We have organised a shareholders club which we have called 6IM. There are six members within 6IM of which we all have £1000 each to invest.
As part of our Investment process we have decided to choose three companies in different sectors and conduct an in depth financial analysis. Due to the three companies working in different sectors we have also analysed key financial data of a major competitor to that particular company. We feel this will enable us to gain a greater understanding of the industry of which the three companies are working in and also a direct financial comparison with our chosen companies.
Our report will begin with a brief profile of the three companies followed by a SWOT analysis to enable us to paint a picture of where the company currently sit and the potential investment opportunities and risks associated with that particular company. In addition to this we will conduct a five forces investigation to understand the industries competitiveness.
In respect of financials we will gain an understanding of the numbers in the annual reports of both our targeted three companies and also our competitors. We will use a number of investment ratios to quantify the numbers which will help us review the performance of our chosen companies against our competitors and in addition devise a brief explanation as to what aspects of the business have made a positive or negative impact on the ratio in which we are assessing. The ratios that we will choose will be independent of each other due to the fact that some ratios are more relevant than others in certain industries. The ratios will be conducted for each of the last 3 financial years for both our targeted companies and competitors. The ratios will be split into four categories liquidity, profitability, financing and investment.
Finally we will then standardise the ratios and compare our three chosen companies. We will use a marking system to identify which company we feel excel in each ratio to help us arrive at our chosen investment vehicle. The three companies in which we will be conducting the report on are:
1) MGM Grand
Sector: Leisure & Tourism Fiscal year: Jan 01st – Dec 31st
2) Rio Tinto
Sector: Mining Fiscal year: Jan 01st – Dec 31st
Sector: Car manufacturing Fiscal year: April 01st – March 31st
- A medium term investment of 5 years
- Provide income through dividends
- Provide capital growth at the end of the term
- We would be looking at an annual expected return of between 8% and 10%
6IM discussed about the tax implications of our investment objectives. We felt that as we were all basic rate taxpayers receiving a dividend would be beneficial as we would not be impeded by the non reclaimable 10% tax credit or would we have a further liability of 22.5% due to the fact we were not higher rate tax payers.
Regarding capital growth it was decided that if our money had grown substantially over the five years and the profit was above the capital gains tax annual exemption we would realise the gains over two tax years to ensure we would utilise as much of the gain tax free as possible.
According to Tax Facts 2009-2010 (2009),
- Current Capital Gains Tax annual exemption is: £ 10,100 (2009-10)
- Current Capital Gains Tax subject to being over the exemption is: 18%
Attitude to Risk
6IM have agreed that we will adopt a moderately adventurous attitude to risk.
As part of our risk assessment, collectively we decided to assess ourselves using a risk attitude profiling questionnaire as per Appendix II which was designed by Scottish Life a leading Life & Pension investment provider.
We discussed our views on ethical investments and we concluded that whilst our opinions were not strong enough to adopt negative screening criteria which would be to completely disregard any unethical company, we would look to see if the companies are trying to improve the way they work.
In respect of the three companies chosen we also discussed that we would need to be aware of currency risk, political risk, market risk and inflation risk which would be in addition to the business risk and investment specific risk of the company.
Finally our thoughts were if we felt that each of the companies were viable in respect of investment we would be happy to spilt our money and invest in all three which would gain potentially reduce our risk through diversification.
2 Marketing and industry data
2.1 MGM GRAND
2.1.1 Background and mission
MGM operates in a very competitive entertainment and hospitality industry and is located on the New York Stock Exchange. The company owns, develops and operates casino and non casino resorts. The majority of MGMs hotels are located in Nevada where they own approximately 700 acres of land on the Las Vegas strip. Whilst MGM have a variety of hotels that occupies this land they also have a meaningful proportion that is considered undeveloped and could offer future investment opportunities. As well as resorts in Las Vegas, MGM also have operations in Michigan, Mississippi, Macau, Atlantic City and Illinois. One of their latest developments is the MGM Grand Ho Tram which will consist of a 4.2 billion multi property resort complex along the beaches of Southern China. In addition to this MGM will also open in December 2009 on the Las Vegas strip a project called City Centre which is a joint venture with Dubai World.
