This report strives to provide a financial analysis of GKN plc over the recent five years (2004-2008). The British engineering and manufacturing group is one of the leading automotive and aerospace tier-one suppliers in the world. This report focuses on the ratio, vertical and horizontal analysis.
First, a brief overview of the automotive and aerospace market in terms of market value, actual situation and outlook of the expected future market development are provided. Subsequently, the most important non-financial company information including business description, strategy and top competitors will be investigated. Further, Tomkins plc as a benchmark will be introduced.
The main part of this report consists of the ratio, vertical and horizontal analysis. The ratio analysis reveals that GKN's liquidity significantly decreased between 2004 and 2008, indicating possible solvency problems in the future. Moreover, potential problems concerning the long-term debt-paying ability are identified, leading to the conclusion that level of debt is too high. In addition, GKN's profitability is appears to be inadequate in comparison to its benchmark Tomkins. The investment ratios reveal GKN as a bad investment in the considered period. Furthermore, since the risk of a bankruptcy significantly increased in the past years, it is concluded that a consistent dividend in recent years cut would have been favourable.
The vertical and horizontal analyses support the previous findings. However, before the crisis GKN improved its operating income through several vertical integrations and restructurings. Therefore, it can be concluded that overall the main business activities of GKN can be considered as stable. The latest disclosure of the company and the analysts' forecasts support this estimation.
Introduction
This report provides a financial analysis of GKN plc, one of the leading automotive and aerospace tier-one suppliers in the world, between 2004 and 2008. The aim is to give statement about the financial condition of the company to the management, shareholders and other stakeholder such as banks.
First, a brief background about the automotive and aerospace industry is given. Subsequently, most important information including a business description, strategy and competitors are provided.
The section 4 gives a ratio analysis about liquidity, long-term debt-paying ability, profitability and investment ratios. Section 5 and 6 analyses horizontally and vertically the company's income statements and balance sheets.
Section 7 will sum up the findings and give an outlook for the company.
Industry Background
In recent years, the automotive industry denoted substantial growth in sales and reached its peak in 2007 with a market volume of $2,129bn. In following years, the worldwide crisis led to slumps in sales and the market shrunk to $2,024bn in 2009 (). Therefore, the industry has to deal with resulting overcapacities and is hence, facing a shakeout (OECD, 2009). A recovery to the peak of 2007 is not expected before 2011 (Datamonitor, 2010).
At the same time, the civilian and military aerospace and defence industry could account strong increases in revenues. Even if the growth rate slowed down in 2009, it is still at a high level (). Actually, the market volume amounts to $744bn. For the next years, stable growth rates between 3.6% and 5.9% are reckoned (Datamonitor, 2009b, p. 36).
Company's Information
Business Description
Founded in 1759 and based in Redditch, GKN plc is a worldwide operating engineering group with about 40,000 employees. The group is listed on FTSE, supplying mainly automotive, industrial, off-highway and aerospace markets (GKN plc, 2009).
In 2008, the group recorded sales of £4,376m (GKN plc, 2009). Europe and Americas are GKN's largest market with 46% respective 40%. The rest of the world accounted 14% of the sales ().
In the automotive, aerospace and off-highway market, GKN is one of the world leading tier-one suppliers (Datamonitor, 2009a, p. 5). The group is organised in four unit segments (GKN plc, 2009, pp. 18,24,30,34):
GKN-Driveline or Automotive (53% of group's sales, ): engineers and manufactures driveline components for light vehicles
GKN-Aerospace (22%): manufactures airframe structures and propulsion systems to the civil and military market
GKN-Powder Metallurgy (13%): produces sintered components such as engines
GKN-OffHighway (12%): produces components for construction and mining equipment such as wheels and power take-off shafts
Strategy and Recent History
GKN's growth strategy is to strengthen its leadership positions through advanced technological products and state-of-the-art production processes. Therefore, GKN acquired in recent years several specialised engineering and manufacturing companies including several of its suppliers (GKN plc, 2009).
In 2006, the group integrated the hitch manufacturer Cramer Kupplung into GKN-OffHighway and the driveshaft manufacturer Rockford Powertrain into GKN-Driveline. Further, GKN-Aerospace acquired Stellex and Teleflex in 2006 and 2007 and launched in 2008 a joint venture with Rolls-Royce (Datamonitor, 2009a, pp. 7-8).
Competitors and Benchmark
The top competitors are the American ArvinMeritor Inc. and Dana Corporation for GKN-Driveline, and the German ZF Friedrichshafen AG for GKN-Driveline and as well as for GKN-Aerospace (Datamonitor, 2009a, p. 22). Being much more comparable in terms of size and using the same accounting standards and methods (e.g. both use FIFO), Tomkins plc is chosen as benchmark.
