HC1010 Accounting For Business

Answer :

Executive Summary

In recent years, there have been many corporate collapses in Australia, such as HIH Insurance where there were multiple reasons of collapse, including manipulation of accounting and reporting data so as to provide a rosy picture to outsiders. In view of such manipulation, the company stock prices soared and ultimately hurt many stakeholders when the company collapsed.

Now, in such a scenario, analysing a company in financial reporting perspective gains tremendous importance. If the company is reporting the numbers in a fair manner and whether it is adhering to various policies and regulations as mandated for the industry gains prime importance.

The following pages analyse the company AGL Energy Ltd. which is one of the largest energy companies in Australia. The company generates and supplies energy through various sources such as, coal, wind, sun, water etc. 

The analysis will include analysis of financial performance in the year 2017 and also comparative numbers from previous year. Additionally, the company will be compared with competitor to understand how it has fared with respect to the industry. A few key financial ratios will also be analysed, both with respect to previous year as well as competitors. The approach of the company will be understood by analysing director’s report through various angles, such as, corporate governance, risk policy, operational data, board members experience and remuneration etc.

Introduction

Background

AGL Energy (ASX: AGL) is an energy generation company based out of Sydney, Australia. The company was founded in 1837 and it operates the largest electricity generation portfolio in the country. Andrew Vesey is the chief operating officer of the company. Currently, the customer base of the company comprises 3.6mn accounts.

The company invests heavily in generation of sustainable and renewable energy and boasts of a portfolio comprising of energy generated from coal, water, wind, solar power, natural gas etc. (Company Website, 2018).

Operating Segments

The operating segments of AGL Energy can be categorized as follows (Annual Report, 2017):

1. Energy Markets: This segment relates to sale of gas, electricity, and energy products to consumers and in turn, comprises of:
   1. Wholesale market: It mainly comprises of price risk management for electricity, gas etc. and further is categorised as:
      1. for gas: sourcing and management of gas supply including transportation
      2. electricity: sourcing key inputs for production and hedging to meet anticipated requirements
      3. Eco markets that comprises of renewable energy related liability management
2. Customer business unit: it caters to customers, both retail and business
3. New Energy Services: it comprises of solar energy and other energy efficiency solutions for both residential and commercial customers
4. Group Operations: This refers to the power generation portfolio of the company, including Newcastle Gas Storage Facility and can be further categorised as:
   1. Thermal power: comprising of coal based power plants
   2. Renewable power: comprising mainly of wind, water and solar power plants
   3. Natural gas: comprises mainly of gas storage facilities
   4. Other operations: comprising mainly of distributed energy services
5. Investments: This refers to the company’s interest in other companies (Powering Australian Renewables Fund, Energy Impact Partners’ Fund, Sunverge Energy, ActewAGL Retail).

Financial Standing

Key performance review

As of financial year ending 2017 (Annual Report, 2017), AGL Energy reported total assets of $14.5bn, a slight decline from $14.6bn in 2016 while total equity reported was $7.6bn. The total liabilities during the year 2017 increased slightly to $6.9bn as compared to $6.7bn in 2016. 

The company earned revenue of $12.6bn in the financial year ending June 2017. This was an increase over $11.2bn revenue earned during the same period in 2016.

For the year 2017, the company earned a statutory profit of $539mn (after tax), a major improvement over loss of $408mn in 2016. The loss in 2016 was mainly on account of significant items.

Further, the gearing ratio for the year 2017 stood at 29.6%, only a slight increase from 25.7% in 2016. The company continued to maintain an interest coverage ratio of 7.5x during 2017 that indicates adequate coverage for fixed obligations created due to debt. 

The company was able to earn a return on equity of 10.2% for the year ending 2017 which is a commendable improvement over 8.3% return on equity earned during financial year 2016. The EPS (on underlying profit) was 119.8 cents, as compared to 103.9 cents in 2016.

It should be noted that the increase in return is also attributable to decline in number of shares outstanding in the market on account of share buyback program. In continuation with the program initiated in October 2016 to acquire its shares through share buyback, the company bought back 18.9mn shares worth $473mn during financial year 2017. The company’s buyback program targeted acquiring 5% of outstanding shares that equates to 33.7mn shares. 

Competitors

The main competitor of AGL energy can be said t be Origin Energy.

The company, Origin Energy, reported revenue of $13.6mn with a net loss of -2.2mn for the year 2017. The operating margin ratio was 6.36% while net margin ratio was -16.31%.

