Top Down And Bottom Up Analysis Of Economic And Industry Factors Impacting Energy Companies In Australia

Top Down Analysis of Australian Economy

It is very essential for the investors to gain an analysis of the macro and micro economic factor that can impact the performance of an entity. In this context, fundamental analysis is a technique used by the investors for identifying the factors that may cause directional changes in the value of a company and its share prices. It adopts the use of both top-down and bottom-up analysis for developing an insight into the macro and micro factors that may impact the performance of an entity.

Top-down analysis is usually carried out by initially examining the macro-economic factors and then conducting a more specific sector analysis. On the other hand, bottom-up analysis emphasizes on evaluation of the key performance indicators of a firm such as its financial performance. The report has carried out an evaluation of the two ASX listed firms for carrying out fundamental analysis with the use of both top-down and bottom-up analysis for evaluation of their current and future growth prospects on the behalf of the investors. The companies selected for the purpose are Origin Energy and AGL Energy Limited operating in the energy industry of Australia.

Top-down Analysis

            Top-down analysis of the selected companies is conducted by evaluation of the overall economic environment of Australia. This will help in forecasting the changes in the economic fundamentals and their impact on the selected company’s performance operating in the energy industry of Australia. The analysis is carried out by an evaluation of the following macro-economic factors of Australia as follows:

Interest & Inflation Rate

            The interest rate within Australia is maintained at very low level by the Reserve Bank of Australia (RBA) at 1.5 per cent since the year 2016. This has been done by the RBA for promoting the economic growth within the country that has been struggling since the past few years. This has promoted RBA to curb the interest rates at low level to foster development in the economy of the country. The low interest rate will help in reducing the level of inflation and decreasing the rate of unemployment.

RBA has even gain success in restoring the economic growth by reducing the rate of interest by having a control over the level of inflation. The central bank of the country is still emphasizing to maintain the interest rates at very low level for promoting wage growth. The wage growth within the country is still maintained at 2 per cent that is same as the rate of inflation. As such, the RBA is maintaining the interest rates at low level because an increase in the interest rate with lower growth of wages could negatively impact the economic growth by raising debt level within the country (Murphy, 2018).

Interest and Inflation Rates

Current Value of $AUD

            The value of Australian dollar (AUD) is subjected to fluctuation in relation to the other currencies across the world. Its current value is recognized to be 75 US cents by the end of the year 2018 and is expected to further decline and reach 77 US cents by the end of the year 2019. The major reason for the decline in the value of AUD can be regarded as the increasing gap between the interest rates of the US and Australia (Reserve Bank Of Australia, 2018). Also, the movement in its value is fluctuated by the downward pressure resulting from the global growth forecast of the country.

The increased volatility in the Aussie market is causing a relative fall in the value of Australian dollar as it is losing value in relation to the value of foreign currencies that have more financial stability. Moreover, its value fluctuates largely because the variability in the prices of commodities. Australia is a major exporter of natural resources and thereby the decrease in the price of commodities such as iron ore and coal have caused the relative decline in the prices of Australian dollar. This has caused a reduction in the demand of the currency and a significant decline in its value in the recent years (What makes the Australian dollar move, 2018).

GDP Growth Rate

            The Australian economy has recorded an annual growth rate in GDP up to 3.40 per cent in the year 2018 which is higher than the previous annual growth rate of 2017. The strong increase in the domestic demand by 0.6% that is driven by 0.7% growth in household spending has lead to a strong increase in the GDP. The increase in the level of consumer spending due to low level of interest rate maintained with the country has caused a rise in the sales of food, recreation and culture, furnishing and household equipment (Janda, 2018).

There is increase in the rate of household consumption by 3% accompanied by rising wages and salaries growth by 0.7% that id riven by increase in the employment rate. It has been stated by the Australian Bureau of Statistics data has revealed that commodities exports are the main driver of economic growth at present within the country. The mining boom within Australia has caused a rise within the exports of mining commodities as the sector output has recorded a growth to about 2.9 per cent supported with increase in coal, iron ore and production of LNG.

