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Company Analysis for Investment Opportunities

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1 Introduction

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

3) Toyota

Sector: Car manufacturing Fiscal year: April 01st – March 31st

Investment Objective

  • 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%

Tax Implications

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

Background

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)

Mission

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

Strength

  • 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.

Weaknesses

  • 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.

Opportunities

  • Joint Ventures to co-develop resorts and Casino's.
  • Expansion in developing countries.

Threats

  • 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

Background

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).

Mission

“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

Strength

  • 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.

Weaknesses

  • 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.

Opportunities

  • 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.

Threats

  • 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 TOYOTA

2.3.1 Background and mission

Background

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).

Mission

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

Strength

  • 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.

Weaknesses

  • 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.

Opportunities

  • 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.

Threats

  • 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.

Company

2008

2007

2006

Rio Tinto

USD : GBP

1 : 1.4649

1 : 1.9912

1 : 1.9571

Toyota

USD : Yen

1 : 98.23

1 : 100.19

1 : 118.05

3.1 MGM GRAND

3.1.1 Profitability

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 goodwill write down and cash taxes paid on the City Centre Project. The City Centre gain was realised in the fourth quarter of 2007 but taxes were paid in 2008. Las Vegas Sands have seen their ROECE reduce on a year by year basis since 2006 and they also made a loss in 2008 but still managed to outperform MGM in both 2006 and 2008 discrete years.

Table 1: Profitability ratios – MGM Grand

Ratio

Company

2008

2007

2006

Gross operating margin (%)

MGM Grand

44.04

47.64

48.23

Las Vegas Sands

36.93

40.83

47.96

Net profit margin (%)

MGM Grand

-11.86

20.60

9.03

Las Vegas Sands

-3.73

3.95

19.76

Return on equity (ROCE) (%)

MGM Grand

-0.79

17.00

10.40

Las Vegas Sands

1.10

3.37

9.20

Return on shareholder's equity (ROECE) (%)

MGM Grand

-5.22

9.20

3.85

Las Vegas Sands

-1.10

1.19

7.10

3.1.2 Liquidity

Current ratio

MGM has seen their working capital reduce year on year to its current ratio of 0.51% which seems very alarming. Comparing its ratio to Las Vegas Sands it is clear to see that the performance is clearly inferior. The majority of investors like to see a cushion against a downturn in sales and therefore generally investors prefer to see that there is sufficient cash that will be generated from current assets in the course of normal business to pay of its creditors. A current ratio between 1.5 and 2 would be healthy. The sharp drop for MGM in their 2008 ratio was mainly down to two areas on their balance sheet. The first is their other accrued liabilities which showed that a vast majority of this liability was down to the delay of the City Centre Project. Each partner of MGM made additional contributions each of US$ 237 million. The second area was the increase in long term debt which took a dramatic increase in November 2008. This was due to the company issuing US$ 250 million in aggregate principle amount of 13% senior secured notes due in 2010 at a discount yield of 15% with net proceeds to the company of US$ 687 million.

Inventory turnover

Referring to Walton and Aerts (2009), Inventory turnover ratio measures the relationship between the inventory and the volume of goods sold during the period. MGM has reduced its stock turnover very slightly over the last 3 years, but in all of the 3 years analysed MGM have demonstrated that it has the ability to control and sell its stock very effectively. Las Vegas Sands has a lower stock turnover which mainly due to the differing size of organisations and the increased outlets of MGM. Stock for both companies comprises of food and beverage, retail merchandise and operating supplies. Sales in stock make up 25% of MGMs revenue therefore maintaining an efficient stock turnover is critical for their profitability going forward.

Debtor turnover

MGM have very good controls over it debtors, whilst the ratio went up in 2007, in 2008 they were down to the lowest rate in three years with on average MGM taking 15 days to collect money from their customers. This compared favourable to Las Vegas Sands across all financial time periods and in fact in 2008 Las Vegas Sands took twice as long to collect its debts. In 2008, MGM also slightly increased its allowance for doubtful debts from US$ 86 million to US$ 100 million due to the ageing of certain accounts. This is an important indication as a large increase in the allowance would effectively make this analysis redundant as it could be manipulated in such a way that it would make the debtor turnover look in reality lower than what it should be. In this industry debtors are usually casino customers but casinos do go to great lengths which include background checks and investigations of creditworthiness before the customer is approved.

