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Capital structure Report


Executive summary

This report analysis the capital structure, use and effect of leverage, dividend policy, long-term financing policies, working capital management practices, and mergers and acquisition. The analysis involves three hospitality industry companies, including Entertainment Properties Trust, Mandarin Oriental Hotel Group, and Host Hotels & Resorts.

The analysis of capital structure and leverage is done through debt/equity ratio analysis. This ratio shows the proportion of debt capital in relation to the equity capital. For all the three companies, the analysis is done for the period between 2006 and 2011.

Introduction

A company’s capital structure can be evaluated by calculating its financial leverage, which can be indicated by debt/equity ratio. This ratio demonstrates the fraction of share capital and debt that an entity has used to fund its assets (Dann, 1993).

Capital structure is a very important aspect of a balance sheet, and companies should always ensure it is balanced as it influences the returns. The analysis will be done on three publicly-held companies, including Host Hotels & Resorts, Entertainment properties trust, and Mandarin Oriental Hotel Group.

Methodology used to perform the analysis

The analysis of capital structure and leverage is done through debt/equity ratio analysis. This ratio shows the proportion of debt capital in relation to the equity capital. For all the three companies, the analysis is done for the period between 2006 and 2011. Dividend payments policies and trends are made clearer by analysis of dividends per share (DPS) for the last six years. All the data is sources form the respective annual reports.

Host Hotels & Resorts

HH & R, Inc. (Host Inc.) runs a self-managed property venture trust. The company has invested in properties, which is administered through Host Hotels & Resorts, L.P., whereby, Host Inc is the principal partner, holding about 98.5% of the interests. Currently, the company has a portfolio of 121 hotels, which mainly specialize in luxury and expensive hotels, holding up to 64,947 rooms (DeAngelo & DeAngelo, 1990).

Capital structure

Host Hotels & Resorts seek to uphold a liquidity and capital structure that is balanced between equity and debt, in order to offer financial flexibility especially considering that it operates in a very volatile lodging industry (Graham, 2000).

The company’s five years capital structure can be demonstrated through debt/equity ratios as shown in the table below. Since 2006, the company’s debt/equity ratio has been on the decline, which is a positive indication because it is believed that companies with a lower ratio are likely to perform well in the long-term (Leary & Roberts, 2005).

2006 2007 2008 2009 2010 2011
Debt 5878 5625 5952 5837 5477 5753
Shareholders’ equity 5222 5441 5517 6211 6332 6713
Debt/equity ratio 1.12 1.03 1.08 0.94 0.86 0.86

Use and effect of leverage

It is evident that the company carried huge debt capital between 2009 and 2011. Although this could be a disadvantages because of the extra costs incurred in paying interest, holding debt capital as the leverage provided by the debt financing carries a benefit for the interest expense payable by the company is a tax deductible expense.

Dividend policy

Host Hotels & Resorts has been adjusting its dividends per share since 2006, perhaps depending on the year’s earnings, or with the aim of retaining funds for reinvestment. The highest DPS, which amounted to $ 6 per share, was paid in 2009, and the least amounted to $ 0.76, which was paid in 2006.

In recent years, the company has adopted a constant dividend payout to enhance long-term strategy, by providing the shareholders with handsome risk-adjusted returns. In addition, this strategy is aimed at attracting investors who are seeking high dividend returns in the industry.

This is also done because the company has established that attractive dividend payout is perhaps the biggest bait for REIT investors because the United States law calls for REITS to give out 90% of their returns to the shareholders in the form of dividends (Zacks Equity Research, 2012; Welch, 2004).

DPS

2006 2007 2008 2009 2010 2011
Dividend per common stock 0.76 1.0 0.65 6.0 2.0 1.0

Long-term financing policy

The company focuses on balancing its long-term financing, by striking a good balance between equity capital and debt capital, with the sole aim of maximizing the returns of the shareholders.

Mergers and acquisitions

To facilitate expansion in the United States and globally, the company has been involved in multiple acquisitions, with $1.2 billion of assets being acquired in 2011 alone. Acquisition during 2011 included San Diego, Manchester Grand Hyatt, and New York Helmsley Hotel among others.

The company focuses on acquiring well performing hotels in strategic locations, and in particular those with great entry barriers. Recently, the Company directly acquired 23 hotels through its own joint ventures. The criteria used for this acquisition was simply to create value for the stockholders through careful assessment of opportunities to realize the maximum returns on investment.