MGM as at 31st December 2008 employ approximately 46,000 full time staff and 15,000 part time staff, they pride themselves on offering excellent customer service which has been demonstrated by many accolades, including AAA five diamond and 4 diamond awards at hotels and restaurants across their portfolio. There quality and reputation was enhanced further in October this year when 7 of MGMs restaurants were honoured with at least one Michelin star which demonstrates the quality they strive for.
MGM’s revenue in 2008 decreased by 6.27% which was largely down to the economic conditions and with MGM having the vast majority of its portfolio in Las Vegas this could be demonstrated by the reduction in visitor volumes during the time period (Appendix I).
MGM feel whilst times are currently tough James J. Murren Chairman and CEO states “There company is well positioned to face the future thanks to our dedicated management team and work force, premier brands and best in class resorts. When the cycle changes, we will be stronger, with a foundation of experienced operators and an efficient operating profile that is not only business ready but has been battle tested.” (MGM Annual Report, 2008 p.8)
MGM Mirage Mission Statement, “Our mission is to deliver our winning combination of quality entertainment, luxurious facilities and exceptional customer service to every corner of the world in order to enhance a shareholder value and to sustain employee, customer and community relationships” (MGM Mirage, 2009).
2.1.2 SWOT analysis
- Quality Employees: MGM have invested heavily in recruiting, training and maintaining employees. They run a variety of programs for example a diversity program which looks at unique strengths of individuals and being able to blend them to work together to achieve greater performance. In addition to training, to ensure they maintain their employees in August 2007 MGM entered into an agreement with 21,000 thousand of its Las Vegas employees to provide an increase in wages and benefits of approximately 4% annually.
- Diversified Offering: MGM would be expected to earn the majority of its revenues from gaming however this is not the case with over half of its net revenue derived from non gaming activities. MGM offer a complete resort experience for its guests, with their non-gaming activities being offered at a premium due to the quality of their offering.
- Brand Name & Awareness: MGM is one of the leading hotel and leisure companies as at December 31st 2008 their operations consisted of 17 wholly owned casino resorts and a 50% investment in 4 other casino resorts. This high brand name awareness gives MGM a distinct advantage when competing against other casino brands and helps enable them to draw more customers.
- Financial Strength: In February 2009 all of the major credit rating agencies – Moody’s, Standard & Poors and Fitch downgraded MGMs rating on long term debt, there was a further downgrade by Moody’s in March 2009. These downgrades will again potentially make it very difficult for MGM to obtain debt finance and may even increase the cost of any future debt financing.
- Amount of Indebtedness: As at the 31st December 2008, MGM had long term debt totalling approximately US$ 13.5 billion dollars. The amount of debt and the inability of MGM to take on further debt could have a catastrophic impact on its business. It is uncertain that the sources of credit they have available will be sufficient to fund current financial commitments, whilst MGM have received a waiver that they do not have to comply with certain financial covenants this has led to further restrictions and requirements for them to adhere to.
- Weak Returns: In 2008 MGM have seen a reduction in the majority of their financial ratios compared with its 2007 figures. The figures can be seen in our ratio analysis section of the report and whilst an explanation of the figures have been discussed, the reduced ratios can only cause investors concern and a reduction in confidence in placing investment into MGM.
- Joint Ventures to co-develop resorts and Casino’s.
- Expansion in developing countries.
- Legal and Regulatory Threat: The gaming industry is highly regulated in which MGM must pay gaming taxes and maintain their licenses to continue their operations. A change in tax laws could adversely affect the profitability of their organization, in addition to tax changes if a regulation is violated in one jurisdiction this could result in disciplinary actions in other jurisdictions.
