oxford brookes (obu) acca applied accounting rap thesis on topic 8 ‘the business and financial...

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Research and Analysis Project

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Honda Atlas Cars [Pak] Ltd

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Project Objectives and Research Approach:The topic I selected for my BSc RAP is ‘The Business and Financial Performance of an Organization over a three year period.’

Reasons for choosing the Topic:For any organization to breath it is essential that it copes with environment through its strengths and strategies and manages finance effectively. An organization’s Business & Financial performance plays a leading role in deciding its position in the industry. That’s why I chose this topic as it is even more important to know an organization’s performance during a Global Economic meltdown when markets have been declining. Even more, this has been the major part of my studies and I had a chance to enhance my knowledge and develop practical skills in the area.

Reasons for choosing the Industry:I chose automobile industry as it is a major sector of the country having a major contribution to the economy.

Secondly, I wanted to know about challenges being faced by the auto sector during the financial crisis.

Thirdly, I was curious to know about the key players of the industry and to find out about one’s performance.

Reason for choosing the Company:Honda Atlas is a joint venture between Honda Motor Company Japan and the Atlas Group of Companies Pakistan. The Company incorporated about 20 years ago in 1992.

The reason I chose this Company is that it is one of the few leading carmakers in Pakistan having a strong share in overall automobile industry.

Another reason was my personal fascination with the brand.

As it is a listed Company at all the Stock Exchanges of the country, easy access to the F/S was another reason to choose.


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Project Aims and Objectives:I aim to achieve the following objectives:-

Carrying out the financial analysis ofHACPL in order to: Know how successful it has been in generating earnings and covering and

controlling costs in the relevant periodby analysing profitability of the Company. Analyse the short-term liquidity of the Company during the financial crunch. Understand the impact of its capital structure on its long-term solvency. Analysing Company’s activities’ impact on its working capital management. Understand the impact of its operations on the investor`s confidence and share

price volatility.Carrying out business analysis of the Company to:

Obtain an understanding of the impact of the external pressures on the internal operations and policies.

Examine the competitive pressures being faced by the Company.


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Research Questions: How will I utilize my time in order to complete my project within time? What sources of information will I access to gain the necessary information? What models will be used in order to achieve objectives of my RAP? Which ratios will be calculated and interpreted for the financial analysis? What models should be used to target my objective for the business analysis? What are the required IT skills? What ethical problems I might face during the research?

Research Approach:To initiate I will gather general information about the Automobile industry to gain an understanding of current and future prospects of the industry and the factors that are affecting it.

Then I will develop an understanding about the Company that I require for the purpose of my analysis. After that I will calculate and then interpret financial ratios using information that I gathered during my initial research. Then, using appropriate business models and techniques I will try to comprehend the effects of the macro-environment on the policies and operations of the Company. I will also try to verify and validate my assumptions through different information sources. I intend to use both primary and secondary sources to gather and validate information about the Company.

Then on the basis of my analysis I will draw conclusions and will give recommendations accordingly.


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Information gathering and business models used

Sources of Information:Two sources could be exploited for the purpose of information collection; The Primary and the Secondary sources. Primary Information sources are those that are closest to actual event, time period or individual in question. These present original thinking and observations such as original research used to write journal articles, reporting on original scientific studies, experiments or observations (Solomon, Wilson and Taylor, 2011). Secondary sources of information consist of descriptions and explanations that are created after a historical event has already taken place (American BookWorks Corporation, 2010).

Information Gathering:Primary Information:

Followed by telephonic calls I paid a visit to the Company’s office seeking to arrange a meeting with the management. I managed to obtain an appointment for meeting with the Company’s finance manager MrAsadMurad, in which I interviewed him according to the questionnaire I prepared beforehand to resolve my queries and to collect information about the Company.

Secondary Information:

Wide range of secondary sources was used to corroborate the information and to validate the interpretations made in the financial and business analysis. The following sources were used:

Annual Audited Reports: These reports provided general information about the Company and data to be used for purpose of ratios calculation.

Internet: Though relatively less reliable, internet provided vast knowledge & information about the industry, Company and much about the macro-environment surrounding such as Government’s policies and economic factors.

Newspapers, Journals & Articles: They were used to get the related information about the automobile industry and the Company.

Analysts Reports: I went through analyst’s reports and watched business channels to get a ‘walk through’ of the general status of the industry and the Company and general state of country’s economy and political situation.


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ACCA and other Textbooks: Text books form the college library was used to refresh the Business and Financial models and techniques I’ve applied for the purpose of business & financial analysis.

ACCA Student Accountants Magazines: They were used to keep an eye on the articles to keep updated with the latest developments in the profession.

Limitations of Data Gathering:Seeking newspapers and searching over the internet used to bring a lot of data and hunting the exact requirement absorbed a lot of energy and occupied a lot of time.

Different analysts had conflicting views and generated confusion about future prospects of the government, industry and the Company. It was often strenuous to make judgment.

