Financial Performance Analysis Of Philip Morris International

Key Financial Ratios

The main purpose of this assessment is to analyze the financial statements of Philip Morris International annual report in order to understand the financial performance of the business for a period of fours year. The analysis will be containing computation of key financial ratios and also analysis of the financial statements as a whole along with the notes to accounts of the business. The notes to account of the business reveals about the various accounting treatments which are undertaken by the business and the same is shown in the annual report of the business. The report will also show evaluation of the capital structure of the business and also calculate the weighted average cost of capital of the business.

Philips Morris International is a leading business which is engaged in the manufacture and distribution of Cigarettes and other tobacco products. The company is American in nature and the headquarters of the company are established in New York. The company serves around 180 countries which are outside United States. The most recognizable product of the company is Marlboro (Philip Morris International 2018). As the main product of the company is tobacco, the company has been subjected to a lot of litigations and also restrictions on the part of the government. As per the estimates of 2015, the company has sold around 850 billion cigarettes and was considered to be among the top 20 most valuable cigarettes brand in the world.

As per the annual reports of the company for the year 2017, the business is concentrating on creation of smoke free environment for which the management has made ground breaking research and developed an alternative for cigarettes which is considered to be less harmful than a cigarette and can be enjoyed by adults. The product which is introduced by the company as a replacement of cigarette is IQOS which is a heated but not bured product and therefore is smokeless. The management of the company takes the responsibility of the business quite seriously and therefore has strategies which can meet the needs of the environment. One of the policies of the business towards environment is to reduce the emission of greenhouses gases for which the management is planning to make the products of the company smoke free.

However, the annual reports which is prepared by the management of the company for the year 2017 shows that the business has shown certain amount of contingency in the notes to account section of the annual report of the business. The contingency which is prepared by the management of the company is related to the tobacco litigation which the business faces due to the operations of the business involves production and distribution of a harmful substances. The number of cases which the business is facing and which is covered in the contingency disclosure which is shown by the management.

Profitability Ratios

The key financial ratios are tools which are used for the purpose of analyzing the financial performance of business by considering the financial information which are shown in the annual reports of the business. The computation of key financial ratios of Philips Morris International which consist of profitability and solvency ratio are shown below. The computation of the financial ratio of the business is computed considering the financial statements of 2015 to 2017.

The above tables show profitability and solvency ratio of the business. The profitability ratio of the business comprises of Gross Profit Margin, Operating Profit Margin, Net Profit Margin, Return on Assets and Return on equity of the business. The gross profit margin of the business which is shown in the above table shows that the profitability of the business for the year 2017 has slightly improved in comparison to previous year analysis (Carraher and Van Auken 2013). The change in gross profit margin of the business is also shown to be 2.18% which is positive in comparison to previous year gross profit. The operating profit of the business is also shown to have increased as per the estimate which is calculated for the year 2017. The operating profit margin for the year 2015 is shown to be 17.10% and the same had decreased significantly in 2016 which is shown to be 14.25%. The operating profit margin of the business for the year 2017 is shown to be 14.47% and therefore it shows the business has improved operational efficiency of the business (Delen, Kuzey and Uyar 2013). The net profit margin shows tremendous improvements and shows a change of 8.27% which suggest that the costs of the business have been cut down which is a direct result for the increase in the profits of the business (Weil, Schipper and Francis 2013). The net profit margin of the business for the year 2017 is shown to be 10.01% as computed in the above table. Based on the analysis of the profit margin ratios, the profitability aspect of the business has improved significantly in comparison to previous year analysis.

The return on equity and return on assets of the business are considered to be financial indicators for the success of the business. The return on assets and return of equity of the business are shown to be negative in estimates which shows that the business is not earning up to the mark. The business is not earning up to the expectations of the shareholders and therefore the management of the company needs to consider these estimates as the same are considered by potential investors while taking investment decisions. The return on assets and return on equity both have declined further as shown in the table which is provided above. The notes to account section of the annual reports for the year 2017 shows the business is in the practice of selling account receivables to financial institution for the purpose of maintaining the liquidity of the business.

Solvency Ratios

The solvency ratios of the business reflect the capital structure of the business which comprises of both debt and equity capital in a mix which is determined by the management of the company. The solvency ratios of the business comprise of debt equity ratio, debt ratio and equity ratio which is computed in the table above. The debt equity ratio of the business is shown to be negative which signifies that the business has negative equity and is relying significantly on the debt capital of the business. This is a risky situation for the business as the debt are borrowed capital and needs to be paid in stipulated time frame. The ratio shows decline in the estimate which can be due to the repayment of stocks program which is undertaken by the management of the company. In the annual report for 2017, it is clearly evident that the business has ample amount of retained earnings which are reinvested in the business in order to get more support from equity-based funds. However, the balance sheet for 2017 also shows that the business has significant amount of accumulated losses and has also undertaken repurchase of equity stocks of the business. The debt ratio of the business is shown to be 1.29 which has slightly reduced from previous year of the business. The equity ratio of the business which is calculated is shown to be in negative which is due to the negative shareholders equity which is shown in the annual report of the business for the year 2017.