- Economic Market: Hotel revenue decreased by 10% in 2008 due to decreased occupancy and lower average room rates. The customers however that do make it to the resorts are spending less, which MGM believe is due to their inability to access near term credit which has led to a shift in spending from discretionary items to more fundamental costs (MGM Annual Report, 2008). A direct impact on MGM is the weak housing and real estate market both generally and in Nevada.
2.1.3 Leisure & Tourism industry Five Forces analysis
Threat of new entrant
- Due to the current economy recession, hotel industry suffered a setback in revenue. Hence, this industry is viewed as unattractive.
- Excessive initial setup investment.
- Extensive regulation generally concerns the firm’s responsibility, financial stability and character of the owners. Also, high license maintenance fee and gaming taxes discourages new entrants.
- New entrants to such markets must then spend heavily on advertising and promotion to gain levels of brand awareness of the existing players.
Intensity of rivalry among competitors
- Hotel, resort and gaming business, especially in Las Vegas and Macau, had became increasingly intense where there is rivalry to build the “biggest and best” hotel/casino.
- Between 1996 and 2000, the number of hotel rooms at Las Vegas casinos doubled and due to the current economic conditions, the demand for rooms had dropped significantly and resulted in reductions to average room rates due to competitive pressures.
- Competition between casino companies involved ever more ambitious differentiation. The new casinos in Las Vegas broke fresh ground in innovative entertainment and design features.
Threat of substitute products
- There had been a growing substitute competition for gaming which included an increasing number of state lotteries and offshore gambling on cruise ships.
- The installation of slot machines in unorthodox gambling area such as horse tracks.
- The growth of internet gambling.
Bargaining power of buyers
- In the entertainment industry, buyers (consumer) usually have relatively high bargaining power as there is a practically negligible switching cost.
- The tendency of buyers to explore different hotel for a different experience.
- Accessibility of information via internet on hotel packages, consumers are now more informed and prepared for the wide range of available hotels specifically in Las Vegas and Macau.
Bargaining power of supplier
- The main sources of supplier power in the service industry are labour unions. The unions cover approximately half of their total employees (30,000 of 61,000 employees) and had successfully negotiated for increases in wages and benefits of approximately 4% annually via the newly signed 5 year collective bargaining agreement in August 2007.
- The other supplies to hotel consist of food and beverage, retail merchandise and operating supplies. Due to economies of scale, big buyers like MGM would have an advantage over their suppliers as they can easily switch due to the wide availability of the supplies and its continuous stream of demand.
2.2 RIO TINTO
2.2.1 Background and mission
Rio Tinto is a leading international mining business headquartered in London. Rio Tinto Group combines Rio Tinto Plc (listed on London Stock Exchange) and Rio Tinto Limited (listed on the Australian Securities Exchange) and operates as a single entity. The group is involved in mining and supply of minerals and metals including aluminium, coal, copper, diamonds, gold, iron ore, uranium and other industrial minerals. It operates in more than 50 countries and employs approximately 106,000 people (Rio Tinto, 2008).
The company’s main production areas are in Australia and North America however there are significant businesses in South America, Asia, Europe and southern Africa. Rio Tinto concentrates on large scale mining operations that have a long life and are cost effective. The company recorded revenue of US$ 54,264 million in 2008, an increase of 83% over 2007. Annual production records set for iron ore, bauxite and alumina. The business had a record net capital expenditure of US$ 8.5 billion, a 71% rise over 2007 (Rio Tinto, 2008).
“Rio Tinto aimsto maximise the overall return to its shareholders by sustainably finding, mining and processing mineral resources – areas of expertise in which we have a clear competitive advantage.A fundamental part ofthis is to deliver value while operating in an ethically and socially responsible manner, and remaining committed to long term sustainable development.” (Rio Tinto, 2009)
2.2.2 SWOT analysis
- International mining group ranks amongst top five commodities producers.
- Rio Tinto has extensive line of business (Iron ore, Copper, Energy, Aluminium, Industrial Minerals and Diamond) and each division provides its services to different industries.
- Company is well diversified in terms of the products and the markets. Geographically companies operations are spread over six continents.
