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Saudi Electricity Company’s Financial Analysis Term Paper


The selected company for analysis in this report is the Saudi Electricity Company, which operates in the energy industry of Saudi Arabia. The company is a utility company, and it has a monopolistic position in the market. It is the only company that controls the entire electricity supply in Saudi Arabia. Currently, it operates 45 power generation plants and generates 65 GW of electricity (“Saudi Electricity Company – Consolidated Financial Statements and Auditors’ Report” 4). The company’s stocks are listed on Tadawul, Saudi Arabia, and its stock id is 5110 (“Saudi Electric Company”). The current report presents findings of financial ratio analysis, break-even analysis, and capital budgeting. Moreover, the report includes short-term cash balance projections and risk management analysis. The calculations made in this report are based on the company’s financial statements for the year ended 31 December 2015.

Short-term Cash Balance Projection

A company needs to have enough cash to fund its operating activities and make investments for expanding its business. The cash and cash equivalent balance of Saudi Electricity Company for the last six years is provided in Table 1.

Table 1 – Short-term Cash Balance. Source: (“Saudi Electricity Company – Consolidated Financial Statements and Auditors’ Report” 4).

2015 2014 2013 2012 2011 2010
Cash and cash equivalents 2,038,229 6,943,507 3,992,142 3,045,786 7,305,124 7,227,776
Yearly Change -70.65% 73.93% 31.07% -58.31% 1.07%
Average -5%

Table 1 indicates that the company’s cash balance varied considerably in the last six years. The company’s cash balance increased by 73.93% in 2014. However, it reduced significantly by 70.65% in 2015. The company maintained the highest proportion of cash at the bank. It also used short-term deposits to generate a return on cash holdings. It could be noted from Table 1 that the average growth rate of cash and cash equivalents was -5%. Therefore, it could be estimated that the company’s cash balance in 2016 would be SAR 1.9 billion (2,038,229 x (1-5%)).

The company’s cash flow statement indicated that its receivables from electricity consumers and accrued revenues increased significantly in 2015, which hurt the operating cash flow (“Saudi Electricity Company – Consolidated Financial Statements and Auditors’ Report” 4). Furthermore, the company invested heavily in the acquisition of fixed assets and construction work in progress. It was due to the company’s plan to expand its power generation capacity (“Saudi Electricity Company – Consolidated Financial Statements and Auditors’ Report” 4). Therefore, it could be inferred that the company’s cash balance will decrease further as it continues to invest in its expansion.

Risk Management Analysis

The company’s annual report for 2015 indicated that the company used derivatives and other hedging techniques and tools to mitigate risks associated with its assets and liabilities. The major risks of the company include the failure to collect payments from customers and the increase in the investment value of its fixed assets. The company provided a provision of doubtful receivables in its financial statements. It indicated that the company faced risks of non-payment that could affect its net income (Berk and DeMarzo 182). The company faced a foreign currency exchange risk of the purchase of fixed assets from foreign entities. The company used currency forward contracts to hedge its cash flows. The company recognized the value of its derivatives at their fair price and recorded gains/losses in its financial statements (“Saudi Electricity Company – Consolidated Financial Statements and Auditors’ Report” 9). The gain/loss on the hedging instrument is recorded in the company’s equity.

Financial Ratio Analysis

The financial ratio analysis is useful to assess the company’s past performance. It determines the values of different ratios that assist in determining the company’s financial performance and identifying areas of success or failure of the corporate strategy (Drake and Fabozzi 265). However, the financial ratio analysis has a limitation that it cannot be used for predicting the company’s performance in the next period. In the current report, different key ratios are determined under various categories including efficiency, cash, liquidity, profitability, solvency, and working capital. The report provides a comparative analysis of ratio values for 2014 and 2015.

Liquidity

Table 2 indicates that the current ratio value was less than one, which implies that the company had liquidity issues. From the annual report, it could be indicated that the company had invested a significant amount of funds in its expansion plan. It hurt its cash position. Furthermore, the quick ratio value was also close to zero. It could imply that the company could face major liquidity issues, and it should improve its current assets position.

