[HWU Assignment] Zotefoams plc. Analysis Report

Introduction

Zotefoams plc. (‘Zotefoams’) is a manufacturer of cross-linked block foams with already 75 year's operation. Its products are used in a wide range of markets including sports and leisure, packaging, transport, health care, toys, building, marine and the military.

From the turnover trend chart, between 2007 and 2008 the sales increased almost 5 million ponds but fell down quickly in 2009, due to previous 2008 world financial crisis, and then went up to about 45 million ponds. So there was a clear up going trend in the turnover in 2007 to 2011 period.

In the business of chemistry sector, there are two different type of market: one is more traditional and large-scale, low-profit-margin product, e.g. soap, fertilisers, cosmetics, etc., and the other is more advanced, high-technology oriented product, for example, foaming, which Zotefoams does. In this newly-developed area, the key points to make money are to invent and to apply the invention. The company either devotes a lot in research and development, or purchases patent-holding companies. The demand side in this industry is linked with world economics, which means if the world suffered from austerity, the industry suffered as well.

Strategy and forward planning

There are two main concerns about Zotefoams in operation strategy and future planning:

First, the particular strength of Zotefoams is the unique technology in the product making process. They have filed patent for it, and continuously developed and looked for applicable and promising foaming processes: for example, Zotefoams acquired MuCell Extrusion LLC (‘MEL’) in 2011 for its specific patent. These exclusive rights are the main profitable drives and valuable assets of this firm whether they are created or bought. The future goal would be targeting at a more environment friendly and economical production process.

Second, the expansion of Zotefoams worldwide is about to lower the transportation costs and keep closer to the customers. Due to the nature of polyolefin (the main product), transporting finished goods to customers globally can be costly and time-consuming. The major clients are in Europe, North American and Asia. Except the factory in UK, Zotefoams began producing foams in the North American market in 2001, with raw materials shipped from UK. For business in Asia, Zotefoams set up an office in Hong Kong as a first step to invest a production site in Asia, but the board was careful with this further investment opportunity and about to make the final decision. According to the chairman’s statement, 2012 would be a year with at least 7 million ponds capital expenditure in restructuring old facilities, adding new factory and investing in extrusion capacity.

Accounting methods

There is no inconsistency in accounting policies or estimates. However, Zotefoams restated 2010 financial numbers for acquisition of MEL in 2011, for better comparability. For the accounting policies used in inventory, intangible assets and fixed assets, unless further evidence suggests, those policies seem suitable for Zotefoams.

Interpretation of technical analysis

According to the annual report figures and the managerial reviews, the analysis will mainly focus on interpreting Zotefoams’ investor ratios, management performance, liquidity & working capital and gearing, also comparing the numbers to its previous results as 2011 vs. 2010 and another benchmark company, Yule Catto & Co plc (‘Yule’), in chemistry sector with similar background as Zotefoams vs. Yule.

Investor ratios

This part gives investors what to expect if they invested Zotefoams, in terms of (i) price-earnings ratio, (ii) dividend yield and (iii) pay-out ratio (see table 1 in appendix):

       i.         To begin with, the report first examined price-earnings ratio, in terms of stock market price over earnings per share. The P/E ratio went down from 11.59 in 2010 to 9.92 in 2011. The change meant that lesser input with the same return for investors. The stock price used in the ratio was end of the year stock closing price. The fluctuated factor is mainly in stock price because the earnings per share for these two years are similar.

      ii.         Second, the report checked dividend yield, which is dividends paid per share divided by share market price. The results were also influenced by year-end stock price. This ratio states how long it will take for investors to retrieve initial investment by collecting dividends and the percentage they pay for dividends in stock price. Judging from the ratio, Zotefoams had quite stable dividends paid for the last two years.

     iii.         Lastly, the report looked at the payout ratio, which is earnings per share over dividends paid per share, implying the ability to secure sufficient profit to expand or pay back investors. Basically, Zotefoams signalled investors that its capacity for business expansion and stability for making money. This ratio decreased 0.13, but earnings were still 2 times of the dividend paid.