- Globally number one producer of Aluminium because of recent acquisition of Alcan in October 2007. Alcan was ranked globally among top three producers of Aluminium and Bauxite.
- World’s largest Uranium supplier.
- Majority of Iron ore and coal contracts are sold at annual contract price rather than the spot market. There is a significant deterioration in the pricing environment of these commodities.
- Production of zinc and silver by the company has been decreasing in recent times.
- BP and Rio Tinto entered into partnership for the formation of a new jointly owned company, Hydrogen Energy, which will develop decarbonised energy projects around the world and lead the path for sustainable future uses of coal.
- The growing importance of uranium as a resource for future energy needs.
- In the recent time there is a significant reduction in the commodity prices and the demand of the market especially because of the global economic crisis.
- Rising concern for environmental issues, health and safety standards across the globe. Especially for the industry to meet standards and quotes agreed in the KYOTO Protocol.
2.2.3 Mining industry Five Forces analysis
Threat of new entrant
- High demand of capital as entry cost makes it tough for new entrant to enter in this field.
- Very low availability of new mining areas (mines) and risk on capital involved in searching for new mining areas restricts new entry in this field.
- Requirement of high, sophisticated and costly technology is again an entry barrier for new entrant.
- High government and environmental regulations.
- Intensity of rivalry among competitors
- High demand and optimum supply leads to limited rivalry amongst competitors.
Threat of substitute products
- Being a standardised product (commodities) and basic raw material to the industry or to the end customers, there is no availability of substitute.
- Prices are fixed at macro level generally by external authorities (government) so the variability in prices of different suppliers is absent.
Bargaining power of buyers
- Strong control on Pricing by government leads to low bargaining power of customers.
- Unavailability of substitute products shifts the favour towards the supplier from the customers.
- Customer’s (Industries) dependency on existing channel of distribution and product is very high; therefore the customer’s power is again low.
Bargaining power of supplier
- Bargaining power of suppliers supplying technology is high because of the sophisticated technology requirement and reduced availability of specialist suppliers.
- Skilled labour requirements are high and availability is lower because of less lucrative future prospects that shift the favour towards suppliers.
2.3.1 Background and mission
Toyota Motor, the world’s largest automotive manufacturer, has a powerful aspiration to become ‘Greener’. The company makes a hybrid-powered (petrol and electric) sedan – the ‘Prius’ — that is being snapped up in US and European markets. Its petrol-powered cars, pickups, minivans, and SUVs include such models as Camry, Corolla, 4Runner, Land Cruiser, Sienna, the Scion brand, and a full-sized pickup truck, the V-8 Tundra. Toyota also makes forklifts, manufactured housing and offers financial services. Once a dark horse in the global automotive game, Toyota overtook Chrysler and Ford in worldwide sales and surpassed General Motors in 2008. The company gets nearly half of its sales from Asia (Just Auto, 2009).
Toyota’s management value has developed from the company’s origins and has been contemplated in the terms“Just in Time Production” and “Lean Manufacturing”, which it was instrumental in developing (Strategonic, 2009). The Toyota Way has five mechanisms (Liker & Jeffrey K., 2003):
- Perfecting business process.
- Eliminating wasted time and resources
- Building quality into workplace systems
- Building a learning culture for continuous improvement.
- Finding low-cost but reliable alternatives to expensive new technology
2.3.2 SWOT analysis
- Toyota has become the lead name in the global market. People have a lot of trust for their name and this is why Toyota is the leader in automobile industry.
- The important edge over the company’s competitors is the ample availability of the spare parts in the markets.
- Toyota is a financially strong company. This can be demonstrated by the analysis of the financial reports.
- Toyota vehicles have got a much stronger resale value than any other car in the global markets. This is why people prefer to buy a Toyota.
- Toyota is proud to have a successful team of competent managers and skilled workers. Extensive training has enabled the employees to perform outstandingly.
- Toyota is the only company having the most sophisticated network of dealerships where customers are treated by professional dealers.
