Exide Corporation Exide Stock Price Had Been Lagging Its Ind

Exide Corporationexide Stock Price Had Been Lagging Its Industry Avera

Exide Corporation's stock price had been lagging behind its industry averages, prompting the board to appoint a new CEO, John Lee. Lee brought in Ashley Novak, a finance MBA with experience in financial statement analysis and forecasting, to develop the financial planning section of the strategic plan. Novak's initial approach involved comparing Exide's financial ratios to industry averages and discussing any substandard ratios with responsible managers to identify improvement strategies.

The financial data for Exide as of December 31, 2013, includes a balance sheet with total assets of $1.2 billion and an income statement with sales of $2 billion. Key ratios show that Exide's operating costs are 90% of sales, with a return on assets (ROA) of 5.5% versus the industry at 10.2%, and a return on equity (ROE) of 10.6% compared to 16.1%industry-wide. Other ratios such as profit margin, total liabilities, and asset turnover also highlight relative weaknesses and strengths. The company's efficiency ratios indicate areas for improvement, particularly in profitability and asset utilization.

Paper For Above instruction

Assessment of Exide’s operational efficiency and financial health compared to industry benchmarks reveals critical insights into its management effectiveness, scalability, and growth prospects. By applying financial ratio analysis and the Du Pont decomposition, we can comprehensively evaluate Exide's strengths and weaknesses.

Financial Ratio Analysis and Comparison

Exide’s profitability ratios, notably the profit margin (3.3%) and ROE (10.6%), fall below industry averages of 4.99% and 16.1%, respectively. This indicates the company is less efficient at converting sales into profits, possibly due to higher operating costs or inefficiencies in asset utilization. Its ROA of 5.5% compared to the industry’s 10.2% underscores this weakness, suggesting that Exide is not leveraging its assets effectively.

Efficiency ratios also highlight areas needing improvement. Exide’s asset turnover ratio of 1.04, slightly below the industry’s 1.04, indicates suboptimal utilization of assets to generate sales. The inventory/sales ratio of 20% versus 15% suggests excess inventory holdings, which could tie up capital unnecessarily. Receivables/sales at 14% versus 11% indicate longer collection periods, impacting cash flows.

From a leverage perspective, Exide's total liability to total assets ratio of 48.3% surpasses the industry’s 36.7%, indicating a higher degree of financial leverage and potential risk exposure. Its times interest earned ratio of 3.9 points to limited coverage on interest obligations, which could be problematic if earnings decline.

Du Pont Analysis

The Du Pont analysis decomposes ROE into profit margin, asset turnover, and equity multiplier:

  • ROE = Profit Margin × Asset Turnover × Equity Multiplier
  • Exide’s profit margin: 3.3%, asset turnover: 1.04, equity multiplier: Assets/Equity = 1.56
  • ROE = 0.033 × 1.04 × 1.56 ≈ 5.37%

This calculated ROE (5.37%) is lower than the reported 10.6%, which may result from different calculation methodologies or data nuances. Nevertheless, the low profit margin and asset turnover are primary contributors to the subdued ROE. The high leverage partially offsets profitability deficiencies but introduces increased financial risk.

Strengths and Weaknesses

While Exide displays weaknesses in profitability and asset utilization, its strengths include manageable liquidity ratios, with cash to sales at 1.0%, aligning with industry standards, and a reasonable current ratio (current assets/current liabilities). Its ability to generate positive net income and retain earnings supports potential reinvestment. However, the elevated leverage and lower profitability pose risks, especially if sales growth does not materialize or operational efficiencies are not improved.

Additional Funds Needed (AFN) Calculation for 2014

Using the AFN formula:

AFN = (A/S0)ΔS – (L/S0)ΔS – MS1(1–b),

where

  • Assets/Sales ratio = 1.2 (from total assets of $1.2 billion and sales of $2 billion)
  • Liabilities/Sales ratio = 0.04
  • Profit margin (M) = 3.3%
  • Retention ratio (b) = 1 – dividend payout ratio = 1 – (2/6.6) = 0.697
  • Sales growth rate = 10%

Calculations:

AFN = 1.2 × 0.10 × $2 billion – 0.04 × 0.10 × $2 billion – 0.033 × $2 billion × 0.697

AFN = $240 million – $8 million – $46 million = approximately $186 million needed for external financing.