Management performances

To evaluate Zotefoams performances, this part would go through (i) return on capital employed (‘ROCE’), (ii) operating margin and (iii) total assets usage (see table 2 in appendix):

       i.         ROCE, profit before tax over total common share equity plus long-term liability, went up 0.51% during last two years. This figure gives a general idea of how well a company use its long term fund. Zotefoams had roughly 13% of ROCE per 2010 and 2011.

      ii.         Operating margin, operating profit over revenue, located around 12% with slightly change over 2010 and 2011. If we considered with gross margin, which was about 30% of revenue over last two years, Zotefoams displayed good control with its costs and competing strength.

     iii.         Total assets usage, net sales over total assets, rose from 80% in 2010 to nearly 86% in 2011. With total assets only increased 1.7 million ponds, net sales boosted about 4.3 million pounds in 2011 compared to 2010. If we took operating cash flow to assets (see table 5) into account, the percentage went down 3.45% from 13.27% to 9.82% because inventories increased (cash outflow) almost 2 million ponds. This shift might suggest that Zotefoams had more inventories and related trade payable at year-end, which would be discussed later in liquidity section.

Liquidity & Working Capital

This part of analysis would concentrate on (i) current ratio & acid test, (ii) inventory holding period, (iii) customers' collection period and (iv) suppliers payment period, factors which determine working capital cycle (see table 3 in appendix).

       i.         Current ratio is total current assets over total current liabilities, and acid test is almost the same with total current assets without inventories, and then divided by total current liabilities. Zotefoams seemed to have good ability in paying back its current debts even the criteria tightened. Compared with Yule, Zotefoams appeared to be more capable in instant debt clearance.

      ii.         To calculate inventory holding period, first the report had to know inventory turnover. Inventory turnover is cost of sales divided by average inventory held. The holding period is 365 days over inventory turnover. Zotefoams seemed to have more holding days in 2011 than in 2010. However, this figure would be affected by the way of average inventory calculation, which used in the calculation was simple average, assuming evenly changes in inventories throughout the year. The ending balance in 2011 inventory was 1.7 million pounds higher than 2010. Judging from five-year inventory figure, the change in 2011 suggests either a big order at the beginning of 2012, or an overstock. Compared with Yule, Zotefoams seemed to have longer holding period, nearly two times than Yule. A possible explanation for this result is that the two companies’ product cycle might be different.

     iii.         The customers' collection period applies the similar method as the inventory holding period, just switching the proxies to credit sales over average trade receivables, and divided it by 365 days. Because it is hard to separate cash sales and credit sales, we assume that most revenue came from credit sales and use net sales instead. As table 3 suggested, there was clearly an increase from about 79 days to near 83 days. Again this figure was influenced by how to calculate average trade receivables and whether credit sales number could be separated. Compared with Yule, Zotefoams once more had closely two times of collection period.

    iv.         Then the report moved on to supplier payment period, which is credit purchase over average trade payable, then divided by 365 days, same as previous two. Assuming that purchases in any period were made by credit payment, we could get the number of total purchase of the year by adding back ending inventory to cost of sales, and then deducting beginning inventory. Zotefoams experienced a huge increase in supplier payment period from 59 days in 2010 to 70 days in 2011, which is more consistent to the customers' collection period, reducing cash shortage gap. One possible explanation is if we considered the change in interest expense during 2010 and 2011, the decrease might be a reasonable explanation for Zotefoams trying to match payment and collection. Compared with Yule, Zotefoams had similar result in payment period. For the long run, the better situation is to have a shorter period in customers’ collection and longer period in suppliers payment, giving the company more flexibility.

Gearing

In this section we would only check on (i) Debt-equity ratio and (ii) interest cover (see table 4):

       i.         Debt-equity ratio is total liability over total shareholders’ equity. This ratio explains about the capital structure of a company and the degree of debt-dependency. Zotefoams had more debt due to trade payable increasing although equity stayed almost the same.

      ii.         Interest cover is earnings before tax over interest expense. This ratio demonstrates whether a company makes enough profit to pay interest. Basically, Zotefoams did a good job in both increasing the earnings and decreasing the interest expenses because the ratio went up from 63 in 2010 to 109 in 2011.

