BILABONG Australia - financial statement analysis assignment

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ACCT 5910-Business Analysis and Valuation

Contents
Executive summary……............................................................................................................3

Executive summary
The purpose of report is to provide a comprehensive analysis of Billabong International Limited. This report is primarily based on a trend analysis of Billabong’s financial performance ratios from 2009 to 2011, common size table of the balance sheet and income statement and analysis of Billabong’s cash flows. Expect to provide a basis understanding of the company’s recent situation and future valuation. The company we compared, as a part of the surfwear industry is Quiksilver.

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Billabong is a multi-brand Australian company that was established by Gordon and Rena in 1973 in Gold Coast. After decades of expansion and restructuration of capitalization, Billabong’s shares have publicly listed on the ASX. Using four-step to analysis Billabong which including business strategy analysis, accounting analysis, financial ratio analysis and prospective analysis that would help a great deal in valuation of Billabong based on its current market situation.

Business strategy includes continuous acquisitions and emerges like taking over strong brand and the products in the same sales area and expansion internationally by reaching more than 100 countries around the world. Billabong’s multicultural design of products featured new and fashion captures customer loyalty among targeted youth group. In order to ensure the company’s accounting information reflects its business reality. Three steps of accounting adjustments are taken in preparation for financial analysis, forecasts and valuation. First is to recast financial statements. This contains re-classifying accounts and preparing standardized balance sheet and income statement, using both reported statements and information from footnotes.

After that is to identify accounts that should be adjusted. By analyzing notes and reports, three accounts are likely to contain distortion information: provision for doubtful debts, leased assets and liabilities and goodwill. Last step is to make adjustments with accounting equation using more appropriate estimations and assumptions for the fiscal year from 2009 to 2011. The profitability of Billabong is unstable from financial analysis.

However, compare with the other competing company, Billabong has higher ROE and ROA. The ability of Billabong sale its inventories decreased as its inventory turnover ratio decreased. It had a good control in liquidity with relative constant current ratio and quick ratio. However, it had decreased ability on unitize long-term asset and control its debt structure. Lacking of good control on debts structure and may face burden on debt expense, which may result a high financial risk and weak solvency. From prospective analysis, Billabong may be more profitable in the future after the reorganization, the decreasing sales growth may be appeared at first few year and then increase again. The ROE of the company will be higher than last year; the company may have better performance in the future. And the company may borrow or finance the equity for the operation or paying the dividend.

1. Introduction
1.1 Background
Billabong is a famous Australian company with many brands, such as Element, Kustom and Xcel. Their main products are including clothing, watches and boardsports hardware. As surfing became more popular, the company constantly expanded its scale and exported its goods to Japan, USA and Europe during the 1980s, after that Billabong achieve leader in surfing area. In the recent ten years, Billabong had restructured its capitalization with growing global opportunities in the boardsports sector.

1.2 Business Strategy Analysis

The business analysis through three aspects: industry analysis, competitive analysis and corporate strategy analysis.
a. Industry Analysis
With the expansion of world economy, surfing is not only a sport but also a life style and that leads to high demand of surfing products. The number of firms enters that industry keep increasing as its attractive potential profits and less barrier to enter into that industry. Both companies have more bargaining power compared with their supplier and customer as their famous brand and diversified products could encourage suppliers to have long term business relationship with the company and satisfy the unique needs of customers. Overall, the prospects of this industry are optimistic; it did not shock too much under the downturn of economy. Surfing is an increasingly popular and well-known culture; companies need to continuing innovation in order to satisfy customer’s needs.

b. Competitive Analysis
As number of firms in the industry keeps increasing, greater competition force firms to earn more market share, innovate substitutes, produce differentiate products and be cost leadership to keep or improve their position in the industry. For example, some of the products of Billabong and Quiksilver are similar, consumer will choose to buy the one with lower price if they have similar function, or buy the one with higher price if the product is different from others. Thus, a firm could run well if it has different products and lower cost compared with rivals.

c. Corporate Strategy Analysis
Billabong hires different design teams for each different region to satisfy with customers from different cultural with different traditions and tastes. Billabong is expansion through strategic takeovers during last 10 years looking increase profitability through business synergies. Currently the group has direct company on operations and more than 50 countries. Sales are more than 100 countries under 13 different brands. The strategies expansion has been changing along with company’s growth. Billabong started with exportation of products to the USA and also licensed follow by relocated production off shore; FDI is the current global expansion strategy. Billabong buys bank licenses to take control of global operations and requires the existing business.