Table 2 – Liquidity.

Liquidity Ratios
Current Ratio
Current assets 37,887,573 38,957,695
Current liabilities 62,691,531 46,949,382
Current Ratio 0.60 0.83
Quick Ratio
Quick assets 17,375,189 23,114,020
Current liabilities 62,691,531 46,949,382
Quick Ratio 0.28 0.49

Efficiency

Table 3 provides the values of different efficiency ratios. It could be noted that the company generated only SAR 0.12 per SAR 1 invested in its assets. The business is highly capital intensive and requires a lot of investment in fixed assets. The inventory period of the company was 61 days, which showed improvement in 2015. The accounts receivable period increased from 150 days in 2014 to 180 days in 2015. It indicated that the company had problems in managing its receivables and realizing cash quickly. The accounts payable period also increased significantly in 2015. All these indicators implied that the company had major weaknesses related to the management of its assets efficiently.

Table 3 – Efficiency.

Efficiency Ratios
Total Asset Turnover
Operating revenues 41,538,732 38,490,670
Total assets 358,029,949 317,908,193
Net Asset turnover 0.12 0.12
Inventory Period
Inventory 6,495,066 6,602,409
Cost of sales 38,953,467 36,462,927
*365 365 365
Inventory Period 60.86 66.09
Accounts Receivable Period
Receivables 20,512,384 15,843,675
Operating revenues 41,538,732 38,490,670
*365 365 365
Accounts Receivable Period 180.24 150.24
Accounts Payable Period
Payables 52,460,414 39,122,255
Cost of sales 38,953,467 36,462,927
*365 365 365
Accounts Payable Period 491.56 391.62

Profitability

Table 4 provides the values of different profitability ratios. It could be noted that the company had low profitability. It had very low ROCE because of the high value of total assets. The company had low-profit margins including ROE, Operating Margin, and Net Margin. However, these values were in line with the industry standards as power generation companies operate at low margins due to controlled pricing by the government.

Table 4 – Profitability.

Profitability
ROCE
Operating Profit 1,592,844 1,098,248
Equity 60,349,127 59,242,496
Liabilities 297,680,822 258,665,697
ROCE 0.44% 0.35%
ROE
Net Income 1,543,642 3,606,594
Equity 60,349,127 59,242,496
ROE 2.56% 6.09%
Operating Margin
Operating Profit 1,592,844 1,098,248
Revenue 41,538,732 38,490,670
Operating Margin 3.83% 2.85%
Net Margin
Net profit 1,543,642 3,606,594
Revenue 41,538,732 38,490,670
Net Margin 3.72% 9.37%

Solvency

Table 5 indicates the values of different solvency ratios. It could be noted that the company had a strong solvency position. The debt to equity ratio value was 1.00, which implied that the company had used both debt and equity to finance its operations. The company’s gearing level is low, which is also a positive indicator of its long-term solvency. The company generated sufficient operating profit to pay its interest expenses.

Table 5 – Solvency.

Solvency Ratios
Debt to Equity
Interest bearing debts 60,554,566 54,615,087
Equity 60,349,127 59,242,496
Debt to Equity 1.00 0.92
Gearing
Interest bearing debt 60,554,566 54,615,087
IBD + Equity 120,903,693 113,857,583
Gearing 50% 48%
Interest Cover
Operating profit 1,592,844 1,098,248
Finance cost 266,483 376,964
Interest Cover 5.98 2.91

Working Capital

Table 6 – Working Capital.

Working Capital
Current assets 37,887,573 38,957,695
Current liabilities 62,691,531 46,949,382
Working capital (24,803,958) (7,991,687)
% of sales -59.71% -20.76%

Cash Operating Cycle

Table 7 indicated that the company had a negative cash operating cycle. It could be stated that the company could face major cash problems. The company’s liquidity needs to be improved. Its expansion plan will be completed by 2020, and it could be anticipated that the liquidity position would improve after the project completion.

Table 7 – Cash Operating Cycle.