The library had just a few numbers of latest editions of books and they often were not available being issued to other students and numerous visits to library were need to made.

Ethical Issues:Being Professional accountants we need to observe ACCA’s code of ethics so I remained prudent throughout preparation of this RAP.

Confidentiality was not an issue as all the information used was publicly available.

During the preparation of thesis, I interacted with certain people of undesirable attitudes but I maintained professional behaviour.

Referring to latest editions of the books and student accountant magazines I kept myself upgrade with professional updates.


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Business and Financial Models used:The techniques and models that I used for the purpose of Business and Financial analysis are:

Ratio Analysis:

It’s a tool for F/S analysis. It can be used to develop a set of statistics that reveal key financial characteristics of a Company. (Droms and Wright, 2010)

Advantages:

Makes easy to grasp relationships between various items. Provides comparative study of various businesses. Highlights changes that took place between time periods.

Limitations:

Often future forecasting becomes difficult with ratios. Inter-related. Single ratio can’t convey any meaning. Quantative measures. Ignores qualitative aspects.

(Murthy and Gurusamy, 2009)

SWOT Analysis:

SWOT Analysis is a careful evaluation of an organization’s internal strengths and weaknesses as well as its environmental opportunities and threats. (Griffin, 2011)

Advantages:

Impetus to analyse a situation and develop suitable strategies. Assesses core capabilities and competences. Evidence for and cultural key to change.

Limitations:

Generate long lists. Ignore prioritisation. Descriptive rather than analytical.

(Mard, et al., 2004)


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PEST Analysis:

It’s a tool for analysing a business and, in particular understanding market growth or decline. (Chapman, 2011)

Advantages:

Increase awareness of environmental change. Facilitates risk management. Acts as an early warning to anticipate opportunities and threats and plan

accordingly.

Limitations:

Contradicting changes may take place. Pace of change may create unpredictability. By the time one change is addressed another may have occurred.

(Evans, Campbell and Stonehouse, 2003)

Porter’s Five Forces:

It’s a framework for industry analysis and business strategy development. It defines competitive intensity and therefore the attractiveness of a market. (Grunig and Kuhn, 2010)

Advantages:

Enables organisation to determine attractiveness of a particular industry. Enables organisation to assess its ability to compete effectively in the industry. Provide indication of the future profits in the industry. (Henry, 2008)

Limitations:

It implies suppliers, buyers and competitors are threats whereas strategies could be made by collaboration.

It claims to assess industry’s profitability while Company specific factors are more important.

It implies that five forces equally apply to all competitors in the industry whereas forces may differ from business to business.(Tiwari, 2009)


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Results, Analysis, Conclusions and Recommendations:

Industry Information and Company Profile:To the country’s manufacturing sector, auto sector contributes 16% with Japanese companies dominating by producing and selling most of the outputs. Majority of annual demand of auto parts of $0.96 billion is manufactured locally and around 22% is imported. (Rohail, 2008)

Currently there is investment of PKR 98 billion (Pakistan Today, 2011) in the auto sector and its contribution to the GDP is more than 12 billion rupees and to the national exchequer is PKR 40 billion (Toyota, 2011a). EDB is seeking to even increase this contribution. Moreover, EDB is trying to enlarge the production capacity and to gain US $3 billion investment in the industry and attempting to grow exports to US $650 billion. (Haq, 2009)

However, the local industry is facing pressures from the government as sales tax raised from 16% to 17% and depreciation allowance on imported cars increased from 50% to 60% (Honda Atlas Cars (Pakistan) Limited, 2011a). Inflation and exchange rates variations have strained costs. Another challenge for the local carmakers is the increase of age limit of imported used cars from 3 to 5 years (Khan and Khan, 2010).

HACPL is one of the major car assemblers in Pakistani market (Khan, 2011). It is controlled by Honda Motor Company Japan which holds 51% shares. It has its Sales, Services and Spare Parts dealership networks spread around in all the major cities of the country. It offers four brands: Honda CR-V, Honda Accord, Honda Civic and Honda City.


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Profitability Analysis

Profitability RatiosHACPL TOYOTA

2011 2010 2009 2011 2010 2009%

Gross Profit Margin

0.90 -1.51 1.25 6.63 8.08 6.14

Net Profit Margin

-1.35 -5.38 -2.84 4.45 5.73 3.66

ROCE -4.42 -16.10 -9.23 28.73 42.44 20.13

2009 2010 2011

-20

-15

-10

-5

0

5

GPNPROCE

GP Margin:

FY 09:

The GP decreased by 71.87% led by the huge decrease in sales of 3.85% and relatively lower decrease in COS of merely 0.82%.

Costs inflated uncontrollably following the recession which in-turn negatively influenced the inflation and exchange rates fluctuations. 35% cash margin of imports of parts was


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also levied by the government (Honda Atlas Cars (Pakistan) Limited, 2009a). HACPL’s management were unable to predict the economic recession and enhanced production capacity to 50000 units from 30000 (Honda Atlas Cars (Pakistan) Limited, 2010a) units which led to extreme underutilization of capacity over these periods, thus further increasing fixed costs and management remained unable to control the swell in costs.

