This report aims at evaluating the financial statements of Xstrata plc. In light of its corporate objectives and the industry practises and performance. To achieve this, this report provides a brief history of Xstrata and analysis of sources of finance, gearing and dividend policies. This report primarily relied on Xstrata financial statements for the last five years; 2007, 2008, 2009, 2010 and 2011.
Xstrata Plc. is a multininational company in the minning industry which is listed in the London Stock Exchange and is part of the FTSE 100 index. It has its headquarters in Zug, Switzerland, however, it has another registered office located in London, United Kingdom. Xstrata Plc is one of the largest producers of coal, nickel, copper, zinc, ferrochrome and primary vanadium. The company operates in over 20 countries across Asia, Africa, Europe, Australia and the Americas. The company can be traced back to 1926. It was founded as a infrastructure investment company. Initialy it was called Sudelektra AG, however, it was renamed Xstrata Plc in 1999 after it started diversifying into the minning industry. It was listed in the London Stock Exchange in 2002. Over the years, it has acquired several minning companies which has led to its rapid growth in the last decade. Its acqusations include; Glenore’s South African and Australian coal business in 2002, Germany’s Nordenham zinc smelter in 2003, MIM holding in 2003, Cerrejon coal operation in Colombia in 2006, Tintaya copper minning in Peru and Eland Platinum holdings to mention but afew. When the company was first listed it had a market capitalization of approximately $ 500 million, today it market capitalization stands at approximately $60 billion. According to the Mick Davis, the current CEO of Sstrata Plc, the company will continue with a string of acquisations and construction of new production lines inorder to expand and stretch throughout the world.
Sources of finance
Companies use various sources of funds to finance their day-to-day operations and the acquisition of capital assets. This section analyses the various sources of funds used by Xstrata Plc. detailing the advantages and disadvantage of each source.
Short term liabilities
Long term liabilities
Lease is a financial contract in which the owner of an asset assigns another party the right to use an asset without transferring legal ownership in exchange for periodic lease payments. There are two types of leases; operating and capital leases. Generally operating leases are short term while finance leases are long term.
There are several advantages that accrue from leases. First, leases are convenient when the lessor requires an asset for a short period of time. Second, leases have fewer restrictive convents as compared to acquiring a loan. In addition, a company does not require any collateral to lease an asset. Consequently, it takes a shorter time to acquire an asset by leasing as compared to taking a loan to purchase an asset because of the fewer formalities. The lessor can also match the lease payments with the expected cash flows of the business which reduces both liquidity and solvency risks. Lastly, a business benefits from tax shield because lease payments are allowable expenses for tax purposes.
There are disadvantages of using leases. First, in the long run the cost of leasing may outweigh that of buying the same asset. Therefore, leasing maybe more expensive. Second, only certain assets can be leased, therefore, it is selective. For example, leases can only finance the acquisition of long term assets and not working capital. Lastly, leasing assets may lower credit rating of a company making lenders shy from lending the company. This is because leasing reduces the collateral that can be attached to loans.
Short term loan and overdraft
These are bank loans who repayment period range from overnight to one year. They are often used solve pressing liquidity problems of a company relating to working capital. They are normally secured. Short term loans and overdrafts are normally expensive.
There are several advantages that accrue from short term loans and overdraft. First, they came in handy in financial crisis that were not anticipated due to an abrupt decline in revenue or increases in recurrent expenses. Second, it may be secured by a company’s goodwill only which makes it flexible. It also has fewer formalities and procedures; therefore, it is processed faster than other types of loans. The loan duration is normally short, therefore if not used frequently; it may not affect a company’s liquidity position. The disadvantages that result from short term loan and overdraft are; they have a higher interest rate than normal bank loans. Secondly, frequent use of short term finance may scare away potential investors since it is regarded as an indicator of poor financial management.
Long term debt
Long term debt refers to loans from financial institutions other third parties with a maturity period of more than 5 years. Loans are ideal if a company has a low gearing ratio; future cash flows of the company are certain, the current market share of the company promises stable sales and when the company future expansion projects justify the borrowing.