Tomkins is a global operating engineering and manufacturing group. Organised in two business units, automotive and industrial, and the building division, Tomkins recorded sales of £2,868m in 2008. The automotive and industrial segment generated 74% and the building unit 26% of the revenues. Just like GKN, Tomkins' main markets are Americas (53%) and Europe (22%) (Datamonitor, 2009c).
Ratio Interpretation
Liquidity Ratios
Tab. : Liquidity Ratios (Average) 2004-2008
This part analyses GKN's short-term debt-paying ability. A company that cannot meet its current obligations will fail into bankruptcy, even if it is highly profitable (Gibson, 2009, p. 201).
On the one hand, the days' sales in receivables were 57.73 in 2004 and decreased significantly until 2006 but increased since then (). However, a reduction by 4.85 days since 2004 indicates an improvement in receivables collections. A comparison to Tomkins suggests that GKN's receivables collection is efficient. Further, the A/R turnover in days decreased constantly since 2005 and is with 50.25 days in 2008 significantly better than Tomkins.
On the other hand, days' sales in inventory dramatically increased during 2004 and 2008 by more than 23 days to 82.49 days. This trend is caused by the strong decrease in COGS due to the vertical integrations in 2006. As a result, the days' sales in inventory increased by 16.79 days. This indicates a negative trend, even if GKN is considerably below its benchmark. Consequently, the operating cycle steadily increased since 2005, reaching 123.21 days in 2008.
Between 2004 and 2008, GKN reduced its working capital from £870m to £133m through several working capital optimisations (GKN plc, 2009, p. 2). It appears to very low in direct comparison to Tomkins. Nevertheless, since total assets are incommensurable, it is more appropriate to focus on the current ratio, indicating the short-term debt ability (Gibson, 2009, p. 221). The current ratio constantly decreased from 1.81 in 2004 to 1.09 in 2008 and, is much lower than its benchmark (2.47).
Overall, the ratios show a strong decrease in liquidity, reducing GKN's short-term debt-paying ability and indicating that there might be a solvency problem in the future.
Long-Term Debt-Paying Ability Ratios
Tab. : Long-Term Debt-Paying Ability Ratios (Average) 2004-2008
In the short-term, companies can often meet its obligation, even if making losses because not all expenses are cash relevant (e.g. deprecations). Nevertheless, the long-term they need to finance all costs (Gibson, 2009, p. 255). As an automotive supplier, GKN is a cyclical firm. Therefore, it is usual that during low profit years the interest may not be covered. In return, times interest earned in good times are expected to be higher (Gibson, 2009, p. 255). However, times interest earned by GKN were zero in 2004 and 2008 (). Additionally, they were not very high between 2005 and 2007. In comparison, Tomkins achieved to earn nearly its interest in 2008.
The operating CF in relation to the total debt indicates a similar picture: Even in the boom year 2007, GKN's cash flow was below Tomkins' of 2008. This indicates that the high level of debt burdens the company.
Furthermore, the debt ratio fluctuated significantly over time. Between 2004 and 2007, the ratio decreased to 65.71%, but due to the losses in 2008, it increased to 77.46%. Consequently, GKN's long-term debt-paying ability is significantly reduced. Hence, not only the risk for the shareholder increased but also for the creditors, who are less protected in case of a bankruptcy. The debt to tangible net worth ratio shows that in case of a bankruptcy, creditors probably would only get back £1 for £8.08 of debt (Tomkins: £1 for £1.30).
Overall, the long-term debt-paying ability of GKN seems to be insufficient. The group is largely debt financed. Taking into account its industry, GKN should consider equity financing options.
Profitability Ratios
Tab. : Profitability Ratios (Average) 2004-2008
The profitability ratios analyse GKN's ability to generate earnings. They indicate that the company improved its situation until 2007, but dramatically fall back in 2008. Further, even in the boom year GKN was way behind its benchmark:
For instance, the gross profit margin significantly improved in 2006 and 2007 to 30.03% due to vertical integrations. With the crisis, it declined again to 27.4%, but being slightly better than the benchmark. Indeed, the operating income margin considerably increased from 3.99% in 2004 to 7.06% in 2007 as well, but not as much as the gross profit margin could have promised. Due to the crisis, it dropped to 4.39% in 2008. In contrast, Tomkins achieved an operating income margin of 7.28% even during the crisis.
A similar tendency with return on operating assets: After a strong decrease in 2005, they increased considerably up to 9.66% in 2007, but slumped in 2008 to only 6.1%. Again, in comparison to the benchmark (10.62%) this performance seems to be too low.
Overall, GKN's profitability seems despite the improvements between 2004 and 2007 to be not satisfactory, especially in comparison to the benchmark.
