Brief Of The Company And Industry Overview
The chosen company for this report is Nippon Paint Holdings limited. It was established in the year 1881 with its headquarter in Osaka, Japan. The company is engaged in paint industry. It offers automotive coatings, which include trade-use paints for buildings, homes, bridges and paints for use in bumpers and plastic components. It also offers industrial coatings which are used in exterior building materials, construction and farming machinery, household electrical appliances and office equipment. In addition, the company provides marine coatings such as paint for automobiles refinish, antifouling paints for saving fuel, road surface markings and DIY (Nippon Paint Holdings, 2022). The company operates its business in Japan, Oceania, Asia, the Americas and internationally. Initially, the company was known as Nippon Paint Co., ltd but it has changed to Nippon Paint Holdings Co., Ltd in the year 2014.
The paints and chemical industry have been moderately impacted by the global pandemic. However, the demand for decorative and architectural paint from DIY consumers have increased in the last few months. The performance of Paints and Coating manufacturing industry was volatile in the last five years (IBIS World 2022). New technologies, global consolidation pressures and the sustainability concerns have affected the growth rate of this industry. The industry revenue is expected to grow at a modest rate of 1.7% over the period of next five years. The major competitors of the company in Australia include Dulux Group Limited, Akzo Nobel Coatings (Holdings) Pty Limited, PPG Industries Australia Pty Ltd, and Hempel (Wattyl) Australia Pty Ltd. The main products and services offered within the industry include industrial, automotive and marine coatings; architectural and decorative coatings; inks; fillers, putty and caulking compounds; and wood care and other products. The major activities of the industry include paint or varnish removers manufacturing; paint manufacturing; Lacquers, enamels, shellacs and stains manufacturing; toner manufacturing; ink manufacturing; water repellant coatings manufacturing; and fillers, putty and rubbing compound manufacturing (Coatingsworld 2022).
Usefulness of Capital Structure
The Capital structure of a company indicates how much capital is used for purchasing its assets and funding the operations of the business. The analysis of capital structure is essential as it provides information regarding the over or under capitalization. It enables the organization to maximize the shareholder’s wealth while minimizing the cost of capital (Hirdinis 2019). The optimal capital structure represents the combination of debt and equity which minimizes the cost of capital and maximizes the shareholders wealth (Antill and Grenadier 2019). The main objective of the company is to determine the lowest WACC. The optimal capital structure is designed to maintain the perfect balance between the equity and debt capital (Alabdullah et al. 2018). Maximizing EPS does not always have a positive effect on the capital structure because EPS can be maximized when the optimal capital structure is determined whereas the maximization of value would may result in obstacles which will restrict the company in reaching the optimal capital structure.
Data Analysis
Capital Structure Theory
The traditional theory on capital structure says that there exist a combination of det and equity financing for every company or investment that maximizes the shareholders value and minimizes the weighted average cost of capital (Brusov et al. 2018). This theory reveals that the company will achieve its optimal capital structure when the marginal cost of debt will be equal to the marginal cost of equity. The theory says that if a company uses more debt, its capital structure will increase in size and WACC will decline, which will further result in higher firm value.
Capital Structure Analysis of Nippon Paint Holdings Co. Ltd.
Debt Ratio
The Debt ratio of company is calculated by dividing the total debt by the total assets owned by the company. The debt ratio is often used to understand the financial risk of the company. The debt ratio examines the percentage of company that is financed through debt (Husna and Satria 2019). While analyzing the debt ratio of Nippon Paint Holdings for the period 2017 to 2021, it has been found that the company was initially more reliable on its equity to purchase its assets and meet the operational expenses. In the last three years, the company has increased its debt burden with the aim of achieving optimal capital structure. The debt ratio of the company is calculated as 6.29%, 9.91%, 30.75%, 34.76% and 28.22% for the year 2017, 2018, 2019, 2020 and 2021 respectively. The debt ratio of the company always remain less than 50% during the last five years which indicates that the total assets of the company is sufficient enough to pay the total interest bearing debt of the company. The debt ratio is less than the industry average of 39%.
Debt-equity Ratio
The Debt-to-equity ratio compares the total debt of the company with the total Shareholder’s capital of the company (Nuryani and Sunarsi 2020). The debt-to-equity ratio of the company has been fluctuating through the period of evaluation. It has increased from 11.12% in 2017 to 66.09% in 2018 and 80.30% in 2020. However, this has improved in the year 2021, as it is reduced to 56.96% in 2021. The company was increasing its debt portion during the year 2019 and 2020. The debt to equity ratio is much higher than the industry average of 35%.
