Factors Influencing Economic Value Added in the Selected Sector of the Industry

Transcription

1 Factors Influencing Economic Value Added in the Selected Sector of the Industry Drahomira Pavelkova Adriana Knapkova Tomas Bata University, Czech Republic Abstract Economic Value Added (EVA) as an indicator of new created value for the owners of the company is an important success criterion of companies activities. The goal of the study is to identify factors influencing the creation of EVA. The sources of the EVA creation will be identified on the basis of comparing companies operating in the plastic processing industry in different geographical regions. Some differences in the EVA of the investigated regions could be correlated to technological level, creativity of management and financial ratios. Background One of the tasks of today s economists is to find an indicator that would describe a company s performance in relation to the shareholders. A possible way is to use Economic Value Added (EVA). It is a quantity indicating whether the operating profit is high enough compared to the total costs of capital employed. The idea behind Economic Value Added is that shareholders must earn a return that compensates the risk taken. The ability of a company to compete can be evaluated by several aspects. Besides the components of the company strategy it is necessary to assess the potential of the enterprise as a sum of its possibilities and abilities. The goal of a company is to satisfy all its stakeholders. The stakeholders, i.e. all who participate in some way in the activities of an enterprise are the suppliers of the capital (owners and creditors), managers, employees, suppliers, customers, the government etc. Each subject that is in some way associated with the given enterprise evaluates its success by the yield of its investment into the enterprise and compares it to alternative investments. The entrepreneur, which has an idea and to realize it, is unique. He uses the resources from the capital market, the workforce market etc. He obtains these resources for a market price. Only after the obligations to other stakeholders are met, there is a residual value belonging to the owners. Thus the owners carry the greatest risk, therefore they also demand a corresponding return. This return should at least equal to the return from an alternative investment with equal risk level. The ultimate goal of an enterprise is the maximization of the market share value (Copeland - Koller - Murrin, 1996, Pertl Zederbauer, 1997, Neumaierová, 1998) for the owners. Therefore, it is necessary to attain satisfactory capital returns at a permanently favorable liquidity and preservation of a long-term existence (an effort of assuring the long-term expansion of the enterprise). A long-term financial stability of a company is then assured by a correct structure of financial resources (an optimum ratio of the equity and the capital provided by others) and by the selection of the most favorable financial resources as well as by a proper allocation of financial resources, i.e. by the optimum structure of assets. The expression of the long-term goals of an enterprise is by the concept of the Economic Value Added EVA (Stewart - Bennet, 1993), defined in the following fashion: EVA = (ROE r e ). E (1) where: ROE = return-on-equity r e = cost of equity E = equity When expressing the situation from the aspect of the total capital investment (from all suppliers of capital), the expression becomes: 1210

