The course builds on my Introduction to Financial Accounting course, which you should complete first. In this course, you will learn how to read, understand, and analyze most of the information provided by companies in their financial statements. These skills will help you make more informed decisions using financial information.
Video 10.4: FSA IV: Investing and Financing Activities
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From the course by University of Pennsylvania
More Introduction to Financial Accounting
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From the lesson
Week 10: Financial Statement Analysis
In the videos this week, I go through a systematic financial statement analysis for a company. There is no homework assignment for this material and it will not be explicitly covered on the exam (although some of the concepts are a review of material we have covered previously). Thus, if you don't have time before the final exam, you can enjoy these videos after completing the exam without adversely affecting your performance.
The final exam will cover material in weeks 5 through 9. The only thing left to do after this exam is to impress your family, friends, and co-workers with your vast knowledge of Financial Accounting!
Meet the Instructors
Brian J BusheeThe Geoffrey T. Boisi Professor
Accounting
Hello, I'm Professor Brian Boucher, welcome back.
In this video we're going to take a look at the investing and
financing activities of bulking immaterials.
To try to get a sense of whether they're investing for
future growth, how they're financing their investment in the future, and whether
they're going to be able to handle the payments on their future debt obligations.
Let's get started.
Next up on our financial statement analysis road map is the question of
whether the company is investing for the future.
And the first two we're going to use to analyze investment is a common size
balance sheet, that's going to express all the numbers on
the balance sheet as a percent of total assets,
which is going to take out the effective growth from the balance sheet.
So that we're able to focus on how the mix of working capital and
long-term assets have changed over time.
Are there any trends in Vulcan's investment, either in short-term assets,
working capital, or in longer-term assets, property planned equipment.
We're also going to take a look at cash flows from investing activities to look at
their recent investments.
So the things that they've just acquired that are going to produce revenue for
them going forward in the future.
And then finally, we'll take a look to see if there are any large intangible assets,
that are not on the balance sheet.
Primarily what I have in mind here,
would be a lot of spending on research and development.
Building up intellectual capital, that doesn't necessarily show up as an asset on
the balance sheet because it's internally developed.
So here is the common size balance sheet.
And again this is taken from the supplemental material at the end.
We go back to 1999 all the way through 2010.
And the big thing that leaps out is if we go back mid, mid 2000s which were their,
sort of their boom period, lot of their assets were current assets.
So 21 to 39% that's been trending now, and now it's less than 10%
of their assets are working capital like accounts receivables, inventories.
What's taken it's place?
Well property plant and equipment got up to about 55 55%, but
it's come down actually to about 44%.
The big difference is Goodwill.
So Goodwill was around 16 to 18%.
And it shot up to 37.1%.
And so the big investment that we're seeing here is this Goodwill asset
representing the premium that Vulcan is paying when they go out and
make these acquisitions.
>> Seriously, you are not even going to talk about other assets?
They seem to be growing at warp speed.
They are almost 10% of assets.
What are they?
>> And what about the growth in par value?
Why is that not on your chart?
>> Yes, the other assets are growing a lot.
And if you look most of that growth has come since 2008 which is
when the big Florida rock acquisition really hit the financial statements.
So if you look in the footnotes you'll see those other assets are intangible assets
that were acquired as part of the Florida rock acquisition.
So it's things like contractual arrangements, non-compete agreements,
customer lists, trade names.
Now as far as the par value comment,
I assume that's your last par value joke of the course.
Clearly we're looking at the balance of common stock.
If anything, we don't see trends and par value on this chart.
But it does raise a point that, since we have the common size balance sheet up
here, we probably should look at what's going on on the stockholders equity and
the liability side.
So even though this has more to do with financing activities,
which we'll talk about later in the video let's look at the liability and
stockholders equity side now since I have it up here.
And so if we go back to the mid 2000s their current liabilities were
15 drop to to six around 16, 14%,
have come down quite a bit sort of in conjunction with their cur,
current assets although there's a lot more volatility in these current liabilities.
On the other hand, long term debt has gone up substantially.
So it's clear that Vulcan has been switching out short-term debt in favor of
borrowing longer-term debt.