Creditor turnover

MGM have paid its creditors very quickly whilst the days it took to pay its creditors spiked in 2007 it dropped to its lowest rate in 2008 only taking on average 7 days to repay its creditors. There is also a very similar pattern with its competitor Las Vegas Sands whom in 2008 have only a slightly better payment ratio. Both businesses have a very good track record in paying its creditors which would demonstrate that they have a very good relationship with its suppliers.

Table 2: Liquidity ratios – MGM Grand

Ratio

Company

2008

2007

2006

Current ratio

MGM Grand

0.51

0.65

0.92

Las Vegas Sands

2.44

0.92

1.49

Inventory turnover (days)

MGM Grand

10

12

12

Las Vegas Sands

4

4

4

Debtor turnover (days)

MGM Grand

15

20

18

Las Vegas Sands

32

23

28

Creditor turnover (days)

MGM Grand

7

10

9

Las Vegas Sands

6

12

8

3.1.3 Financing

Gearing ratio

Gearing ratio shows the relationship between two funding sources debt and equity (McLintock, 2009). MGM has seen their gearing ratio fluctuate over the past 3 years. From 2007 to 2008 they saw over a 10% increase from 64.84 to 75.75%. The reason for this was down to the increase in long term debt and also the companies Shareholder Equity dropping from US$ 6,060 million to US$ 3,974 million in 2008. The Shareholder Equity reduction comprised of two factors firstly was the net income loss for the year of US$ 855 million which reduced their retained profits and secondly MGM also conducted 20 million share repurchase which cost US$ 1,241 million. When comparing the statistics to Las Vegas Sands again they were very similar but in both 2006 and 2008. Though MGM had a higher debt to equity ratio than its counterpart, this is not alarming as the gearing ratio is still below 100%, MGM's huge investment on City Centre project and the additional 2 billion dollars in Las Vegas Sands shareholder equity due to distribution of common stocks.

Interest cover

Though Las Vegas Sands sales growth had increased by 48% from 2007 to 2008, however the reported Income before tax and interest in 2008 was 50% lower than 2007. This was resulted from the additional US$ 304 million depreciation and amortization of the 3 newly opened hotels (The Venetian Macao, The Palazzo and the Four Seasons Macao). Besides that, despite the fact of lower interest rate (from 7.6% to 6.1%), interest payables had increased by 72.5% due to the additional US$ 3 billion long term debts bared by the company on various development projects.

Due to the decrease in the income before tax and increase in interest payables, the interest cover had drop from 1.35 to 0.39, where the decrease from 2006 to 2007 was mainly due to the introduction of Bethworks project started 2007 and the continuous of Venetian Macao.

In comparison to Las Vegas Sands, MGM is in a better position as they had shown a strong repayment capability in 2006 and 2007. MGM ratio in 2008 has to be excluded for assessment as the loss in operation was due to the one time off impairment charges. Another important note, the income before tax and interest for Las Vegas Sands in 2008 is lower than its interest expenses, hence with the additional US$ 3 billion long term debt in 2008, we foresee that interest expenses in year 2009 to be higher, and we doubt that Las Vegas Sands will be able to generate sufficient sales in such tough economy climates.

Table 3: Financing ratios

Ratio

Company

2008

2007

2006

Gearing ratio (%)

MGM Grand

75.75

64.84

77.15

Las Vegas Sands

70.08

76.88

66.59

Interest cover

MGM Grand

-0.21

4.04

2.31

Las Vegas Sands

0.39

1.35

4.23

3.1.4 Investment

Earnings per share (EPS)

As stated by Walton and Aerts (2009) earnings per share are a way of checking whether profitability is growing from a shareholder-only perspective. MGM had recorded a US$ 1.18 billion impairment charge related to goodwill and indefinite-lived intangible assets recognized in the Mandalay acquisition in 2005. The impairment had resulted the loss in share of US$ -3.06 in year 2008. Alternately, in 2007, MGM had recorded a US$1.03 billion pre-tax gain on the contribution of the City Centre assets to a joint venture. The gain caused a hike in the EPS to US$ 5.52 which was almost double of EPS recorded in 2006. In Nov 2008, Las Vegas Sands had issued 200,000,000 shares in common stock; hence this had increase the weighted average shares outstanding by 10% which caused the EPS drop to -0.48. As the incidents in 2007 and 2008 had distorted MGM EPS trending it would not be possible to draw a valid comparison conclusion.