Current Value of $AUD

Thus, the rise in GDP growth of the country is supported by the rise in mining exports and removal of restriction in the trade policies. These all factors are contributing to a sharp increase in the GDP growth of the country and as such it is expected to have faster rate of annual expansion that is expected to continue in future because rising export level supported by weakened Australian dollar (Hutchens, 2017).

Business Cycle of Economy

Australia is regarded to be presently in a developing phase of economy with a rapid increase in the economic growth supported by low interest and inflation level. There is an expected increase in the wage growth due to reducing rate of unemployment within the country. The increased consumer spending and the rising profits realized by the government due to net rise in the exports is causing a direct increase in the economic growth (Murphy, 2018).

Impact on the Performances of Companies

            The strong GDP growth within the country supported by sharp increase in process for energy-related commodities due to mining boom is supporting the growth and development of the energy companies such as AGL and Origin Energy within Australia. This has caused a rapid increase in the job opportunities within the energy companies and therefore leading to a reduction in the unemployment rate. The low level of inflation is further causing an increase in consumer spending to buy energy products.

The weakening Australian dollar is causing a high demand of energy products overseas and thereby leading to an increase in the production of energy products is helping them to realize economies of scale and thus reducing their operational cost. Therefore, it can be said that the overall economic condition of Australia is providing a favorable environment within Australia promoting the growth of the energy companies in the future context (Roarty, 2010).

Bottom up analysis of Energy Industry of Australia

Bottom up analysis is part of fundamental analysis that aims to evaluate the company from various perspectives such as financial performance, quality of management, product or service, and industry comparison. So in contrast to top down approach, bottom up approach will evaluate the fundamentals of company whereas top down information on market trends. It compares individual company within the sector with any other company in same section to know the industry performance. In this section, energy sector of Australia has been examined through conduction fundamental analysis of Origin Energy and AGL Energy.

GDP Growth Rate

Profitability Performance of both the selected companies

Profitability performance aims to evaluate the ability of company to turn the available resources to the revenue. It can be performed through conducting the ratio analysis that evaluates the profitability performance.

 (AGL Annual Report, 2017 and Origin Annual Report, 2017)

Net profit margin: This ratio is an important profitability ratio and it can be vital for comparing profitability performance of companies in same industry. If any company has higher net profit margin ratio it means that company is performing well and is successfully converting sales in net profit.

Formula: Profit (after tax)/Revenue (Schlichting, 2013)

On the basis of calculation it has been found that profitability performance of Origin Energy was much weaker than AGL Energy. In year 2016 both companies has suffered the loss. In year 2017, the net loss percentage of Origin was further increased while AGL Energy has able to maintain net profit at 4.28%.

Return on Equity: This ratio reveals the net income earned by the company as the percentage of shareholders equity. It means percentage of net profit that company has earned on total shareholders’ equity invested by the company.

Formula: Net Income After tax/Shareholder’s Equity (Arnold, 2013)

The above graph clearly shows that Origin Energy has failed to keep up with the profitability performance as it has suffered with major loss in both the years in review. On the other hand AGL Energy has able to earn positive return on equity of 7.12% in year 2017 but suffered a loss of 5.13 in year 2016.

Overall profitability performance of industry seems to be weaker in year 2016 as both the selected companies has suffered a net loss but in year 2017 there has been some improvement in profitability performance of industry.

Solvency Position of both the companies

Solvency position is also referred as the leverage position as it aims to analysis the debt capital held by the company. The solvency ratios aim to analyse the financial health of the company. It measures the ability of the company to pay the liabilities as and when it falls due.

(AGL Annual Report, 2017 and Origin Annual Report, 2017)

Debt to Equity Ratio: It is an important financial ratio that helps to analyse the financial leverage position of the company. It means it measures the financial ability to the company to bear the debt obligations.

Formula: Total Liabilities/Shareholder’s Equity

On the basis of analysis it has been found that debt to equity position of both the companies it not satisfactory as they both hold same portion of debt as their equity which is a big concern for these energy companies. The comparison of both the companies shows the debt of equity position of AGL Energy was better than the Origin Energy. However there has been sharp increase in the debt position of both the companies from year 2016 to 2017.