Time Interest Earned Ratio
The time interest earned ratio is calculated by dividing the Earnings before interest and taxes by the total interest expenses incurred by the company during that period (Ahmed and Nobanee 2020). The company EBIT was much higher than the interest expense payable by the company. The interest earned ratio is calculated as 70.17, 29.42, 14.88, 15.97 and 15.57 for the year 2017, 2018, 2019, 2020 and 2021 respectively.
Analysis of Company’s Capital Structure Policies
Overall, the company’s capital structure keeps on fluctuating in the last five years as the company has shifted from relying on equity to debt capital. The debt portion of the company’s capital has increased largely in 2019. The time interest earned ratio reveals that the company has the ability to borrow more funds and pay their interest efficiently.
Relationship Between Bond Prices and Interest Rates
The bond prices and interest rates have inverse relationship with one another. With the interest rates of bonds increases, the bond prices usually fall, and vice versa. The interest rates and bonds prices have negative correlation with one another (Hordahl and Shim 2020). It is important for the managers and investors to understand this relationship because return for bond investments is paid at a fixed rate. It becomes more attractive for the investors when the interest rates are low. In contrast, when the interest rates rises, the investors will not accept the fixed interest rate paid by a bond, which will further result in decreased prices of the bond.
Long-term Borrowings Available to the Company
Currently, there is no bond issued by the company (Bond and Ratings | NPCPF 2022). The company enjoys high creditworthiness that is supported by a few excellent factors. Recently, the company has obtained a loan on January 19, 2022 from Suitomo Mitsui Banking Corporation MUFJ Bank ltd. The amount of borrowing was ¥172,700 million. The tenure of borrowing is one year and it is unsecured. The total long-term borrowings of the company was ¥457,919 million.
Types of Shares Held by The Company And Dividend Policy
Currently, the total number of shares issued by the Nippon Paint Holdings was 2,370,512,215. The total number of shareholders of the company is 12,588. Different types of shares held by the company include ordinary shares and treasury shares. Different types of investors in the company include 71.66% foreign investors, 2.88% individual and other investors, 20.58% financial institutions, 0.94% treasury shares investors, 0.54% financial instruments business operators, and 3.04% Japanese corporations.
The company has adopted fixed dividend policy from the last three years. The annual dividend per share paid by the company was ¥42 in 2017 and ¥45 for the period from 2018 to 2020. The company has maintained stable dividend policy for its shareholders. The schedule date for starting the payment of dividend was March 30, 2022. The company has declared only ¥10 as dividend for the year 2021. The composition of dividend for the year 2021 was ¥4 for ordinary dividend and ¥1 for 140th anniversary of the company’s establishment.
Analysis of Company’s Long-term Debts
Nippon Paint Holdings Company calculates its retained earning by adding the net income to the last years retained earnings and then subtracting any dividend paid to the owners. The current year retained earnings of Nippon Paint Holdings was 349.31 billion. The retained earnings of the company was much higher than the industry and its peers.
Benefits Of Debt Financing And Cost Of Capital
The main benefit of debt financing is that the owners does not have to give away the voting rights or control of the business, as in the case of equity financing (Xin et al. 2019). The interest paid on debt financing are tax deductible, however, large increase in debt will increase the default risk. This will further increase the interest rate that must be paid by the company. By utilizing too much debt, the company’s cost of capital will increase, which will eventually lead to a decline in the present value of the company. However, the cost of debt is cheaper than that of cost of equity.
The cost of debt, cost of equity and the weighted average cost of capital increases with the increase in the financial leverage of the company. This is because the use of financial leverage increases the level of risks as well as stock volatility, which further results in increased expected rate of return. The weighted average cost of capital will increase with the increase in leverage due to the fact that the lenders and bondholders would require higher interest rates for companies having higher leverage. When the operating profits of the company will become critically less, the cost of equity will reduce with the reduction in company’s value.
Importance Of Knowledge Of Cost Of Capital Of Nippon Paint Holdings Ltd
There exists large number of shareholders of Nippon Paint Holdings limited. The knowledge about the company’s cost of capital will help the business management and the investors in identifying and evaluating the investment opportunities within the firm (Dovale 2018) The management also make use of cost of capital for making important budgets. It is one of the most important concept that is used in financial decision making. It is generally the measurement of the sacrifices made by the investors to earn a fair return on the investment. It is often used while determining the capital structure, making capital budgeting decisions, evaluating the financial performance of difference capital projects and it provides information regarding the expected income and the inherent risks associated with the company. Most of the management decisions such as financing and dividend decisions are taken after considering the cost of capital.