Due to the financial crisis and therefore, weakening purchasing power parity, overall sales went down. The government raised sales tax by 1% and FED of 5% was imposed (Honda Atlas Cars (Pakistan) Limited, 2009b) and vehicles thus got expensive. ‘Honda City,’ HACPL’s main product was at its decline along with intense competition from the major assembler’s subcompact cars decreased its sales by as much as 83% (Institute of Business Administration, 2010a). It was late this year when the new 3rd Generation model of ‘Honda City’ was launched (Honda Atlas Cars (Pakistan) Limited, 2009c) and therefore it was not much helpful in saving the reducing sales. To exacerbate, most banks withdrew car financing facilities (Hallian, 2009). Thereby, Industry sales went down by 50% and Honda Atlas’s by 28% (Institute of Business Administration, 2010b).

GP therefore fell due to the worsening economy, lost sales and certain future events that management could not have predicted beforehand.

FY 10:

There was further a larger decrease in GP of 235.72% despite 12.05% increase in sales. With 15.18% increase in COS, the GP ratio was -1.51%.

HACPL remained deficient in controlling costs due to economic upset. PKR lost sustainability and severely depreciated against Yen (Figure 1, Appendix) and US $ (Figure 2, Appendix) together with inflation resulting in increasing prices of raw materials to which 77% rise in the international steel price (IBA, 2010) added too. The underutilization of the capacity kept pressure on the production costs (Interview, Appendix).

However, following the introduction of new ‘Honda City’ model and reasonable prices, sales experienced rise. Later this period economic condition improved and commercial banks restored their position in consumer financing (Osama, 2010) encouraging the demand despite rising costs. The government helped a little by withdrawing the FED on locally assembled cars (Honda Atlas Cars (Pakistan) Limited, 2010b).

The Company therefore achieved growth in sales but due to large increase in costs that could not be completely passed on to the customers due to competitive prices (Interview, Appendix) the GP fell significantly.


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FY 11:

GP attained health increasing by 183.20% achieving GP ratio of 0.9%. Sales considerably increased by 38.93% with lower increase in COS of 35.62%.

Such an increase in COS was due to immense increase in Raw Materials costs bringing undue pressure on management to maintain the costs. The price of steel sheets went high almost by 50% per ton and price of aluminium primary ingot rose by 59% per pound (Jamal, 2010a). Similarly, the cost of rubber also expanded globally (Kumar, 2009). Further pressurising COS, Yen gained nearly 10% against PKR making import of high tech parts, like CKDs which are almost 35% of a product’s cost, even expensive (Jamal, 2010b). The introduction of new accessories (Honda Atlas Cars (Pakistan) Limited, 2011b) also added to costs. Fixed costs remained high due to capacity underutilization (Interview, Appendix).

Hence, Selling Prices increased, also incorporating the rise in sales tax of 1% (Honda Atlas Cars (Pakistan) Limited, 2011c). Surprisingly, customer’s behaviour remained positive despite political and economic tensions. Sales increased incredibly (KHan, 2011). It was deduced that the growth in the agricultural sector particularly Rabi season crops (Khan, 2010) increased the spending of the country and the introduction of new accessories in the Honda cars captured the interest of customers. The growth in car financing facilities also backed up the increase (Honda Atlas Cars (Pakistan) Limited, 2011c).

Therefore, despite raised costs Company performed excellent in sales thus improving GP.


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2009 2010 2011

-2

0

2

4

6

8

10

HACPLTOYOTA

Competitor Comparison

Toyota has been the foremost competitor of HACPL and has been performing way better than HACPL in GP over the years due to its higher market share and costs management. Toyota’s management has been controlling costs through application of Kaizen costing methodology (Toyota, 2011b) which include the elimination of waste in the production, assembly and distribution process as well as elimination of work steps in any of these areas (M. Bragg, 2009). Higher sales resulted in better capacity utilization and lower fixed costs than HACPL.


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NP Margin:

FY 09:

The NP ratio reduced dramatically to -2.84% as compared to the last year’s 0.5%.

Subsequent to fall in GP, Company reduced advertisement expenses despite launch of new models keeping costs under control. Achieved 257% rise in profits on deposits owing to high deposit rates (Figure 3, Appendix) was advantageous; however fuel & power prices went up during the year increasing operating costs. Up to 31% increase in electricity prices (The Nation, 2008) and 127.43% in Gas prices (Daily Times, 2010) occurred. Company faced huge exchange losses during the period as currency miserably weakened against Japanese Yen and US $ (Figure 1 and 2, Appendix). PPE and old Honda City’s part’s written-off further contracted profitability. FC remained unchanged as borrowing costs of raised long-term loans were capitalized to PPE. (Honda Atlas Cars (Pakistan) Limited, 2009d) Effective tax rate was -35.43% as compared to 17.90% last year to due to 83.37% reduction in current tax because of Company making loss (under section 113 of ‘income tax ordinance, 2001’ a Company is charged minimum tax on turnover in case of losses) and 69% increase in deferred tax assets mainly comprising unused tax losses aided profitability slightly.