Investment Decision Ratios
Tab. : Investment Ratios (Average) 2004-2008
As one of the most important investors' ratios, GKN's earnings per shares improved until 2007 to £0.28. In 2008, EPS dramatically fell to ‑£0.16, being four times as big as of Tomkins. Additionally, the share price dropped from £282 in 2007 to £92 in 2008.
However, for an investor it is crucial that the company is able to payout the dividend. Therefore, the operating cash flow/cash dividends ratio expresses how many times dividends are covered by the operating CF. Except for 2006, GKN's CF exceeded the dividends.
Nevertheless, GKN's dividend yield, which puts dividends per share in relation to the share price, stayed relatively constant over time around 0.05%, being significantly higher than the benchmark (Gibson, 2009, p. 341).
In sum, this analysis reveals that GKN was a bad investment in recent years. However, since the whole stock market is at its low and the stock price of GKN was never that low in since 1998 (GKN plc., 2010b), it could be good investment.
Vertical Analysis
Income Statement
Between 2004 and 2008, GKN's gross profit increased from 10.56% to 27.4% of its base amount. The net income on the other hand, dramatically dropped from 16.6% in 2004 to 1.5% in 2005. After a recovery in 2006 and 2007, the net income slumped to ‑2.5% in 2008 due to the crisis () and being below Tomkins (-1.16%).
The operating income slightly fluctuated around 5% over time, despite the significant decrease in cost of goods sold in 2006 due to several vertical integrations of suppliers. The reason is that the integrations came along with an increase of operating expenses (). In 2008, the operating income decreased below 4.4%, due to an increase in COGS majorly caused by strong sales reductions in GKN-Automotive and GKN-Powder Metallurgy since mid 2008 (GKN plc, 2009). In comparison, Tomkins achieved a significantly higher operating income of 7.28%.
The strong decline of net profits in 2005 results from a non-recurring gain due disposal of discontinued segments (): the sales of Walterscheid Rohrverbindungstechnik, AgustaWestland and Aerosystems International (GKN plc, 2005, p. 51).
Further, the net profits were considerably distorted by unusual or infrequent items in 2004 (‑7.2%), 2005 (‑3.7%) and 2008 (‑6.7%). In 2004 and 2005, these were in large parts asset-write downs and costs for the automotive restructuring program including the transfer of production capacities from Western Europe and US to low-cost countries (GKN plc, 2005, p. 51; GKN plc, 2006, p. 48). In 2008, GKN extended the restructuring program to all units, in order to face the economic downturn (GKN plc, 2009, pp. 48-49).
Fig. : VA: Income Statements - Unusual or infrequent item and disposal of disc. segments
Balance Sheet
Over the past years, GKN's asset structure significantly changed (): The long-term assets increased gradually from 47.87% in 2004 to 61.25% in 2008. In consequence, the liquidity worsened. In comparison, Tomkins only had long-term assets of 49.21% in 2008.
Fig. : VA: Balance Sheet - Total assets
Despite an increase inventory from 13.6% to 17.88% between 2004 and 2008, the current assets decreased, mainly due to the decline of cash and marketable securities (). In 2004, marketable securities were very high, while cash was very low. In 2005, cash almost completely replaced the marketable securities. Since then, the cash constantly declined to 2.84% in 2008.
The total long-term assets enlarged during the five years due to the constant increase of net tangible and intangible assets majorly due acquisitions and capital expenditure (GKN plc, 2006, p. 83; GKN plc, 2009, p. 99). Between 2004 and 2008, the tangible and intangible assets increased gradually from 34.27% and 5.28% to 44.76% respectively 12.95%.
Fig. : VA: Balance Sheet - Total liabilities and total equity
However, the capital structure changed significantly as well (). While GKN's current liabilities decrease from 35.44% in 2004 to down to 32.28% in 2006 and then stayed relatively stable around 29%, the equity and long-term liabilities strongly fluctuated. The equity increased from 22.54% in 2004 to 34.29% in 2005, while the long-term liabilities fell from 42.02% to 33.42%. Since 2006, the equity decreased gradually from 28.04% to 25.07% in 2008. In comparison to GKN, Tomkins had equity of 43.47%. Consequently, GKN's total long-term debt rose from 42.03% to 46.12%.
As mentioned above, the current assets continuously decreased due to the decrease of accounts payable. While being relatively constant around 20% during 2004 and 2005, the A/P continuously decreased ever since to 13.9% in 2008 (). The long-term debt on the other hand was largely driven by the reserves. Between 2004 and 2005, the reserves slumped from 22.24% to 11.28%. In the following two years, they increased up to 27.1% and finally, slightly decreased to 24% in 2008. These fluctuations are caused by the change in post-employment obligations due to the acquisitions and disposals (GKN plc., 2007, p. 98; GKN plc, 2009, pp. 113-117).