This indicates that to support a 10% increase in sales, Exide needs to secure about $186 million in additional funds, assuming ratios remain constant.

Capital Intensity and Its Impact

Capital intensity is defined as the amount of assets required to generate one dollar of sales, calculated as Total Assets divided by Sales. For Exide, this ratio is 1.2 ($1.2 billion / $2 billion). A decline in capital intensity suggests that the company can generate sales with fewer assets, improving efficiency and potentially reducing the need for external financing. Conversely, an increase in capital intensity indicates higher asset requirements per sales dollar, which could elevate AFN.

Economies of scale, when achieved, typically reduce capital intensity by spreading fixed costs over larger sales volumes. However, rapid growth might temporarily increase capital intensity due to the need for substantial investments in lumpy assets at the beginning of expansion phases. Over time, as assets are optimized, economies of scale can lower capital intensity, reducing external funding burdens.

Influence of Growth Rate, Payout Ratio, and Other Factors on AFN

Increasing the growth rate directly increases AFN, as more assets and working capital are needed to support higher sales. A higher accounts payable balance acts as a source of financing, thus reducing AFN, while a higher profit margin enhances retained earnings, decreasing the need for external funds. Conversely, a higher payout ratio reduces retained earnings, increasing AFN, as less internal funding is available for growth.

Internal and Sustainable Growth Rate

The internal growth rate (IGR) is the maximum growth rate a firm can sustain without external financing, given its retained earnings, calculated as:

IGR = ROA × (1 – dividend payout ratio).

For Exide, with an ROA of 5.5% and a dividend payout ratio of 30.3%, the IGR is approximately 3.8%. The sustainable growth rate (SGR), however, considers leverage and is given by:

SGR = ROE × (1 – dividend payout ratio).

Thus, SGR for Exide is 10.6% × 0.697 ≈ 7.39%, indicating the firm can grow at this rate indefinitely without requiring external capital, given current profitability and payout policies.

Changes in the capital intensity ratio or other factors, such as profit margins or leverage, directly affect the SGR, as they influence ROE and retained earnings.

Forecasting Future Strengths and Performance Metrics

Assuming sales grow at 10% in 2014, followed by 8%, 5%, and 5%, and operating ratios remain constant, the forecasted financial statements reveal increasing sales and assets proportionally. Calculations of net operating profit after taxes (NOPAT), net operating working capital (NOWC), and total operating capital facilitate estimation of free cash flows (FCF) for each year.

For example, in 2014, FCF can be derived by subtracting net investments in operating assets from NOPAT, considering depreciation and changes in NOWC. The forecast indicates that initial FCF is likely negative, reflecting investments needed for growth, implying a financing requirement.

Comparing forecasted ROIC to WACC (9%) assesses value creation. A ROIC higher than WACC indicates value creation; a lower ROIC suggests destruction. The initial FCF deficit implies the need for external financing unless the company can improve operational efficiency or profitability.

Economic Value Added (EVA) further confirms performance, calculated as (ROIC – WACC) × beginning capital. Positive EVA indicates value creation, supporting strategic initiatives aimed at enhancing efficiency and profitability.

Terminal Value and Intrinsic Stock Price

Assuming FCF grows perpetually at 5%, the terminal value at 2017 is computed as:

Terminal Value = Final Year FCF × (1 + g) / (WACC – g)

With the present value of FCFs from 2014 through 2017, discounted at WACC, the total enterprise value can be obtained. Deducting net debt provides an estimate of equity value. Dividing by the number of shares yields an estimated intrinsic stock price, which should be compared to the current market price ($52.80). Discrepancies can highlight over- or undervaluation, guiding investment decisions.

Conclusion

Overall, Exide exhibits several operational weaknesses relative to its industry but maintains manageable leverage and liquidity ratios. Its growth prospects depend heavily on operational improvements, asset efficiency, and strategic financing plans. Applying financial modeling, ratio analysis, and valuation techniques provides a comprehensive understanding of its financial health and future potential, essential for strategic planning and investor evaluation.

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