Financial Analysis of Morgan Advanced Materials

Morgan Advanced Materials is a manufacturing company that is located in the United Kingdom. The company has 85 sites with operations in more than 30 countries specializing in specialist products by utilizing composites, advanced ceramics and carbon (Halfords, 2014). As a result, the company has built a reputation of building world class engineering products for the customers. The industrial products for the company are in major categories which include technical ceramics, seals and bearings, thermal ceramics, molten metal systems and electrical carbon. In 2017, the company managed to generate global sales of worth £1,021.5m being one of the first global manufacturing companies to enter the billion-revenue bracket by selling to 100 countries with approximately 8,000 employees.

Moreover, the products of the company is utilized by the different sectors such as healthcare, electronics, energy, security and defence, petrochemicals, transportation and industrial. Transportation contributed to 20% of the total revenue through the manufacture of high performance products for the aerospace and automotive sectors. Petrochemical industry contributed to 8% of the revenue earned in 2017. Hence the financial report will focus on analysing the performance of the company using financial ratios. The ratios under focus will be the profitability ratios and the liquidity ratios. Moreover, the report will again focus on the financial appraisal of the opportunity that Morgan Advanced Materials worth £30,000,000 and whether the management should pursue the opportunity. Based on the findings of the report, the recommendation will be given on whether the organization should proceed with the investment or not. Hence the key objective of the report is to provide the management with insightful information on the performance of Morgan Advanced Materials, whether they should invest in the potential opportunity and the analysis of the effects of a merger to the operations of the company.

Financial Performance and Evaluation

Financial performance and evaluation plays a critical role in providing insights to the management team on whether they are progressing or not (Wild, 2008). As a result, in order to rise against the competition, the organization should invest in projects that will differentiate them from the competition (Porter, 2008). Moreover, the strategic choices by the management team should aim at ensuring that the organization maximizes on the revenues while minimizing on the costs. Hence the results given by the analysis will give crucial insights to the management team of Morgan Advanced Materials on whether the company is headed in the right direction. Financial ratios give the situation of the company in terms of the liquidity and profitability position of the company (Mclaney & Atrill, 2002). However, despite the fact that ratios ignore the environmental and economic conditions, the management team should validate the results that they obtain (Watson & Head, 2016). For the analysis of Morgan Advanced Materials liquidity and profitability ratios have been analysed.

2.1 Profitability Ratio

Profitability ratios focus on the company’s ability to generate income. All companies that are in business strive towards being profitable. As a result, the profitability ratios measure whether the firm’s assets are being utilized efficiently to generate income. Weygandt et al. (2002) emphasizes that the ratios are also vital in measuring whether the company’s income is growing or not. Hence the analysis for the organization will focus on the gross margin ratio, operating margin, return on assets and the return on equity.

2.1.1 Gross Margin

Gross Margin as a ratio analyses what is retained by the company from each dollar of sales. As one of the largest manufacturing companies, it would be key to analyse how much Morgan Advanced Materials retains based on their sales

The gross margin is computed: Gross Profit / Revenue X 100%

(Bamber & Parry, 2014).

2.1.2 Operating Margin

By calculating the ratio, the management of Morgan Advanced Materials will determine how much revenue is retained by the company once the operating expenses and cost of goods sold are deducted.

The formula for the ratio is: Operating Income / Net Sales X 100%

(Bamber & Parry, 2014).

2.1.3 Return on Equity

Morgan Advanced Materials investors will be interested to know the ratio of the return that they get based on their capital investment.

Return on Equity is calculated by: Net Income / Shareholder’s Equity X 100%

(Atrill & McLaney, 2015).

2.1.4 Return on Asset

The management is always keen to determine whether the assets invested in the business generate the targeted income required. The ratio provides the insight.

Return on Asset is calculated by: Net Income / Total Assets X 100%

(Atrill & McLaney, 2015).

