Fundamental Analysis For Business Valuation

Conduct a Bottom Up Analysis of Financial Ratios

The investors are largely adopting the use of technique of fundamental analysis for business valuation for taking significant investment decisions. This approach of value evaluation of businesses integrated the use of top-down and bottom-up analysis that guides the investors to estimate the likely changes that can occur within a company value in the future context. The analysis will provide assistance to the investors to take accurate decisions regarding investment within the companies. This report has evaluated the future economic and financial performances of the two companies with the use of fundamental analysis technique, that are, Wesfarmers and Woolworth. The selected companies are listed on the ASX and are recognized to be leaders within the retail industry of Australia and thus face stiff competition from each other.

This approach in the fundamental analysis consist of primarily examining the macro economic factors for gaining a review of the market conditions as a whole to identify the feasibility of macro-economic environment to support the growth of a specific industrial sector. The macro-economic factors that are evaluated for conducting top-down analysis of selected companies are stated as follows:

Reserve Bank of Australia (RBA) determines the interest rate within the country through the use of its monetary policy. There is a low interest rate of 1.5 per cent maintained at present within Australia to achieve the economic growth objectives. The reduce growth realized in the private sector and the inflation pressure within the country can be regarded as the major reason behind this move of RBA. The inflation rate is maintained at 2.1% with slow growth realized in the wages sector and higher uncertainty existing in relation to the U.S. international trade policy. RBA is adopting the use of lowering the interest rate as a medium to restrict the increase in inflation within the country for promoting the economic growth. This is because a control on the level of inflation would helps in controlling the economic growth due to low recession, reduces unemployment and increased spending power of consumers (Interest Rate in Australia, 2018).

The improvement in the growth rate of wage presents an opportunity to trigger the inflation rate within the country. As such, the bank can tighten its monetary policy and consequently can hike the interest rate by the end of the present year. This is because the rise inflation would promote a hike in interest rate to promote fewer consumers spending and reducing the borrowing power of companies resulting in reduced growth of economy and thus the level of inflation.

Macro-Economic Factors for Top-Down Analysis

The value of Australian dollar is moving downwards over past few years and is presently recorded at $0.74 due to RBA policy to keep the value of dollar low to maintain a low growth in the interest rate. The central bank of the country has emphasized to maintain a low value of Australian dollar in order to promote the trade and investment policies. This will promote the export of mining products from the country as the foreign countries will be attracted to buy the exports from Australia due to lower exchange rate. The products priced at Australian dollar will be relatively cheaper for the foreign countries to buy and thus promoting the export of products (Becker, 2018).

However, despite of the decreasing trend of the Australian dollar, the RBA has placed emphasis on maintaining its value lower in the future years also. This is done to promote the growth of a slowing economy of Australia. The weakened value of Australian dollar will help in reducing the unemployment rate within the country and promoting the economic stability. Also, it is providing boost to the Australian economy by promoting the export of natural commodities such as iron and coal to the foreign countries. This is providing to be a major source of revenue realization for Australia after the occurrence of mining boom. Thus, all these factors have caused a weakened Australian dollar that might continue this trend in the future to boost the slower economic growth within the country (Mulligan, 2015).

The Gross Domestic Product (GDP) of the county has recorded an increase of about 3.4 per cent in the present year as compared with that of the previous year. The GDP of Australia  is regarded to have an value of about A$1.69 trillion as of the end of the year 2017 and it is regarded to be one of the wealthiest nation in terms of wealth per adult. It is presently regarded as a healthy economy on account of having a balance rate of inflation and unemployment that is surging its economic growth causing rises in its GDP growth rate. This indicates that the Australian economy is growing at a higher pace supporting by high consumer spending and mining boom. The country is having a fastest annual growth rate of since the year 2012 after the occurrence of mining boom. In addition to this, the household sector with an increase in the wages growth can be regarded as the major contributor of the growth rate realized within the GDP of the country. The strong labor market with improving arte of employment within the country is further supporting the rise of GDP (Australia Real GDP Growth, 2018).

Interest Rate in Australia

Australia in the recent years has particularly undergone the major economic changes that have promoted the growth and development of its industrial sector. The lower rate of interest to keep the inflation low and weakening value of Australian dollar is all the policies adopted by the central bank to promote growth within the Australian economy. The country is presently regarded to have a growing economy in which economic growth is rising steadily as per the growing value of industrial production particularly from the mining and services sector (Reasons why we should expect a lower Australian dollar, 2013).

It can be stated from the overall analysis of the macro-economic environment of Australia that the increasing GDP and weakened Australian dollar presents a state of positive growth for the retail sector. This is because the increasing GDP will help in maintaining a low level of inflation promoting the consumers to spend more on buying retail goods and services. In addition o this, the weakens Australian dollar will promote export of retail goods from the country to foreigners as they have to pay less money for buying the products from Australia due to lower exchange rate. This will promote the growth of the retail products in the foreign countries thus promoting their production and revenue realization. In addition to this, the growth of retail sales in the recent years due to growing savings rate of households also presents a positive sign for the growth to be realized within the retail industry of (Australia Productivity Commission Inquiry Report, 2011).

Bottom up analysis is the part of the fundamental analysis and it aims to analyze the financial performance of individual stocks to provide opinion on whole industry. The purpose of bottom up analysis is to provide the detailed investigation of financial performance and market position of individual stocks that falls in same industry (Higgins, 2012). In this report, financial performance of Wesfarmers and Woolworth that belongs to the retail industry of Australia has been examined. In order to measure the financial performance of the selected companies and compare them with each other or with the industry averages it has been decided to perform the ratio analysis for last two years for both the companies.

The accounting tool or method used to analyze the financial performance through calculation various accounting ratios is referred as ratio analysis. Ratio analysis can be performed through analysis the profitability performance, solvency position and market position of both the companies.