2. Accounting analysis
Billabong’s performance from 2009 to 2011 shown downward trends in profitability and market performance, therefore, it is possible that manipulation exists. In order to compare Billabong with other companies, standardized format and accounting equation-based adjustments are required.

2.1. Recast financial statements

Because of the differences in the format of Billabong’s financial statements over years and that with other organizations, standardized financial statements should be made in preparation for accounting analysis, financial analysis and prospective analysis.

2.2 Accounting adjustments

2.2.1 Adjustments of revenues and provision for doubtful debts As can be seen in appendix, PDD (6.4%) has declined since 2007. Therefore PDD should be adjusted to 6.4% for the years 2008-2011. At the end of the fiscal year, the adjustments should be made to recognize PDD according to the adjustment calculation (Appendix A table (1)).

2.2.2 Adjustments of leased assets and liabilities

As disclosed in Billabong’s financial report, it leases plant, machinery and warehouses of large dollar amount in order to maintain normal operation. Most of the leases are classified as operating lease. Thus, we need to record leases as assets and liabilities on balance sheet to make comparison with other companies (Appendix A table (2, 3, and 4)).

2.2.3 Adjustments of goodwill
By calculating the proportion of goodwill in total non-current asset from 2007 to 2011, it can be seen that instead of being impaired, goodwill increased substantially from 12.94% to 42.13%. Set 12.94% as the standard level and overvalued goodwill could be recognized (Appendix A table (5)). 3. Financial Analysis

Ratio analysis include time series and cross sectional analysis has been performed in this case to give investor’s direct understanding of the company’s historical and recent performance.

3.1 Dupont Analysis
Exhibits 1:
Dupont (Billabong)
2009
2010
2011

NOPAT/Sales
0.1141
0.1211
0.0989
× AT
1.4837
1.2428
1.4528
= ROA
0.1692
0.1504
0.1437

Spread
0.0597
0.0936
0.0945
× NFL
0.1993
0.1811
0.4031
= Financial Leverage Gain
0.0119
0.0169
0.0381
NI Margin
0.0994
0.1128
0.0853

ROE ( ROA + Spread * NFL)
0.1811
0.1674
0.1818

The Dupont approach can be decomposed into items as ROA, AT and net profit margin，which exists downward in 2011 compared with 2009. However, Billabong makes the new borrowings in its balance sheet and increases its financial leverage in 2011. Moreover, ROE is affected by ROA and financial leverage gain. As financial leverage increases and financial leverage gain increase, then ROE is back up to 0.1818 (almost similar to 2009) in 2011.

Moreover, the enhancement in AT and leverage ratio also strengthened the ROE. The greater AT can increase company’s revenue. The higher leverage ratio reflected the lower capital cost. Consequently, high ROE of the company is represented the strong profitability in the same industry comparison, and company can increase ROE through changing the leverage by borrowing.

3.2 Operating Management Analysis
Exhibits 2
Profitability (Billabong)
2009
2010
2011
Pre-Tax Income Margin
13.25%
15.23%
9.11%
NI Margin
9.94%
11.28%
8.53%
EBIT Margin
15.23%
16.39%
10.58%
EBITDA Margin
17.51%
18.78%
13.06%
NOPAT Margin
11.41%
12.11%
9.89%

From exhibit 2, these margin ratios has increased from 2009 to 2010, and declined between 2010 and 2011. Pre-tax income margin is unstable; especially dramatically decrease from 15.23% to 9.11% in 2010 and 2011 due to revenue decreasing and expenses increasing. NI margin has been low, it had been increase from 9.94% to 11.28% between 2009 and 2010, but it again fell to 8.53% in 2011. Billabong should reduce its operating and interest expenses to increase the margin of net income, EBIT and EBITDA. NOPAT margin clearly shows the operating performance of Billabong is unstable. Therefore, Billabong should reduce expenses to increase revenue.

Exhibits 3
Profitability (Quiksilver)
2009
2010
2011
Pre-Tax Income Margin
-0.33%
0.65%
-1.82%
NI Margin
-3.70%
-0.44%
-0.91%
EBIT Margin
-0.33%
7.03%
2.13%
EBITDA Margin
2.45%
9.78%
4.79%
NOPAT Margin
-9.70%
-0.34%
-0.92%

From comparison, Quiksilver has lower performance than Billabong just simply from profitability analysis. Because pre-tax income margin, NI margin and NOPAT margin have shown negative value from 2009 to 2011, only EBIT margin and EBITD margin are displayed positive value for these three periods. That indicates Quiksilver has higher expenses on interest, tax, depreciation and amortization than revenues.