FY 10:

NP declined to -5.38%.

Following huge fall in GP, management extensively reduced advertisement expenses keeping costs under check. Profit on bank deposits sharply decreased shrinking profitability as after huge investments last year, Company commenced year with a heavy overdraft (Interview, Appendix). Despite rise in costs of electricity (Business News, 2010) and gas (Aqeel, 2010) fuel & power expenses lowered slightly sinking costs as the production level decreased. Since last year exchange losses lessen as currency became relatively stable (Figure 1 and 2, Appendix) and Company’s overall exposure to currency risk reduced. Narrowing profitability, FC increased by 104% due to newly availed loans by Company to finance investment for new car models. Enlarged sales raised current tax by 654.14% with lesser deferred tax assets rise of 40.56% upraised effective tax rate to -13.74% dipping NP.


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FY 11:

NP rose by 65% to -1.35%.

As GP attained health, Company enhanced spending on advertisement of new car models with new accessories, burdening costs. With healthier cash-flow status, Company gained enormous rise in profit on deposits enjoying high deposit rates (Figure 3, Appendix) improving NP. Production rose and electricity and gas prices went up by 15% (Umeed, 2010) and 8% (Zeeshan, 2010) respectively, fuel & power expenses ascended raising costs. The currency further depreciated and increase in Company’s currency risk exposure increased exchange losses. Aided by liquidity support on CKD supplies by the Holding Company, HACPL repaid short-term & long-term borrowings achieving reduction in FC. Effective tax rate reached 21.90%. 103.77% rise in current tax was the upshot of increased sales with increase of 15.42% in deferred tax assets available to net off.

2009 2010 2011

-6

-4

-2

0

2

4

6

8

HACPLTOYOTA


Toyota’s strong performance in GPs cushioned it from inflated prices and preserved the NP ratios. Toyota’s profits on bank deposits were grander than HACPL’s due to stronger cash position. Unlike HACPL, Toyota kept its currency risk low by entering foreign exchange contracts (Toyota, 2011c) and so lower exchange losses. Toyota has not been using borrowings and so had much lesser FC than HACPL consisting only of mark-up on advances from customers and the bank charges.


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ROCE:

FY 09:

ROCE was -9.23% compared to the last year’s 8.81%.

OP fell by 234% and the Company went to loss, unable to generate return on Capital invested. Equity decreased due to increased accumulated losses yet CE increased due to raised long-term finance for the investment in Capital expenditure (Honda Atlas Cars (Pakistan) Limited, 2009e) of the new model of ‘Honda City.’

Company thus appeared to be underutilizing resources.

FY 10:

ROCE even deteriorated to -16.10%.

OP even worsened by 33% and despite decreased CE due to reduction in renewed long-term finance with part of it becoming current and decrease in equity on account of increased accumulated losses and transfer of reserves to P/L, ROCE further shrunk representing further underutilization.

FY 11:

ROCE improved to -4.42%.

Company’s improved performance achieved a reduction in operating loss of 83% but Company still failed to produce return. The year added lesser to accumulated losses but due to large transfer from reserves to P/L, equity reduced. Company reduced its long-term finance (Honda Atlas Cars (Pakistan) Limited, 2011d) by 69% as well and therefore overall CE reduced.

Consequently, ROCE became better but the persisted negative figure still presented poor utilization of resources.


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2009 2010 2011

-20

-10

0

10

20

30

40

50

TOYOTAHACPL


Toyota remained profitable and ungeared and has been earning much higher returns on CE than HACPL thus, much better ROCE.


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LIQUIDITY ANALYSIS

Liquidity RatiosHACPL TOYOTA

2011 2010 2009 2011 2010 2009times

Current Ratio

0.67 0.62 0.70 1.84 1.67 1.69

Quick Ratio

0.26 0.21 0.17 1.38 1.31 1.28

2009 2010 20110

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Current RatioQuick Ratio

Current & Quick Ratio:

FY 09:

CR was 0.70 times, even riskier compared to last year’s 0.80 times.

Despite 91% decrease in cash & bank due to huge cash used in operations and heavy investments, CA increased by 61% mainly because of 83% rise in stock level as sales lessened. The CL raised by 82% when Company obtained short-term loan to finance working capital requirements of the new car model. (Honda Atlas Cars (Pakistan) Limited, 2009f)


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Matching just the liquid CA with CL gives QR of 0.17 times which was dangerously low as stock has been the major part of CA.

The destabilized liquidity concerned investors as it could lead to going-concern issue in future.

FY 10:

CR worsened to 0.62 times.

Despite improved cash & bank balances due to high cash from operations and lower investments than last year the CA decreased by 11% due to immense decrease in finished good’s stock as sales increased. Company paying off short-term loan did not lessen CL as other payables, particularly bills payable (1054% rise) increased considerably. (Honda Atlas Cars (Pakistan) Limited, 2010c)

QR improved just a little to 0.21 times as all current liquid assets, mainly cash & bank increased.