- Being big has its own problems. The World market for cars is in a condition of oversupply and so car manufacturers need to make sure that it is their models that consumers want. Toyota markets most of its products in the US and in Japan therefore it is exposed to fluctuating economic and political conditions in those markets. Perhaps that is why the company is beginning to shift its attentions to the emerging India and Chinese markets. Movements in exchange rates could see the already narrow margins in the car market being reduced.
- There are some weaknesses in the dealership network. The dealers sometimes tend to deviate from the recommended course of action and principles of Toyota. This can result in customer complaints.
- A lot of effort is put into the sales forecasting because of the changing political and economic scenarios. For these reasons inventory has to be kept low.
- Export is a major opportunity for Toyota Motors.
- Toyota can do better by focusing on segments much more than what is presently being done.
- Toyota is to target the ‘urban youth’ market. The company has launched its Aygo, which is targeted at the streetwise youth market and captures (or attempts to) the nature of dance and DJ culture in a very competitive segment. The vehicle itself is a unique convertible, with models extending at the rear. The narrow segment is notorious for it narrows margins and difficulties for branding.
- Switching diesel market toward petrol and CNG market.
- Even though Toyota enjoys the position of being the no.1 automobile company, still it faces some threat from competitors especially Honda. Honda has adopted aggressive strategies for capturing the market.
- In 2005 the recall of 80,000 SUV’s negatively impacted on the brand of Toyota and posed a threat to its future reliability and sales.
- Even though Toyota keeps a careful eye on the changing trends, still the changing customer needs and trends can prove to be a threat.
2.3.3 Automobile industry Five Forces analysis
Threat of new entrant
- Slow lethargic state of economy resulting in low per capita income leads to declined consumption. Hence, the productivity decreased at manufacturing level.
- Automobile sector is already over saturated market for the provided demand base.
- Initial cost of capital is very large.
- Industry requires highly specialised technology or plants and equipments.
- Constant R&D: Patent and proprietary of auto designs restrict the entry into an industry.
Intensity of rivalry among competitors
- Due to high cost of competition automobile industry earns low returns.
- Competition has intensified rivalry by offering rebates, long-term warranties and preferred financing to lure the customers which have put pressure on the profit margins.
- Foreign Trade increased the degree of rivalry.
- Export becomes essential for expansion and competition.
- High exit barrier: Entrants are reluctant to commit to acquiring specialised assets that cannot be sold or converted into other uses if the venture fails.
Threat of substitute products
- Consumer seek substitute like bus, train or aeroplane to reach their destination.
- People’s likeliness to seek alternative transportation depends upon the cost of operating a vehicle. Higher the operating cost less likely people will buy the automobile.
- Consumers’ decision to buy vehicles largely depends upon the price of petrol.
- Emergence of very small and economical car segment in automobile sector.
Bargaining power of buyers
- Consumers are highly price sensitive and generally don’t hold much buying power as they never do bulk purchase of cars.
- Wider range of product, negligible switching cost, readily available.
- More shrewd customers: Customers are very particular in terms of brand selection, technology and price of product.
- Dealers are cherishing the freedom of selling more than one brand at any time.
Bargaining power of supplier
- Due to the fragmented automobile industry, most of the suppliers depend on just one or two automakers to buy majority of the products. Switching the supplier is devastating to the business of previous supplier.
- Long term supplier relationship in the automobile sector, which is considered to be an oligopoly, makes the relationship obligatory for suppliers and hence the supplier has lower grip on the prices
- Suppliers provide secondary material and have little responsibility over the design and assembly of automakers. Therefore, essentially little power is given to suppliers.
3 Financial Analysis
The report describes a financial statement analysis between companies of our choice with their closest competitor which is followed by a 3 year trend analysis to provide an indication of the consistency of the company’s performance. Assessment of performance will focus on 4 main areas namely profitability, liquidity, financing and investment.
In order to provide comparability, relevant financial figures are converted to US dollar as per exchange rate stated in respective annual report.
