Financial Management Resubmission Paper
The decision of the investment is crucial in the current business environment. Typically, investors like to invest in a firm that is performing well compared to its competitors in the industry. The financial performance of a company depends on the various significant factors. The purpose of this, the report is to conduct a financial analysis to make the investment decision. For this report, Danone that is Food Products Corporation based in Paris is selected. At the same time, Nestle is selected as the competitor as a benchmark company. This report includes discussion on Danone and food products industry. It also enhances the knowledge on the ratio analysis, WACC, free cash flow and value of the operation.
1. Presentation of the Company
- Products and services of Danone
As Danone is operating the business in the food product industry, the company has four products lines that are fresh dairy products, Early life nutrition, water and medical nutrition. In the fresh dairy product, major products of the company are Activia, Taillefine, Light & Fit, Actimel, Danette, Velouté, Gervais, Danacol, AC, Danio and Prostokvashino. The product line Early life nutrition includes Aptamil, Milupa, Malyutka, Cow&Gate, Bebiko and SGM etc. The third product line contains Waters includes Evian, Volvic, Hayat, Agua Salus and Bonafont etc (Danone, 2017). Beside of this, the product line Medical nutrition comprises Fortisip, Nutricia, Neocate, Complan and Nutillis.
- Major geographical markets covered by Danone
Danone is a multinational company that operates the business in the various contraries. In this, the company has the business operation in Bangladesh, India, Israel, China, Russia, and Africa. The company also has 18 Danone Institutes around the world. They institutes are situated in Italy, Japan, Poland, Russia, France, Germany, US, etc.
iii. Names of current CEO and other key managers of Danone
The current CEO of Danone is Emmanuel Faber which is also vice chairmen of the company. At the same time, Franck Riboud is chairman of the Board. The company organises a meeting of the executive persons of the company that is conducted under the CEO of the company. In the management team includes the number of manager for every department. In this, the company divided its business operation in sales, sourcing & Suppliers development, communication, management, and supply chain, legal & regulatory, marketing, information system, human resources and research & innovation (Danone, 2017).
- Brief history of the company Danone
Danone was founded in 1919 by Isaac Carasso. Initially, the company name was Danon that was based on nick name of Isaac son Daniel Carasso. The company started its business in the Spain, and after ten years the company had spread its business in France and Germany. In 1951, Daniel Carasso took the responsibility of its family business. During that period, the company merged with Gervais that was leading fresh cheese producer. After 1981, the company started to try the business in the different products line with establishing its business the many countries. Now, Danone is operating the business in approx 130 markets with 100000 employees.
- Any recent meaningful development in the company Danone
Danone is continuously emerging in the research and development where the company expenses lots of money to find out the ways of improving the quality and reducing the cost of the operation. Recently, the company has adopted the lots of the technologies and machinery that will help the company to improve the quality of the product as well as the decreasing the cost of operation.
B. Industry
- Other major players in the industry and benchmark company
Danone is doing business in the food processing industry. In this industry, various key players have significant market share. In this, Nestle is main competitor Danone that has large market share in this industry. It offers a wide range of the products that include the food and beverage. Along with this, other major players are Britannia, KRBL, Kwality, Pepsico Inc, Tyson Foods Inc, Dean Foods Co, Pilgrim’s Pride, Bimbo Bakeries USA, Maple Leaf Foods and California Dairies Inc (Danone, 2017).
- Is the industry very concentrated of fragmented? Explain
In the contract of competition, companies in the food processing industry are facing high competition. In this industry, there are thousands of companies that are offering product and service at the different level. However, it is easy to enter in this industry, but it is difficult for the company to achieve the sufficient market share.
iii. Approximate market share of the company
Danone offers the various products in the various geographic markets. The company has the different market share in the context of different product lines (Lasher, 2010). The below graph shows that the market share of Danone in the context of fresh dairy products, waters, baby nutrition and medical nutrition:
- Major recent changes in the industry (e.g., technology, regulatory environment)
In the recent time, some major changes have been seen in the food processing industry. In this, the agency that controls the quality of the food and beverage industry passed new guideline for maintaining the quality of the food processing products. Along with this, in this industry, researcher and engineers developed new technologies and machinery that are helpful for the companies to improve quality and reduce the cost.