For Investors, even poorer liquidity meant trouble for the Company in the future.

FY 11:

CR increased insignificantly to 0.67 times still being treacherous.

CA raised by 61% by virtue of increased CKDs stock as Company was trying to stock as much as possible due to future uncertainty about supply chain as Japan was hit by natural disaster. Moreover, advanced cash-flow position raised cash & bank by 959%. CL increased by 50% due to increase in current portion of long-term loan and increased trade & other payables including 94% rise in bills payables. (Honda Atlas Cars (Pakistan) Limited, 2011e)

The increase in cash & bank balances raised CA improving QR to 0.26 times.

The Company’s liquidity throughout these years has been risky indicating cash-flow difficulties. However, ‘credit payment’ support from holding Company on CKD supplies to some extent was a comfort. (Honda Atlas Cars (Pakistan) Limited, 2011f)


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2009 2010 20110

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

HACPL Current RatioHACPL Quick RatioTOYOTA Current RatioTOYOTA Quick ratio


Toyota maintained almost twice the CA than CL by having high cash & bank and stock levels due to high market share than HACPL. Whereas HACPL’s CA have been lesser than CL due to much lower cash and bank and stock levels than Toyota’s. Unlike HACPL, Toyota did not rely on short-term borrowings.

Therefore Toyota’s current and quick ratios have been much superior to HACPL’s.


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SOLVENCY ANALYSIS

Solvency RatiosHACPL TOYOTA

2011 2010 2009 2011 2010 2009Gearing Ratio (%)

19.90 40.29 34.66 0.00 0.00 0.00

Interest Cover (times)

-0.61 -1.17 -1.79 88.77 53.50 78.02

2009 2010 2011-5

0

5

10

15

20

25

30

35

40

45

GearingInterest Cover

Gearing:

FY 09:

Gearing Ratio of the Company rose to 34.66% led not only by decreased equity but also by huge increase in long-term liabilities.

Besides reduction in equity due to huge rise in accumulated losses the large increment in long-term debt as Company obtained new loans for purpose of capital investments abruptly increased the gearing and discomforted the shareholders by increasing the financial risk.


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FY 10:

Gearing ratio rose to 40.29% due to further decrease in equity and sustained reliance on long-term borrowings.

There was a further fall in equity on account of huge increase in accumulated losses further elevating the gearing. Company renewed its Long-term loans.The minor decrease in long-term loans figure was due to part of it becoming current.

Raised gearing was of concern to investors as already negative profitability had to bear further FC.

FY 11:

Gearing ratio dropped to 19.90% owing to reduction in loans.

After major portion of reserves were transferred to P/L, equity further decreased. Long-term debt fell with larger percentage as Company fully repaid one of its loans and half of remaining loan became current.

Hence, Gearing relaxed decreasing the degree of risk of equity holders providing them ease.


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2009 2010 20110

5

10

15

20

25

30

35

40

45

HACPLTOYOTA


Toyota’s Capital Structure only consisted of equity and so it was not geared whereas HACPL`s gearing kept fluctuating by the use of borrowings to finance their capital & working capital requirements keeping the gearing high.


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Interest Cover:

FY 09:

Interest Cover turned -1.79 times from 1.3 times last year due to Company making loss.

Although, substantial loans obtained did not affect FC as the borrowing costs were capitalized to PPE,(Honda Atlas Cars (Pakistan) Limited, 2009g) OP since last year decreased by 234% turning into loss which turned interest cover negative reducing investors’ confidence and raised questions about management of the Company.

FY 10:

Interest Cover was -1.17 times.

Although Company’s FC raised owing to long-term and short-term loans obtained for the Capital and Working capital requirements of the new ‘Honda City’ model but as operating loss increased by lesser percentage of 33% than 234% last year resulting in lesser difference between FC and Operating loss, interest cover demonstrated a minor improvement. Company couldn’t cover its FC indicating profitability was too low given the gearing of the Company.

FY 11:

Interest Cover improved to -0.61 times with decreased FC and reduced loss.

As Company reduced its loans helped by credit payment facility by the Holding Company, there was a large decrease in FC. Operating loss too achieved 83% reduction improving ratio, but improvement was yet not enough for the Company to cover its FC.

Shareholders thus remained disappointed.


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2009 2010 2011

-20

0

20

40

60

80

100

HACPLTOYOTA


As Toyota remained un-geared its FC has been much lesser than HACPL’s consisting only of mark up on advances from the customers and the bank charges. Earning delightful OP, Toyota’s Interest Cover has been exceptionally well than HACPL’s over these periods.


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EFFICIENCY ANALYSIS

Efficiency RatiosHACPL TOYOTA

2011 2010 2009 2011 2010 2009Days

Payable Days

7 5 10 6 9 7

Inventory Days

58 53 77 36 34 42

2009 2010 20110

10

20

30

40

50

60

70

80

90

Payable DaysInventory Days

Payable Days:

FY 09:

Payable days were 10 rose from 3 days last year as creditors raised.