There are several advantages that accrue from long term debt. First, interest payment is an allowable expense for tax purposes, therefore, the company benefits from interest tax shield. Secondly, the cost of debt if fixed irrespective of the level of profits achieved which results in lower financing costs in times of rising profits. In times of rising inflation as well the borrower benefits because the amount that will be repaid will be lower in real terms. Lastly, long term debt can be self-sustaining in that the cash flows obtained from the purchased asset maybe enough to repay the loan plus interest hence reducing liquidity risk. There are also disadvantages that result from long term debt. First, long term debt is a conditional finance and the investment must be approved by the lender in some instances. Second, during financial crisis, a company may risk liquidation if its cash flows are not enough to pay the loan and interest. Use of long term liabilities increases gearing which reduces the market share price. This is because the increased gearing ratio increases financial risk perceived by investors. Lastly, long term debt requires collateral that can be attached to the loan
Recommendation on finance
Xstrata Plc. should minimize the use of bank overdraft facility because it is expensive. Xstrata should employ prudent financial policies and use appropriate financial forecasting tools to anticipate future financing needs of the company well in advance. Such tools include; cash budgets, proforma financial statements and scenario planning. The company should use debt to finance its expansion since its future cash flows of are certain, its current market share promises stable sales and the company’s future expansion projects justify the borrowing. However, when raising additional funds the company should consider both debt and equity to avoid raising the gearing level of the company to very high levels.
Debt ratio indicates the fraction of total assets that were financed by both current and long term liabilities. A company with a high debt ratio implies that the company has high solvency risk. Therefore, a lower debt ratio is preferred. Generally, a company with a debt ratio of over 50 per cent is considered to have high risk.
Debt ratio = Total Debts/ Total Assets
Total assets = current assets + Fixed assets
Total debt = Current liabilities + long term liabilities
The debt ratio increased slightly from the year 2007 to 2008; however it declined steadily for the rest of the years up to 2011. This indicates that the company has sound debt management policies. The overall solvency risk of the company is declining indicating an improvement in the financial health of the company. In the latest year, 2011, the debt ratio of the company is below 50 per cent which implies the company is solvent and is not too risky. However, a debt ratio of 0. 417 is still high.
Times Interest Earned Ratio
The times interest earned ratio (TIER), is used to indicate how many times interest charges can be paid from the earnings before interest and tax (EBIT), otherwise referred to as operating profit.
The times earned interest ratio decreased from 2007 to 2009, however, it increased tremendously in 2010 and continued with the improvement in 2011. This is because whereas the interest charges declined, the operating profits increased between 2009 and 2011.
According to Reuters, the times earned interest ratio of the industry is 138. 97. Therefore, the company is performing below the industry average.
Recommendation on gearing
Xstrata Plc. Needs to reduce its level of fixed charge debt. The company is highly geared compared to other companies in the industry as indicated by its times earned interest ratio. The debt ratio is equally high. Considering that the company is seeking to expand further, it could seek other avenues of raising finances without increasing its gearing levels. The company could use a rights issue to raise additional funds.
The company could also save funds by issuing bonus shares instead of issuing cash dividends. Lastly, the company could convert some of its debt into equity to reduce the current gearing level.
Dividend Pay-out Ratio
Dividend pay-out ratio indicates the fraction of total earnings that dividends represent. It is the portion of earnings paid out to shareholders. It is computed by;
Dividend pay-out Ratio = Dividends per Share/ Earning per Share
It can also be computed as;
Dividend pay-out Ratio = Total Dividends/ Earning attributable to equity shareholders
The dividend pay-out ratio increased steadily from 2007 to 2009 after which it declined in 2010 and then increased in 2011. The dividend pay-out ratio for the industry is 23. 77 per cent . Therefore, the company has a lower dividend pay-out ratio as compared to the industry. The company is keen on expanding further, which could explain why it has a lower dividend pay-out ratio compared to the industry average.
Dividend cover indicates how many times dividends can be paid from earning after tax. Dividend Cover = Earnings per Share/ Dividends per
It can also be computed as;
Dividend pay-out Ratio = Earnings attributable to equity shareholders/ Total dividends
The dividend cover decreased between the years 2007 and 2009 and then increased in 2010 and declined again in 2011. The pattern could be explained by the decrease in earnings after tax which declined from 2007 to 2009 and then increased in the years 2010 and 2011. The industry dividend cover for the year 2011 is 4. 2. Xstrata has a higher dividend cover because the company is paying lesser dividend per share than the average dividends per share paid by other companies in the same industry.
Recommendations of Dividends
The company still needs funds to expand its operations and world-wide presence. From the dividend pay-out ratio, it is evident that the company is paying lesser dividends to its shareholders compared to other companies. The company could further reduce the dividends it pays shareholders to save more funds to finance expansion instead of borrowings. Shareholders will still gain from capital appreciation when the market share price of Xstrata Plc. increases. Alternative the company can give shareholders bonus shares instead of paying cash dividends.
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