USD : GBP
1 : 1.4649
1 : 1.9912
1 : 1.9571
USD : Yen
1 : 98.23
1 : 100.19
1 : 118.05
3.1 MGM GRAND
Gross Operating Margin
According to Walton and Aerts (2009) gross operating margin is the preferred ratio to measure operation efficiency. In the hotel industry, cost of sales revolve around payroll related expenses, gaming related taxes, room, convention, retails and other expenses. In year 2008, MGM’s gross operating profit had dropped from 48% to 44%, due to drop in room occupancy by 10% affecting sales with no reduction in Cost of Sales in comparison to 2007. Stagnant Cost of Sales could be explained as there are several fixed expenses like payroll, electricity, food, etc would still be maintained regardless of room occupancy and further to that, in August 2007, there are total of 21,000 MGM employees entered into a 5 year agreement which provides approximately 4% annual increment in wages and benefits. This had contributed to the increase of the payroll expenses in 2008.
As for Las Vegas Sands, through the opening of new hotels like Venetian Macao, The Palazzo and Four Seasons in 2008 it had increased its sales, however there were a substantial amount of additional payroll, advertising and promotion as part of opening activities related expenses and the launching of new passenger ferry service operations in Macao where it had an additional US$100 million in operating expenses. This had affected its gross operating profit margin to drop from 40% to 36% in 2008.
In terms of gross operating profit margin, MGM had been observed as a better company in controlling cost as its margin had been higher than competitor Las Vegas Sands by 7% on annual basis.
Net Profit Margin
According to Walton and Aerts (2009), net profit margin explains that the ratio shows how successful the management is in creating profit from a given quantity of sales. MGM has steadily increased its net profit margin except in 2008, this compares favourably to its competitor Las Vegas Sands who has shown a trend of reducing profits since 2006. The size of the loss however in 2008 was far greater for MGM. Whilst the revenues for MGM have remained fairly constant, the reduction in profit was largely down to certain areas of its operating expenses in particular US$1.2 billion impairment charge related to goodwill and an indefinite lived intangible asset recognised in the Mandalay acquisition in 2005. Having reviewed the accounts, we would also address an area of caution in the MGM profit margin in 2007 as there was a one off recognition of a US$1.03 billion gain in relation to the City Centre Project.
Due to the fluctuation in MGM net profit margin due to several onetime adjustments in the years 2007 and 2008 which makes it insufficient for comparison against Las Vegas Sands, hence only figures from 2006 would be taken for assessment where Las Vegas Sands net profit margin seems more favourable than MGM.
Return on capital employed (ROCE)
Return on capital employed (ROCE) is a performance ratio that demonstrates how much the company has earned on invested long-term funds (Walton and Aerts, 2009). In 2008, MGM board of directors had announced 20 million share repurchase which caused the total shareholder equity to drop by 34%. With this drop, we would be expecting an increase in ROCE ratio from 0.17 to 0.19 if income before tax and long debt remains the same in 2008. However due to the loss in 2008, the actual ROCE ratio indicates a negative return of 0.79% in relation to equity.
On the other hand, Las Vegas Sands ROCE ratio in 2008 had dropped by 2% due to the increased of total asset by 33% due to the distribution of common share and preference stock amounting US$ 2.56 billion, which increased the stockholder equity by 50% and additional long term debts amounting US$ 2.84 billion. Despite the fact that Las Vegas Sands ROCE ratio had dropped in 2008, Las Vegas Sands still stand a better position than MGM as there are still positive returns.
Return on shareholder’s equity (ROECE)
MGM over the three years have had a very volatile ROECE which saw progression from 2006 to 2007 but in 2008 produced a negative 5.22% return in relation to Shareholder Equity. The components that make up the ROECE are very similar to the ROCE except that the ROECE is after interest and tax but before payments of dividends. In respect of MGM dividends are irrelevant as they have not paid a dividend in the last three years. The negative return in 2008 was solely down to their losses of US$670 million from their continuing operations before income tax. This loss was further inflated by US$186 million provision for income tax expense even though the company made a loss. The provision was for a non deductable good
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