is equal to the amount of tax that would be payable on the dividends received by a lower-rate taxpayer.
For the case of BG, we assume that the lower income tax rate is as the basic tax rate or 20% (http://www.direct.gov.uk). Therefore, the results for these mathematical calculations are 0.95% in 2008 and 0.62% in 2007. These numbers tell us a positive increase in the dividend yield of BG from 2007 to 2008; though, the small figures also show us a low earning from the investment made by investors. Clearly, if a prospective investor invested in the corporation at the beginning of 2007 or 2008, for every £100 of investment in the business, the return for year 2007 and 2008 would be £0.62 and £0.95 respectively. Comparing these to the returns from saving in the centre bank in these two years; the saving scenario seems to be more profitable.
Meanwhile, with investors who are more interested in the share value, they would prefer to look at EPS ratio and P/E ratio.
The (EPS) ratio relates the earnings generated by the business, and available to shareholders, during a period to the number of shares in issue.
The ratio is as below formula:
In BG's case, the earning available to ordinary shareholders is the profit for the year that attribute to the shareholders. Computation of the EPS for 2007 and 2008 give an EPS of £0.52 and £0.62 respectively. These numbers illustrate healthy increase in the EPS between the two years, despite the downturn in the economy starting mid 2008. Moreover, the value of earnings each year is relatively high. Thus, it is a good sign for investors to consider investing in BG.
The P/E ratio relates the market value of a share to the earnings per share.
The ratio is calculated as following formula:
According to our calculations, the results for year 2007 and 2008 are 22.14 times and 15.3 times respectively. This ratio has shown the level of market confidence in the future earning power of the business. Clearly, there is a slump in the level of market confidence on the earning power of BG during these two years. This strongly reflects the fact of the economy recession. Nonetheless, the level of market confidence seems to remain at the high level for the firm. Theoretically, a stock's P/E tells us how much investors are willing to pay per pound of earnings.
PE Ratio gives an estimate of what is the amount the market is willing to pay for the company's stock. A high PE Ratio may convey that the confidence of investors on this stock is high, but it may also mean that the stock is overvalued. At the same time a low PE may be seen as the best time to buy a company's stock as the price is less.
Appendix
Table 1: 10-year commodity price chart for Natural gas, Europe
Source: Energy Information Administration -Official Energy Statistics from the U.S. Government, (2009),
Table 2: 10-year commodity price chart for Crude oil (Units: U.S. dollars per barrel)
Source: Energy Information Administration -Official Energy Statistics from the U.S. Government, (2009),
Reference
BG Group, 2008. Annual report 2008. [Online] Available at: http://bgara.blacksunplc.com/ara/index.html [Accessed 4 November 2009]
Atrill P and Mclany E. (2008), "Accounting and Finance for Non-specialists", 6th edition, Essex, England: Pearson Education Limited.
Wednesday, 22 April 2009, "Income Tax and National Insurance rates for 2009-10", [Online], Available: http://www.direct.gov.uk/en/Nl1/Newsroom/Pre-BudgetReport2008/DG_172915 [Accessed on 07/12/09]
"Petroleum Navigator", [Online], Available: http://tonto.eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WTOTWORLD&f=W [Accessed on 07/12/09]