2.2 Liquidity Ratio

Liquidity ratio usually assess the ability of the company to pay their short-term liabilities as and when they arise. Hence the liquidity ratios measure the strength of the company’s ability (Tarun, 2005) to meet these short-term obligations. Morgan Advanced Materials operates in the manufacturing segment and in most cases, they may require short-term facilities to cover any operational needs that they have. Hence the liquidity ratios assess whether Morgan Advanced Materials will meet their short-term obligations when they arise. The ratios under analysis include the current ratio, quick ratio, financial leverage and the debt to equity ratio.

2.2.1 Current Ratio

The company’s ability to pay their short term and long-term obligation is measured by the current ratio. The desired ratio is always for the assets to be twice as much as the liability.

Thus, Current Ratio = Current Assets / Current Liabilities

(Atrill & McLaney, 2015)

2.2.2 Quick Ratio

The quick ratio aims at determining whether the company still has the capacity to cover its liabilities while excluding the inventories. Hence the position is more reliable compared to the current ratio

Thus, Acid Test = (Current Assets – Inventories) / Current Liabilities

(Atrill & McLaney, 2015)

2.2.3 Financial Leverage

Financial leverage assesses the capital structure of the company to determine the proportions to assign to debt and equity. Ideally Morgan Advanced Materials should have a lower leverage ratio

Thus, Financial Leverage = Total Debt / Total Assets

(Atrill & McLaney, 2015)

2.2.4 Debt to Equity Ratio

The ratio provides an overview on the proportion of debt and equity which has been used to finance the operations of the company. Ideally, Morgan Advanced Materials should have a lower ratio

Thus, Debt to Equity Ratio = Total Liabilities / Stockholder’s Equity

(Atrill & McLaney, 2015)

2.3 Evaluation of Morgan Advanced Profitability and Liquidity Ratios

2.3.1 Analysis of the Gross Profit Margin of Morgan Advanced Materials

The gross margin for Morgan Advanced Materials has been growing which is an indicator that the company’s profitability has been rising. The huge contributor of the growth has been the revenue which has been growing steadily. The turnover in 2013 was £958,000,000 which later dropped in 2014 and 2015 but there was an increase of 3.2% of the sales to £989,000,000 and last year the revenue hit a billion with the company recording £1,022,000,000. As a result, there was a stable growth of 57% to 60% over the five years.

2.3.2 Analysis of the return of Capital for Morgan Advanced Materials

ROE is useful in comparing the profitability of the company in relation to the shareholder’s equity invested. The shareholders are normally very keen in ensuring that they get the maximum return based on their investment according to Bamber & Parry (2014). In 2013, the shareholders employed £238 million since during that period Morgan Advanced Materials was undergoing through rapid expansion and there was need for additional investment of the technology which was to be used. Hence through the years the shareholders equity has been declining due to cash out by some of the investors or in other cases where the other investors chose to convert the equity to capital. Currently in 2017, there was an additional capital invested of £74 million due to the need of the company to invest in additional products such as the electric carbon and the molten metal systems. Hence from 2014 after the expansion of the company operations the investors have enjoyed a growth in the return of equity from 20% to 60% which has encouraged some of the shareholders to inject additional capital.

2.3.3 Analysis of the Current Ratio of Morgan Advanced Materials

Morgan Advanced Materials is in a healthy financial position since their average current ratio is at 1.5. As a result, for every £1 of liability there is a £1.5 asset to cover the liability which signifies the ability of the company to cover their short-term liabilities. If the ratio was at 1, it would translate to the fact that the company’s assets would match the company’s liabilities (Hermanson, et al., 1989). The sharp decline that the company had in their liquidity ratio was in 2016 when the ratio dropped to 1.2 since the company took a huge proportion of the short-term liabilities to cover for the production of the Braze Alloys whose demand has increased. However, when the money was later recovered in the sales, the ratio later stabilised in 2017 at the average of 1.5.

2.3.4 Limitations of Financial Ratios:

According to Halkos et al., (2004) most of the large corporations operate in different industries and hence the financial ratios may not provide a solid basis for analysis of the performance of the company. Moreover, external factors may also negatively influence the performance of the company such as inflation and foreign exchange fluctuations and hence the ratios may not correctly predict the performance of the company.