Trade Creditors rose by 204.35% from last year. Due to the economic recession Company’s sales fell together with colossal cash used in operations. Furthermore, Company heavily invested during the year in NCA. Therefore, due to feeble cash position, Company faced difficulty in payments increasing creditors affecting WC management adversely.


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FY 10:

Payable days halved to 5 owing to reduced creditors.

Despite 15% rise in COS, Trade creditors reduced by 40.02% reflecting tightening credit facilities after HACPL’s deteriorated financial performance and cash position last year. However, with sales rising, cash position grew stable and Company timely paid back its creditors and improved its WC management.

FY 11:

Payable days became 7 as creditors rose.

There was an increase of 36% in COS and 67.19% in creditors. Due to future doubt over CKDs supply chain being affected due to tsunami in Japan, Company was increasing stock of CKDs (Interview, Appendix) in attempt to avoid future stock outs, and thus raised trade payables. Company’s revived financial performance and Cash position earned it extended credit period.

2009 2010 20110

2

4

6

8

10

12

HACPLTOYOTA


Toyota’s Payable days were not much different from HACPL’s.


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Inventory Days:

FY 09:

Inventory days were 77 compared to 42 days last year as stock rose.

There was a huge increase in finished good’s stock due to steep fall in ‘Honda City’ sales representing slowdown in trading due to the model’s decline stage and economic fall down.

The inventory days hence increased, undermining WC.

FY 10:

Inventory days fell to 53 with decreased stock.

There was a vast decrease in finished good’s stock indicating of re growth of sales following introduction of new car model and re-entry of consumer financing services with slight improvement in economy. The working capital thus improved.

FY 11:

Inventory days rose to 58 with increased stock.

Immense increase in raw material described this rising. Major supplier, Japan struck by natural disaster was going to affect future CKD supplies and so Company was acquiring as much as it could to avoid stock outs (Interview, Appendix).

2009 2010 20110

10

20

30

40

50

60

70

80

90

HACPLTOYOTA


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Due to higher sales and thus higher inventory turnover than HACPL, Toyota’s inventory days remained better than HACPL’s over these years displaying better WC performance by Toyota than HACPL.


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INVESTORS ANALYSIS

Investor's RatiosHACPL TOYOTA

2011 2010 2009 2011 2010 2009

Earning per Share (PKR)

-2.09 -5.97 -2.81 34.90 43.81 17.62

Share Price (PKR/Share)

10.00 16.00 12.00 220.00 262.38 107.72

Price Earning Ratio (times)

-4.78 -2.68 -4.26 6.30 5.99 6.11

2009 2010 2011

-10

-5

0

5

10

15

20

EPSShare PriceP/E

EPS:

Number of shares did not change during the three years therefore the change in EPS has been solely because of the earnings. HACPL being in losses generated negative EPS for


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all three years of -2.81/share, -5.97/share and -2.09/share in 2009, 2010 and 2011 respectively.

2009 2010 2011

-10

0

10

20

30

40

50

HACPLTOYOTA


Toyota with healthy profits generated attractive EPS in all three years of 17.62, 43.81 and 34.90/share respectively while HACPL’s losses produced negative EPS.


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P/E Ratio:

FY 09:

MP of HACPL’s shares fell to PKR 12 from PKR 44 last year. The P/E ratio became -4.27 times compared to last year’s 83.02 times.

Reduction in earnings played havoc on performance of the Company along with difficulties in management of liquidity and recession in the country reduced investors’ confidence leading to sudden slump in MP. Together with negative EPS, P/E fell exceedingly.

FY 10:

Share price rose to PKR 16. The P/E ratio became -2.68 times.

Though Company made further loss increasing loss per share together with continued delicate liquidity, investor’s confidence rose after huge investment by Company in new ‘Honda City’ that resulted in increased sales (Interview, Appendix). MP of shares hence rose in expectancy of future success and P/E became better.

FY 11

Share price fell to PKR 10 and P/E ratio to -4.78 times.

Despite notable rise in sales HACPL yet remained lossmaking as even costs rose significantly along with continuous poor liquidity. Company also not declaring dividends for a longer period reduced investor’s trust and share price and P/E ratio thus fell.


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2009 2010 2011

-6

-4

-2

0

2

4

6

8

HACPLTOYOTA


Toyota’s profits over these years and payment of dividends kept investor’s trust and thus MP high. Together with Toyota’s attractive EPS, its P/E has been much better than HACPL’s.


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SWOT ANALYSIS

STRENGHTS:Strong brand loyalty and smart marketshare.ISO 9001(QMS) and EMS certified and therefore maximum quality focused and environmental friendly.Providing greatest passenger safety through ABS, SRS & G-CON technology and fuel efficient cars via i-VTEC technology.Countrywide sales, services and spare parts dealership networks and therefore presence and sales in all the major cities.Credit support from the Holding Company on CKD supplies comforting cash position.