Liquidity ratio defines the state of an enterprise regarding financial health as it refers to the ability of the firm to pay its short-term obligations. It can be determined by current ratio and liquid ratio. Current ratio provides information about the ability of the firm to pay its current liabilities, while liquid ratio measures the ability of the firm to meet its short-term obligations with its most liquid assets (McIntosh, et al. 2010). Both ratios are calculated by using the below formulas:
Current ratio = Current assets / Current liabilities
Quick ratio = (Current assets – Inventories) / Current liabilities
For Danone and Nestle, liquidity ratios are calculated in the below table:
| Danone (€M) | Nestle 2016 | ||||
| Ratio | Formula | 2016 | 2015 | 2014 | |
| Liquidity ratios | |||||
| Current ratio | (Current Assets/Current Liabilities) | 0.84 | 0.79 | 0.67 | 0.85 |
| Current Assets | 8188 | 8732 | 7559 | 32042 | |
| Current Liabilities | 9781 | 11007 | 11224 | 37517 | |
| Quick ratio | (Quick Assets/Current Liabilities) | 0.69 | 0.65 | 0.55 | 0.63 |
| Quick assets | 6706 | 7198 | 6155 | 23641 | |
| Current Liabilities | 9781 | 11007 | 11224 | 37517 | |
On the basis of the above table, it can be interpreted that current ratio of Danone is showing the increasing trend from 0.67 in the year 2014 to 0.84 in the year 2016. There is no unusual trend as this ratio is improved during the specified period indicating improving capability of the firm to meet its current obligations. But at the same time, it is less than one indicating that it is not effective to meet its short-term obligations as it has no sufficient fund to meet its daily operational fund requirements. The reason behind this is ineffective cash management strategies of the firm. The company is not able to collect the receivables on time and pay more due to ineffective credit policy and supplier policy (Pingle, 2013). Its competitor named as Nestle has current ratio of 0.85 in 2016 that is little more than Danone. So, both companies are at the same level in liquidity position as they have insufficient cash to meet their daily requirements. The same condition is with the quick ratio which is also less for both firms. Danone has insignificantly higher quick ratio indicting similar liquidity position. It means Danone and Nestle both are incompetent to meet their short-term obligations even in the contingency that may cause a situation of the bankruptcy (Herman, 2011).
Asset management ratios refer to the ability of the firm to use the assets effectively to generate sales or returns. In this, different ratios including average collection period, days inventory, days payable and total asset turnover are determined.
Average collection period is effective to determine the firm’s ability to collect its receivables on time to manage cash position. It can be calculated by using the below formula:
Average collection period = (Avg. account receivable / sales revenue) * 365
Days’ inventory shows the ability of the firm in managing its inventory to generate sales. High inventory ratio indicates better performance as the inventories are being sold more quickly (Sabre and Ketz, 2014). It can be calculated by using the following formula:
Days’ inventory = (Inventory / COGS) * 365
Days’ payables are the days taken to pay the suppliers and creditors. It can be computed by the below formula:
Days’ payables = (Avg Account payable / purchase) * 365
Total asset turnover refers to the ratio that indicates the ability of the management to convert assets into sales. It can be calculated by using the formula below:
Total asset turnover = Net sales / average total assets
The below table shows the calculation of all asset management ratios for Danone and Nestle:
| Ratio | Formula | 2016 | 2015 | 2014 | Nestle |
| Assets management ratio | |||||
| Average collection period | Avg. account receivable / sales revenue * 365 | 80.38 | 72.73 | 76.02 | 50.31 |
| Average account receivable | 2434 | 2270 | 2180 | 12331.5 | |
| Sales revenue | 11052 | 11392 | 10,467 | 89469 | |
| Days inventory | Inventory /cost of sales * 365 | 100.21 | 97.02 | 92.15 | 69.38 |
| Inventory | 1482 | 1534 | 1404 | 8401 | |
| Cost of sales | 5398 | 5771 | 5561 | 44199 | |
| Days payable | Avg Account payable / purchase * 365 | 243.13 | 217.14 | 223.42 | 146.45 |
| Avg account payable | 3561 | 3510.5 | 3497 | 17833.5 | |
| purchase | 5346 | 5901 | 5713 | 44447 | |
| Total asset turnover | Net sales / average total assets | 1.22 | 1.29 | 1.23 | 0.70 |
| Net sales | 40973 | 42227 | 38346 | 89469 | |
| Average total assets | 33485 | 32835 | 31203.5 | 127946.5 |
From the above table, it can be interpreted easily that asset management ratio of Danone is effective in comparison to Nestle. While calculating the ratio, it is found that Danone collects the receivables, i.e., from 76.02 days (2014) to 80.38 days (2016) which is high from Nestle Company, i.e., 50.31 days (Warren, et al. 2013). On the other side, Danone has effective inventory turnover ratio, i.e., 92.15 days (2014) to 100.21 days (2016) is a high difference observed in the sales margin as compared to Nestle which is 69.38 days. At the same time, days’ payable of Danone indicates that company is effectively paying to its suppliers and creditors, i.e., within 243.13 days (2016) which is higher than the days payable of Nestle which is 146.45 days (2016). Further, Total asset turnover is also calculated in which it is determined that Danone is effectively converting its assets into sales, i.e., 1.22 (2016) whereas Nestle is less efficiently able to convert its asset into sales, i.e., 0.70 (2016). Therefore, above stated calculation help in determining that Danone is performing and effectively managing its assets in comparison to Nestle (Shepherd, 2015).
