The Financial Study Of Kraft Food Inc
This financial evaluation is based on Cadbury’s published annual accounts spanning the last two years of trading, 2006-2007 and 2007-2008
The aim of this report is to ascertain the financial performance of Cadbury Plc in order for potential investors to make a decision on whether to invest in this company.
In analysing the financial performance relevant financial ratio indicators to investors such as;
Profitability and Return on Capital Employed (ROCE)
Liquidity ratio and Collection Period
Debt to Equity ratio
Profitability and Return on Capital Employed (ROCE)
The profitability ratio analysis is conducted in order to ascertain whether Cadbury is making use of its resources efficiently and effectively in order to have a competitive edge over the other companies within the same industry.
In terms of having a competitive edge Cadbury’s position within the industry in terms of performance it is in between the median and upper value, there was an improvement in Cadbury’s performance when compared to the previous year’s trading.
ROCE is considered to be one of the best measures of profitability in order to measure the overall performance of a company. It shows how well the management has used the investment made by owners and creditors into the company. As the main aim of Cadburys is to earn profit and maximise shareholders wealth, the higher the ROCE, the more efficient Cadbury is using its funds.
2. Liquidity ratios
The liquidity ratios helps to determine the amount of cash a company can obtain quickly in order to pay for liabilities that fall due within a year. Both current and quick ratio is a short term measure of a company’s liquidity.
The current ratio - Cadburys should have enough current assets that give a promise of “cash to come” to pay off its current liabilities when fall due. A ratio in excess of 1 should be expected, but a relatively low current ratio represents that the liquidity position of the Cadburys is not good and the company may not be able to pay its current liabilities in time without facing difficulties
The quick ratio it excludes the value of inventory in order to show the immediate solvency of the company. The ratio supports that Cadbury may be having liquidity issues but they are on the way to achieving industry median averages, as the increase in the current and quick ratio represents improvements are being made in the liquidity position.
Although it takes on average 54 days in 2008 for Cadbury’s clients to settle their debt, while within the industry it takes 42 days in the worst scenarios. It is apparent that Cadbury needs to improve on their credit control management, which could help immensely increase the liquidity ratios.
These ratios and should be used cautiously because it suffers from many limitations. Thus, suggested that it should not be used as the main indicator of short term solvency. The ratio can easily be manipulated by overvaluing the current assets it would increase current ratio.
3 Debt to Equity ratio
The debt ratio determines the company’s ability to sustain its activities. The safe limit is 50%. Cadbury’s debt ratio is very good compared to the others within the industry.
Based on the above financial analysis, I would recommend that you invest in Cadbury Plc for the following reasons;
Profitability and debt to equity ratios are good which means that Cadbury Plc has a higher probability of operating longer than those within the industry. Cadbury’s financial performance is improving compared to the previous year.
The economy might be on the road to recovery from the deep recession, with consumer confidence on the decrease, but this does not seem to concern Cadburys. Instead of having of worrying about things they cannot control, they would rather worry about the Cadburys brand, and developing the business which spans over 186 years. Across the border of the food and beverages, particularly Cadburys sector , they have coped better than many analysts expected in the recession, helped by cost cutting and a boost to consumers from lower mortgage rates, Value added tax from 17.5% to 15% and a smaller than anticipated drop in employment.
Free cash flow
This calculation of the free cash flow was extract from the Cadbury Plc 2007-2008 Annual Report.
Free Cash Flow (FCF) is a measure of financial performance, similar to earnings. Specifically, it measures the cash flow available for distribution among all the security holders of a company, including equity holders, debt holders, preferred stock holders, convertibles holders, and so on. It can also be thought of as the cash left after the financing of projects required to maintain or expand the asset base. Many investors prefer to track free cash flow as opposed to earnings because it is much more complex for companies to falsify cash flow. Looking at the table Cadbury has drastically decreased by £403 million
Answer to Q2b Critical evaluation of the equity valuation methods identified above
The profit earning ratio (P/E ratio) method of valuation is a common method of valuing a controlling interest in a company, where the shareholders can decide on dividend and retention’s policy. The P/E ratio relates earnings per share to a share’s value and the share values do fluctuates a lot for instance Cadbury’s shares fluctuated between 445p and 820p within a year.