3.0 Appraisal of Investment Opportunity

For Morgan Advanced Materials to experience growth, the management needs to ensure that they invest in projects which will yield the company adequate return. Dixit et al. (1994) emphasizes that before investing in any venture, companies need to ensure that they evaluate the potential return which the projects are likely to yield over a time. As a result, even for the case of Morgan Advanced Materials they need to assess the level of return that the investment will yield and whether it is in line with the revenue objectives of the company.

Frankly (2000) emphasizes that during the appraisal process, adequate data relating to the investment needs to be captured to enhance effective decision making. Moreover, there are techniques which were developed to ensure that organizations can evaluate an investment before they make the decision. The key techniques used to analyze a potential investment mainly include the Internal Rate of Return and Net Present Value

3.1 Net Present Value

The investment that Morgan Advanced Materials will chose to engage in needs to generate both inflows and outflows. Hence, Net Present Value provides a basis that for every investment that the organization engages in yields the return that exceeds the investment. Hence Peel et al. (1998) advises that organizations should only invest in projects where the cash inflows outweigh the cash outflows.

Thus: NPV= FV1/(1+r)1 + FV2 /(1+r)2+ FV3/ (1+r)3+ FVn / (1+r) n - I0

Where FV = investment’s future value

n = investment duration in years

r = available rate of return on risk security equivalent in marketplace

I0 = initial investment

(Geddes, 2002)

3.2 Internal Rate of Return:

Internal Rate of Return evaluates an investment while it is being benchmarked at zero. As a result, Cooper (1999) emphasizes that internal rate of return evaluates that an investment is worth considering when the net present value of all the cashflows of the investment should be equal to zero. Moreover, the technique compliments the NPV evaluation method but does not consider other external factors such as inflation and the cost of capital (Rohrich, 2007).

Thus:

IRR = A% + NPV at A% x (B% - A%)/ (NPV at A% - NPV at B%)

Where: NPV = Net Present Value

A% = the lower discount rate

B% = the higher discount rate

(Geddes, 2002)

3.3 Net Present Value Computation for Morgan Advanced Materials

The management of Morgan Advanced Materials used the £30 million to invest in the technology that would enhance the production of their Ceramics products. As a result, over 10 years, the return of the different investments will be as shown below;

The technology will enable Morgan Advanced Materials to produce Ceramics which will enable the company to earn £8,000,000 in the first year based on the number of Ceramics which will be sold. Additionally, the capacity of the technology is expected to reduce by 50 units every year due to depreciation. Hence the computation was done at 15% interest rate and a positive net present value was determined. Hence due to the high returns Drury (2008) emphasizes that with an investment which yields a positive net present value of the investment should be considered by the management. Hence the management of Morgan Advanced Materials should consider investing in the technology of producing the Ceramics. Moreover, the internal rate of return will validate the figures.

3.4 Internal Rate of Return Computation for Morgan Advanced Materials

Net Present Value A = £4,399,00.15

Net Present Value B = (£828,499.80)

Therefore, the IRR on this investment is 18.5%.

The above IRR computation has even provided more insight on the evaluation. Hence, since the return of the investment at 18.5% is greater than the required return of 15%, the management of Morgan Advanced Materials can proceed with investing in the technology to produce the Ceramics.

3.5 Likely Consequence of the Investment on Morgan Advanced Materials

The implication of investing £30,000,000 in the technology of producing more Ceramics will position Morgan Advanced Materials in the market as a key player in the industry. Moreover, they will be able to increase their market share since with the increased production capacity of the ceramics, they will be able to capture more customers. Moreover, the revenue, over the ten years, for the company will increase by £4,399,000 which will enable the shareholders get a return on their investment. In addition, the asset base of the company will grow by investing in the project. (Osiris, 2018).

3.6 Uncertainty and Risk in Appraising Investments

One of the key risks that the company is likely to face is that when implementing the investment, there may be a variance between the projected revenue and the actual revenue. Lumby (1994) addresses the fact that most of the investment appraising techniques do not factor in the environmental and economic factors such as inflation and even fluctuation in the foreign exchange market which may influence the revenue that the investment may generate.