Non-financial performance indicators

 Source: http://www.economist.com/blogs/graphicdetail/2012/06/focus-3

Considering that the industry fact and the linkage between other industries, the report would suggest that World gross domestic product (GDP) as a non-financial performance indicator. Compared with Zotefoams five-year turnover trend, the high and low movement was similar.

Questions to Finance Director

1      The first question is about distribution fees of main product. Since the distributing fee percentage in gross profit dropped from 28% to roughly 25% given the revenue growth, will it continue to decrease if reducing expenses is one of the goals of operation? And to what degree would you consider reasonable?

2      The second question is about supplier payment period change. The payment period increases 10 days, is there any delayed payment in such situation?

3      The third question is about inventory increase. Is there a cycle of high and low in sales? And according to the 2011 annual report, there is a part mentioning next year order book. Is there a major order at early 2012? Because the ending inventory is 43% more than last year, it’s a huge increase compared to previous year. In related, trade payable also increases 58%.

4      The forth question is about bad debt coverage. Is the current coverage enough considering the increase in sales? Does company pay attention to its customers’ financial situation?

5      The last question is about capital expenditure. How much does the company plan to raise debt or use retained earnings? How long will the facility take to operate? The reason for this question is to understand how the capital structure will change and potential debt stress.

Appendix

Table 1: Investor ratio (Zotefoams 2011 vs. 2010)

	Definition of Ratio	2011	2010	% Change
Price-Earnings ratio	Market Value per Share/ Earnings per Share (EPS)	9.92	11.59	-14%
Dividend Yield	Dividends per Share (DPS)/ Market Value per Share	4.19%	3.40%	23%
Payout ratio	EPS/ DPS	2.41	2.54	-5%
Data related to above calculation:
Earnings per share Basic (p)		11.80	11.80	0%
Dividends per ordinary share (p)		4.90	4.65	5%
Stock Price at year-end (p)		117.00	136.75	-14%

Table 2.1: Management performances (Zotefoams 2011 vs. 2010)

	Definition of Ratio	2011	2010	% Change
Return on Capital Employed	Profit before Tax/ (Total Assets - Current Liability)	12.96%	12.45%	4%
Operating Margin	Operating Income/ Net Sales	12.64%	12.10%	4%
Gross Margin	Gross Profit/ Net Sales	28.47%	28.71%	-1%
Distribution Expenses % in Gross Profit	Distribution Expenses/ Gross Profit	24.75%	28.12%	-12%
Admin. Exp. % in G/P	Administrative Expenses/ Gross Profit	30.83%	29.72%	4%
Total Asset Usage	Net Sales/ Total Assets	85.82%	80.00%	7%
Fixed Asset Usage	Net Sales/ Fixed Assets	173.82%	155.80%	12%
Data related to above calculation:
Revenue		44,208	39,879	11%
Gross profit		12,584	11,449	10%
Distribution costs		-3,114	-3,220	-3%
Administrative exp.		-3,880	-3,403	14%
Operating profit		5,590	4,826	16%
Profit before tax		5,465	5,324	3%
Property, plant and equipment		25,433	25,597	-1%
Total assets		51,515	49,847	3%
Total current liabilities		-9,334	-7,069	32%

Table 2.2: Management performances (Zotefoams 2011 vs. Yule 2011)

	Definition of Ratio	Zotefoams 2011	Yule 2011
Return on Capital Employed	Profit before Tax/ (Total Assets - Current Liability)	12.96%	12.65%
Operating Margin	Operating Income/ Net Sales	12.64%	4.86%
Gross Margin	Gross Profit/ Net Sales	28.47%	18.74%
Distribution Expenses % in Gross Profit	Distribution Expenses/ Gross Profit	24.75%	36.66%
Admin. Exp. % in G/P	Administrative Expenses/ Gross Profit	30.83%	17.29%
Total Asset Usage	Net Sales/ Total Assets	85.82%	118.90%
Fixed Asset Usage	Net Sales/ Fixed Assets	173.82%	608.32%