Cash operating cycle
Inventory days 61 66
Receivables days 180 150
Payables days 492 392
Cash operating cycle (250) (175)

Capital Budgeting

Capital budgeting is a process by which a company determines the feasibility of investment in new assets (Berk and DeMarzo 398). The company can estimate future cash flows from its investment and use different investment appraisal techniques to conclude whether it is worth investing in the new project or asset. In this report, the company’s investment in fixed assets in 2015 is considered. It could be noted from the company’s cash flow statement that it invested SAR 56.2 billion in fixed assets in 2015. The company’s free cash flow is calculated and then proportioned to the company’s investment in 2015 as provided in Table 8. For the allocation of free cash flow, the proportion rate is determined as follows.

Proportion rate = Additional investment in fixed assets in 2015 / Total Assets

Proportion rate = SAR 56.2 billion / SAR 358.03 billion

Proportion rate = 15.7%

Table 8 – Free Cash Flow.

2013 2014 2015 2016f 2017f 2018f
Net Income 3,035,869 3,606,594 1,543,642
Add:
Depreciation / Amortization 11,730,666 13,559,970 14,933,508
Less:
Changes in Working Capital -606,410 -11,976,005 -18,484,652
Capital Investment 40,846,881 50,170,729 56,111,297
Free Cash Flow -26,080,346 -33,004,165 -39,634,147 -48,876,107 -60,273,124 -74,327,718
Proportioned to Additional Investment -7,673,549 -9,462,880 -11,669,452

Table 8 indicates that the company had negative free cash flows in the last three years. It was mainly due to heavy investment in fixed assets as the company aims to increase its power generation capacity from 65 GW to 91 GW by 2020. Therefore, the growth rate assumed for projecting future free cash flows is also negative. It is determined as the average of growth rates of the previous two years (Ryan 276). However, it must be noted that it was not possible to calculate the cost of equity of the company as its beta value is not available from any informational source. Moreover, the company acquired Islamic financing from different banks, and the information related to these loans did not indicate the value of the use of funds incorporated in the repayment amount by banks.

Break-Even Analysis

The break-even analysis is performed in Table 9.

Table 9 – Break-Even Level.

Operating Revenues 41,538,732
Cost of Sales 38,953,467
Contribution Margin 2,585,265
Fixed Costs
General and administrative expenses 607,762
Fixed assets depreciation – General and administrative 384,659
992,421
Break-Even Level Fixed Costs / Contribution Margin
992,421/2,585,265
0.38

It could be noted that the company can break-even at a low level. It suggested that the company had low fixed costs and high contribution margin.

Asset-Liability Management

Table 10 indicates the total assets and total liabilities of the company.

Table 10 – Liabilities to Assets Ratio.

2015 2014
Total Assets 358,029,949 317,908,193
Total Liabilities 297,680,822 258,665,697
Liabilities to Assets Ratio 0.83 0.81

It could be indicated that the company has SAR 0.83 in liabilities for every SAR 1 in its assets. The ratio value increased in 2015, which could imply that the company could face financial difficulties if its business does not generate sufficient profit in the coming periods.

Conclusion

Based on the detailed analysis provided in this report, it could be concluded that Saudi Electricity Company has a strong position in the market as it is the only company that is generating power and fulfilling the energy needs of Saudi Arabia. The company has an aggressive strategy to increase its power generation capacity by the end of 2020. Therefore, it is noted that the company had negative free cash flows and low cash balance. However, the company is expected to generate positive results after its expansion plan is completed. The financial ratio analysis also indicated certain weaknesses related to liquidity and cash operating cycle. The company should take steps to increase its efficiency by improving its receivables turnover and reducing the accounts payable period.

Works Cited

Berk, Jonathan B. and Peter M. DeMarzo. Corporate Finance. Pearson Education Limited, 2016.

Drake, ‎Pamela Peterson and Frank J. Fabozzi. Analysis of Financial Statements. John Wiley & Sons, 2012.

“Saudi Electric Company.” Tadawul, 2016, Web.

Saudi Electricity Company, 2016, Web.

Ryan, Bob. Corporate Finance and Valuation. Thomson Learning, 2007.

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