report analysis

report analysis
This part of the report is an analysis of Severn Trent’s Financial Report for the year 2011 and will focus on items affecting the company in that specific year. The first part will be a short outline of what occurred in 2011 and then the second part will be a detailed ratio analysis of certain figures, including an analysis of the separate business entities.
1.Financial summary
Table 1 shows the main financial information for the year 2011. The first thing we can see is that Severn Trent’s revenue increased by 0.4% on the previous year. There was drop in price of supplying water compared to the previous year of 0.7% but increased consumption meant the turnover was slightly higher than the previous year.

Operating costs were also slightly higher than the previous year, but an increase of more than 0.4% means that PBIT was lower by 7.3% from 2010. According to the 2011 annual report, the total exceptional items for 2010 is £49.7 million compared to only £21.4 million in 2011 which mainly arose from £13 million of costs relating to restructuring and realigning the business which could be related to the company’s relocation to a new centre in Coventry.

A £14.2 million loss on financial instruments compared with a £45 .7 million gain the year before was the main contributor to net profit before tax being significantly lower than the year before. This was mostly down to the loss of £15.7 million on interest rate swaps.

Both net debt and financial liabilities are higher than last year as the company took out some long-term loans and reduced capital investment.

The net profit however was raised up to a similar value to the year before, partially due to a lower loss on exceptional items than the previous year, but mainly boosted by the £67 million deferred tax credit due to a rate change on corporation tax in the UK. The rate was changed from 28% to 26% on the 1st April 2011.

So in summary although revenue was similar in 2011 to 2010, PBIT and profit before tax were considerably lower because of the loss on financial instruments and higher operating costs. Although the value of profit for 2011 indicates that they performed similarly to 2010, this is not the case as profit would been £67 million lower was it not for the lowered rate of corporation tax.

2.Liquidity Ratios
Table 2 above is concerned with the current ratio and acid test ratio, which are used universally in financial ratio analysis. The difference between the two ratios is the inclusion of inventory in the calculation. Severn Trent has very low inventory because they mainly provide water supply services and utilities. This is why the ratios have a very similar value.

The ratios have shown a large increase since the previous year which shows the company has changed something to make it less at risk of not being able to pay its short term debt, although a value of 0.89 is still not troubling for a company this size. The main reason for the rapid increase in the current ratio is the decrease in short term borrowings from £260.9 million in 2010, to just 23.9 million in 2011, which has greatly decreased the value of current liabilities from the previous year.

Severn Trent’s current assets have increased due to the £64.9 million increase in short-term bank deposits from the previous year’s value.

A current ratio of 1.67 puts Severn Trent in an excellent position as a company to pay off its short term debts with its liquid assets such as bank deposits and cash at hand.
3.Solvency Ratios
Let’s first look at the interest cover ratio. The interest covers are quite similar in both years, as shown in table 4, this is still a good level of interest cover for Severn Trent and they are in a good situation to cover their interest payments.

Comparing the debt to equity ratio to the previous year it can be seen that it decreased by 14% in 2011. Total liabilities remains relatively unchanged from 2010 which means the fall in ratio is due to the increase in total equity from £947 million to £1106.1 million which came from around a £150 million increase in retained earnings from the previous year.The lower ratio means that the company’s creditors and lenders have less leverage in the company and the shareholders have more leverage. If the company can get this value to further decrease this value it will have a better balance between equity and debt. However, for a utility company of this size, a high debt to equity ratio such as this is expected.

Dividend cover increased by 21.2% in 2011. This is because earnings per share increased in 2011 while dividend payments decreased. The higher dividend cover implies company is safer and a dividend cover of 1.77 is still adequate for the company not to worry about paying its dividends.

A larger percent increase in equity than net debt means that the gearing ratio has fallen slightly but this doesn’t really affect the company at all as it is still quite high, but as mentioned earlier in the report, the high gearing ratio is expected from a large utility company such as this with a lot of its business financed by debt.

Price to earnings ratio has increased slightly in 2011 due to an increase in the share price from £10.50 to £13.40 and the decrease in earnings per share that was mentioned earlier. [9] This had led to the higher price to earnings ratio, although it is not a drastic change.
Comparing the return on net asset figures for 2011 shows that there is decline in the company’s ability to utilise its assets to make a profit, as the figure decreased from 8.97% to 7.68%. Although when looking at the company report it seems that this isn’t the case. The current liabilities have greatly decreased due to the fall in short term debt, and total assets also increased because of an increase in cash and cash equivalents. Both of these have increased the value of the denominator of the equation but neither of these 2 items will assist the company in making a profit. PBIT did decrease slightly from 2010 but if return on fixed assets was analysed it may indicate that there was less of a decrease in asset utilisation.
Asset turnover has again not changed much on the previous year and remains pretty constant year on year. This is a less volatile indicator of asset use than the return on net assets.
The return on equity has fallen by 35.2% and this is mainly due to an increase in shareholder equity as mentioned previously with a decrease in profit before tax also, largely due to loss on financial derivatives.
A declining return on equity implies that the company is decreasing its capability to yield profit without any new capital and is having problems utilising the capital from the shareholders.

The pre-tax profit margin has also decreased but this again is because of the fall in profit before tax due to the loss on interest rate swaps. The financial instruments show a loss of 14.2 million pounds in 2011 but gain 45.7 million pounds in 2010.

4.Analysis of the Separate Business Entities

Looking at table five we can see that nothing much changed in either sector of Severn Trent between 2010 and 2011. A lower sales margin that fell by 0.88% for Severn Trent Services can be attributed to municipal budget shortfalls and limited infrastructure spending on products in USA. Moreover, “delaying in financing in European markets led to a slowdown in product shipments”
In 2011, liabilities for Severn Trent Services reduced by 4.8% because uncertain politics in the Middle East made financing the project more difficult and borrowings were less available and slower to obtain.
Turnover and PBIT remain unchanged, which is surprising for Severn Trent Services as they have experienced good growth figures for the last few years. No real change in exceptional items was the cause of a similar PBIT but operating profit was in fact lower than the previous year, due to slowdown in the economic conditions.

 
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