Question

REQUIREMENT:

Choose any TWO companies listed in the construction sector of the Main Market of Bursa Malaysia.

1. Using the relevant profitability ratios (supported with detailed workings), analyse and explain the trends in the companies’ ratios over the past five years (2013 - 2017).

2. Compare the companies’ financial performance based on the calculated ratios.

3. Outline the companies’ strengths and weaknesses as revealed by your analysis.

4. What are some potential problems and limitations of the financial ratio analysis when evaluating and comparing the two companies?

5. What are some qualitative factors that should be considered when evaluating the companies?

[Total: 60 Marks]

Answer 1

Companies selected are:

Gamuda Berhad (Gamuda) & WCT Holdings Berhad (WCT)

a. The main profitability ratios are: (all below numbers are in millions of Remnibi)

Gamuda Berhad WCT Holdings Berhad

1. Operating Profit Margin 2013 = = 13.18%       = 18.31%

2014 = = 18.22%       = 11.67%

2015 = = 18.02%       = 13.85%

2016 = = 18.72%       = 9.41%

2017 = = 14.48%       = 16.42%

2. Net Profit Margin 2013 = = 14.16%    = 11.90%

2014 = = 15.07%    = 7.40%

2015 = = 14.32% = 12.53%

2016 = = 15.01% = 3.52%

2017 = = 10.56% = 8.13%

3. Return on Assets 2013 = =  6.01%    = 3.61%

2014 = = 6.93% = 2.09%

2015 = = 5.76%    = 3.22%

2016 = = 4.55%    = 0.97%

2017 = = 4.02%    = 2.00%

4. Return on Equity 2013 = = 10.77%       = 8.94%

2014 = = 11.34%     = 5.51%

2015 = = 10.19% = 8.01%

2016 = = 8.67%     = 2.46%

2017 = = 7.67%       = 4.94%

5. Return on Capital Employed 2013 = = 7.51%          = 4.58%

2014 = = 8.94%    = 2.68%

2015 = = 7.42%       = 3.95%

2016 = = 6.69%      = 1.23%

2017 = = 5.72%       = 2.63%

Formulas for the above ratios are given as below:

1. Operating Profit Ratio =

2. Net Profit Ratio =

3. Return on Assets =

4. Return on Equity =

5. Return on Capital Employed =

Gamuda has been pretty consistent in its profitability ratios from 2013-2015 then witnessed a slight dip in almost all ratios in 2016 followed by a bigger decline in 2017.

WCT has not shown any consistent pattern over the years in its profitability ratios. 2013 and 2015 were better years in terms of profitability compared to 2014, 2016, and 2017.

b. In terms of comparison between the companies, Gamuda has performed better in almost all ratios for all the given years except for in Operating Ratio in 2013 & 2017.

Net Profit Ratio was better for Gamuda in all the 5 years and was always above 10% whereas for WCT profit fell in single digits in 2014, 2016, and 2017.

Return on Assets was higher for Gamuda in all the years. Gamuda's ROA ranged in values from 4.02% to 6.93% whereas for WCT the range was 0.97% to 3.61% Gamuda showed a declining trend from 2014 to 2017. WCT had quite low values for 2016 & 2017.

Return on Equity was higher for Gamuda in all the years. Gamuda's ROE ranged in values from 7.67% to 11.34% whereas for WCT the range was 2.46% to 8.94% Gamuda showed a declining trend from 2014 to 2017.

Return on Capital Employed was higher for Gamuda in all the years. Gamuda's ROCE ranged in values from 5.72% to 8.94% whereas for WCT the range was 1.23% to 4.58% Gamuda showed a consistent declining trend from 2014 to 2017

c. Strengths for Gamuda:

1. ROE is higher than ROCE for all the years. It means that Gamuda is able to utilize its borrowings effectively in order to improve the return on shareholders' equity

2. Gamuda has shown consistency in the ratios except for in 2017 (where it showed significant decline). This is a good sign for investors who like to see consistent profits without too many negative surprises

Weaknesses for Gamuda:

1. It seems that 2017 has been a bad year in comparison to earlier years (It should be noted that even in 2017 Gamuda has done quite well compared to other years of WCT). So management should be looking into their projects to identify areas of improvement

2. There has been a declining trend in all profitability ratios from 2014 to 2017. This is not a favorable trend for investors and the management should work on reversing this trend

Strengths for WCT:

1. Return on Equity has consistently been higher than Return on Capital Employed. This signifies that the management has been able to use long-term borrowings effectively in order to increase the return to the shareholders

Weaknesses for WCT:

1. WCT has performed quite poorly in 2016 and 2017 and management needs to pull up its socks in order to improve the performance of the business

2. In comparison to Gamuda, performance of WCT is quite poor. Every investor looks at competitors before investing and with this sort of poor performance, any rational investor would choose Gamuda over WCT.

Limitations of Financial Ratio Analysis:

1. No importance is given to the size of each company that is being compared. Size can have significant impact on the performance of the company and on the performance of the stock price (generally it is seen that stock prices of smaller companies move quicker - both up and down)

2. We do not get to know about the exact nature of business of each company from Financial Ratio analysis. For example, in the above comparison, it is difficult to know whether one company does more of government contractual work, or public-private partnership work, or whether they are into construction of roads, railways, or airports, etc. This information may be important before making an investment decision

3. Financial Ratio Analysis does not disclose information such as abilities and experience of Management of the firm. A good Management with few years of bad performance (due to market circumstances) might be better to invest in rather than a mediocre management that has performed well due to favorable circumstances