2 EVA = (1 T) (WACC. C) (2) where: = Net operating profit T = Tax rate WACC = Weighted average cost of capital C = + bearing debt The essence of the indicator EVA is that the amount of the economic profit differs from the amount of profit shown by accounting methods. In the profit obtained by accounting the costs of the capital provided by others are included, but not the costs of the equity. This is not determined by an accurate measure, such as an interest rate, but must be estimated. It is affected by a variety of factors, such as the risk of the given enterprise, bank interest rate, returns of risk-free investments etc. Since 1997 the Economic Value Added concept has been applied officially in the Czech Republic for financial evaluation analysis of the domestic industry as well. When analyzing the method of calculation of the Economic Value Added, we can see factors that could positively influence the performance of the enterprise and the growth of its market value. These are mainly the amount of the operating profit, the amount and structure of the used assets and capital and the amount of costs of the used capital. The amount of operating profit is given by the amount of receipts and operating expenses. The amount of sales is related to the volume of realized production and by the price of that production. The amount of operating expenses depends on the type and level of manufacturing process and on the ability to use the available manufacturing effectively. Companies increase their ability to compete as long as they create a sufficient space between the price of the product and the variable manufacturing costs and in the total of its activities attain profit. The amount of the used capital corresponds to the total value of the company assets. The ratio of attained sales and the assets available to the enterprise is important. If the assets do not create a sufficient amount of sales, it is not used effectively and this fact can have an unfavorable effect on the amount of operating profit (the value of operating profit is reduced and so is EVA) and at the same time a high amount of capital is required for covering these assets (again negative effect on EVA). The structure and the rate of turnover of the components of the assets, such as fixed assets, inventory, receivables and financial assets are important. Long turnover times generally cause high expenses and lost profits. Because in the formula for the calculation of EVA only interest-bearing capital is used, it is important to analyze its allocation in assets. As long as it is a long-term capital, it should cover the fixed assets and the part of current assets (the part which is permanently located in the company). This creates working capital for the company. Low working capital may cause liquidity problem, a too high coverage of the current assets by the long-term capital may be too expensive. The amount of capital expenses available to the company relates to the structure of this capital, i.e. to the ratio of the equity and the capital from other sources that carry certain expenses. The amount of capital expenses depends on the possibility of the company to obtain the capital and on the effectiveness and the risk of business activities of individual companies. Companies with high rating usually obtain capital at lower costs or can obtain it easier and at lower cost on international financial markets (it is possible to take advantage of different interest rates and taxation in different countries). A company can enter international financial markets either independently or as a part of existing multinational corporations. Companies operating in different areas of business have different asset and capital structures that depend on the type of business. Their structures of returns, of costs and profitability are also different. Currently companies carry different degree of risk in ventures and finances and consequently also different opportunity costs, i.e. different costs of equity (r e ). These costs can be expressed (in ) as the sum of the risk-free interest rate of the given capital markets and risk surcharges (for the venture risk, for the reduced liquidity of assets, for financial structure and for financial stability) or can be calculated by the Dividend Model or the Capital Pricing Model. The next part of this contribution will focus on the companies in the plastic processing industry. The effects on the formation of Economic Value Added discussed above are demonstrated on a sample of companies from 1211

3 different regions. The companies were selected according to the availability of data and according to their importance within a given region. Characteristics of the Plastic Processing Industry The plastic processing industry has a wide variety of raw materials, processes and final products. Plastics processing facilities are more or less spread in all regions and have certain elements of regional character. In more developed regions fully automated production facilities are predominant that assure a certain independence on the labor cost. In developing economies lower initial investments in plastics manufacturing facilities with higher proportion of labor are more common. Additional significant differences can be seen in the management methods applied. In the more developed regions the sophistication and effectiveness of management is on a higher level, particularly in the area of financial management, marketing and clearly defined concepts of development. The evaluation of the effectiveness of management can be done only indirectly, usually based on results of subjects operating under equal conditions. Here the EVA concept is eminently suitable for the evaluation of managerial effectiveness. The Financial Figures of the Plastic Processing Industry in the USA, Scandinavia and the Czech Republic Table 1 and 2 contain financial ratios from companies in the Czech Republic. At the same time, this table also shows the comparison of effectiveness of the plastics industry to that of the industry overall. Figures 1 and 2 demonstrate the difference between the companies generating Economic Value Added (ROE>r e ) and those that cannot. Companies that cannot create a positive value of EVA can be further divided into those that attain profitability of equity (ROE) lower than the opportunity costs (r e ), but at the same time their ROE is higher than the risk-free interest rate (r f ) of the given capital markets. Companies in regions where this rate is lower do not need to attain such a high profitability. Other group is represented by companies with a ROE that is positive, but lower than riskfree interest rate. The last group includes companies operating with losses. The plastics industry in the Czech Republic grows faster than the average growth of the Czech industry in general. In spite of the dynamic growth of the main production characteristics it is still lagging behind the state of the art in developed industrial countries. The industry is greatly dependent on the economic cycles of the world commodity markets and mainly on the price of crude oil. The weaknesses of this industry are particularly low proportion of products with a high value added, relatively slow response to market demands and a low degree of specialization. In the framework of economic research Inka and Ivan Neumaier have developed the INFA model (Neumaierová, 1998). The model enables a breakdown of return on equity and basic factors contributing to its level, including their mutual interdependencies. At the same time the INFA model enables quantification and analysis of Economic Value Added. Table 1: SELECTED FACTORS AFFECTING THE FORMATION OF EVA. COMPARISON OF VALUES OF THE FACTORS AND EVA IN THE INDUSTRY OVERALL, PLASTICS INDUSTRY AND SELECTED COMPANIES IN THE PLASTICS INDUSTRY IN THE CZECH REPUBLIC IN 1999 in thous. USD No. of per th.usd / / / EAT/ Current Quick Cash Position Inter. Covera ge Industry 22,669, * * Plastic 527,975 * * industry Granitol 8, Strojplast 2, TIÚ-Plast 2, Gumotex 19,