Debt Ratio is a ratio which measures the total debts of the firm in respect of overall total assets. In simple words, the Debt ratio is used to calculate the firm’s total liabilities which indicate that firm has an ability to pay off its liabilities from its total assets.
Debt Ratio =
Times Interest Earned ratio is also called interest coverage ratio, which helps in measuring the proportionate income that can be used to covering the future interest expenses. In this, times interest ratio, firms measure its ability to make the payment of debts and interest expenses on time.
Times Interest Earned = (Ambrosini, et al. 2015)
The below table calculates the debt management ratio for Danone and Nestle:
| Ratio | Formula | 2016 | 2015 | 2014 | Nestle |
| Debt management ratio | |||||
| Debt ratio | Total liabilities / total assets | 0.63 | 0.63 | 0.65 | 0.50 |
| Total liabilities | 20790 | 21409 | 20410 | 65920 | |
| Total assets | 32,779 | 34,191 | 31,479 | 131901 | |
| Times interest earned | EBIT / annual interest expense | 12.39 | 5.01 | 6.95 | 23.13 |
| EBIT | 1,499 | 872 | 925 | 12562 | |
| Annual interest expense | 121 | 174 | 133 | 543 | |
From the above table, it can be interpreted easily that debt management ratio of Danone is indicating the performance and increasing trend in comparison to Nestle. While calculating the debt ratio, it is found that company is efficiently meeting its debt obligations on time through its total assets. From last three year, in the year 2014, the debt ratio is calculated 0.65 which is high from the debt ratio calculated in the year 2016, i.e., 0.63. But at the same time, in other competitor company like Nestle, it is observed that debt ratio calculated is 0.50 which is low from the Danone. This means that Nestle has high total assets due to which firm developed its ability to pay off its liabilities (Bental, et al. 2015). On the other hand, times interest earned ratio is also calculated from both the companies and from which it is identified that Danone is easily paying out the interest i.e., 12.39 times in the year 2016 as compared to the year 2014, i.e., 6.95 time. In like manner, Nestle is also paying off its interest expenses 23.13 times which is more than Danone. Thus, this analysis indicates that Danone is less competent to meet its liabilities and interest in comparison to Nestle (Harris, 2014).
In the ratio analysis, profitability ratio is used to measure the profitability of the company. It is helpful evaluate the financial performance of the company. Profitability shows the ability of the company to earn the profit and reducing the cost of the company. Typically, profitability ratio includes gross margin, operating margin, net profit margin, basic earning power, return earning power, return on assets and return on equity.
- Gross Margin
In the ratio analysis, gross margin depicts the profitability of good and service of the company that it offers in the market. It also defines how much it cost the company to produce the product. The gross profit margin can be calculated by dividing the gross profit by the net sale of the company. For this, below formula is use by the financial analyst
Gross Margin = Gross Profit/Net Sales (Bogsnes, 2016)
- Operating Margin
Operating margin is also important that determines the profitability situation of the company. In order to calculate the operating profit, financial analyst divides operating profit by the net sales. It shows the efficiency of the company to manage operating expenses. It can be calculated by below method:
Operating margin = Operating expense / net sales
iii. Net Profit Margin
It is the very important ratio in ratio analysis that depicts that what is actual percentage of the company to earn the profit. It can be calculated by dividing the net cost profit by the net sales. For this, below formula is used:
Net profit margin = Net profit / net sales
- Basic Earning Power (BEP)
The basic earning power ratio measures the ability of the company to achieve the profit from conducting its operations. It is helpful to identify the whether the underlying company is worthy of investment. It can be calculated by below formula:
Basic earning power = EBIT / total assets
- Return on Asset (ROA)
Return on assets defines the how a company produces income through its assets. Return on assets is calculated by dividing net income by the value of the net assets of the current year. The below formula is used to calculate the return on assets.
