Comprehensive Financial Analysis of Adairs Ltd: Valuation and Strategy

This report provides a comprehensive financial analysis of Adairs Ltd, a well-known Australian retail company. It begins with an introduction and table of contents, followed by an analysis of debt valuation, including short-term and long-term debt, debt structure consistency with the industry, and th...Read More

FINANCIAL MANAGEMENT
ANALYSIS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Debt valuation..................................................................................................................................1
(1)Short term and long term debt used by firm...........................................................................1
(2) Consistency of debt structure with industry...........................................................................1
(3) Industry and its impact on debt..............................................................................................1
(4)Company cost of debt.............................................................................................................1
Share valuation................................................................................................................................1
(1)Cost of equity for company.....................................................................................................1
(2) Analysis of earnings, EPS and dividend................................................................................2
(3) PE ratio and dividend growth model......................................................................................3
(4) Suitability of method..............................................................................................................3
(5) Data needded for valuation....................................................................................................4
Cost of capital..................................................................................................................................4
(1)WACC calculation..................................................................................................................4
(2)Company tax rate....................................................................................................................4
(3) Reason for difference in cost of equity and debt...................................................................4
(4) Current liability and WACC..................................................................................................4
(5)Value of WACC and its application.......................................................................................4
(6) Projects in which WACC used...............................................................................................4
(8)Optimal capital structure.........................................................................................................5
Market analysis................................................................................................................................5
(1)Performance of Adairs Ltd relative to industry......................................................................5
(2) Analysts comments on Adairs Ltd performnace...........................................................5
(3) Items important or different from company...........................................................................5

CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................7
Table 1PE ratio of busines firm.......................................................................................................3
Table 2Calculation of WACC.........................................................................................................4
Figure 1Sales revenue of firm..........................................................................................................2
Figure 2EPS of firm.........................................................................................................................2
Figure 3Dividend of firm.................................................................................................................3