Exhibits 4

From exhibits 4, Billabong has higher ROA and ROE than Quiksilver for the last three years. It must be pointed out that ROA of Quiksilver has decreased to -65.33% in 2009. Higher sales and expenses of the company can lead to lower ROE and ROA. In terms of ROA and ROE which might attributed to lower net profit margin. Moreover, compared to Quiksilver, Billabong has a relatively stable ROE and ROA from 2009 to 2011. Overall, Billabong has better performance than Quiksilver from probability ratio analysis.

3.3 Investment Management Analysis

3.3.1 Working Capital Management
a. Inventory Turnover
Exhibits 5

Billabong’s inventory ratio decreased from 3.08 in 2009 to 2.23 in 2011, it's indicates that the ability of Billabong sale its inventories are decreasing. In contrast, Quicksilver also has decreased ratio but with higher overall level than Billabong. It implies that Quiksilver may face a problem of getting sufficient inventory to meet sales demand.

Exhibits 6

b. Receivable Turnover Ratio
Exhibits 6 indicates that Billabong operate on a credit basis. As Billabong increase receivables with store benefit card, with low account receivable turnover ratio. This low ratio implies that Billabong might need to re-assess its credit policies in order to ensure the timely collection of imparted credit that is not earning interest for the firm.

c. Payable turnover ratio
Payable ratio decreased from 2.32 in 2009 to 1.77 in 2011. It’s indicates that Billabong is taking longer time to pay its suppliers than before.

d. Operating Working capital turnover ratio

Exhibits 7

The working capital ratio of Billabong keeps increase from 5.17 in 2009 to 6.00 in 2011 (5.59 on average). It's indicates that the effectiveness of
Billabong using working capital to obtain revenue increase. However, the average ratio of Quiksilver (3.84) is quite lower.

3.3.2 Long-Term Asset Management
Exhibits 8

The net long-term AT ratio of Billabong decreased from 1.63 in 2009 to 1.25 in 2011. It implies that there is a decline trend of Billabong’s long-term asset utilization. Compared with Billabong, Quiksilver have quite stable net long-term asset turnover (2.30,2.21,2.37 respectively), which indicate that Quiksilver could utilizing its resources to increase its production more efficiently.

b. PP&E Turnover
Exhibits 9

From exhibits 9, there is a significant increase of Billabong’s PP&E turnover ratio from 4.60 in 2009 to 6.41 in 2010. It implies that BBG use its PP&E efficiently during that period, however it following a critical decrease from 6.41 to 4.34 in 2011. As the sales increased by $13299 from 2009 to 2011, too much investment in plant and equipment may be the reason of decreased PP&E turnover ratio. We can conclude that Billabong has been utilizing its fixed asset from 2009 to 2010 better than from 2010 to 2011.

3.4Financial Management Analysis

3.4.1Short-Term Liquidity

Exhibits 10
Billabong
2009
2010
2011
Average
Quiksilver
Current Ratio
2.76
2.10
1.85
2.24
2.06
Quick Ratio
1.99
1.44
1.04
1.49
1.33
Cash Ratio
0.91
0.51
0.30
0.57
0.46

Overall, exhibits 10 illustrate the liquidity ratios of Billabong did not change much from 2009 to 2011 and Billabong had a good control in liquidity. From the analysis of the past three years, it’s indicated that the consistently falling of Billabong’s current ratio is due to a higher level of liabilities relative to assets. Current ratio produces a value that’s large than one means the current assets are greater than the current liabilities. Quick ratio also produces a value that’s large than one implies that Billabong has very less "dependency" on inventory or other "less" current assets to liquidate short-term debt.