4 Loffler 4, Kunststoff werk 1) EuWeEugen 4, * Wexler CR 1) Pipelife- 6, Fatra 2) Dura-line CT 3) 3, ) 100 of the base capital belongs to a foreign investor 2) Two thirds of the base capital belongs to a foreign investor 3) 75 of the base capital belongs to a foreign investor * Data - not available Table 1, continued /assets Long-term Capital/Fixed Depreciation/ Material/ Labour / / Industry No, Plastic industry No, r e >ROE> r f Granitol No, Strojplast No, TIÚ-Plast No, Gumotex No, LofflerKunstst offwerk 1) Yes, * Yes, ROE>r e EuWe Eugen Wexler CR 1) ROE>r e Pipelife-Fatra ROE=r e (EVA=0) Dura-line CT Yes, ROE>r e Sources of the primary data: Ministry of Industry and Trade, Czech Republic; Albertina data s.r.o.- Firm Monitor 2001; Aspekt kilcullen 2002 Table 2: SELECTED FACTORS AFFECTING THE FORMATION OF EVA. COMPARISON OF VALUES OF THE FACTORS AND EVA IN THE INDUSTRY OVERALL, PLASTICS INDUSTRY AND SELECTED COMPANIES IN THE PLASTICS INDUSTRY IN THE CZECH REPUBLIC IN 2000 in thous. USD No. of per thous.u SD / /sales / EAT/ Current ROE Quick r e EVA Cash Position Inter.C overag e Industry 22,275,36 * * Plastic industry 560,711 * * Granitol 8,

5 Strojplast 2, TIÚ Plast 2, Gumotex 18, Loffler 5, * Kunststoff Werk 1) EuWe Eugen Wexler CR 1) 5,289 * * * 1) 100 of the base capital belongs to a foreign investor * Data - not available Table 2, continued Long-term /assets Capital/Fixed Depreciation/ Material/ Labour / / Industry No, Plastic industry Yes, ROE>r e Granitol No, Strojplast No, TIÚ-Plast 65, No, r e >ROE> r f Gumotex No, Loffler Kunststoff werk 1) EuWe Eugen * Yes, ROE>r e Wexler CR 1) ROE>r e * Yes, Sources of the primary data: Ministry of Industry and Trade, Czech Republic; Albertina data s.r.o.-firm Monitor 2001; Aspekt kilcullen 2002 ROE r e EVA 1214

6 ROE>r e 2. r e >ROE>r f ROE<0 0 plastic industry industry Fig 1: COMPARISON OF COMPANIES IN THE INDUSTRY OVERALL AND PLASTIC INDUSTRY IN THE CZECH REPUBLIC BY THE FORMATION OF EVA IN AND BY SHARE OF TOTAL RETURNS (Source: Ministry of Industry and Trade, Czech Republic) ROE>r e 2. r e >ROE>r f ROE<0 0 plastic industry industry Fig 2: COMPARISON OF COMPANIES IN THE INDUSTRY OVERALL AND PLASTIC INDUSTRY IN THE CZECH REPUBLIC BY THE FORMATION OF EVA IN AND BY SHARE OF TOTAL NUMBER OF COMPANIES (Source: Ministry of Industry and Trade, Czech Republic) 1215

7 A breakdown of individual factors influencing year-on-year changes in EVA ( ) for Czech industry and plastic processing industry is presented in the following schematic part. Industry and plastic industry Economic value added - breakdown of year-on-year change EVA Indicator Indicator Industry Plastic industry ROE - r e x -14,89-7, ,29 0, ROE - r e 0,97 4,96 15,86 12,59 12,74 11,24 14,03 11,03 Net profit ROE = Pretax profit ROA paid Loans + Debent. 1 Loans + Debent. Ext.res. + Oth.liab. ROA Net profit/pretax profit / paid / 0,0423 0,0601 0,2224 0,5567 0,4686 0,4688 (Loans+Debentures) 0, ,6100 0,6019 0,6754 0,5270 0, ,73 9,87 12,79 8,80 (Loans+Debentures) / (External resources + / * / Other liabilities) 0,0427 0,0555 0,9910 1, ,23 34,97 0,0875 0,0754 1,4571 1,4909 0,28 0,37 In 2000 the sharp increase of return on equity and decline of alternative cost of capital were reflected in an improvement of Economic Value Added. The improvement of the financial situation of enterprises was reflected in increased return on equity by 4 points to 5 in total industry. A positive effect was exerted by the following factors: - growth of net profit to profit before tax as a result of increased number of profitable organisations and of their profit on one side, and of decrease of loss volume and of number of loss making organisation on the other, 1216