Price earnings ratio (P/E)

P/E ratio reflects how the market judges the company's performance (Walton and Aerts, 2009). In comparing the P/E ratio for MGM and Las Vegas Sands, it is rather strange that Las Vegas Sands P/E ratio in 2006 was three times higher than MGM and with a P/E ratio of 268 was 17.6 times higher in 2007. In order to gain further understanding, we had extracted the P/E ratio of the industry as per graph below where the average P/E ratio of 33.2 in 2006, 50.5 in 2007 and 15.2 in 2008. As the P/E ratio of Las Vegas Sands in 2006 and 2007 are too high in comparing to the industry standard hence, it would not be advisable to invest in Las Vegas Sands as it might suggest that the share price is too high in relation to the profits earned by the company. If we could see the P/E ratio for Las Vegas Sands in 2008, it had dropped significantly and according to Fung (2008), the drop of Las Vegas Sands share price from US$ 144.15 to US$ 12.43 within 52 weeks are due to the concerns about the US economy slowdown, profitability of Macau casinos and it's high gearing ratio in 2008.

As for MGM, its P/E ratio in year 2006 and 2007 are lower than average industry P/E ratio, hence we could conclude that the market perceived MGM performance to be lower than the average industry performance. Further to that, MGM P/E ratio in 2008 meaning the company have no positive earning, hence it would not be advisable to invest either on MGM or Las Vegas Sands.

Graph 1: Sector P/E ratio (YChart, 2009)

Table 4: Investment ratios – MGM Grand

Ratio

Company

2008

2007

2006

Earnings per share (USD)

MGM Grand

-3.06

5.52

2.29

Las Vegas Sands

-0.48

0.33

1.25

Price earnings ratio (P/E)

MGM Grand

-4.49

15.22

25.04

Las Vegas Sands

-14.77

268.70

71.58

3.2 RIO TINTO

3.2.1 Profitability

Gross operating margin

According to Walton and Aerts (2009) gross operating margin is the preferred ratio to measure operation efficiency. As Table 5 below illustrates Rio Tinto's gross profit margin seemed to stabilise on a lower level during 2007 and 2008 comparing to 2006 which could be due to investing into businesses with specific operating costs. Iron Ore accounted for the biggest part of sales until 2007 when the company acquired Alcan with operations in aluminium segment that has become the most significant player in Rio Tinto's sales revenues (Rio Tinto, 2009).

Net profit margin

Rio Tinto's net profit margin compared to its competitor Anglo American has been decreasing from 35.02% in 2006 to 10.02% in 2008 (see Table 5 below). Walton and Aerts (2009) explain that the ratio shows how successful the management is in creating profit from a given quantity of sales. However data published in Rio Tinto's annual reports for the past 3 years reveal that sales had been very strong and doubled in 2008 compared to sales in 2006. The drop in net profit is largely attributed to increase in taxable profits and net interest paid on Alcan debt that was taken on after its acquisition in 2007 (Rio Tinto, 2009).

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). It can be noticed in Table 5 that Anglo American has maintained its return on capital employed in the region of 30% in 2006, 2007 and 2008, whereas Rio Tinto's ROCE significantly decreased from level 47.87% in 2006 to 15.14% in 2007 and 17.79% in 2008. This drop was caused by major investment decisions and increase in long-term debt over the past two years. Rio Tinto strategy is one of creating long term value and is expected to focus on reduction of debt to strengthen its position which could mean increasing return on capital employed.

Return on shareholder's equity (ROECE)

Return on shareholder's equity ratio shows the company's earnings on funds invested by its shareholders (equity). Rio Tinto shareholder equity was in 2008 and 2007 15.9% and 35.6% respectively higher than the amount of shareholder equity in 2006 (Rio Tinto, 2009 and 2008). Taking in an account also decreasing profit before distribution since 2006 – due to the significant investments and difficult economic conditions – the return on shareholder's equity had been in decline since (Table 5).