Working capital refers to the funds which are required by the business for the purpose of meeting the day to day expenses of the business and also for financing different activities which are carried on by the company. As per the annual reports of 2017, the balance sheet of the company shows both debt capital and equity capital which shows that the business used both equity and debt capital in the capital mix of the business (Ehrhardt and Brigham 2016). The share capital of the business is shown to be $ 1,972 million which has increased slightly in comparison to previous year’s figures. The debts of the business are shown in liabilities section of the balance sheet which is $ 31,334 million which shows that the management of the company relies on debt capital financing rather than equity capital financing (Brooks and Mukherjee 2013). The shareholder’s equity which is shown in the annual report of 2017 shows that the estimates to be negative which is mainly due to the accumulated losses which the business had to suffer and also because of repurchase of the stocks of the business during the year 2017.

The debt capital of the business seems to be the source of capital which is in current situation financing the activities of the business (Ding, Guariglia and Knight 2013). The notes to accounts of the annual reports of 2017 shows that the breakup for the equity share capital of the business and the same reveals that the management of the company puts emphasis on retained earnings of the business as the same is reinvested in the business again (Mathuva 2015). The debt capital of the business as per the notes to accounts section of the annual report of the company comprises of a long term debt of $ 23,291 million and the rest is made up of foreign currency obligations which is shown for Euro, Swiss France notes and other similar types of notes.

As per the case which is provided in the question, the management of Philip Morris Internationals is considering a change in the policies of the business with relation to the main products of the business. The management is also planning to evaluate the proposal of Terracycle which uses the used plastics products in the production of electronic cigarettes which can help the management to look after the needs of the environment and also develop a sustainable practice for producing the main product of the business (Baker and Wurgler 2015). The proposal is anticipated to reduce the overall costs of the business significantly and therefore contribute to the profit generating capacity of the business. The proposal will also contribute to preservation of the environment and therefore the proposal is being considered by the management.  8420371843

 The proposal of the management of the company is to establish a recycling unit which will help the management of the business in meeting the sustainable practice in the business. The management of the business will be requiring additional funds in order to finance the project which the management is considering. In order to fully establish the worth of proposal of recycling of plastics, the management needs to check the financial viability of the proposal for which the anticipated cash flows are considered and Net present value of the proposal is computed. The management has option as to which capital structure mix should the management use for optimal utilization of resources and also maximization of the revenue generating capabilities of the business.  In this proposal the management considers meeting the finance requirements of the business using all equity capital. The computation of NPV is shown below under one of the options which is available to the management

Under this option, the management is considering to finance the proposal of recycling of plastics so that the same can be used by the management in production of electronic cigarettes by using all equity capital. The management will be using full equity capital to finance the project. The computation of cost of equity is shown in the above table. In order to calculate the cost of equity of the business, the management has applied Capital Asset Pricing Model (CAPM). The risk-free rate of return is shown to be 2.75% and market rate of return is shown to be 11.80% and Beta which represent the risks of the business is shown to be 0.6.  The cost of equity of the business which is computed is shown to be 8.18% in the table above.

The cash flows of the business are computed for the period of five years as shown in the computation of NPV of the business. The cash outflow or the initial investment which is required by the management is shown as capital investment of $ 440 million and a requirement of working capital of 15 million. In addition to this, the management will also be requiring capital investment of $ 10 million every year. In the first year the net cash flow which is shown in the table is shown to be negative and after the first year the cash flows from the project is shown to be positive (Attig et al. 2013). The overall NPV of the business as shown in the table is shown to be negative which is $ 72.26 million. The management of the company earns negative cash inflows in case the business opts for a capital structure which is made up of only equity capital (Agha 2014). In this option, the management in the long run will be earning negative cash inflows and therefore the management should not accept this proposal.