8 - decline of share of resources subject to payment in assets, - decline of costs of external resources subject to payment. Results of the financial analysis confirmed an year-on-year improvement of the financial situation, particularly of total industry. Conversely, in plastic industry, return on equity went down 1,5 points to 11,2. A negative effect was exerted by the following factors: - increase of share of resources subject to payment in assets, - decline of the indicator of /sales. The sample of plastic processing companies operating in the Czech Republic consists of both local companies with Czech or foreign owners and of companies, which are part of multinational corporations. The companies operating in the USA or having at least the headquarters in the USA are shown in Table 3 and 4 and Scandinavian companies in Table 5 and 6 (since Scandinavian companies are privately held ones and these companies management have requested no publication of their names, they are represented by numbers). Table 3: SELECTED FACTORS AFFECTING THE FORMATION OF EVA. COMPARISON OF VALUES OF THE FACTORS AND EVA IN SELECTED COMPANIES IN THE PLASTICS INDUSTRY IN THE USA IN 1999 in thous.usd No. of per in thous.usd / / / EAT/ Current Quick Cash Position Coverage Carlisle 478,133 10, DuPont 13,299,000 94, ,46 8,27 0,66 28,57 1,64 0,88 0,19 4,16 3M 6,289,000 70, Dana Co. 13,289 84, Table 3, continued /assets Long-term Capital/Fixed Depreciation / expenses/ sales Carlisle Yes, ROE>r e DuPont 31,57 0,69 6,28 1,99 5,97 8 No, r e >ROE>r f 3M Yes, ROE>r e Dana Co Yes, ROE>r e Source of the primary data: Companies Annual Reports available on the websites Table 4: SELECTED FACTORS AFFECTING THE FORMATION OF EVA. COMPARISON OF VALUES OF THE FACTORS AND EVA IN SELECTED COMPANIES IN THE PLASTICS INDUSTRY IN THE USA IN 2000 in thous.usd No. of per in thous.usd / / / EAT/ ROE Current r e Quick EVA Cash Position Coverage Carlisle 547,879 10, ,70 10,10 1,36 5,43 1,77 0,79 0,03 6,38 DuPont 12,875,000 93, M 6,631,000 75, Dana Co. 2,628,000 * * PolyOne 827,600 9, * Data - not available 1217

9 Table 4, continued /assets Long-term Capital/Fixed Depreciation / expenses/ sales Carlisle * Yes, ROE>r e DuPont Yes, ROE>r e 3M Yes, ROE>r e Dana Co Yes, ROE>r e PolyOne No, Source of the primary data: Companies Annual Reports available on the websites Table 5: SELECTED FACTORS AFFECTING THE FORMATION OF EVA. COMPARISON OF VALUES OF THE FACTORS AND EVA IN SELECTED COMPANIES IN THE PLASTICS INDUSTRY IN SCANDINAVIA IN 1999 (thous. USD) No. of Emplo yees per thous.usd / / / ROE EAT/ r e Current Quick EVA Cash Position Coverage No.1 2, No.2 12, No.3 4, No.4 3, No.5 2, No No.7 1, No.8 5, No.9 12, Table 5, continued /assets Long-term Capital/Fixed Depreciation/ Material/ Labour / expenses/ No Yes, ROE>r e No Yes, ROE>r e No Yes, ROE>r e No No, No No, No No, ROE<0 No Yes, ROE>r e No ROE=r e (EVA=0) No Yes, ROE>r e Source of the primary data: Companies Annual Reports ROE r e EVA 1218