And over this whole period, total liabilities have gone up from the 40s
up to 52% as stockholders equity's gone down.
And this, I think, reflects again the big shift in leverage around the time that
they acquired Florida Rock.
They took on a lot of debt to do that, and since then, their leverage has increased.
And here is the cashflow from investing activities part of the Vulcan cash
flow statement, which I pulled out of the report.
Top line is purchases of property, plant, equipment.
And as we saw earlier with the free cash flow calculation,
this has been dropping precipitously suggesting that in the last couple
years Vulcan has severely cut back on their investment in property, plant, and
equipment which is probably not a good trend.
>> Listen child.
Vulcan is based in my sweet home state of Alabama.
I don't take kindly to you Yankees speakin' bad about my kinfolk.
How do y'all know this level of Capex is bad?
>> Okay, let me continue and then I'll show you why it's bad.
So the benchmark we want to use to figure out whether these
capital expenditures are reasonable or not is often times depreciation.
So if you remember earlier in the videos we
saw that the depreciation in 2010 was 382 million.
And Vulcan is only spending about $86 million on Capex so they're
not even replacing the depreciation of their existing capital stock.
Now it's a rough measure of using up your, the value of your equipment.
Now it makes sense to cut back on Capex during times that are really
tough where their trying to conserve cash, but
obviously though Vulcan is going to have restart reinvesting in new property, plan,
equipment if they want to continue to grow into the future.
You can get away with this for a couple years, but I want to see this turn
around pretty quickly if I'm going to see any kind of long term prospects for
this company.
Now an alternative to capex would be to go out and buy other businesses.
And so here is the payments for
business acquired, which you can see has been pretty stable.
Remember, they made their big acquisitions in 99 and 2007.
And in fact these are, these payments for
acquisitions are not that much bigger than proceeds from sale of business.
So, one of the things that also's been going on they've been divesting some of
their businesses and it's almost a wash at this point.
So, we're not seeing a whole lot of growth in terms of these cash flows for
investing activities.
Final thing to pull in would be research and development.
This is not in the cash flow from investing activities.
It's an operating cash flow where, on,
on page 12 of the report, and I won't, I won't show to you, but you can look it up.
They disclosed that their R&D was about $1.5 million per year.
So this is important because this is spending on a long-term asset that
wouldn't show up on the balance sheet, so
you're building intellectual capital that doesn't show up as an asset.
But this amount of spending seems pretty small so
it doesn't seem like they're doing a lot of investment in the R&D segment either.
But again, that may make sense because there may not be as much need for
R&D within their kind of industry.
Next up on our road map is we're going to look at Vulcan's debt obligations and
their financing activities.
So we're going to take a look at their cash flow from financing activities to
take a look at their trends in issuance and repayments of debt.
We'll look at their debt ratios, both short-term liquidity ratios,
long-term leverage ratios like we looked at earlier in the course.
And we'll try to get a sense for their future debt servicing requirements.
So what are the debt rating agencies think about the ability to repay their debt?
What are their upcoming principle interest payments, and
what are their interest coverage ratios look like?
Here's the cash flow from financing activities section of Vulcan's cash
flow statement.
But I also brought in at the top the cash from operations, and
cash from investing opportunities.
And so here we get a sense for the fact that they're generating free cash flow.
This is not exactly a free cash flow, but they're generating more cash in
operations, than they are investing in the business.
So the question is, what are they doing with all this excess free cash flow?
Looks like they're paying a lot of debt but
they're also have a lot of proceeds for debt.
And so that's sort of a pattern that continues.
That looks like they're just paying off long-term debt with taking new
long-term debt.
The big thing that they're using their cash flow on seems to
be paying big dividends to their shareholders at,
to the result where their net cash from financing activities is actually negative.
It's an outflow.
So instead of raising money through issuing stock or borrowing new debt
securities to invest in the business, they're in a position where they're
generating a lot of cash from they're business, they're not investing much, and
so they're paying out these huge dividends to they're shareholders.
>> Seriously, Vulcan paid out almost as much in dividends as it had come in
from operating cash flow.
What the lam is the reason for that?
>> Now that's an excellent question.
We've been all over Vulcan for cutting back on their investment.
Yet they're paying out almost 128 million in dividends.
