Ratios and Accounting Drivers
Ratios – commentary
I found the actual calculation of my ratio’s quite easy. It is after all simple math to follow the formula and produce an outcome. However when it came down to actually constructing sentences about what my ratio’s tell or don’t tell me about my firm, then it became difficult. Is it simply ok to just see that SEEK produces positive ratio’s only, and therefore must be a ‘good buy’? If only it was that easy. The first step is to know what the ratio is actually telling me about what has happened with the firm over that period. Then I need to work out where that fits in the progression of time and what direction it seems to be taking.
Profitability Ratios
Net profit margin will show how much of the company’s revenue is turned into profit. It is generally only useful when comparing to other companies in similar sectors. Looking at the financial information of SEEK Limited, it is primarily an online employment classifieds, and should not be compared with for example Heidi McCormick’s company, Apollo Tourism & Leisure Ltd, a campervan hire company. The net profit shown in her ratio’s would be calculated after including items of cost of goods sold, motor vehicle expenses, and other significant overheads that SEEK itself would just not have. These are two completely different industries and are not comparable.
The sales growth for SEEK is consistent over the years, however profit is down significantly in 2018, but then seemingly on its way up again for 2019. So what happened in 2018 to cause a drastic drop in net profit? There was a significant impairment loss in 2018 of $181,700,000 which according to note 13.d of the 2018 Financial report comes from the impairment review of Brasil Online (BOL) and OCC. For the most part the BOL impairment review for 2018 took into account the fair value less costs of disposal (FVLCD) discounted cash flow (DCF) model, and was attributed to reflect Mexico’s macro and political uncertainty, competitive intensity, and operational issues in education. I feel as though this decrease in net profit was out of the ordinary and would not affect the future outlook.
In the same way Return on net assets will show how effectively a business is deploying assets to generate sales. Apollo Tourism & Leisure Ltd holds mostly tangible assets – inventory and equipment, whilst SEEK’s major asset consists of intangibles.
Efficiency Ratios
An efficiency ratio is used to tell how well a company is using its assets to generate sales, and is generally used to work out short term performance. The higher the asset turnover ratio, the more efficient the company is at using its assets to generate income. Again, this ratio would depend on the type of business being analysed. For SEEK, where the main asset is intangibles, and subject to amortisation. It includes goodwill, brands and licences, software and website development. These calculations can be extremely subjective and susceptible to significant variations.
For SEEK, the Current Asset Turnover ratio increased significantly in 2018, and remained steady for 2019. The sales were fairly consistent for these years, however the current assets showed a decrease of 26.57% between 2017 to 2018. There was a decrease in cash holdings of 44.52% mainly attributable to the Zhaopin privatisation and delisting. Zhaopin is a Chinese subsidiary of SEEK.
Liquidity Ratios
I have found liquidity ratios the easiest to comprehend. They provide a quick analysis of a firms overall health in the short term. Looking at the current ratio for SEEK, they had moderate liquidity in 2016 and 2017 at 1.5:1 but then in 2018 and 2019 that dropped to 0.8:1. So what happened in 2018 to change the liquidity? A combination of the decrease in cash as well as the increase in unearned income and current borrowings had an impact on this ratio calculation.
Due to the nature of the business, there is no inventory held, and only a small amount of receivables, so the Quick Ratios are only slightly affected compared to the current ratio. These ratios do concern me as a potential investor. I would want to know that in the current period the firm would be able to meet its debt obligations without a problem.
Financial Structure Ratio’s
Debt to Equity Ratio is used to look at the financing leverage of the firm. In other words it is used to see how much of the firm is financed through debt, versus equity. This ratio can be hard to compare between different companies in differing sectors because leverage will affect each company in a different way. I was surprised to see Heidi McCormick’s company Apollo Tourism & Leisure Ltd had a debt to equity ratio average over the 4 years of 344.15%. When I looked at SEEK’s debt to equity ratio I found it was sitting around 80% for 2016 and 2017, but then again in 2018 things changed. The level of long term borrowings increased significantly by 31.1% in 2018 and again increased 20.34% in 2019. The level of non-controlling interests in equity decreased at the same time resulting in the debt to equity ratio moving to 132.9% in 2018 and 150.8% in 2019.
The Equity Ratio shows equity as a proportion of total assets. It would indicate how much of the assets were funded by equity. In the case of SEEK this ratio remained quite steady but with a slight decrease in 2018 when leverage was increased through debt.
Market Ratio’s
The earnings per share calculation for SEEK again showed a significant decrease in 2018 with a steady increase for 2019. However this calculation would only concern existing shareholders. As a potential investor I would want to know if moving forward this EPS experienced a temporary drop.
The Dividends per share and dividend yield calculations for SEEK are not good indications for future investment as they are highly dependent on SEEK’s dividend policy. SEEK has shown increases in DPS over the four year period despite a decline in overall profit.
I find the use of market ratios to blur my evaluation of what the company might actually be worth. I strongly disagree with the efficient market hypothesis theory and believe that the stock markets are highly volatile and not indicative of the current actual value of company equity. This can be seen in the March/April 2020 period of uncertainty due to COVID19. Many share prices fell, including that of SEEK. This could be attributed to a lack of investor confidence to investing in general and panic selling.
Other Ratios
Now reviewing the restated financial statements ratios, I feel these may give a clearer picture of the actual health and viability of my company. The Return on Equity ratio continued to show a decrease in the 2018 ratio, but a viable increase in 2019 back to similar levels shown in 2016. The comprehensive income (without the impact of financing activities) shows a much better return on equity and possibly a clearer indication of the leveraging used.
Return on Net Operating Assets also shows a temporary decrease for 2018 but recovery in 2019. Compared to the Return on Assets, the impact of taking out financing activities will show a result that is clearer according to operating activities only.
Asset Turnover shows sales related to net operating assets. It indicates how well the net operating assets are being utilised to generate income. Sales continued to grow steadily and this ratio shows consistent increases in the ATO in line with this. This means that the net operating assets were being used more efficiently.
Accounting drivers – commentary
What is driving the economic profit (abnormal OI) for SEEK Limited? The key drivers of economic profit in the past are measured by RNOA, PM, ATO, WACC, NOA and FCF.
Return on Net Operating assets is operating income divided by net operating assets. A great majority of the net operating assets is the value of the intangibles held. SEEK is primarily an online business, with a high investment in Artificial Intelligence.
The Free Cash Flow is Operating Income less the change in Net Operating Assets. Free Cash Flow measures the amount of residual cash left over after a company reinvests revenue in operating assets. This shows the amount of cash that can be utilised in other ways, such as paying down debt, paying dividends etc. Since completing my first assessment spreadsheet, I found the Free Cash Flow was wrong for 2018. SEEK experienced a decline in NOA between 2017 to 2018 and I had to adjust my formula accordingly.
After analysing in more depth the ratios and accounting drivers of Seek Limited I find that I am still unsure of the future. Whilst firms like this can show great milestone achievements and report on the financials they want you to see, I am finding great value in reading between the lines. At this point I am swayed neither way, but hope to find some more clarity in the next steps.