Table 5: Profitability ratios – Rio Tinto

Ratio

Company

2008

2007

2006

Gross operating margin (%)

Rio Tinto

28.54

28.20

38.18

Anglo American

26.03

32.48

23.81

Net profit margin (%)

Rio Tinto

10.02

26.08

35.02

Anglo American

23.89

32.08

20.93

Return on equity (ROCE) (%)

Rio Tinto

17.59

15.14

47.87

Anglo American

29.59

33.00

30.50

Return on shareholder's equity(ROECE) (%)

Rio Tinto

24.20

29.46

40.58

Anglo American

28.90

33.59

25.52

3.2.2 Liquidity

Current ratio

Current ratio is one of two most common liquidity tests (Walton and Aerts, 2009). In 2006 and 2007 Rio Tinto maintained current ratio above 1 (see Table 6). In 2008 the company's current ratio dropped to 0.83. According to McLintock (2009) “A too low ratio may indicate a lack of funds with which to operate satisfactorily and an extremely low ratio could mean that the company is unable to meet obligations as they mature”. The main reasons why Rio Tinto's current ratio decreased in 2008 are attributed to significant increase of tax on one hand and an impairment relating to current assets held for sale on the other. The main circumstances that led to the impairment were adverse change in capital markets which made it difficult for potential buyers to fund acquisitions, and global economic downturn (Rio Tinto, 2009). Anglo American's current ratio has decreased, in comparison to Rio Tinto, every year since 2006 which was due to growing short-term debt and other financial liabilities (Anglo American, 2009).

Inventory turnover

Inventory turnover ratio measures the relationship between the inventory and the volume of goods sold during the period (Walton and Aerts, 2009). In 2008 Rio Tinto inventory turnover was 54 days compared to 51 days of Anglo American (see Table 6). However in 2007, Rio Tinto reached significantly higher inventory turnover of 95 days, which didn't seem to satisfy the industry standard. Inventory turnover ratio can be affected by many factors. In this case Rio Tinto's major acquisition of Alcan in 2007 could affect this type of ratio mainly as their inventories were up 111% on 2006 and cost of sales increased only by 53% (Rio Tinto, 2008).

Table 6: Liquidity ratios – Rio Tinto

Ratio

Company

2008

2007

2006

Current ratio

Rio Tinto

0.83

1.12

1.19

Anglo American

0.67

0.85

1.35

Inventory turnover (days)

Rio Tinto

54

95

69

Anglo American

51

50

44

3.2.3 Financing

Gearing ratio

Gearing ratio shows the relationship between two funding sources debt and equity (McLintock, 2009). It can be seen in Table 7 that in 2008 and 2007, Rio Tinto gearing ratio dramatically increased to 56.96% and 59.52% respectively from just 9.38% in 2006. This increase was due to Rio Tinto's need to finance its major investments and acquisitions using long terms loans. According to Walton and Aerts (2009) higher debt may both increase the return and increase the risk of a company. However for a company such as Rio Tinto, involved in a diversified production of important industrial minerals, these levels of gearing are relatively normal. Gearing ratio of Anglo American is on a lower level compared to Rio Tinto (see Table 7).

Table 7: Financing ratios – Rio Tinto

Ratio

Company

2008

2007

2006

Gearing ratio (%)

Rio Tinto

56.96

59.52

9.38

Anglo American

24.89

8.99

13.46

3.2.4 Investment

Earnings per share (EPS)

As stated by Walton and Aerts (2009) earnings per share are a way of checking whether profitability is growing from a shareholder-only perspective. EPS of Rio Tinto grew steadily over 2006 and 2007 however in 2008 it dropped to approximately half of its 2007 level (see Table 8). This was caused mainly by the lower net earnings in 2008 and therefore Rio Tinto's earnings per share were US$ 1.48 lower than EPS of Anglo American.

Price earnings ratio (P/E)

P/E ratio reflects how the market judges the company's performance (Walton and Aerts, 2009). P/E ratios of Rio Tinto compared to Anglo American can be seen in Table 8. It cannot stay unnoticed that Rio Tinto's P/E ratio almost doubled in 2007 which represents market expectations following the company's growing presence on the market with basic industrial metals and minerals. However due to adverse global economic conditions the company's P/E ratio was much lower in 2008 compared to the previous 2 years. Anglo American's performance on the market worsened every year since 2006.

Dividend cover

The dividend cover ratio shows the amount by which profits could fall before the payment of dividends is placed at risk (McLintock, 2009). Rio Tinto dividend cover decreased in 2008 compared to previous two years (see Table 8). However this is still a positive signal about its future in contrast to Anglo American that had no dividend payments in 2008.