Accounting rate of return is used to assess the maximum amount Kraft Food Inc can afford to pay. This is because it is a measure of management efficiency and the rate used can be selected to reflect the return which Kraft Food thinks should be obtainable after any post-acquisition re-organisation has been completed. This is a subjective estimate because the rate used might not be achievable after the takeover.
In the net assets method of share valuation it is very difficult to establish a realistic asset values because it would be difficult to accurately quantify the existing liabilities (such as the contingency liability or deferred tax) or the assets (such as the values of machinery, fixtures and fittings, stock held, debtors being collectable). All quantifying hidden liabilities such as redundancy payments and closure costs would be difficult.
Generally shareholders rely on information provided by companies when they make their investment decisions, usually the information being historical. This is no longer satisfactory and there is a mounting challenge for managers to disclose their assessment of future business prospects so that investments can build a well informed investment decisions.
Analysts have being filling that gap in the market for many years, and even making a tidy profit of releasing their opinion on whether to invest the desired company.
Answer to Q3a - Analysis of stock market reactions in terms of Stock market efficiency theory
Arnold (2005) states the “efficient market hypothesis (EMH) implies that, if new information is revealed about a company it will be incorporated into the share price rapidly and rationally”.
There are three levels of efficiency depending on the type of information which is reflected in prices.
Weak-form efficiency - claims all past prices of a stock are reflected in today's stock price. Therefore, technical analysis cannot be used to predict and beat a market.
Semi-strong form efficiency - implies all public information is calculated into a stock's current share price. Meaning that neither fundamental nor technical analysis can be used to achieve superior gains.
Strong- form efficiency - states all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor the advantage.
In regards to semi strong efficiency information announcements can have a great impact on the stock market reactions. Warren Buffet is the most influential investment theorist of today and he happens to be the most influential shareholder of Kraft (the bidder). On the 5th January 2010 Warren Buffet voted NO against a potential takeover bid by Kraft for Cadbury (target company), which shocked the investors around the world, expectedly conspiracy theories were thriving whether it was tackle to push down the Cadburys final acquisition price. As the value of Kraft's currency increases while Cadbury's decreases, helping the Kraft board structure an agreement that eventually minimises the use of shares and maximises cash.
The prices of shares change quickly to reflect all new information about future prospect of the organisation for instance on the 19th of January 2010 Cadbury PLC agreed to an offer made by Kraft because of this information Cadbury’s share price rose by 29pence while Kraft’s declined by 47cents.
No individual or company dominates the market hence the market is competitive that is why we have other chocolate ‘giant’ companies such as Mars Inc, Krafts Foods, Cadbury PLC, Hershy and Ferrero SpA, transaction costs of buying and selling are not so high as to discourage significant trading.
Investors need to press for a greater volume of timely information. Semi-strong efficiency depends on the quality and quantity of publically available information, and so Cadbury and Kraft should be encouraged by investor pressure to provide as much as is compatible with the necessity for some secrecy to prevent each other and other competitors gaining useful knowledge.
As Arnold states “The equity markets are generally efficient, but the person with superior analytical ability, knowledge, dedication and creativity can be rewarded with abnormal high returns”.
Answer to Q3b - Analysis of stock market reactions in terms of merger and acquisition theory of bidder and target share price movements
Kraft and Cadbury illustrates a horizontal merger whereby two companies which are involved in similar lines of activity are mutual. One of the main motives for horizontal mergers is the enhancement of market power resulting from the reduction in competition.
When two or more companies join together, there should be a ‘synergistic’ effect. Synergy occurs when a takeover bid results in a better rate of return than was being achieved by the same resources used in two separate operations before the take over.
A better rate of return may be due to cost savings for instance Kraft is already projecting that by acquiring Cadbury they would be able to generate pre-tax cost savings of at least $675million annually by the end of its third year. The acquisition would add 5cents to Kraft’s 2011 earnings per share and increase its long term sales growth target.
Sometimes the ability to share sources of supply or production facilities improves the competitive position of the company.
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