10 Table 6: SELECTED FACTORS AFFECTING THE FORMATION OF EVA. COMPARISON OF VALUES OF THE FACTORS AND EVA IN SELECTED COMPANIES IN THE PLASTICS INDUSTRY IN SCANDINAVIA IN 2000 (thous. USD) No. of Emplo yees per thous.usd / / / EAT/ Current Quick Cash Position Coverage No.1 2, ,81 0,74 2,45 0,15 2,12 1,23 0,004 1,08 No.2 15, ,94 6,67 1, ,87 0, ,11 No.3 6, ,47 12, , ,37 0,35 632,28 No.4 No.5 3, , ,6 4, , ,71 No , , ,93 1,40 0,19-0,59 No.7 1, ,31 1,78 2, ,99 0,005 4,01 No.8 5, ,31 6,44 1,45 4,82 1,32 0,90 0,07 11,81 No.9 18, ,38 5,12 1, ,98 0,53 0,03 10,75 Table 6, continued /assets Long-term Capital/Fixed Depreciation/ Material/ Labour / expenses/ No.1 28,28 2,55 2,68 69,56 17,5 0,69 1,26 19 No, No.2 53,12 0, ,36 19,37 0,94 18,31 10 Yes, ROE>r e No.3 46,63 1,26 7,00 46,76 33,35 0,02 21,95 9 Yes, ROE>r e No.4 No.5 22, ,44 58,88 30,85 0,52 35,18 10 Yes, ROE>r e No.6 3, ,90 61,16 28,41 2,78-1,85 30 No, ROE<0 No.7 22,80 1,82 3,58 44,90 34,17 0,82 19,41 10 Yes, ROE>r e No.8 49, ,20 51,38 22,17 0,55 14,15 10 Yes, ROE>r e No.9 35, ,75 46,79 25,13 0,48 11,21 8 Yes, ROE>r e Source of the primary data: Companies Annual Reports By comparing their economic results it is possible to see factors that positively affect the formation of the Economic Value Added. The following relations can be applied: ROE r e EVA ROE = EAT = EAT (3) ROA = = (4) This means that the profitability of the equity increases as long as the company increases the profit margin, improves utilization of assets and increases debt. However, greater debt contributes to the increase of the return-onequity only as long as the profitability of the invested capital is higher than the interest rate at which the company borrows money from creditors. On the other hand, as long as a company increases its debt, it can result in reduced liquidity and in an increase in surcharge for the financial structure (low interest coverage in Strojplast, Granitol, Gumotex, TIÚ-Plast - in 1999, No.4, 5 and 6, PolyOne) and financial stability (low liquidity ratios in Strojpast, Gumotex, No. 2). Higher debt brings about higher interest expenses and consequently a reduction of profits after deduction of interest expenses. A high coverage of long-term assets by the long-term capital brings about financial 1219

11 stability but, on the other hand, reduces profitability of the company; long-term capital is usually more expensive than short-term capital (No.1, Carlisle). In the sample of companies that was analyzed it is evident that in companies that do not generate EVA the main problem is a small profit margin or possibly high costs of capital. These high costs of equity (r e ) are in this sample, mainly in the Czech Republic caused among other things by a higher risk-free interest rate and, in the Czech Republic and Scandinavia smaller company size (higher risk surcharge for the reduced liquidity of assets). In other cases the risk surcharge increases due to a financial instability as was mentioned above. When comparing the structure of expenses, the labour costs in the Czech Republic are clearly lower than in northern Europe, but there is a higher ratio of costs of material, energy and services to sales. At the same time, in the sample from the Czech Republic it can be seen that companies with foreign investors have markedly better economic results. The participation of foreign investors opens the possibility of a better utilization of markets, less expensive and more accessible capital and, what is even more important, the access to know-how and to modern management methods. The sample of companies operating in the USA represent large multinational corporations (MNC), which carry only a minor risk of nonliquidity of the shares. These companies can also profit from the possibility to diversify the portfolio of their products and territories where they operate. They stand out by a higher productivity (measured by sales per employee) when compared with other companies. All MNCs mentioned here attain, based on the consolidated financial statements, positive values of EVA (except PolyOne due to mainly very low profit margin in 2000.) Conclusion The evaluation of selected plastics companies by means of the EVA concept has shown that there are differences between developing regions and regions with developed market economies, but also between individual companies. Technical and technological level of the companies may be comparable, however the conclusion is that a higher managerial creativity, mainly increased ability to accept and apply advanced management method are the main factors for the creation of EVA. 1220

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