(Honda Atlas Cars (Pakistan) Limited, 2011d)

WEAKNESSES:Higher car pricesacting adversely on market share.(Daily Times, 2011)Capacity underutilization creating high fixed costs.Inefficient costs management.Not providing smaller cars that have the maximum demand. (Pak Top 10, 2011a)Reliance on borrowings and therefore high FC.

OPPURTUNITIES:Global demand for more fuel efficient cars such as hybrid cars and applying latest technology to target this demand can capture more market share. (Deloitte, 2012)Higher demand for smaller cars and diversification therein can achieve enhanced market share and better capacity utilization. (Pak Top 10, 2011b)Escalating sales due to growth in agriculture sector can grab healthier supplier’s relations by negotiating improved credit policies. (PAKISTAN Today, 2011)

THREATS:Rising fuel prices making use of cars uneconomical for consumer. (Tirmizi, 2012)Power shortage distressing production. (APP, 2012)Swelling raw material prices increasing input costs which may make production uneconomical.Government supporting new competitors raising rivalry.Uncertainty over future supply of CKDs may lead to stock outs.Cheap imitates and smuggled auto-parts harming Company’s auto-parts business. (The Dawn, 2012)


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PEST ANALYSIS

POLITICAL:

Political factors are connected with government and its policies relating business.

Government is attempting to knot-up long-term automobile policies with Japan (KHAN, 2011). Government is also providing free of cost seeds to boost up agriculture to advance economy and spending (Asif, 2011). However, continued changing government policies are unpleasant for the auto sector (Interview, Appendix) and government is not trusted by foreign investors. Government raised sales tax and age and depreciation limit of imported used cars to inspire competition. AIDP which was set to take the auto sector up is expiring in near future and needs to be redeveloped (Rind,2012). Power shortage has not for long been resolved by government keeping industry under operational constraints.

ECONOMICAL:

Economic factors relates to general state of country’s economy.

Economy has gone down. In recent years inflation has run very high. This means expensive inputs, increased selling price and affected sales. Interest rates have gone up generating higher return on deposits but resulting in higher borrowing costs. Regularly rising fuel prices are making use and manufacturing of cars uneconomical. Recent floods left devastating effects on agriculture sector massively declining farm income though government is promoting the sector that will rise future spending. Although car financing facilities are growing (Sabir, 2011), economy has touched the worst extensively weakening purchasing power with worst effects on imports.

SOCIAL:

Social factors are related to the culture and trends of the country’s population.

Most Pakistani population are middle class families (Jafri, 2011) mostly being able to afford small economical compact cars. HACPL only offers subcompact luxurious cars with high maintenance and prices. Japan tsunami has disrupted the supply chain raising car and spare parts prices which will further discourage demand for expensive cars. High illiteracy (Javed, 2010) means shortages of educated and capable workforce resulting in high training costs but cheap labour availability.


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TECHNOLOGICAL:

Technological factors relate to the availability and reliability of the technology in the country required by a business.

HACPL use imported Japanese technology and provides auto-parts locally as technology has been transferred to Pakistan’s OEM (Mirza, 2010). Public has alternative sources too such as smuggled parts at low prices and cheap imitates. Government has spent heavily on roads infrastructure (Business recorder, 2012). HACPL provides countrywide auto-parts and services.

PORTER’S FIVE FORCES ANALYSIS

THREAT OF NEW ENTRANTS:

These are the threats that potential new entrants will enter market.

Existing carmakers including HACPL have gathered a vast know how of customers and have created brand loyalty building barriers to entry. Capital requirements are high. However HACPL has not been able to achieve economies of scale working far under capacity. Switching costs are low. Government is providing relief to newcomers by reducing levies on imports for primary years (Rind, 2011) and encouraging Indian (Ali, 2012), South Korean and Chinese manufacturers (Hussain, 2011). Therefore, threat is high.

THREAT OF SUBSTITUTE PRODUCTS:

These are the threats that customers will move to some alternative/replaceable product or technology with comparable price, performance and Capital expenditure by similar or another industry that satisfies the same needs.

There are alternative sources people can use to travel by like motorbikes and public transports including busses, vans and three wheelers but these are in no comparison with a personal own car. Therefore only substitute for HACPL cars would be competitor’s and used imported cars. With regular increase in fuel prices such as petrol, diesel and CNG, the customers are turning to lower maintenance, lower fuel consumption cars i.e. 800 and 1000 CC cars. Nevertheless, by maintaining quality at affordable prices HACPL has created strong brand loyalty and Honda users would prefer not to move to lower quality products. Therefore threat is low.

BARGAINING POWER OF SUPPLIERS:


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These are the factors that indicate position of suppliers of the industry.

For auto sector there are technological and other auto-parts required. For technological parts HACPL depends on Holding Company and the group to supply parts. Bargaining power here would be high. As for suppliers of other parts such as steel, aluminium, rubber etc. the bargaining power is low because there are many such suppliers, low switching costs and there are only a few leading car makers in the country and if Company decides to shift to another supplier there would be a drastic effect on the supplier. Hence, the overall threat is moderate.

