Question

"What recommendations would you make to Lucasfilm’s CEO regarding the actions that management needs to take to sustain the company’s growth and financial performance...increase sales as well as net income and profit margins (new products, new markets as in customers and locations, mergers and/or acquisitions, higher/lower pricing of products and services, lowering costs)?"

Information about Lucasfilm

	2019 #'s (In millions)	2018 #'s (In millions)	2017 #'s (In millions)
Net Income (Earnings)	$11,584	$13,066	$9.366
Total Revenues (Sales)	$ 69,570	$ 59,434	$ 55,137
Total Assets	$ 193,984	$ 98,598	$ 95,789
Total Equity	$ 93,889	$ 52,832	$ 45,004
Operating Income	$ 14,868	$ 15,689	$ 14,775
Total Debt	$ 59,791	$ 26,783	$ 30,042
Total Shareholder's Equity	$ 88,877

Following information for 2019:
Operating Margin: 21.37%
Profit Margin: 16.65%
ROE: 12.34%
Debt-Equity Ratio: 0.64
Debt-to-Assets Ratio: 30.82%
Equity Multiplier: 2.07
Asset Turnover: 35.86%
Return on Assets: 5.97%
Return on Equity: 12.34%

Answer 1

I am assuming that the net income for 2017 is incorrectly shown as $9.366 million and is actually $9,366 million.

With this assumption, let's calculate the financial ratios for all the three years. Based on the information shared, we can categorize ratio into following buckets: 1) Growth Ratios 2) Profitability Ratios 3) Solvency Ratios 4) Efficiency Ratios. The ratios are calculated as per the formulae shown in the table below:

Following are our observations based on the trend:  

1. Growth: The company has been growing it's revenue at high growth rate as reflected in the sales growth rate
2. Solvency: Company's financial strength is strong for all the 3 years as reflected in its comparable Debt-Equity, Debt-Assets and Equity Multiplier ratios. While company is not completely debt free, it has deployed reasonable financial leverage signifying a balanced capital structure. There is no immediate insolvency risk.  
3. Efficiency: The company has been utilizing its assets in-efficiently as reflected in lower asset turnover during 2019 as compared to the past. During 2019, company generated comparatively lower sales while utilizing the assets signifying poor capital allocation
4. Profitability: Profitability has declined over the years as reflected in decline in operating margins, return on equity and return on assets during 2019. Return on assets declined sharply during to poor asset turnover ratio as mentioned above.

We can employ Du-pont Analysis technique to confirm our analysis as follows:

Return on Equity for 2019 = Net profit margin * asset turnover * equity multiplier   = 16.65% * 2.07 * 35.86% = 12.34%. If we compare the constituents of return on equity for 2018, then we will come to know that return on equity was higher during 2018 purely because of strong operational profitability and high asset utilization without material changes in capital structure. In fact, equity multiplier declined slightly during the year. Hence I would advise CEO to resort to cost optimization measures along with existing pursuit of growths and utilize capital efficiently. This can involve one or more measures like organic cost cutting measures or mergers and acquisitions which may yield some cost synergies along with ensuring more efficient capital allocation.

Happy Learning!