INTRODUCTION
Adairs Ltd is one of well known retail company of Australia and in current report
analysis of same is done in proper manner. In this regard, sales revenue and other variables data
that is related to firn is analyzed and charting of same is done. In middle part of the report,
weighted average cost of capital is computed and overall cost of capital is identified. At end of
the report, company analysis is done and analysts comments are analyzed.
Debt valuation
(1)Short term and long term debt used by firm
As short and long term loan bank loan is used by the business firm as can be seen from
balance sheet long term loan stood at 42.
(2) Consistency of debt structure with industry
Debt equity ratio of firm is 0.92 which reflect that there is very high proportion of debt in
capital structure. Industry capital structure is 0.30 which reflect that firm capital structure is not
consistent and it is imbalanced.
(3) Industry and its impact on debt
Intensity of competition is high and due to this reason expansion of business is necessary.
Thus, both long and short term loan increased in business in order to meet day to day needs and
financing capital projects.
(4)Company cost of debt
Compnay cost of debt is 4 million as it can be said that interest rate is 5% for the business
firm and it is cost of debt for company.
Share valuation
(1)Cost of equity for company
Cost of equity for company is 21% as there is high beta value of firm which is 2.12.
Hence, due to high volatility cost is also high.
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(2) Analysis of earnings, EPS and dividend
1 2 3
0
50
100
150
200
250
300
210.9
253.2 265
Sales Revenue
Figure 1Sales revenue of firm
1 2 30.01
0.33
0.25
EPS
Figure 2EPS of firm
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1
2
3
0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16
0
0.07
0.14
Dividend
Figure 3Dividend of firm
With increase in sales revenue dividend and EPS is also increasing which reflect that firm is
giving more return to investors wih increase in income.
(3) PE ratio and dividend growth model
Table 1PE ratio of busines firm
Market price of share 1.64
EPS 0.25
PE Ratio 6.56
Industry PE ratio 18
Dividend payout ratio 0.175396
Required rate of return 21%
Dividend expected growth
rate 2%
Value of equity 0.90
PE ratio value is 6.56 and same of industry is 18 which means shares are undervalued. Value of
firm shares is 0.90 and current market price is 1.64 which means shares are overvalued. Change
in profit may affect share price and PE ratio model cover it.
(4) Suitability of method
Compared to market price PE ratio value seem appropriate because for computing same
market price is taken in to consideration.
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(5) Data needded for valuation
For valuation purpose additionally data of cash flow is needed as it can be used in DCF
modeling approach that is used for equity valuation (Ondraczek, Komendantova and Patt, 2015).
Cost of capital
(1)WACC calculation
Table 2Calculation of WACC
Debt Equity
Weightage
E/(D+E) @ Enterprise
Value 97.75%
D/(D+E) @ Enterprise
Value 2.25%
Interest Rate (%) 5%
Tax Rate (@) 30%
WACC Calculation
WACC 21%
(2)Company tax rate
Corporate tax rate is 30% and currently government intends to reduce it to 25%. In this
regard bill is already on table in senate.
(3) Reason for difference in cost of equity and debt
There is difference between cost of debt and equity because rate charged on bank loan is
usually lower then that rate which is charged on equity. Thus, cost of both source of finance is
different.
(4) Current liability and WACC
CL must be included in WACC because interest is also paid on it like long term liability.
In appropriate manner cost can be computed if CL included in WACC. Limitation is that if CL
proportion is very low then it unnecessarily may elvate WACC.
(5)Value of WACC and its application
WACC of firm is 21% and it is used to discount expected cash flows of project which are
finally used to evaluate project.
(6) Projects in which WACC used
Firm is operating two projects under which it will open its branch in multiple locations.
On these projects WACC value is taken in to account to compute present value of cash flows. It
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is considered as one of best approach to discount cash flows (Koziol, 2014). This is beccause it is
always difficult task to determine exact rate that can be used to discount cash flows.
(8)Optimal capital structure
Optimal capital structure is balanced debt and equity mix where cost of finance is
minmum. Consistent loss in business or sudden changes in economic environment of the nation
are one of basic factors that may lead to change in capital structure of the firm.
Market analysis
(1)Performance of Adairs Ltd relative to industry
In comparison to indsutry firm performance is similar as it can be observed that in
industry revenue is not increasing at fast pace and in current time period also same trend remain
in existance. On this basis it can be said that performance of the business firm does not very
much from industry.
(2) Analysts comments on Adairs Ltd performnace
Analysts have common belief that in future Adairs Ltd performance may
become poor because its profitability is not very much high small change in
economic environment may negatively affect it (Don’t you Adairs, 2017). Hence,
due to this reason it is estimated that there is likely probability that revenue
of the firm may reduce. I am fully agree with comment because currently it
can not be said that firm is earning super normal profit in its business. In
case it earn negative profit in its business then same may be badly affected.
Hence, due to this reason I am fully agree with statement.
(3) Items important or different from company
There are number of points that are important for the company and one of them is its
capital structure. A large portion of equity is covered by debt. In case in future if firm
performance become worst its dependency on bank loan will increased at rapid rate which is not
good for business. Adairs Ltd must restructure its capital structure so that from future point of
view it can be ensured that there will be less burden of finance cost on the business firm.
CONCLUSION
On the basis of above discussion it is concluded that firm is on growth stage but its profit
are not increasing at very fast rate. It needs to restructure its capital structure so that debt
proportion can be reduced in the business and debt payment liability can be controlled. It is also
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concluded that it is following coorect approach for determining discount rate of the project.
Thus, it can be said that firm is on growth stage but it needs to improve its performance to great
extent.
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REFERENCES
Books and Journals
Koziol, C., 2014. A simple correction of the WACC discount rate for default risk and bankruptcy
costs. Review of quantitative finance and accounting. 42(4). pp.653-666.
Ondraczek, J., Komendantova, N. and Patt, A., 2015. WACC the dog: The effect of financing
costs on the levelized cost of solar PV power. Renewable Energy. 75. pp.888-898.
Online
Don’t you Adairs, 2017. [Online]. Availabke through:<
https://www.intelligentinvestor.com.au/dont-you-adairs-1813286>. [Accessed on 14th
Octomber 2017].
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