Working capital management practices

The company provides operating capital to facilitate operation of the property, including payment of wages, property taxes, utilities, among other expenses, as well as purchase of inventory. The hotel managers are concerned with distribution of cash for operations, which replicates the level of the hotel’s sales, less operating expenses for the property-level. This is done every four weeks or on a monthly basis, depending on the discretion of the managers.

Entertainment Properties Trust

Capital structure

The debt/equity ratio for this company is relatively balanced and close to that of Host Hotels & Resorts, whereby for the 5 years, the company over relied on debt in 2007 only. Compared with Mandarin Oriental Hotel Group, this company seems to have a less balance capital structure.

The company is spending very little in terms debt interest expenses compared to Host Hotels & Resorts. The trend of debt/equity ratio for this company for the five years is very close to that of Mandarin Oriental Hotel Group because they are in the same industry, and have similar capital structures (EPT, 2010).

2006 2007 2008 2009 2010 2011
Debt 675,305 1,081,264 1,262,368 1,141,423 1,191,179 1,154,295
Shareholders’ equity 857,156 1,026,100 1,292,651 1,467,957 1,631,258 1,498,103
Debt/equity ratio 0.79 1.05 0.98 0.78 0.73 0.77

Use and effect of leverage

The company has mostly maintained a ratio that is less than 1 as shown in the table below, which means that it is financing the better part of its assets through equity. This way, the company has saved extra expenses, which could be spent on debt interest.

Dividend policies

Although dividend per share was reduced significantly since 2009, the company has maintained a relatively stable payout. Entertainment Properties Trust is also compelled to pay out 90% of its income to its shareholders as dividends, as this is a real estate investment trust policy. Apart from making these distributions, the company does not have full ability to acquire properties using internal capital. Therefore, in order to diversify and grow its portfolio, the company must persistently raise capital (Byoun, 2008).

Long-term financing policies

The ability of the company to raise long-term capital relies on external factors, including conditions of credit and equity markets, the situation of the tenants as dictated by the industry, and generally the performance of real estate venture trusts. To raise additional capital, the company assesses a number of potential dealings; however, attractive sources are not always a guarantee (Barry, 2010; Fama & French, 2005).

Working capital management practices

The company provides operating capital to facilitate operation of the property, including payment of wages, property taxes, utilities, among other expenses, as well as purchase of inventory. Allocation of working capital is dependent on the management (Baker & Wurgler, 2002).

DPS

2006 2007 2008 2009 2010 2011
Dividend per common share 3.02 3.04 3.36 2.60 2.60 2.80

Acquisition and merger

As a growth and development strategy, the company considers acquisitions or come up with public charter schools and extra megaplex theater properties or developing other entertainment and recreational properties.

Mandarin Oriental Hotel Group

Mandarin Oriental Hotel Group is an associate of the Jardine Matheson Group with investments in major cities around the world. It mainly invests in first class hotels, residences and resorts.

Capital structure

Capital structure shows the relationship that exists between equity shares, preference shares and debt capital in the company’s balance sheet (Schmidgall & DeFranco, 2004). Basically, the different modes of financing give the financial structure of an enterprise. Mandarin Oriental Hotel group has a capital structure that comprises both the share capital and debt capital.

However, the company tends to finance its operations mainly from equity capital as shown in the table below. The capital structure for this company is very close to the other two, perhaps because they all belong to the same industry.

2006 2007 2008 2009 2010 2011
Debt capital 575.1 663.9 653.9 557.1 574.5 578.5
Share capital 841.2 930.7 863.6 915.6 903.9 915.6
Debt/ Equity ratio 0.68 0.71 0.76 0.61 0.64 0.63

Use and effect of leverage

For Mandarin Oriental Hotel group, Share capital forms the bigger weight of the capital structure. The share capital is considered much safer as opposed to debt capital for it does not leave the company with the obligation of paying the cost of finance (Falk & Heints, 1975). By holding debt capital, the company is liable to pay high interest expenses. However, the company maintains an average mix of both debt and equity capital, thus shielding itself from the high cost of debt and also the high returns expected by the shareholders (Taylor, 1989).

Dividend policy

The Company pays dividend based on profitability achieved in every given year. This is indicated by the following dividend per share declared and paid between 2006 and 2011 as shown below (Mandarin Oriental the Hotel Group, 2011).