Horizontal Analysis
Income Statement
Since 2004, GKN's net sales grew to 125.6% of the base year. However, gross profits slumped in 2005 down to 85.33%, before increasing sustainably in 2006, 2007 and 2008 to 277.99%, 315.76% and respectively 325.82% (). This development is due to the under proportional growth of COGS, resulting from the mentioned integration of several suppliers. On the other hand, the integrations entail a boost in operating expenses: In 2006, the costs rose to 344.1% and reached in 2008 439.74% of the base year ().
However, the net income dramatically dropped down in 2005 to 9.5% (). Nevertheless, this result is biased, because on the one hand the company had large gains from disposal of discontinued segments () in 2004 (GKN plc, 2005, p. 51). Without this sale, GKN would have suffered a considerable loss. On the other hand, as mentioned before (section , p. ) the company was burdened by assets-write downs and restructuring costs in 2004, 2005 and 2008. Therefore, a trend analysis of the net income is leading nowhere.
Balance Sheets
Fig. : HA: Balance Sheet - Total assets
GKN's total assets decreased and reached their trough in 2006 with 85.3% (). They were driven by the decrease of current assets, which arrived at their trough of 70.16% in 2006 as well. Since then, current and total assets increased until 2008 to 80.04% respectively 107.67%. The decrease in current assets is in large parts caused by the reduction of cash and marketable securities after 2005. Further, the inventories decreased in 2005 and 2006 despite of sales increases, but increased significantly until 2008 to 141.62% (). This decrease is due to working capital optimisation of the mentioned restructuring programs.
Contrarily, the long-term asset slightly rose, while increasing their growth rate since 2007. In 2008, the long-term assets reached 137.76%, due to the significant growth of tangible and especially intangible assets, which reached in 2008 140.61% and 263.96%. This long-term assets enlargement arises majorly from the mentioned acquisitions.
Fig. : HA: Balance Sheet - Total liabilities and total equity
However, GKN's capital structure significantly changed between 2004 and 2008 (): The current liabilities decreased until 2006 to 88.64%, but increased considerably until 2008 to 132.5%. They were majorly driven by A/P ().
The long-term liabilities reduced continuously, reaching their trough in 2007 with 80.71%. With occurrence of the crisis in 2008, they increased to 111.3% (). The dynamics of the long-term liabilities are majorly driven by the reserves (). On the other hand, GKN's long-term debts stayed relatively constant over time.
The equity slightly decreased in 2006, but increased to 125.88% in 2007 due to high net profits. In 2008, the equity dropped to 96.8% due to the occurred losses, which were in large parts caused by the high restructuring costs.
Conclusion and Outlook
Note that there are several limitations to this report: Although both disclosures are stated under IFRS, personal judgements allow the preparer to interpret transactions differently. Therefore, financial statements should be adjusted in order to ensure the comparability. Further, GKN and Tomkins do not exactly operate in the same markets, having different products with unequal vertical ranges of manufacture. Consequently, the required cost and asset structures differ. Finally, there are factors that are not considered by the financial statements, but can affect the company: E.g. the launch of a revolutionary product, which lead to high profits.
However, this report gives a first indication about GKN's situation. The ratio analysis revealed that in recent years, GKN's liquidity significantly decreased. This might lead to solvency problems in the future. Further, the long-term debt-paying ability seems to be inadequate. This suggests that the debt level is too high. Further, GKN's profitability is not satisfying, especially in comparison to the benchmark. The investment ratios unveil that GKN was a bad investment in the considered period. The dividend payout ratio appears, regarding the level of debt, to be too high. Hence, the risk for shareholders and creditors is in relation to the poor returns too high. Therefore, a consistent dividend cut would have been favourable, even if this could have lead to a reduction of the share price in the short-term. However, GKN's stock price is at its lowest point since 1998 and thus, could be an opportunity.
Vertical and horizontal analyses support the previous findings. The risks augmented due to a significant debt increase and equity decrease. The liquidity of the asset structure worsened. However, before the crisis GKN managed to improve its operating income through several vertical integrations and restructurings. Some of these arrangements launched in mid 2008 are expected to show results in the near future. Overall, the main operations can be considered as stable.
The measures already started to show first results. While GKN was rated in February 2009 at BBB- (Reuters, 2009), the rating improved to BB+ in March 2009 (Standard&Poor's, 2009). Furthermore, GKN disclosed its results for 2009 in recent days. They indicate a sales reduction of 3.5% but a considerable amelioration of the net losses to only ‑£34m (GKN plc, 2010a). Therewith, GKN significantly exceeded analysts' expectations and let them give a positive outlook for the net income of 2010 (£160.5m) and 2011 (£227.63m) (Yahoo!Finance, 2010).