The key comparison metrics for AGL Energy limited and Origin Energy can be presented as follows (MorningStar, 2018):

It is clear from above that AGL Energy has performed better than Origin Energy in the year 2017 even with a slightly less revenue than Origin Limited. AGL Energy reported a higher profit as well as margin ratios. This converted to higher rate of return on assets as well as equity. Further, AGL Energy has relatively lower financial leverage and better interest coverage. While with a net loss, Origin Energy has high debt in the structure and negative interest coverage indicating stress on profitability of the company. Further, the liquidity is almost similar in both the companies.

Cash Flow Statement

The company reported cash and equivalents of $154.0mn for the financial year 2017, a slight decline from $252.0mn in the year 2016. However, the current ratio and quick ratio of the company stayed strong at 1.33 and 0.77, respectively.

The cash flows from operating activities were reported at $891mn for the year 2017, as compared to $1,186mn in 2016.

The cash flows from investing activities were reported at ($302)mn for the year 2017, as compared to $81mn in 2016. The 2016 year was marked by disposal of subsidiaries, leading to positive cash flow from investing. However, there was no disposal in year 2017.

The cash flows from financing activities were reported at ($687)mn for the year 2017, as compared to ($1,274)mn in 2016. Company raised fresh debt worth $1,472mn, mainly through treasury that led to positive financing cash flow. This was offset by negative financing cash outflow attributable to the share buyback program under which company bought back shares worth $403mn through market buyback method.

Balance Sheet

The total assets of the company reduced slightly in the year 2017. The property, plant and equipment constituted almost 45% of the total assets.

The current ratio of the company was 1.33, only a slight decline from 1.41 in previous year. Similar was the case with quick ratio which decreased slightly from 0.87 to 0.77. However, both these ratios indicate adequate solvency for the company.

On the debt side, the financial leverage increased slightly from 1.85 to 1.91. The debt equity ratio also increased slightly from 0.39 to 0.42 indicating fresh debt raised as well as reduced equity on account of share buyback during the year. The share buyback was also the reason that shareholders equity percentage reduced from 54.25% of the liabilities to 52.39% of the liabilities.

Ratio Analysis

The key ratios for AGL Energy can be presented as follows (Annual Report, 2017):

• Return on Assets: Return on assets indicate profit earned per dollar of assets employed by the company. It indicates efficiency with which assets are employed so as to generate profit by the company. The formula is profit after tax of the company divided by total assets employed (Fridson & Alvarez, 2014).

For the year 2017, the company reported return on assets ratio of 5.5%, an increase over 4.8% reported in 2016. The increase indicates that assets are being employed with higher efficiency so as to increase earnings.

Origin Energy reported the ratio at -8.23% for 2017 while Energy Australia reported it at -5.06%. Comparatively, AGL Energy Ltd. seems to have performed much better than competitors (Morningstar, 2018).

• Inventory Turnover: In order to attain high profitability, a company needs to ensure operational efficiency as well as ensure that each and every asset employed by the company is effectively employed. This can be measured through turnover ratios that indicate revenue earned per dollar of an asset employed. A high ratio indicates high efficiency with which the asset is being utilized. On the other hand, a low turnover ratio indicates that asset is not being utilized to full possible extent as fewer dollars of sales are being generated with respect to each dollar of that asset employed. 

Some of the most popular turnover ratios include inventory turnover ratio, asset turnover ratio and receivables turnover ratio. A unique feature of all turnover ratios is that the numerator is revenue or sales (Brigham, 2010).

The inventory turnover ratio indicates revenue generated per dollar of inventory of the company. The typical formula used for the purpose is revenue divided by average inventory. 

AGL Energy limited reported an inventory turnover ratio of 32.9 times in the financial year 2017, an increase from 27.5 times in the year 2016. When converted to days, the ratio has declined to 11.1 days in 2017 as compared to 13.2 days in 2016 which indicates that inventory is moving faster leading to lower storage costs and other risks associated with piling inventory, such as, obsolescence. It indicates better use of inventories available to convert it into sales. 

Origin Energy reported the ratio at 57.51times for 2017 while Energy Australia reported it at 37.79times Comparatively, AGL Energy Ltd. seems to have churned its inventory at a lower rate as compared to its competitors (Morningstar, 2018).

• Quick Ratio: Also known as solvency ratios or liquidity ratios, these indicate a company’s ability to meet short-term obligations. The quick ratios is also known as acid test ratio because it is an acid test for the company as it indicates company’s ability to meet short term obligations from its current assets which can be immediately liquidated. Hence, it excludes current assets such as inventories that cannot be immediately liquidated. The formula for quick ratio is quick current assets divided by current liabilities. Higher ratio indicates better liquidity and vice versa. The main line item to be excluded from current assets is inventories (Kokemuller, 2018).

