Introduction
Purpose of Study
Al Rajhi Bank is following Islamic Laws in practicing banking and investments functions. It is one of the largest banks in the kingdom of Saudi Arabia with paid up capital of SAR 13500million. It branches network is all over the kingdom of Saudi Arabia with more than 500 branches. This study is under taken to evaluate the financial performance of the bank over the years both from its earnings and growth point of views.
Methodology and source of data
The financial statements and other information of the bank available at its website have been used to evaluate the performance of the bank. As the bank is listed with the Saudi Stock Exchange (Tadawul), the information available at the site of exchange has also been taken into consideration for evaluation purposes.
Production and Cost Analysis
Nature of Products and Underlying Technology
The mission of the bank is ‘to be most successful bank admired for its innovative service, people, technology, Sharia Compliant products both locally and internationally.’(Al Rajhi Bank.Com)1 Beside the normal banking operations, Al Rajhi has developed cash management solution for its customers. The bank has developed some Islamic related banking products like Bai Al Ajai, Murabaha, Musharaka, Istnisana, Ijara, and others.
Bai Al Ajai is facility to provide cash to customers. Murabaha enables customers to purchase products like raw materials, capital assets, and other goods from local as well as international markets. Musharaka is a sort of partnership between bank and its customers who need to import goods and equipments but have insufficient financial capacity to do so. Under Istnisana scheme the bank finances real estates for its clients. Ijara is a fixed and floating lease project where under the banks acquires assets and then leases those assets to its customers for their uses. There are other products and normal banking operations and products that Al Rajhi deals in.
Breakeven Analysis
Breakeven analysis provides a tradeoff situation where revenue equals the costs required to earn that revenue. The breakeven analysis brings forth a situation where there are no profit and no losses and the revenue is just breaking even with costs. This is because the margin earned by the company at breakeven revenue is the same as the total costs. Therefore break even analysis is a necessary exercise to establish a status in the business that has to be acquired when business goes worst. For calculating breakeven status we need to distinguish variable costs from the fixed costs of the products. Fixed costs do not change with,VisionandValues.aspx time, it varies as per its us. At breakeven point EBIT (earning before interest and taxes) are equal to total costs and can be calculated using following formula:
EBIT = (P 8 Q) – FC – (VC 8 Q), where
P= sales price per unit, Q= sales quantity in units, FC = fixed operating cost per period, and VC = variable operating cost per unit.
Bank’s financial statements do not provide details about fixed and variable costs. Hence the break even has been analyzed at the level of revenue where total costs of earning that revenue equal to the revenue itself. The calculations are made as under:
Degree of Operating Leverage
Operating leverage is caused because of existence of fixed operating costs. Every change in revenue or sales provides some changes in the earning before interest and taxes. The degree of changes in EBIT caused by changes in sales is called degree of operating leverage. It is measured as effect of percentage of changes in sales over the percentage of change in EBIT. When the changes are more than one, the degree of operating leverages occurs and below that it is considered that there is no degree of operating leverage. The degree of operating leverages of Al Rajhi Bank is calculated hereunder:
As the effect of change in revenue over EBIT in 2007 is less than one (in fact it is a negative figure) it is concluded that there is no degree of operational leverage in 2007. On the other hand degree of operational leverage in 2006 is calculated as 1.17.
Financial Ratios and Trend Analysis
Liquidity
Liquidity of a bank is a relative issue with statutory requirements to keep minimum cash reserves. Liquidity of a bank implies ‘ability to fund all contractual obligations of the bank, notably lending and investment commitments and deposit withdrawals and liability maturates, in the normal course of business, that is the ability to fund increases in assets and meet obligations as they come due.’(CPO instructions, page 1)2
Accordingly a bank develops its liquidity standards. However, as per normal procedures and norms established in the banking industry a bank’s liquidity ratio calculated based on following formula should at least be 15%; only than a bank can be said to have a solvent liquidity status. The formula is as under:
Bank Liquidity Ratio = Highly Liquid Assets/ Total Liabilities not including equity. * 100
Where highly liquid assets include the following:
Vault Cash, Precious Metal (Gold), Statutory deposit with Central Bank, Deposits with other financial institutions, readily marketable securities, and Net Inter- bank lending and borrowings with a remaining maturity period of up to one month.
On basis of above formula the liquidity of Al Rajhi Bank is calculated for three years as under:
It is observed that liquidity ratio of the bank in all the three years is below the required standard of 15%. Accordingly the bank is continually facing liquidity crunch from the point of view of banking standards, and bank may find difficulty in meeting its contractual obligations of deposit withdrawals and liability maturates.
Activity
The optimum to judge activities of a bank is through the ratio of ‘loans to deposits ratio’. In fact ‘banks that want a strategic earning advantage must strive for loan to deposit ratio. They must cultivate loan business, maintain it, and attract new business. Increasing the loan to deposit ratio by one percentage point will likely add four or five basis points to net interest margins.’(John Y Lee and marc J Epstein, page 146)3 Loan to deposit ratio of more than 50% shows that bank is willingly efficient to promote its activities. However LDR less than 40% present bank’s inefficiency in promoting its business. As Al Rajhi Bank follows Islamic rules, its investments are of the nature of loans and deposits. Accordingly LDR is calculated hereunder treating investments (reduced by installment sales) as loan and advances:
The bank has increased its investments in loans and advances from 46.58% of deposits in 2005 to 54.46% of deposit in 2007. This is very stimulating sign for the bank and shows efficient activities of the bank.
