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Corporate Financial Management

Corporate Financial Management

Executive Summary

The company collects its capital from the market and tries to increase shareholders’ wealth by providing values through the company’s products or services. In this report, the key discussion is to show whether British Petroleum PLC, our selected company, has provided value to its shareholders successfully or not. In order to see this, TSR and EVA approaches are being used to see the returns provided to the company’s shareholders. In this report, the last 5 years financial statement has been used for that purpose. The financing policies and the dividend policies are also discussed to present the company’s ability to meet the shareholders’ expectations. Moreover, there is a valuation of the equity of the company using the NAV and P/E Ratio. By using these tools, the share price of British Petroleum PLC is determined.

 

Introduction of the company

British Petroleum PLC is a renowned name in the field of power and energy all over the world. The company started its journey in 1889, and the location of the company is in London, UK. The company is engaged in different kinds of products and services such as exploration, refining, marketing and distribution of oil and gas, and power and petrochemical products. Suppose the company’s activities are divided into three main segments. In that case, the segments will be a) Upstream which deals with exploration and development of natural gas and oil, b) midstream which deals with the activities related to the storage, processing and sales of natural gas and c) downstream involves activities the production and marketing of petroleum and petrochemical products. Although the company is producing biofuel, it is very careful about the issues related to the environment. So the company is also an active player in the field of Corporate Social Responsibilities (CSR). Moreover, the company is always known for its best effort to provide value to its shareholders.

 

Shareholders’ Value Analysis

Shareholders are the parties who supply the necessary bloodline of funds for the company to execute their plans and strategies. In exchange, the shareholders expect the company will reply to them with a higher value and return. Shareholders’ value refers to the return that the company provides to its shareholders. British Petroleum PLC has almost 3.351 billion shares outstanding in the market. So it is a responsibility for the company to create positive value for the shareholders. The shareholders’ value analysis is done through two approaches.

Total Shareholder Return (TSR)

One of the main reasons the shareholders are interested in investing funds into a public limited company is the return provided by the company. According to Features (2016), the return can take the form of any two of the options. a) Capital Gain and b) Dividend (i.e. cash dividend, stock dividend). So it is a good way of measuring the value provided by the company through the return generated from the share. Total shareholder return is a measure that expresses the return as a percentage of the initial investment. 

British Petroleum PLC provides quarterly dividends to its shareholders. The dividends are not that high but significant for the analysis. As we can see in appendix A, the calculated TSR is positive in most of the periods except the months where the dividends are provided. As the dividend is provided, the share prices decline in those months, and the TSR becomes negative. Apart from that, the company is generating value in terms of TSR almost every month. TSR becomes highest in October and November and lowest in August and September. 

This analysis of shareholder value indicates that the company is generating shareholders’ value at a moderate level. The investment can be risky. But the company has been thriving in the market for quite a long, and if there is no global downturn in the economy, the company can create even greater shareholder value (Robertson & Wright, 2006).

In a nutshell, the company provides quite a handsome and fair shareholder value concerning the overall industry performance and the global economic condition. So it can be concluded that British Petroleum PLS has been fair to its shareholders and generating enough value compared to the industry and overall economy (Ballow, McCarthy & Relvas, Accenture Global Services GmbH, 2008).

Economic Value Added (EVA) 

As the purpose is to analyse and determine the value that British Petroleum PLC has created, Economic Value Added can be a great tool to do that. EVA helps determine the value that the company has created for its shareholders compared to the investment. The formula for calculating Economic Value added (EVA) is – 

(Net investment) x (Actual return on investment – Percentage cost of capital)

After calculating the net investment and actual return on investment, the cost of capital is calculated. The EVA for British Petroleum PLC shows that the company hasn’t added any value; rather, it has destroyed value for the last 5 years, and the percentage of destroying value is increasing. In appendix B, there is a chart showing the EVA for the last 5 years of BP. This value destruction might be caused by some inappropriate acquisition and the slow pace of growth of the biofuel industry because of the increased care for the environment. But the company can add economic value to the company as the company is big and has long experience in the industry (Losey & Vaughan, 2006).

 

Financing sources and related policies

Campello, Graham & Harvey (2010) have emphasised that financing is one of the most important parts of any company. It becomes even more important when a company is undergoing growth in sales and needs to expand its production facility. British Petroleum PLC is a big company, and the company has both the equity and the debt source of funds in its capital structure. The company is experiencing some change in the structure of capital, especially in the debt section. The gearing ratio measures the proportion of equity compared to the proportion of long-term debt in the capital structure. As per the financial statement of the last 5 year, the calculation of the gearing ratio reflects the fact that the amount of debt is decreasing over time. In appendix C, it can be seen that the amount of debt financing declined sharply in 2014 compared to equity financing. It is not the case that the company has reduced its debt; rather, the company has increased its equity to such a level that it has decreased the gearing ratio over the last 5 years.

Although the company has less debt than equity in the capital structure, the interest coverage ratio is declining over the last few years and becomes negative in 2015. In appendix D, the interest coverage ratio has been presented in the form of a chart.

As per the analysis presented above, it can be inferred that the company has lower debt in the capital structure than the company’s equity value. So, the bankruptcy risk is very low for the company. As there is a low risk of default and a capacity for raising funds through debt financing, which is much cheaper than equity financing, the company can raise funds through a bank loan or bond issuance at a fixed rate. But the interest coverage ratio is concerning. The company is facing some downturn in revenue. But that downturn is very temporary, and the company expects to recover from it very soon.

As British Petroleum PLC has a good reputation in the market and has a favourable capital structure, debt financing would be a favourable source of financing. Currently, the company is a low geared company. So the company can increase the level of debt a little higher, keeping the company a low geared company because a highly geared company in a cyclical industry is faced with the probability of bankruptcy. The company is using those funds for the acquisition and other needs.

 

The current valuation of share price

British Petroleum PLC has about 335.1 million shares outstanding in the market and traded regularly. It is necessary to find the value of the share-based on some reliable method. 

Net Asset Value Approach

The net asset value approach seeks to find the value of the share, netting the assets and liability and dividing the value by the outstanding shares (Ycharts.com.,2016). As per the formula, the net assets value is calculated, and the share’s value is calculated. The value of the shares in the current condition would be – 

Particulars

Amount (In Million)

Net Assets Value

98387

Share Outstanding

335.1

Share Price

293.605

 Here, the net asset value and share outstanding represent the amount as of 31st December 2015. So the share price will be 293.605 pence. As per the given information in appendix E, the share is traded at a price of 354 pence. So according to this pricing method, the share price is overpriced in the market.

P/E Ratio Approach

As per Brealey, Myers, Allen & Mohanty (2012), the P/E ratio refers to the price-earnings ratio. How much is the price one investor pays relative to the earnings of the company? The P/E ratio and EPS as of 31st December 2015 has been collected from the website (Shares.telegraph.co.uk.,2016). As per the information, the current share price should be – 

Particulars

Amount

P/E Ratio

-9.91

EPS

-35.39

Share Price

350.715

Here the calculated share price is 350.715 pence which is very much closer to the current price in the market. So the P/E ratio approach can be considered as one of the methods for valuing shares.

 

Conclusion

British Petroleum PLC is a prominent company in the share market and has a far-reaching impact on the overall performance and condition of the market. The company should take good track of the company’s share price and be vigilant and careful regarding the decisions that can affect the current share price.

 

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