AGL Energy limited reported a quick ratio of 0.84 in the financial year 2017, a decline from 1.05 in 2016. However, the ratio still seems to be good. Very high solvency ratios (including quick ratios) indicate deployable funds that are lying idle and can be allocated more profitably elsewhere. Hence, till the ratio is sufficient to cover current liabilities, it is good to have a lower ratio as it indicates better allocation of available funds so as to increase revenue.

Origin Energy reported the ratio at 0.64 for 2017 while Energy Australia reported it at 0.13%. Comparatively, AGL Energy Ltd. seems to have performed much better than competitors in maintaining solvency ratios (Morningstar, 2018).

• Price-Earnings Ratio: This ratio is calculated by dividing current share price of the company by its earnings/share for the period. It indicates the willingness of market to pay for one share of the company with respect to a dollar of the earnings. It also provides an indication about market valuation of the company. Very high P/E ratio indicates overvaluation and the fact that market is bullish on the stock while very low P/E ratio indicates undervaluation and the fact that the market is bearish on the stock. This may happen due to market sentiment regarding the future earning potential of the company or, it may be driven by other factors as well.

The company had a P/E ratio of around 47.9 times as of June 30, 2017 (ycharts, 2018). The ratio is quite high indicating that the market was bullish on the company share prices.

The Director’s Report

The 2017 director’s report for AGL Energy limited is very detailed and explains various aspects of the business as well as industry.

With regard to corporate governance, the company monitors it continuously so as to ensure the company stays in consistency with the ASX Corporate Governance Council recommendations and principles. The Board of the company provides continuous direction and strategic alignment of the governance of the company. These are aimed at safeguarding the company’s interests and attain maximum possible value creation while at the same time ensuring that interests of all the stakeholders involved (employees, shareholders, customers, communities, etc.) are also safeguarded.

To this end, the report clearly explains the details about various directors that comprise the board, including the remuneration. The members are extremely experienced and seem qualified to direct a company as big as AGL Energy Ltd. To this end, the report provides a matrix of skills required to be a board member and corresponding skills of each existing member. To ensure performance, the remuneration is a combination of fixed component as well as performance based incentives.

The risks involved with the business are clearly explained in a separate section called Risk Management policy. The risk policy separately explains how the company tackles risk at various levels of defense. The report specifies what risk objectives are to be attained through these. 

Regarding the business of the company, the report clearly sets out operational segments and sub categories and extraordinary events under each category that require to be mentioned, such as acquisition, disposal, changes in segments, etc.

The financial performance section in the report is quite detailed and explanatory and provides information for previous years as well. The report also clearly sets out various key financial performance metrics and reasoning behind change from the previous year. Such as, the debt in capital structure, interest coverage as well as changes in equity (such as, buyback). The report also lists the profit for the year, earnings per share as well as dividend declared for the year. The key numbers such as, revenue, profit etc. are also reported basis segmentation.

The report also clearly states the future direction that business will be taking and revisions in strategies, such as, moving away from coal-based energy or exploration of natural gas and investing more in renewable energy. The company also discusses special events such as impairment, restructuring, change in value of financial instruments, restructuring of operational segments.

Conclusion

As seen above, AGL Energy limited is one of the largest and oldest players in the Australian energy market. The company has a lot of experience in the field. Financially, the company seems on track as the indicated by the profit and margin ratios of the company. The return on assets and equity is also reasonable. Further, the company has sufficient cash so that it is buying back shares from the market that increases earnings for existing shareholders. The debt has increased only slightly but the interest coverage is good enough to cover the same. The company is also environmentally conscious and is moving away from thermal and coal-based energy to reduce carbon footprint. It invests heavily into energy generated from renewable resources. Further, the company has strong governance policies and code of ethics not only for direct employees but also for other stakeholders such as suppliers, manufacturers, third party contractors etc. The company tries its best to safeguard interests of all the parties involved with AGL Energy limited by providing proper policies, rules and regulations.

With respect to competition also, the company is doing better. While the competitor, Origin energy had reported losses for the year even with higher revenue, AGL Energy had reported profits. The margin ratios and return ratios are also better for the subject company. The solvency ratios are almost similar. However, the debt component is higher in case of Origin Energy and given the fact that company is in losses, it may be difficult for that company to meet fixed interest obligations which will lead to further pressure on its profit goals. Comparatively, AGL Energy is much better placed with financial metrics.