3.7 Recommendation

Based on the findings of the appraisals, Morgan Advanced materials should proceed with the investment. However, continuous appraisal should be conducted especially in line with some of the environmental factors to ensure that the investment that the company is engaging in will generate revenue to the company despite the economic shocks that they may face.

4.0 Potential Acquisition and Acquisition by Morgan Advanced Materials

The company that would suit Morgan Advanced Materials for a acquisition would be General Electric. The company, which is a limited liability company is located in Boston in the United States (BBC, 2010). The company also specializes in different sectors such as power, lighting, healthcare, digital, capital and aviation, transportation and aviation. Hence by acquiring the company there would be synergy in their operations and they would take 80% of the market.

Asset base of General Electric

4.1 Rationale and Gains of Choosing General Electric

The main intention of Morgan Advanced Materials to acquire the stake in General Electric is to increase synergy by becoming the largest manufacturing entity in the world by controlling 80% of the market share. Acquisitions and acquisitions ensure that the organization grow in their industry (Straub, 2007). Moreover, the reports indicate that General Electric has been looking to merge to control the market and hence Morgan Advanced Materials stands a good chance of completing the transaction (Yang,2017).

4.2 Financing Options for Morgan Advanced Materials

4.2.1 Offer shares on the London Stock Exchange

Morgan Advanced Materials, as a liability company can take advantage of the opportunity to raise capital by selling some of the stake to the members of the public. Through this means of raising funds the company will be in a position to raise the required value of the investment.

4.2.2 Long-term Loan Financing

Through their revenue of £1,022,000,000,000, the company can easily convince the largest banks to give them access to financing. Through the long-term loan the company will be in a position to raise the required capital for financing the acquisition.

4.2.3 Quasi-Equity Debt

The option of quasi-equity allows organizations to trade their shareholding for debt used to acquire the company (Bugg-Levine et al., 2012). Through the method the company can sell some of the stock to General Electric as a method of fund raising.

4.3 Challenges of the Acquisition

4.3.1 Control Issues

Since Morgan Advanced Materials will be acquiring an organization that is robust and well established, there will be challenges on the restructuring of the organization once the power has been handed over. Acquisitions normally have a lot of challenges of harmonizing the power centres (DeYoung et al., 2009)

4.3.2 Branding Challenges

Companies that operate in the same sector normally experience the challenge of maintaining their brand visibility (Das et al., 2009) The companies produce the same products for the same sectors. As a result, there will be a challenge on which of the products should be continued for production and which ones should be discontinued.

4.4 Risk and Uncertainties

For every acquisition truncation, there are normally uncertainties that the management team experiences which may pose a challenge to the successful execution of the project.

4.4.1 Complexity of harmonising operations

Canada (2014) emphasizes that organizations normally have a challenge of harmonising operations once the transaction for the acquisition is completed. Hence, it is critical that the board members conduct the process seamlessly.

4.4.2 Loss of Identity

The company also stands the risk of focusing too much on the acquisition that they may lose their brand identity and focus, and this may negatively affect their operations

4.5 Implication of the Acquisition on the Performance of Morgan Advanced Materials

Morgan Advanced Materials stands a chance of increasing their market share by 80% once they are able to lock down the acquisition. Moreover, the company predicts that their revenue will grow by 20% which will enable them to expand their operations to more countries such as areas in the Middle East, Africa and Asia.

Conclusion

In conclusion, the report has provided the investment overview for Morgan Advanced Materials. Moreover, the first part of the report focused on the description of the company. The second part of the report analysed the financial position of the report with a focus on the liquidity and profitability ratios which revealed that the company is performing well from a financial perspective. The financial statements of the company were obtained from www.osiris.com. Furthermore, the company also evaluated the potential of the investment by conducting the IRR and NPV analysis. The results revealed that the company should undertake the investment. Finally the report analysed the possible acquisition of General Electric and the implications of the acquisition in terms of financing, benefits and risks.

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