Financial Analysis of HAYS plc
Hay plc is a recruitment services company. According to its 2004 annual report ‘Hays provides specialist recruitment services for clients and candidates requiring permanent and temporary, professional and technical staff’ (Hays, 2004).
For the year ended 30 June, 2004, Hays had £530.2m of assets on its balance sheet, made up of £137.9m of fixed assets and £392.3m of current assets. Appendix 1 gives a summary of Hays consolidated balance sheet. Hays has £323.5m of current liabilities and hence £68.8m of net current assets. Total assets less current liabilities of £206.7m are being financed through long-term creditors, provisions and shareholders funds.
The company has only £0.1m of long-term bank loan. The company has long term other creditors of £6.7m which represents the amount due for the acquisitions made by it. The company has also £125.4m of provision for liabilities and charges relating mainly due to pensions (£10.6m), deferred taxation (£17.1m), property (£34.9m) and other (£42.3m).
These provisions are being financed through internal accruals. The company has taken money out of profit and loss account and put it into provisions for items that it think it may have to pay in future.
The book value of shareholders funds is £74.5m. If Hays doesn’t have provisions that shareholders funds would increase by £125.4m and would instead be £199.9m.
Hays has £79.4m of cash at bank and in hand. The total short and long term bank borrowings and overdraft are only £2m, less than 0.4% of total assets. The company as net debt of -£77.4m and so the gearing ratio is zero.
Cash flow statement shows that Hays financing moved away from debt towards equity and internal accruals. Hays plc almost completely reduced its debt in 2004. During the year ended 30 June 2004, the company reduced its borrowings from £400.4m (£196.7m + £203.7m) to £2m only, a reduction of £398.4m. This was achieved by repaying £306m of long term borrowings and £39.9m of short term borrowings. The company also disposed some of its businesses and that further reduced its debt by £44.9m.
The reduction in debt was financed mainly by sale of some of its businesses in the year. The net cash due to disposal of business was £334.7m (352.9-18.2). The debt repayment was also helped by £18m increase in cash before acquisitions and disposals. Hays also issued £0.6m of ordinary shares and disposed off another £1.4m of its shares.
Hays has very less debts, £2.0m in short and long term bank borrowings. Most of the financing, £199.9m were being financed by shareholder funds and internal accruals in terms of provisions.
Equity financing is much more costlier than debt financing, especially when company debt levels are no where near bankruptcy. Hays could use more debt at a lower cost and return the costlier capital to shareholders. The company had higher debts in 2003. But it sold some businesses in 2004 and used the cash to retire almost all of debt.
Returning capital to shareholder by taking more debt would decrease shareholders funds and increase interest costs. Higher interest costs would reduce tax costs, reducing net interest costs. But the consequent decrease in shareholders funds mean that the returns on capital will increase significantly.
Earnings per share
Only once in the last five years did basic earnings per share increase. Over the five year period, basic earnings per share have dropped by 50 %. From 2000 to 2002, basic earnings per share decreased gradually from 7.7p to 4.82p. Then it drops significantly to -28.39p. This is mainly due to a very high exceptional charge of £490m. Exceptional charge relates to goodwill written off from acquired businesses of £442.8m and restructuring charges of £47.2m.
This is a better reflection of earnings as goodwill amortisation is a non-cash charge. Earnings per share before goodwill amortisation and exceptional items also declines over the five year period but the fluctuations in it are much less than in basic earnings per share. While basic earnings per share was hugely negative in one year, earnings before goodwill amortisation and exceptional items were positive in all five years.
Five year dividend policy
In the five year period from 2000 to 2004, dividend increases in the first three years and decreases only in the last year. In the first three years from 2001 to 2003, dividend increase each year by 15%. Only in the last year, dividend decreased by 44 %.
The constant 15 % rise in the first three years of five year period is not consistent with the pattern observed in basic earnings per share, which have declined in all three years. In 2003, basic earnings per share was negative but dividend still increased to 5.38 p.
The contrast growth pattern observed above is also seen when we use earnings before goodwill amortisation and exceptional items. But dividend is still less than earnings before goodwill amortisation.
Companies normally have a dividend policy and most of the companies follow a constant increase policy. Security markets like companies with less uncertainty. By adopting a constant dividend growth policy, companies want to convey the message that business is going well and take this opportunity to assure investors. Hays has also followed this constant growth or progressive dividend policy as stated in its 2004 annual report. ‘The Board intends to follow a progressive dividend policy’ (Hays, 2004).
Hays earnings have declined in most of the five year period. Managers use progressive dividend policy to convey the message that fundamental business is strong and earnings will soon increase. It is assumed that if managers are not sure about business’s fundamentals, they won’t increase dividend and instead would like to conserve cash for future. Any fall in dividend, like the one observed in 2004, indicates that managers now accept tough conditions ahead and this leads to sharp reduction in share prices. So a progressive dividend policy, even at times of adverse conditions, prevents rapid share fall.
PE ratio
Hays plc’s price to earning ratio, as taken from Financial Times, was 38.51 on 9th March 2005 (Financial Times). This multiple is based on a share price of 133 p and an earning per share of 3.45 p. Financial Times website explains that ‘EPS value is taken from the basic or adjusted EPS figure reported directly by the company’ (Financial Times).
Hays Annual Report 2004 has basic earnings per share and diluted earnings per share of 3.87 p and 3.86 p respectively (Hays, 2004). Using a basic earning per share of 3.87 p, the PE ratio for a share price of 133 p is 34.37.
If we look at earning per share before goodwill amortisation, we will see that average in the five years is around 9.23 p. If Hays returns to average performance this year, PE on expected earning would be only 15, which is close to average market PE.
Hays has a progressive dividend policy with 15 % annual growth. 15% is a good growth rate. If Hays increases its dividend by 15 % each year, dividend yield will increase from 2.2% now to 4.0% in 4 years.
Hays plc has a higher PE ratio than the sector. PE ratio in mid-thirties looks to be high. But PE alone is not a complete indicator of value of the stock. High PE ratio means that market is expecting bigger improvements in profits in near future. Last two years had been very volatile for Hays and it had negative earnings in 2003. Market now expects things to improve greatly for Hays.
Also Hays has sold some of its businesses and is now focused on specialist recruitment. Hays Chairman said ‘We disposed of almost all of our non-core businesses and assets during the year and in so doing we believe we achieved good value for our shareholders’ (Hays, 2004 p 6). Market prefers focused companies and rewards them by increasing their PE ratios.
Hays has also reduced its massive debts to almost zero. Hays business model doesn’t need large tangible assets and reduction in debts means less chances of bankruptcy pressures.
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