Return on assets = Net income / assets
- Return on Equity (ROE)
In the financial ratio, the return on equity draws how much a company earns for money put by investors in the business (Dash, 2016). The financial analyst can calculate the return on equity through the below formula:
Return on equity = Net income / value of the equity
| Ratio | Formula | 2016 | 2015 | 2014 | Nestle |
| profitability ratio | |||||
| Gross margin | Gross profit / net sales | 0.13 | 0.12 | 0.11 | 0.15 |
| Gross profit | 1,478 | 1,381 | 1,180 | 13693 | |
| Net sales | 11,052 | 11,392 | 10,467 | 89469 | |
| Operating margin | Operating income / net sales | 0.14 | 0.08 | 0.10 | 0.15 |
| Operating income | 1,499 | 872 | 1,084 | 13163 | |
| Net sales | 11,052 | 11,392 | 10,467 | 89469 | |
| Net profit margin | Net income / net sales | 0.08 | 0.04 | 0.06 | 0.10 |
| Net income | 417 | 1289 | 538 | 8883 | |
| Net sales | 11,052 | 11,392 | 10,467 | 89786 | |
| Basic earning power | EBIT / total assets | 0.03 | 0.01 | 0.02 | 0.10 |
| EBIT | 935 | 475 | 666 | 12562 | |
| Total assets | 32,779 | 34,191 | 31,479 | 131901 | |
| Return on assets | Net income / total assets | 0.01 | 0.04 | 0.02 | 0.07 |
| Net income | 417 | 1289 | 538 | 8883 | |
| Total assets | 32,779 | 34,191 | 31,479 | 131901 | |
| Return on equity | Net income / average Shareholder equity | 0.03 | 0.10 | 0.05 | 0.13 |
| Net income | 417 | 1289 | 538 | 8883 | |
| Shareholder equity | 11,989 | 12,782 | 11,069 | 65981 | |
From the above table, it can be found that gross profit margin of Danone is increasing because it is founded 0.13, 0.12 and 0.11 in the financial year 2016, 2015 and 2014 in the given order. But, at the same time, it is also identifies that gross profit margin of Nestle for the year ended 2016 is 0.15 that is high compared to Danone. It shows that Nestle is good compared Danone. At the same time, operating margin for Danone and Nestle is 0.14 and 0.15 for the year 2016 (Jochimsen and Thomasius, 2014). It means that Danone is also weak in the context of earning operating profit. Furthermore, net profit margin shows that Danone has 0.08 and Nestle has 0.10 profit margins. From this, it can be interpreted that Nestle situation is good compared Danone. In the context of basic earning power is also found that situation of Danone is also worst compared to Nestle because is 0.10 and 0.03 for Nestle and Danone respectively. Return on assets is calculated for Danone and Nestle where it is found that it is 0.01 and 0.07 in the given order. At the same time, return on assets is calculated 0.03 and 0.13 for Danone and Nestle. On basis of above ratios, it can be interpreted that Danone is weak compared to Nestle (Collis, et al. 2012).
Market value ratio is calculated to measure the value of the current stock price of the company. It includes price /earnings ratio and price/ EBITDA ratio.
- Price / Earnings ratio
The price earnings ratio determines the current market price of company share. It is calculated by the below formula:
Price / Earnings ratio = Market price per share / earnings per share
- Price/ EBITDA ratio
Price/ EBITDA ratio is used to measure the price of the company’s stock. It can be calculated by the help of following formula:
Price EBITDA ratio = EBITDA/ Revenue
| Ratio | Formula | 2016 | 2015 | 2014 | Nestle |
| Market value ratio | |||||
| Price earnings ratio | Market price per share/earnings per share | 39.72 | 39.01 | 36.00 | 24.58 |
| Market price per share | 63.55 | 58.52 | 54 | 67.85 | |
| Earnings per share | 1.6 | 1.5 | 1.5 | 2.76 | |
| Price EBITDA ratio | EBITDA/ Revenue | 0.08 | 0.04 | 0.06 | 0.28 |
| EBITDA | 935 | 475 | 666 | 12526 | |
| Revenue | 11,052 | 11,392 | 10,467 | 89786 | |
On the basis of above table of market value ratio, it can be interpreted that Danone and Nestle have 39.72 and 24.58 price earnings ratio. Price EBITDA ratio is 0.08 and 0.28 for both companies for the financial year 2016.