Business Cycle of Economy

Interest Coverage ratio: This ratio measures the ability of company to meet the interest payments arising on debt capital. Interest payments reflect the charge on the profit of the company so it important to earn sufficient profits that can help to pay the interest on time.

Formula: Earnings before interest and tax /Interest expenses (Ross, Jaffe and Kakani, 2008)

The interest coverage ratio of AGL Energy and Origin Energy was worst in year 2016 as they are not capable to bear the interest expenses through the profits earned by them. Moreover in year 2017, the position of Origin Energy has become even more worse as they have suffered with huge losses while AGL Energy had improve its financial performance in year 2017 that makes the interest coverage ratio to 4.17 times.

The overall solvency or debt position of energy sector was not satisfactory in year 2016 as well as in year 2017. It is because many big companies have increased their debt liability which in turn has increased the burden of interest payment that has impacted the profitability performance the industry sector.

Market Performance of energy industry of Australia and selected companies

Market performance can be measured through performing the market value ratios analysis of the company selected and comparing them with the performance of whole industry. The market value ratio evaluates the current share price of the company that has been traded on the stock exchange. The market value ratios help the potential investors to find out whether market value of equity shares is over-priced or under-priced. Some of the important market value ratios are earnings per share,   P/E ratio, Price to book ratio etc (Ross, Jaffe and Kakani, 2008).

(Source: AGL: Investsmart, 2018 and ORG: Investsmart, 2018)

The above table critically analysis the market performance of both selected companies in current year i.e. 2018. All the information has been gathered from the well-known source called as Investsmart. Based on information gathered above it can be said that market performance of Origin Energy was quite better than AGL Energy in current year. The earnings per share (EPS) of Origin Energy was almost twice the earnings per share of AGL Energy in year 2018 that convey that there has been significant improvement in.

the profitability performance of Origin Energy in year 2018 as and when compared to 2017. The price to earnings ratio reflects that market price of Origin Energy is trading at higher level as compare to AGL Energy. When the market performance of both the companies has been compared with industry average it has been found that both companies have weaker position as compared to many other companies in similar industry (AGL Annual Report, 2017 and Origin Annual Report, 2017).

Summary & Recommendations

It can be stated from analysis of the macro-economic condition of Australia that the overall economic environment favors the growth and development of the energy sector within the country. The low inflation rate, developing phase of economy, strong annual growth rate of gross domestic products and weakening value of Australian dollar are all supporting the growth of the energy companies. The bottom up analysis of AGL Energy and Origin Energy has revealed that financial performance and position of both the companies was not satisfactory due to change in regulatory reforms in the energy sector and increase in leverage capital over the year.

The current market performance of Origin Energy was satisfactory as compared to AGL Energy. In this context, it is recommended to the investors to wait and analyze the future performance of the companies as forecasted economic fundamentals can lead to an increase in their financial performance.

References

AGL Annual Report. 2017. AGL Energy Limited. 

AGL: Investsmart. 2018. AGL Energy. 

Arnold, G., 2013. Corporate financial management. Pearson Higher Ed.

Hutchens, G. 2017. Australia’s economy hits 3.4% annual growth rate, exceeding expectations.

Janda, M. 2018. Australian economy beats expectations with 3.1pc annual GDP growth. 

Murphy, J. 2018. We just got a glimpse of Australia’s future — and it is not good.

ORG: Investsmart. 2018. Origin Energy.

Origin Annual Report. 2017. Origin Energy Limited. 

Reserve Bank Of Australia. 2018. The Exchange Rate and the Reserve Bank’s Role in the Foreign Exchange Market.

Roarty, M. 2010. The Australian Resources Sector its contribution to the nation, and a brief review of issues and impacts. 

Ross, A., Jaffe, J. and Kakani, R.K. 2008. Corporate Finance. Pearson.

Schlichting, T. 2013. Fundamental Analysis, Behavioral Finance and Technical Analysis on the Stock Market. GRIN Verlag.

What makes the Australian dollar move. 2018.

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