Why not cut the dividend and plow some of that into investment?
Well, there's probably a couple reasons.
One is we've talked about earlier in the course,
companies are very reluctant to cut dividends or
cut them dramatically because it's viewed as a very negative signal to shareholders.
So Vulcan is probably trying to do whatever than can to keep their
shareholder confidence and maintain their dividends is one way to do that.
The second reason, and, and
to be fair to Vulcan, maybe the reason that they're cutting back on
their capex is they're over capacity from this Florida rock acquisition.
So they, they bought Florida Rock, they have all this extra capacity, and
then their business slows down.
So, it doesn't make sense to be able to go build new capacity invest in new
equipment or new facilities or new land if you're drastically under capacity already.
So in that case, why not just give money back to the shareholders, and
maybe they can find something to invest in,
where Vulcan doesn't have those opportunities right now?
>> And why are the tax benefits from stock options dropping while
exercises remain high?
>> Another great question.
And if you look the proceeds from exercise of stock options is remaining high.
So employees are still exercising stock options, but
the tax benefits are plummeting substantially.
Now remember, the tax benefits are based on the difference
between the stock price when the employees exercise and then the strike price or
exercise price on the stock option.
And what's been going on is Vulcan stock price has obviously not been skyrocketing.
It's not been going up a lot.
So maybe three years ago, when employees were exercising stock options,
they were able to make $10 or $20 profit at that time.
In other words, the current stock price was $10 or $20 above the exercise price,
but by 2010 maybe when they're exercising, the stock price is only a dollar or
two above the exercise price.
So basically, the employees are exercising just to get the dollar to a profit.
And then sell the stock before it goes bankrupt.
I mean, before it continues to drop.
So the, the tax benefits from stock options.
It makes sense that it's going down.
Because Vulcan's stock price has not been increasing like it had been in the past.
Okay, now we're going to look at some of the liquidity ratios that we've looked at
earlier in the course.
So here we're trying to answer the question,
does Vulcan have enough liquid assets to cover it's current obligations?
So that the current ratio, which is current assets to current liability.
So, do you have enough current assets that are going to turn into cash to pay off
your current liabilities which you will owe in cash in the next period?
Now a more conservative or probably more accurate ratio is the quick ratio.
Which says just take cash plus accounts receivable,
that's the stuff that's really going to turn into cash, and
see is that enough to cover your current liabilities in the next period.
Then we had some long term debt or leverage ratios, so these help us answer
questions like how the company's financing its growth and what's its bankruptcy risk.
So, we have debt to equity which is this total liabilities over
stockholders equity.
Long-term debt to equity, long term debt over shareholders' equity.
And then sometimes you can use total assets in the denominator instead of
shareholders' equity.
We'll look at all of these.
So here are the liquidity and leverage ratios for Vulcan going back to 1999.
And what we can see is, if we again go back to the middle parts of the 2000s,
it was really high, their quick ratio and their current ratio.
It started to go down a bit,
but it's actually rebounded so that their current ratio's greater than one.
So they have more current assets than current liabilities.
And their quick ratio is 0.65.
So just their cash and receivables,
alone, are 65% of the way there of covering their current liabilities.
So, what's gone on is that their short-term liquidity's been improving and
part of the reason is that we're replacing a short-term debt with long-term debt as
we saw earlier.
Then if we look at the long-term leverage ratios, we can see that they
were fairly low mid 2000s so liabilities to equity was below 1.
Long-term debt was very small.
What's happened is those have both gone up and
they've gone up because of the acquisition that happened in 2007.
So you can see the big jump right here in long-term debt to equity and
liabilities to equity.
Similar thing if you look in terms of assets.
We see a jump in 2007 and
a higher level of leverage than there was earlier in the 2000s.
>> Hunny lets keep this in perspective.
Even though leverage has gone up it is still pretty darn low in absolute terms.
Am I right or am I right?
>> Yeah y'all are right on this one.
To, to be fair to Vulcan, their leverage is still pretty low.
Even though it's gone up, it's in absolute terms it's not that high.
Now I don't know what it looks like for industry competitors.
That would be an interesting thing to look at, but
just in absolute terms this isn't big.