Nippon Paint Holdings Cost of Capital
The weighted average cost of capital of Nippon Paint Holdings is presented below:
The cost of capital of the company is calculated around 11% for the period from 2017 to 2021. The risk-free rate is taken at 2.734%, which represents interest rates for 15-year Australian bonds (Australian Government Bonds, 2022). The market return is taken at 11.49 % which represents the annual average market return. The beta for the purpose of WACC is taken as 1.02 (Yahoo Finance., 2022)
Conclusion / Recommendation
From the above discussion and analysis, it has been found that the company’s capital structure was such that it relies on equity for financing its activities and purchasing its assets for the year 2017 and 2018. However, the leverage ratios shows that the company has focused on maintaining the balance between equity and debt by borrowing large amount of funds from financial institutions for taking advantages of debt funds. The company’s dividend policy for the period 2018 to 2020 is such that it gives a return of ¥45 annually. However, in the year 2021, the company has distributed only ¥10 as dividend per share. The weighted average cost of capital is often used by the investors to evaluate the investment opportunities and make various financial decisions.
It is recommended that the company should maintain balance in its capital structure as it has the capability to pay the interest on such borrowings. In order to lower the debt equity ratio, the company should focus on improving its profitability position through increased sales and lower operational costs. The cost of debt is always lower than the cost of equity to the increased risk in equity. In order to lower the WACC of the company, the company should focus on lowering the cost of equity by changing its capital structure in favor of debt. By focusing more on debt capital, the risks characteristics of the company will be reduced which will eventually lead to decreased weighted average cost of capital.
References
Ahmed, H.M. and Nobanee, H., 2020. Financial Statement Analyses of Netflix. Available at SSRN 3647452.
Alabdullah, T.T.Y., Laadjal, A., Ries, E. and Al-Asadi, Y.A.A., 2018. Board features and capital structure in emerging markets. Journal of Advanced Management Science, 6(2).
Antill, S. and Grenadier, S.R., 2019. Optimal capital structure and bankruptcy choice: Dynamic bargaining versus liquidation. Journal of Financial Economics, 133(1), pp.198-224.
Australia Government Bonds, 2022. Available at: https://www.worldgovernmentbonds.com/country/australia/ (Accessed: 16 March 2022).
Bonds and Ratings | NPCPF (2022). Available at: https://www.nipponpaint-holdings.com/en/ir/stock/bond/ (Accessed: 16 March 2022).
Brusov, P., Filatova, T., Orekhova, N. and Eskindarov, M., 2018. New meaningful effects in modern capital structure theory. In Modern Corporate Finance, Investments, Taxation and Ratings (pp. 537-568). Springer, Cham.
Doval, E., 2018. The cost of capital and financial risk from investors’ perspective. Review of General Management, 27(1).
Hirdinis, M., 2019. Capital structure and firm size on firm value moderated by profitability.
Hördahl, P. and Shim, I., 2020. EME bond portfolio flows and long-term interest rates during the Covid-19 pandemic. BIS Bulletin, (18).
Husna, A. and Satria, I., 2019. Effects of return on asset, debt to asset ratio, current ratio, firm size, and dividend payout ratio on firm value. International Journal of Economics and Financial Issues, 9(5), p.50.
IBISWorld – Industry Market Research, Reports, and Statistics (2022). Available at: https://www.ibisworld.com/au/market-size/paint-coatings-manufacturing/ (Accessed: 16 March 2022).
IBISWorld (2022). Available at: https://www.ibisworld.com/au/market-size/paint-coatings-manufacturing/ (Accessed: 16 March 2022).
Market capitalization (2022). Available at: https://companiesmarketcap.com/nippon-paint/marketcap/ (Accessed: 16 March 2022).
Nippon Paint Holdings CO.,LTD. (2020). Available at: https://www.nipponpaint-holdings.com/en/ (Accessed: 16 March 2022).
Nuryani, Y. and Sunarsi, D., 2020. The Effect of Current Ratio and Debt to Equity Ratio on Deviding Growth. JASa (Jurnal Akuntansi, Audit dan Sistem Informasi Akuntansi), 4(2), pp.304-312.
Xin, K., Sun, Y., Zhang, R. and Liu, X., 2019. Debt financing and technological innovation: Evidence from China. Journal of Business Economics and Management, 20(5), pp.841-859.
Yahoo Finance | NPCPF – Financials (2022). Available at: https://finance.yahoo.com/quote/NPCPF/financials?p=NPCPF (Accessed: 16 March 2022).
Yahoo Finance (2022). Available at: https://finance.yahoo.com/quote/NPCPF/financials?p=NPCPF (Accessed: 16 March 2022).
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