Value of Australian Dollar

Profitability measurement is very important part of ratio analysis as it helps to find out the strength of company to convert or use the resource available with them to earn the maximum revenue. The profitability analysis aims to measure the performance of management through evaluating their ability to convert the resources into revenue. In this section the most important profitability ratios used to evaluate the performance of both retail companies are net profit ratio, and return on equity.

Profitability Ratios	Wesfarmers	Woolworth
	2017 year	2016 year	2017 year	2016 year
Net Profit Ratio	4.20%	0.62%	2.86%	-4.38%
Return on Equity	12.00%	1.77%	16.13%	-26.74%

(Source of financial data can be found in appendix section)

Net income/profit Ratio: Net profit is an important ratio from the investor’s point of view and it also helps in evaluating the management performance to provide the maximum profits to their investors. This ratio measures the ability of company to utilize the resources in such manner that results in maximum profits.

The graph clearly shows poor performance in year 2016 with some improvement in year 2017. In year 2016, Woolworth has suffered net loss of 4.38% in year 2016 and in year 2017 it increase to 2.86%. It indicates that Woolworth profitability position has improved but it is not enough to cross the profitability position of Wesfarmers in respective year. It can be said that either company has very good profitability position net profit percentage of both companies was not satisfactory.

Ratio that measure percentage earned on shareholder’s equity (Return on Equity): This is the most significant and widely used performance ratio as it indicates the management efficiency to make use of equity capital in such a way that it derives maximum profit to the investors. This ratio provides how management has applied the equity capital to earn the maximum revenue.

As this ratio is crucial for investment point of view, it is important to give emphasis on it. On looking at the above table it has been found that in year 2016, return on equity of the Wesfarmers was good as compared to Woolworth but in year 2017, there has been significant increase in return on equity ratio of Woolworth that makes it greater than return on equity ratio of Wesfarmers.

Overall profitability performance of Wesfarmers was satisfactory in both the years with some growth seen in year 2017. On the basis of review of performance of retail companies in Australia it can be said that overall profitability of this sector was poor in year 2016 due to less consumer spending power.

Gross Domestic Product of Australia

It is also refers as the debt analysis as shows the leverage position of company at the end of particular period. The ratios calculated under solvency analysis helps to evaluate the strength of the company to pay the long term debts as and when they get due. Some of important solvency ratio calculated to analyze the leverage position of both the company is debt to equity ratio and interest coverage ratio.

Solvency Ratios	Wesfarmers	Woolworth
2017 year	2016 year	2017 year	2016 year
Debt to Equity ratio	67.56%	77.71%	132.03%	167.62%
Interest Coverage ratio	16.67	4.37	12.01	6.09

(Source of financial data can be found in appendix section)

Debt/Equity ratio: This ratio shows the relative proportion of company’s debt and equity that has been used by the management to make available for the assets. This is the reason why this ratio is also known as financial leverage.

The debt to equity ratio of Woolworth was 167.62% in year 20116 and it has been reduced to 132.03% in year 2017 that indicates company has paid some of their debt and increase the amount of equity through issue of new shares. On the Wesfarmers has debt to equity ratio of 77.71% in year 2016 that was decreased to 67.56% in year 2017 reflecting improvement in the leverage position of company.

Interest Coverage Ratio: This ratio measures the ability of company to meet the interest payments that arises on debt capital. Company uses earnings to pay the interest expenses and it must sufficient enough to cover all the debt expenses with significant left for the equity shareholders.

Clearly indicates that both companies earn significant portion of earnings before tax and interest to pay the interest liabilities. There was significant increase in this ratio in case of both the companies that shows that there was some improvement in leverage condition.

The overall solvency position was improved in year 2017 as compared to previous year as there was decrease in debt capital with apparent increase in equity capital and also interest liabilities have been lowered to some level.

Current Market position of Wesfarmers and Woolworth (Comparison with industry)

Market Performance
Companies	EPS	P/E Ratio	P/E Growth	Dividend Yield	Mkt. Cap.
Wesfarmers	1.02	18.6	10.01%	4.51%	$ 56,034 M
Woolworth	1.15	22.4	4.61%	3.35%	$ 36,418 M
Retail Industry	1.02	16.00	4.61%

(Source: Investsmart: Wesfarmers, 2018 and Investsmart: Woolworth, 2018)

Earnings per share (EPS): EPS calculates per share earnings earned by the company on per dollar invested in each share. This ratio is very important form investor’s point of view as this ratio provide information on holding period return that one received if they invest in this company for a particular period. Both companies have very good EPS in current year and it was equal or greater than industry average.

Bottom-Up Analysis of Wesfarmers and Woolworth

Price Earnings Ratio: This market ratio calculates times the share price of the company in comparison to its EPS. Every company demand higher P/E ratio in order to increase their market value. Woolworth has highest P/E ratio as compared to Wesfarmers.

Conclusion and Suggestions

The macro-economic environment analysis of Australia has depicted a positive growth environment for the retail industry as inferred through the use of technique of top-down. The low rate of inflation supported by weakening Australian dollar and positive growth rate of GDP are the driving forces to support the growth of retail sales within the country in future context. The bottom-up analysis has also supported the findings of top-down valuation approach as it ahs depicted the improvisation in the financial outcomes of the selected companies during the financial period 2016-2017. As such, the investors are recommended to wait and analyze the future financial performance of the companies before taking investment decision. This is further supported by the findings of top-down analysis as per which low interest rate and positive GDP growth will support the spending power of consumers. This will help in promoting the sales of retail products and services and such the financial performance is expected to improve in the coming period of time.

References

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Annual Report: Woolworth. 2017. [Online]. Available at: https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf [Accessed on: 27 September, 2018].

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