And really, the key question is can Vulcan handle this amount of leverage.
In other words, can they handle the interest and
principal payments they'll have to make in the future.
And we're going to go on next to look at is what are the magnitude of
some of these upcoming payments, and
do they seem like they are reasonable enough that Vulcan won't have any
trouble meeting those with their cash that they generate from operating the business?
There is other information that we can pull out of the Vulcan report related to
their debt.
So one thing I found in there was that S&P downgraded their credit rating in 2010.
So because of their troubles S&P said it's,
it's a little bit less likely that they're going to pay back their debt.
And their bankruptcy risk has gone up by a little bit.
Their commercial paper rates have gone up by 30 basis points.
This was talked about in page 35.
Commercial papers extremely short-term debt.
So it's usually about 90 days, you're borrowing for about 90 days.
And so this is the lowest risk borrowing that a company can really do.
because all you need is the company to be there in 90 days to pay you back and
that very short-term borrowing has gone up by 30 basis points indicating that
the market is a little bit skittish about Vulcan's prospects that it's
gotten a little riskier.
And then there a disclosure about upcoming principle payments and
other future contractual obligations on page 41.
I'm going to bring that up to show you.
So, this is page 41 of the MDMA, there's cash contractual obligations.
And we can see,
in 2011, they had a big payment due on their line of credit of 285.
Then if you look at 2012 to 2013, you
have the principal payments on their long-term jet, debt jump from 5 to 590.
But note that this is over two years.
So that's about 295 per year,
which is similar to what it's going to be 2014, 2015.
So even though you see what looks like a big jump here in payments, and
a really big jump here.
Note the columns that this 571 is 2011 then
these two columns are two years combined.
So again, it's about 500 per year and then thereafter is everything beyond that.
So, even though principle payments are going up,
we're getting rid of this big line of credit payment.
And it looks like going forward Vulcan has about, let's call it
300 million of debt payments that they're going to have to make per year.
Next another disclosure I want to show you is the estimated fair value of
the long-term debt.
Which is on note six, page 72.
So I'm here on page 72, footnote six,
where Vulcan talks about its long-term debt.
There's a required disclosure which is to compare the fair value of
the debt to the long-term debt.
And what we can see here is that the fair value of their long-term debt
is higher than their book value of their long-term debt.
Now what that means is that interest rates have dropped, because what happens
is as market interest rates go down the fair value of debt goes up.
>> More good news.
>> Now while it looks like good news we have to keep in mind that what's been
going on is market rates as a whole have been going way down during this period so
this is the aftermath of the financial crisis.
The Fed has been trying to lower interest rates dramatically to get
the economy stimulated.
And the fact of the matter is this fair value of debt probably should've gone up
much more than it did given how market rates have dropped.
But what happened is, as market rates have been dropping, as we saw in
this other data like with the commercial paper rates, Vulcan's risk has gone up.
And so what happens is the net effect is that, yes, their interest rates have
dropped, but not as much as they should because Vulcan is becoming riskier.
And it wouldn't be surprising if some point these interest rates started to go
up even when the market rate still tends to be low, just due to the riskiness.
So last thing I want to look at is interest coverage.
So we saw early in the course the interest coverage ratio operating expense over
interest expense.
So here again is all the data since 1999 to present.
And in the hay day, salad days of the mid 2000s
very strong interest coverage ratio couple things happen.
One is interest expense went up dramatically because of
all the debt taken on in the acquisition.
Meanwhile, performance plummets due to the recession, and
so we have almost no interest coverage in 2009.
And then, it's getting recalculated in 2010 because we
have negative operating earnings.
Now another way we could probably look at this is operating cash flow over
cash interest payments.
And it might look better there, but
that wasn't something that I was necessarily able to find.
But the bottom line is one thing that we have to continue to worry about for
Vulcan is their ability to generate enough cash from operating the business to
cover this very high interest expense they have from their high debt load.
And that wraps up the penultimate video this week looking at
financial statement analysis of Vulcan Materials.
Next time we're going to look for
off-balance sheet activities where Vulcan is either investing or financing, but
the implications of that is not shown on the face of the balance sheet.
I'll see you then.
>> See you next video.
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