In the second option the management has the adoption to use 50% of debt capital and 50% equity capital for the purpose of financing the project which is being considered by the management of the company. The management of the company will be able to take advantage of the application of debt capital in the business for claiming tax advantage of the business.  In order to evaluate the financial viability of the proposal which the management is considering, NPV analysis is undertaken considering the use of debt capital in the capital structure of the business. The computation of NPV of the business under this option is shown below:

The management considers debt capital to be 50% of the total capital which is used by business and the other 50% is made up of equity capital as shown in the above calculations. The management has added debt capital to the capital mix in order to ensure that the management is that the management is able to attain an optimal capital structure which can improve the profitability of the business and also ensure that overall cost of capital of the business is kept as low as possible (Makori and Jagongo 2013). The cost of equity of the business is computed in the same manner and the cost of the equity of the business is shown to be 8.18%. With the help of cost of equity and the future cash inflows which are provided NPV is computed considering the previous scenario and the same is shown to be 72.26 million which is shown in negative (Jones and Tuzel 2013). Now if the management brings about a change in the capital structure of the business, the debt capital will reduce the tax expenses of the business and thereby allowing the business to make profits in the long run with the help of the project (Frank and Shen 2016).

As per the table which is shown above, the revised NPV is computed considering the debt capital in the capital mix and thereby this also changes the weighted average cost of capital of the business as the same is computed to be the sum of equity and debt capital which is used by the business. The total investment which is required by the management of the company for the purpose of the project is $ 455 million and out of which the management has decided that half of the capital will be coming from long term borrowings. The figure of debt capital which is used by the management in the capital mix of the business is shown to be $ 277.5 million in the table above.

The cost of debt is computed in the table above considering the tax rate which is applicable in the country which is shown to be 35% and the cost of debt is shown to be 0.80 in the above figure. The table which is provided above shows that use of debt capital in the capital mix for the project results in significant amount of tax savings and therefore the revised NPV which is computed under the new capital structure is shown to be $7.37 million which is a significant improvement from the situation where the business wanted to all of equity capital for the purpose of financing the requirements of the project (Hann, Ogneva and Ozbas 2013). Therefore, from the analysis of the both the options which is available to the management of Philips Morris International, it is recommended that the management selects the option where the management uses part equity capital and partly debt capital for the purpose of financing the requirement of the project. In the option of part equity and part debt capital the NPV of the project is shown to be positive which suggest that the management of Philips Morris International will be able to earn positive cash inflows from the project and also the project might also prove to be profitable for the business.

Conclusion

The management of Philip Morris ltd should accept the capital structure which has debt and equity capital in equal mix. The reason for accepting such a proposal is due to the fact that the management will be able to take advantage of tax benefits which are associated with the application of debt capital in a business. However, the management can also use an alternative capital structure mix which can comprise of more debt capital than equity capital which will be able to take advantage of the leverage effect in a business and thereby further reduce the costs which are associated with the business. The management however, must also consider the risks of such a structure before adopting the same.

Reference

Agha, H., 2014. Impact of working capital management on Profitability. European Scientific Journal, ESJ, 10(1).

Attig, N., Cleary, S., El Ghoul, S. and Guedhami, O., 2013. Institutional investment horizons and the cost of equity capital. Financial Management, 42(2), pp.441-477.

Baker, M. and Wurgler, J., 2015. Do strict capital requirements raise the cost of capital? Bank regulation, capital structure, and the low-risk anomaly. American Economic Review, 105(5), pp.315-20.

Brooks, R. and Mukherjee, A.K., 2013. Financial management: core concepts. Pearson.

Carraher, S. and Van Auken, H., 2013. The use of financial statements for decision making by small firms. Journal of Small Business & Entrepreneurship, 26(3), pp.323-336.

Delen, D., Kuzey, C. and Uyar, A., 2013. Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), pp.3970-3983.

Ding, S., Guariglia, A. and Knight, J., 2013. Investment and financing constraints in China: does working capital management make a difference?. Journal of Banking & Finance, 37(5), pp.1490-1507.

Ehrhardt, M.C. and Brigham, E.F., 2016. Corporate finance: A focused approach. Cengage learning.

Frank, M.Z. and Shen, T., 2016. Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), pp.300-315.

Hann, R.N., Ogneva, M. and Ozbas, O., 2013. Corporate diversification and the cost of capital. The journal of finance, 68(5), pp.1961-1999.

Jones, C.S. and Tuzel, S., 2013. Inventory investment and the cost of capital. Journal of Financial Economics, 107(3), pp.557-579.

Makori, D.M. and Jagongo, A., 2013. Working capital management and firm profitability: Empirical evidence from manufacturing and construction firms listed on Nairobi securities exchange, Kenya. International Journal of Accounting and Taxation, 1(1), pp.1-14.

Mathuva, D., 2015. The Influence of working capital management components on corporate profitability.

Philip Morris International 2018. [online] Available at: https://www.annualreports.com/HostedData/AnnualReports/PDF/NYSE_PM_2017.pdf [Accessed 7 Sep. 2018].

Weil, R.L., Schipper, K. and Francis, J., 2013. Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.

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