3.4.2Debt and Long-Term Solvency
a. Debt Ratios

Exhibits 11

The value of Billabong’s D/E decreased from 0.49 in 2009 to 0.36 in 2010 and then increase to 0.53 in 2011. The reason for this change is that debt structure and policies of Billabong was changed during the three years. Similarly, as total debts change from 2009 to 2011, L/E and Net debt to equity had the same trend to D/E.

a. Coverage Ratios
Billabong
2009
2010
2011
Average
Quiksilver
Financial leverage ratio
0.49
0.36
0.53
0.46
0.45
Interest Coverage ratio
-2.34
-5.33
-4.41
-4.03
-4.59
Exhibits 12
Both firm have similar financial leverage ratio which means that each $1 of equity supports for $0.45 or $0.46 of total assets. The interest expense of the firm ($50840, $38367 and $50072 respectively) shows that Billabong had no good control on debts structure. Both firm’s interest coverage ratio is negative indicates that they may face huge stress on debt expense which may result a high financial risk and weak solvency. Exhibits 13

Billabong
2009
2010
2011
Average
D/E
0.49
0.36
0.53
0.46
Retention Rate (b=1-D/E)
0.51
0.64
0.47
0.54
ROE
0.18
0.17
0.18
0.18
Sustainable Growth Rate (g=bxROE)
0.09
0.11
0.09
0.10

Exhibit 13 shows the changes in dividend payout ratio, retention rate and ROE from 2009 to 2011, which are used to generate the sustainable growth rate. On average, dividend payout ratio is 46%, retention rate is 54% and ROE is 18%. Thus, the growth rate is 8%.

3.5 Cash Flow Analysis
Exhibits 14
$’000
2009
2010
2011
Net cash (outflow)/inflow from operating activities
175,685
187,247
24,336
Net cash (outflow)/inflow from investing actives
-215,243
-105,764
-266,935
Net cash (outflow)/inflow from financing activities
249,873
-192,102
200,951
Net (decrease)/increase in cash and cash equivalents
210,315
-110,619
-41,648

The CF from operating activities has increased from $175.685m to $187.247m, and then followed a rapidly decrease to $24.336m in 2011. Large payments to suppliers and employees are the main reason drive CF from operating activities down and further decrease net cash (outflow)/inflow from operating activities. The CF from investing activity had outflows from 2009 to 2011. As the Company has largely used its cash for purchase new subsidiary and this led to a net cash outflow in 2011.

4. Forecasts and valuation
4.1 Assumptions and forecast

Billabong may be more profitable in the future after the reorganization as it will close underperforming stores based on the recent announcement. This would decrease expenses and increase EBITDA and may further lead to a higher profit in next decade. Therefore, sales growth may appear downward sloping at first few years and then increase again. However, stable turnover ratio with approved new strategies may enhance the development of the company although the sales growth changes more than AT during the last few years.

In addition, from the financial analysis, there will be a downward trend in ROA but a rise in the financial leverage. As the result, it can be forecasted that the company’s ROE may not vary obviously during next few years, which offset by the sum of ROA and financial leverage gain/loss. Therefore, some assumptions may be undertaken to forecast the performance of the company in the next decade and to estimate the PV of the company by using the abnormal earning valuation model.

As the sales growth has a downward trend, the assumption for growth rate is 8.64% (average of last three years) in 2012 and it will keep constant in the future. It is forecasted to be 9% during next 10 years as possible potential profit growth may appear after downward sales. For the NOPAT to sales ratio, it is assumed to 7.89% in 2012 due to an evident declined historical pattern. Moreover beginning net operating working capital to sales ratio might have a decreasing trend in the future based on the historical data.

Thus, it is assumed to be 13.69% on average with puny decline than last year and it is believe that the change of working capital of the company is slight. As we use average method in this assumption, the beginning net operating long-term asset to sales ratio was 6.92% that also be considered as long-term rate as the change of the rate was insignificant. Ratios that we assumed based on historical (Appendix B table (1)).

Overall, as the forecast under the assumptions, Billabong will have higher ROE and better performance than previous. The company may have insufficient operating assets to generate operating profit with relatively lower ROA. From this, the company may borrow funds or finance equity to keep operating and pay dividends.

4.2 Cost of capital

Cost of capital is a critical method of evaluating company’s asset, and it is using equation WACC=Vd/(Vd+Ve)*rd (1-T)+Ve/(Vd+Ve)*re, the cost of equity (re) is estimated by CAPM with a constant capital structure. Thus, it is assumed that the company has not change the capital structure. re is estimated to 16.13% in terms of the equity beta (1.49), market premium (7%) and risk-free rate (5.7%) from market. The cost of debt is 6% according to historical YTM for the publicly traded bond. Therefore, WACC is calculated by:

Exhibit 15
Debt
448,422 ($000)
Equity
1,109,155 ($000)
Value of firm
1,557,557 ($000)
Cost of debt
6%
Cost of equity
16.13%
Tax rate
28%
WACC
12.73%

4.3 Valuation

The Discount Abnormal Earnings Valuation Model is a measure of determining the value of the company by abnormal earnings and discount rate. The abnormal earning is the difference between net income and change in equity. Through forecasting the sales growth and NOPAT/sales ratio to forecast net income; and working capital to sale ratio and long-term asset to sales ratio to calculate the change in equity.