Leverage
The presence of fixed cost in company’s cost structure is the reason for leverages. There may be operational leverage that is the relationship between sales and EBIT. There may be financial leverage as well that reflect the relationship between borrowed capital and equity capital employed by the firm. Total leverage is the relation between entity’s sales and its earning per share. In case of bank financial leverage is more effective and It is calculated based on debt ratio of the company. For Al Rajhi Bank the calculations are as under:
The Al Rajhi Bank is a high geared company as its debt ratio is more than 50% all along. Though the percentage of high debt leverage has dropped from 85.83% in 2005 to 81.1% in 2007, but still the company is highly geared. The shareholders can take advantage of the situation by trading on equity.
Profitability
Return on total assets and return on equity ratios are employed to assess the profitability of Al Rajhi Bank. The ratios are calculated hereunder:
Al Rajhi Bank has been able to maintain some stability on its earnings on assets employed, as the earning on assets in 2005 was 5.93% and that has come down to 5.16% in 2007 and in between during 2006 there was great hike to 6.94%. But the return on assets is sliding if the bank does not take concrete steps to maintain the profitability.
On the other hand return on equity has come down from 41.82% in 2005 to 27.32% in 2007. This should because of concern for the bank as profitability the bank’s performance is poor because of under utilization of assets employed.
Growth
The loan and advances are not rising. Instead the company has introduced certain investment schemes that are mostly in the shape of investments. The bank’s total net investments in such schemes have risen from SR (in ‘000) 80134684 in 2005 to SR (in’000) 104875445. From this point of view the company’s growth is has improved over the years. The ratio of company’s Loan and advances to public deposit has risen from 46.58% in 2005 to 54.48% in 2007 and this is an encouraging sign. But the earning per share has gone down from mighty 8.35 in 2005 to poor 4.78% in 2007.
Capital Investment and Financing
Analysis of Capital Expenditure
During the year 2007 the net increase in capital expenditure on property and equipment SR (in’000) 614550 as compared capital expenditure of SR (‘000) 612346in 2006. This explains that the growth on capital expenditure is almost static over the years and that has no significant overall impact on the growth of banking business of the company.
Average rate of return on investment
Average rate of return is calculated hereunder:
The average rate of return on investment is fluctuating. These fluctuations are due to fact that capital employed is not being directly advanced as loans and advances but under different schemes. Such schemes have certain other consideration like sale of investments, and these results into the fluctuating nature of return on assets employed by the bank.
Dividend Policy
The company is following a cash dividend policy. Total amount of dividend declared by the company over the years is as under:
Year 2007 2006 2006
Dividend declared in SR (in’000) 1223917 998021 591709
No. of outstanding shares 135000000 675000000 450000000
Dividend per share (SR) 9.06 0.145 1.31
Source and Uses of Funds
Al Rajhi Bank has used both borrowed capital as well as equity capital to finance its total assets. The company’s capital structure over three years is as under:
SR in ‘000
Year 2007 2006 2005
Total assets 124886482 105208744 95037981
Equity Capital 23606112 20179476 13469294
Borrowed Capital 101280370 85029268 81568687
Estimate of the Cost of Capital
The company is using both borrowed capital as equity capital to finance its assets. A company’s cost of capital is the weighted average cost of various sources of finance used by it. As the company is using both debts and equity capital, its cost of capital would be (proportion of equity) * (cost of equity) +(proportion of debts) * (cost of debt).
Cost of capital is an important rate of return expected by the existing capital providers. The company must earn at least its estimated cost of capital.
It is difficult to estimate cost of capital employed by Al Rajhi Bank in view of the fact that financial statements available at the site of company do not carry the required information to calculate such cost of capital.
Evaluation of Stock Price Performance in the Market
The required values are calculated hereunder:
P/E ratio indicates that value investors are ready to pay for the shares. That means investors were ready to more for Al Rajhi Bank’s share in 2007 as compared to 2006 and 2005.
Summary and Conclusion
The market value of share has gone up in 2007 as compared to 2006 but was lower than 2005. This is because the earning per share is greater in 2007, but over all assessment shows that Al Rajhi Bank has lowered its profitability over the years. This is mainly because the bank is not directly promoting loans and advances but under schemes that some time suit the customers and some time against the interest of customers. It is suggestible that bank should confine its activities to basic and direct banking instead of investing into projects that may be influenced by factors other than maximizing the profits of shareholders.
References
- Al Rajhi Bank.Com, Our Mission, 2009. Web.
- CPO Instructions, Instructions on Bank Liquidity, page 3. 2009. Web.
- John Y Lee and marc J Epstein, Advances in Management Accounting, Emerald Group Publishing, 2004, page 146.