BARGAINING POWER OF CUSTOMERS:

These are the factors that indicate the position of the customers of the industry.

Bargaining power of customers is high as there are many options available to them including competing carmakers and lower price imported cars. Switching costs are low. However, HACPL has maintained the customer’s loyalty by providing high quality at reasonable prices and use of latest technology to make products fuel efficient and safe for customers. It has developed dealership networks all around the country providing sales and after sales services. The government however, is putting pressure on automakers to reduce their prices (Jamal, 2010). The power is high.

COMPETITION AND RIVALRY:

These describe the nature of local market competition.

The local market has become saturated, main rivals being the leading carmakers. Plus government has raised competition by providing relief to used imported cars. There are price wars going on between rivals and costs to exit the business are high. Government is still trying to bring in new competitors which mean that already under capacity working companies would face more trouble. The competition therefore, is very high.


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Conclusion and Recommendations

HACPL holds a major share in Pakistan’s automotive sector. However, its performance in recent years remained lacklustre.

Company’s profitability has been frail for the recent years as the recession attacked economy. Devastating floods further eroded the situation. Company’s production capacity enhancement prior to these events led to underutilization and therefore higher fixed costs. Company’s one of the mainstream product ‘Honda City’ reached decline in FY09 and withdrawn car financing facilities by banks deteriorated sales. Minor improvement in economy and Company’s introducing new model helped in achieving rise in sales in succeeding years but continued currency devaluation and inflation kept exchange losses high and profitability unstable. Interest rates kept raising FC but brought in high profits on deposits too. Government remained unkind by raising sales tax and encouraging competition. The competitor, Toyota’s high market share achieved better capacity utilization and cost management through Kaizen costing kept its profitability well. The foreign exchange contracts safeguarded it from exchange losses. Being ungeared, it kept its FC minimal.

Short-term liquidity of Company too remained ominous. In FY09 huge investments by Company placed it in weak cash position. Company obtained short-term loan for working capital purposes which endangered its short-term liquidity. Lately, though Company improved the cash status and paid off short-term borrowings but high other payables kept short-term liquidity risky. However, credit help by Holding Company to some extent comforted HACPL. Toyota did not rely on short-term borrowings because of high cash levels maintained and so had much better short-term liquidity.

Long-term solvency too has not been very satisfactory. Company has been relying on long-term loans aiming to finance capital investments hence raising gearing. Though lately gearing relaxed, the negative interest cover during these years was of concern. This was on account of financial losses and raised FC. Toyota remained independent of long-term borrowings and had durable solvency.

The working capital remained questionable as well. Company’s tensed financial performance kept its credit period tight. Adequate level of inventory has not been maintained as well. Toyota’s inventory management has been fine due to high sales.


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Investor’s confidence in Company subsided as Company has been in losses and have not been declaring dividends. EPS and P/E ratio went down. This resulted in decreased share price. Toyota enjoyed profits and kept paying dividends keeping investor’s confidence high.

HACPL has certain strengths such as strong brand loyalty created by providing luxury at reasonable prices and strong market share but it needs to cope with weaknesses like capacity underutilization and high production costs. It has ability to cease opportunities like capturing the small cars segment and to deal with threat of losing customers to competitor’s substitute products and imported used cars.

The External environment has to be looked upon too. Government’s perpetually changing and unfriendly policies are harmful for the industry. Deteriorated economic factors of inflation, interest rates, taxes, depreciated currency, raw material and fuel prices had unfavourable impacts. There is high demand for smaller cars, illiteracy and cheap labour availability. Original auto-parts should be made available at reasonable prices to prevent losing customers to cheap parts.

Barriers to entry by existing players and capital requirements are high but government is supporting new entrants. Although there are no other substitutes but competitors lower maintenance cars and imported used cars. The overall supplier’s power is moderate. Numerous providers, imported used cars and low switching costs create high customer power. The saturated market has created rivalry in the sector leading to price wars.

Although the country is emerging market for automobiles, political uncertainty and terrorist activities are creating challenges. Economy has yet not recovered. Inflation and depreciating currency are expected to keep necessities high. Raw materials like steel are rising and future availability of CKDs is a question. Rising fuel prices will create smaller cars demand. Though government is to reduce 3.5% in duties & taxes () but is further encouraging competition now by approving Indian auto imports () increasing customer’s power. Therefore I think the sector has challenging future. However, much is dependent on successor government that follows after 2013 elections.


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Recommendations:

I would recommend that HACPL should:

Try to reduce production costs through effective management.Hedge against currency risk.Try to increase credit period by building healthy relations with suppliers.Think about diversifying in smaller cars segment as this opportunity will incredibly raise market share leading to better capacity utilization. Maintain investor’s confidence by deriving a better dividend policy as this is an important factor for long-term stability of the Company.


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