PV of equity is $436,567,619, which is discount by the abnormal earning each year and the number of share outstanding is 253,321,020. For that reason, the share price is estimated to be $1.72. A reduction in the abnormal earning during the assumption periods may result in lower share value compared with currently. (Appendix B table (2)).

4.4 Sensitivity analysis

The sensitivity of the share price to changes was calculated in multi-factors, such as growth rate and beta. This analysis is performed to check how susceptible the company is to the changes in key factors in the future. Firstly, the share price shows a negative relationship with the growth rate when the growth rate changes to 10%.

There will be 13% dropped on the share price if the growth rate increases by 11%. Secondly, the share price is increasing if there is a decrease on the beta of the company. If the beta changes from 1.49 to 1.2, the share price will increase to $2.34, which closes to the company’s current share price. Therefore, the share price is inversely affected by the change of beta.

5. Conclusion
Above analysis would help a great deal in valuation of Billabong based on its current market situation. From time series analysis, Billabong had a good control in liquidity but it need to re-assess its credit policies in order to ensure the timely collection of imparted credit that is not earning interest for themselves, increase account payable turnover as it take longer time to pay its suppliers than before and increase interest coverage ratio to lower their financial risk and strong their solvency. Even though, the working capital ratio increase from 2009 to 2011, but very high working capital turnover ratio does not show good position of company because its shows company is operating with high short-term debt obligations.

From cross sectional analysis, compared with Quiksilver, Billabong needs to improve ability of inventory management, asset utilization and debt control. From prospective analysis, revenue of Billabong increased, but expenses also increases at the same trend, the performance of Billabong is still unsatisfied. From valuation, Billabong’s share value still decreases with sales decrease. Therefore, we highly recommend that investors should hold their shares or do not buy it if Billabong continuously running business as its historical model.

Reference:
1. Billabong Investors Home. http://www.billabongbiz.com
(Accessed 5 April 2012)
2. Hoover's company profiles: Billabong International Limited
http://www.answers.com/topic/billabong-international-ltd
(Accessed 3 May 2012)
3. Hoover's company profiles: Quiksilver, Inc.
http://www.answers.com/topic/quiksilver-inc
(Accessed 3 May 2012)
4. Palepu, K. G., P. M. Healy, V. Bernard, S. Wright, M. Bradbury, P. Lee. (2010) Business Analysis and Valuation Using Financial Statements: Text and Cases. Asia Pacific Edition, Cengage Learning. 5. Quiksilver Investors Home. http://www.quiksilverinc.com

(Accessed 13 April 2012)
6. Calif, A.V. (2011), ‘SIMA Retail Study Confirms Significant Changes-Surf Industry’s Footwear, Westuits and Board Categories Lead Growth in 2010.’ http://www.sima.com/news-information/news-detail/id/108.aspx (7 August 2011, accessed 8 May 2012)

7. Calif, A.V. (2009), ‘Surf Industry Riding Out the Economic Storm - Findings of SIMA’s Retail Research Show Resiliency of the Surf/Skate Industry.’ http://www.sima.com/news-information/news-detail/id/68.aspx (7 Sep 2009, accessed 8 May 2012)

8. Wikinvest. http://www.wikinvest.com
(Accessed 13 April 2012)

Appendix:
Appendix A ---Accounting Analysis
Table 1 Worksheet: adjustments to BBG balance sheet and income statement ($’000)

Asset = Liability + ShareCap’ + RetEarning + Rev + Exp +Div 2009
Provision1
-6,964 -6,964

Deferred tax2
1,797 1,797
2010
Provision
-12,306 -12,306

Deferred tax
3,507 3,507
2011
Provision
-14,169 -14,169

Deferred tax
989 989

Table 2 Worksheet: adjustments to BBG balance sheet and income statement for year 2009 ($’000)
Current Assets
Non-
Current Tangible Assets
Deferred Tax Assets
=
Current Debt
Non-
Current Liabilities
Income
Equity Retained Earnings
13

153,484

-29,162

-29,162
2

-8224

-8,224
35

45,276

-32,997
-12,279

102,373

-24,159

-2,280

57,824
-57,824

Total
-
202,536
-10,504
=
57,824
165,036
6,558
-37,386