Table 3.1: Liquidity & Working Capital (Zotefoams 2011 vs. 2010)

	Definition of Ratio	2011	2010	% Change
Current Ratio	Current Assets/ Current Liabilities	2.13	2.59	-18%
Acid Test	(Current Assets - Inventories)/ Current Liabilities	1.49	2.01	-26%
Inventory Turnover	Cost of Sales/ Average Inventory	6.29	6.68	-6%
Stock Holding Period	365 Days/ Inventory Turnover	58.06	54.67	6%
Accounts Receivable Turnover	Credit Sales/ Average Receivable	4.42	4.64	-5%
Customers' Collection Period	365 Days/ Accounts Receivable Turnover	82.55	78.68	5%
Accounts Payable Turnover	Net Purchase/ Average Accounts Payable	5.19	6.18	-16%
Suppliers' Payment Period	365 Days/ Accounts Payable Turnover	70.32	59.07	19%
Working Capital Cycle	Stock Holding Period + Customers' Collection Period - Suppliers' Payment Period	70.29	74.28	-5%
Data related to above calculation:
Total current assets		19,863	18,313	8%
Total current liabilities		-9,334	-7,069	32%
Revenue		44,208	39,879	11%
Cost of sales		-31,624	-28,430	11%
		2011	2010	2009
Inventories		5,927	4,134	4,382
Trade and other receivables		10,533	9,463	7,729
Trade and other payable		-7,887	-4,989	-4,132

Table 3.2: Liquidity & Working Capital (Zotefoams 2011 vs. Yule 2011)

	Definition of Ratio	Zotefoams 2011	Yule 2011
Current Ratio	Current Assets/ Current Liabilities	2.13	1.20
Acid Test	(Current Assets - Inventories)/ Current Liabilities	1.49	0.93
Inventory Turnover	Cost of Sales/ Average Inventory	6.29	13.04
Stock Holding Period	365 Days/ Inventory Turnover	58.06	27.99
Accounts Receivable Turnover	Credit Sales/ Average Receivable	4.42	8.66
Customers' Collection Period	365 Days/ Accounts Receivable Turnover	82.55	42.15
Accounts Payable Turnover	Net Purchase/ Average Accounts Payable	5.19	5.49
Suppliers' Payment Period	365 Days/ Accounts Payable Turnover	70.32	66.48
Working Capital Cycle	Stock Holding Period +Customers' Collection Period -Suppliers' Payment Period	70.29	3.66

Table 4: Gearing (Zotefoams 2011 vs. 2010)

	Definition of Ratio	2011	2010	% Change
Debt/ Equity ratio	Total Liabilities/ Total Equity	46.13%	42.36%	9%
Interest Cover	Profit before Tax/ Interests Expenses	109.30	62.64	75%
Data related to above calculation:
Interests: On bank loans and overdrafts		50	85	-41%
Profit before tax		5,465	5,324	3%

Table 5: Cash-generating efficiency (Zotefoams 2011 vs. 2010)

	Definition of Ratio	2011	2010	% Change
Cash Flow Yield	Net Cash from Operating Activities/ Profit for the Year	1.09	1.42	-23%
Cash Flow to Sales	Net Cash from Operating Activities/ Net Sales	11.26%	15.44%	-27%
Cash Flow to Assets	Net Cash from Operating Activities/ Average Total Assets	9.82%	13.27%	-26%
Data related to above calculation:
Net cash from operating activities		4,979	6,157	-1,178
Profit for the year		4,554	4,329	225
Revenue		44,208	39,879	4,329
		2011	2010	2009
Total assets		51,515	49,847	42,926

References

Zotefoams plc. Annual report for 2011, 2010, 2009

Yule Catto & Co plc. Annual report for 2011

www.zotefoams.com

http://www.economist.com/blogs/graphicdetail/2012/06/focus-3