2006 2007 2008 2009 2010 2011
Dividend per common stock 3 6 7 7 5 6

Based on the comparison of dividend paid from 2006 to 2011 as indicated in the above table, the company seems to have been paying constant dividend, which is a good indication that it has reached its maturity stage. Further, this can be supported by lack of an indication of additional investments through mergers and acquisitions or even new set ups, which could be reflected on the financial statements. As such, board of directors distributes the earnings to shareholder through dividends.

Long-term financing policy

The Company mostly finances its operations through long-term financing. This is well illustrated by significant long term borrowing, which ranges from $ 557.1m to $ 663.9m (Mandarin Oriental the Hotel Group, 2011).

In addition, the company has financed its operations through share capital, which as indicated in the financial statements increased from 48.4m in 2006 to 49.8m in 2011. Notably the company favors equity capital as compared to debt capital. This can be attributed to the cost of capital whereby equity capital is cheaper as compared to debt capital (O’Connor, 1973).

Working capital management practices

Working capital of the company has significantly reduced between 2006 and 2011, from 490m to 394.9m.This can be attributed to increase in current liabilities as compared to current assets. However, the general manager, operations manager, and executive heads usually works on an operational budget which is agreed on with the group’s proprietors after which once signed off, the management team maintains the agreed standards to check the expenses and cash movements.

Mergers and acquisitions

In 1974, the Mandarin Oriental Hotel Group expanded though acquisition of 49% of the oriental Bangkok. This merger placed the group in a better and competitive position in the hospitality industry, than before.

Conclusion

Capital structure is a very important aspect of a balance sheet, as it reflects the financial stability of a company. In particular, use of equity and debt capital needs to be well balanced as affects the operations of the company, including profitability. One of the most effects of leverage, which results from use of debt as capital, is increased interest expenses.

As such, analysis of these companies has been closely tied to their leverage status. Debt/equity ratio has been found very useful in analysis of capital structure, and leverage in particular; it ratio shows the proportion of debt capital in relation to the equity capital. The three companies have been found to be keen on maintaining a stable debt/equity ratio; by limiting their debt capital compared with equity capital.

References

Baker, M., Wurgler, J. (2002). Market timing and capital structure. The Journal of Finance, 57, 1-30.

Barry, E. (2010). Financial Accounting, Reporting and Analysis. London: International Edition publishers.

Byoun, S. (2008). How and When Do Firms Adjust Their Capital Structures Toward Targets? The Journal of Finance, 63(3), 3069 – 3096.

Dann, L.Y. (1993). Highly leveraged transactions and managerial discretion over investment policy: An overview. Journal of Accounting & Economics, 16(1), 237- 240.

DeAngelo, H., DeAngelo, L. (1990). Dividend Policy and Financial Distress: An Empirical Investigation of Troubled NYSE Firms. The Journal of Finance 45(1), 1415-1431.

EPT. (2010). Annual reports. Retrieved from

Falk, H., & Heints , A. (1975). Assessing industry risk by ratio analysis: The Accounting club industry. The Journal of Hospitality Financial Management, 12(1), 1-14.

Fama, E.F., French, K.R. (2005). Financing decisions: who issues stock? Journal of Financial Economics, 76(1), 549-582.

Graham, J.R. (2000). How big are the tax benefits of debt? The Journal of Finance, 55, 1901-1941.

Leary, M.T., Roberts, M.R. (2005). Do Firms Rebalance Their Capital Structures? The Journal of Finance, 60(2), 2575-2619.

Mandarin Oriental the Hotel Group. (2011). Financial Report. Retrieved from

O’Connor, M. (1973). On the usefulness of financial ratios to investors in common. Review, 50(4), 758-779.

Schmidgall, R. & DeFranco, A. (2004). Ratio analysis: Financial benchmarks for the stock. The Accounting Review, 48 (2), 339-352.

Taylor, H. (1989). How to analyze financial statements. Economic Development Review, 7 (2), 62-67.

Welch, I. (2004). Capital Structure and Stock Returns. The Journal of Political Economy, 112(6), 106-131.

Zacks Equity Research. (2012). Host Hotels Hikes Dividend. Retrieved from

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IvyPanda. "Capital structure." June 13, 2019. https://ivypanda.com/essays/capital-structure-report/.

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IvyPanda. 2019. "Capital structure." June 13, 2019. https://ivypanda.com/essays/capital-structure-report/.

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IvyPanda. (2019) 'Capital structure'. 13 June.

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