DuPont analysis is conducted by multiplying the financial leverage, profit margin and total assets turnover. It is a kind of performance measurement that is developed by the DuPont Corporation in the 1920s.
| Ratio | Formula | 2016 | 2015 | 2014 | Nestle |
| Du Pont analysis | Profit margin*total assets turnover * financial leverage | 0.07 | 0.03 | 0.05 | 0.03 |
| Profit margin | 0.08 | 0.04 | 0.06 | 0.10 | |
| Total assets turnover | 1.22 | 1.29 | 1.23 | 0.70 | |
| Financial leverage | 0.63 | 0.63 | 0.65 | 0.50 | |
From the Du Pont analysis, it is found that Dupont is for Danone is 0.07 and for Nestle 0.03. It means that the overall financial wealth of the Danone is better compared to Nestle.
WACC indicates to the cost of the company that company pays to its shareholders as the return. The term WACC is acronym form of the weighted average cost of capital. It is used to calculate the cost of the capital. In order to calculate the WACC, each source of capital is weighted. Mainly, there are two sources of capital that are debt and equity Droms, W.G. and (Wright, 2010).
Assumptions using to estimate the WACC
In the reference of Danone, it is assumed that there is no change in the debt and equity position of the company. The company will also maintain the same capital for the future projects. In this, it is found that weight of equity and debt in the capital are 0.365 and 0.635. Hence, it will be same for future project and investment.
CAPM model to estimate the company’s cost of equity
Cost of equity E(ri) = Rf + Bi (E(rm) – Rf)
Where,
E (ri) = return required on financial assets
Rf = Risk-Free Rate of Return
Bi = Beta of Asset
E (Rm) = Average return on the capital market
In this, it is found that
Beta of assets = 0.88
Risk free rate of return = 1.77
Average return on capital market = 6.27
Cost of equity = 1.77 + 0.88 (6.27- 1.77)
= 1.77 + 0.88 (4.5)
= 1.77 + 3.96
= 5.73%
Cost of debt = Interest expenses / Value of debt (DuBrin, 2011)
Danone interest expense was 121€ million
And total value of debt was 20790 € million
Hence cost of debt is = 121 / 121
= 0.58%
In order to calculate the WACC for Danone, there is need to calculate weight for debt and equity. The calculation of the weight for debt and equity canbe understood by the help of below equation:
Weight of equity = E / (E + D) = 11989 / (11989 + 20790) = 0.365
Weight of debt = D / (E + D) = 20790 / (11989 + 20790) = 0.635
WACC = E / (E + D) * Cost of Equity + D / (E + D) * Cost of Debt *(1 – Tax Rate) (Edmonds, et al. 2015)
Where,
w = the respective weight of debt, preferred stock/equity, and equity in the total capital structure
t = tax rate
D = cost of debt
P = cost of preferred stock/equity
E = cost of equity
= 0.365 * 5.73% + 0.635 * 0.58% * (1- 30%)
2.35%
4. Free cash Flow (in € millions)
Definition of the free cash flow and how it is calculated
The term free cash flow can be defined as the measurement of the economic performance of the company by the calculation of capital expenditure and operating cash flow. It represent that money that is free after paying the short term liabilities.
In order to calculate the free cash flow the below formula can be used:
FCF = (Operating cash flow + Disposal of tangible assets + Transaction fees related to business combinations) – Capital expenditure (Field, 2012)
Calculation of the free cash flow for three years
Free cash flow for 2016
Operating cash flow = 1072
Capital expenditure = 358
Disposal of tangible assets = 15
Transaction fees related to business combinations = 2
Free cash flow = (1072 + 15 + 2) – 358
= 1089 – 358
= 731
Free cash flow for 2015
Operating cash flow = 905
Capital expenditure = 378
Disposal of tangible assets = 15
Transaction fees related to business combinations = 2
Free cash flow = (905 + 15 + 2) – 378
= 922 – 378
= 544
Free cash flow for 2014
Operating cash flow = 641
Capital expenditure = 457
Disposal of tangible assets = 20
Transaction fees related to business combinations = 3
Free cash flow = (641 + 20 + 3) – 457
= 664 – 457
= 207
5. Value of Operation (in € millions)
Value of the operation = [free cash flow (1 + growth rate)] / (WACC – growth rate)
= free cash flow (Graham and Smart, 2011)
Growth rate 5%
WACC = 2.35%
Value of operation = [731 (1+ 0.05)] / (0.0235 – 0.50)
= 731(1.05) / (-0.0265)
= 767. 55 / (-0.0265)
= 28964.15
From the above calculation and evaluation, it can be concluded that investors should not invest in the Dancon because company is not performing well compared to Nestle. Instead of Danone, investment decision can be made for Nestle because it is looking good each area.
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