Table 8: Investment ratios – Rio Tinto

Ratio

Company

2008

2007

2006

Earnings per share (USD)

Rio Tinto

2.86

5.69

5.58

Anglo American

4.34

5.58

4.21

Price earnings ratio (P/E)

Rio Tinto

7.62

18.62

9.54

Anglo American

5.22

10.99

12.72

Dividend cover

Rio Tinto

2.81

5.14

3.06

Anglo American

-

7.93

6.25

3.3 TOYOTA

3.3.1 Profitability

Gross operating margin

Gross Profit Margin illustrates to us how efficient the management is in using its labour and raw materials in the process of production (Finance Scholar, 2009). Toyota by enforcing cost reduction efforts like reduced inventory by adjusting vehicle, reduced labour costs, and general and administrative expenses, managed to generate an earnings improvement of approximately ¥130.0 billion. But, due to much lower revenue caused by substantial contraction of the automotive market in 2009, Toyota were unable to minimise the fix cost on per unit sold. Due to which gross operating margin for Toyota decreased drastically from 8.64% in 2007 to -2.25% in 2008.

Net profit margin

According to Walton and Aerts (2009) net profit margin shows how successful the management is in creating profit from a given quantity of sales. From 2006 to 2008 both Toyota and Honda net profit margin appeared a downward trend. The reason for the loss in 2008 was a decline in net revenue by 21.9%, and increases in expenses, such as valuation losses from interest rate swaps, depreciation expenses, and capital expenditures.

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). From 2007 to 2008 both Toyota and Honda ROCE had a downward trend. The reason for this trend is that the long-term debt increased during the 2009 fiscal year by 0.9% and the non-current portion increased by 5.3%. The company also suffered from heavy losses with a negative growth of -3% (income before tax and interest).

Return on shareholder's equity (ROECE)

Return on shareholder's equity ratio shows the company's earnings on funds invested by its shareholders (equity). From 2006 to 2007 both Toyota and Honda ROECE appeared to be stable but has fallen down in 2008 because profit before distributions has decreased drastically.

Table 9: Profitability ratios - Toyota

Ratio

Company

2008

2007

2006

Gross operating margin (%)

Toyota

-2.25

8.64

9.35

Honda

1.89

7.94

7.68

Net profit margin (%)

Toyota

-2.45

5.80

6.20

Honda

0.52

4.24

4.59

Return on equity (ROCE) (%)

Toyota

-3.14

13.91

13.44

Honda

3.10

14.29

12.61

Return on shareholder's equity (ROECE) (%)

Toyota

-4.34

14.47

13.89

Honda

3.42

13.19

13.21

3.3.2 Liquidity

Current ratio

The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm's current assets to its current liabilities. Toyota's current assets and liabilities decreased during the 2009 fiscal year primarily due to the impact of fluctuations in foreign currency translation rates but due to lower interest rates there is a much larger drop in liability that leads to increase in current ratio.

Inventory turnover

Stock turnover ratio measures the relationship between the inventory and the cost of goods sold during the period (Walton and Aerts, 2009). Toyota had lesser stock turnover than Honda which meant that Toyota had faster moving stock. For Toyota, this happened due to reduced inventory by adjusting vehicle production. For cost reduction, Toyota suspended, postponed, and downsized projects for new plants. Since, the cost of sales was much lower compared to the reduced amount of inventory, lead to lower inventory turnover.

Table 10: Liquidity ratios - Toyota

Ratio

Company

2008

2007

2006

Current ratio

Toyota

1.07

1.01

1.01

Honda

1.09

1.12

1.21

Inventory turnover (days)

Toyota

25

28

30

Honda

46

40

42

3.3.3 Financing

Gearing ratio

The gearing ratio measures the proportion of the company's total capital that is borrowed (Biz/ed, 2009). Greater the borrowing, the bigger is the risk attached to the investment. The increase in total borrowings primarily resulted from funding obtained to maintain sufficient liquidity. As of March 31, 2009, approximately 28% of long-term debt was denominated in U.S. dollars, 21% in Japanese yen, 15% in Euros and 36% in other currencies.

Sales growth

Sales growth is the increase in sales over a specific period of time, often but not necessarily annually (Investor Words, 2009). It was observed that Toyota and Honda sales growth decreased drastically in 2008 as vehicle sales worldwide were strongly damaged by a substantial contraction in the automotive market caused by the rapid deterioration of world economic growth.

Table 11: Financing ratios - Toyota

Ratio

Company

2008

2007

2006

Gearing ratio (%)

Toyota

38.51

33.51


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