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Industry Structure and Fundamental Evaluation - Domino's Pizza

University: University of Northampton

  • Unit No: N/A
  • Level: Undergraduate/College
  • Pages: 16 / Words 3961
  • Paper Type: Assignment
  • Course Code: SWK 5007
  • Downloads: 278
Organization Selected : Domino's Pizza Enterprises Limited.

INTRODUCTION

Debt security are the financial instruments which are invested in order to gain profit. These securities are government bonds, corporate bonds, certificate of deposit, preferred stock and many more. Main aim of this project report is to analyse securities of an organisation by implying various analysis. In order to better understand this concept a company is selected which comes under top 100 Australian Stock Exchange market index that is Domino's Pizza Enterprises Limited. This company is a pizza chain retail organisation which operates in Food and beverages industry (AriffIqbal and Mohamad, 2012). In this project report, two analysis are conducted that is capacity analyses and Altman Z analysis. These evaluation techniques are developed in order to ascertain credit worthiness of Domino's Pizza Enterprises Limited. Food and Beverages industry is analysed with the help of industry structure and industry fundamental evaluation. The selected company is analysed by using ratio analysis and Altman Z evaluation in which Z score model is used.

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Capacity analysis

This is a process that is related to analysis of capability of a company within its industry in which it operate. This analysis is basically done to ascertain the productivity of a company at its maximum rate. Capacity analysis is meant to measure the actual output that can be resulted with the available stock of goods and product. Different companies usually follow a regular capacity analysis to ensure that their existing factories are operating at their best values. For example, company strength needs to know that it would be achievable to double production susceptibility at a plant. Capacity analysis has the three different part depending upon the requirement such as Industry structure analysis, Industry fundamental and company fundamental.

a. Industry structure analysis

This is related to the process of analysing a particular industry in respect of of the opportunity and warning conferred to a firm by the instantly predominant environment. There are number of threats and opportunity that are faced by food and beverage industry such as consumer avoiding centre of store product, increasing demand of natural and organic product, adapting to shift toward E-commerce etc. Importance of doing Industry structure analysis is that it help to evaluate the attractiveness of the industry to the new entrant In that industry, to gift competition scheme right to the industry in interrogation. There is a tool for doing industry structure analysis that is known as Porter's Five Forces that help to observe profit margin between industry and provide a starting point for making strategies and understand the competition viewpoint of industry in which company operates (Avdjiev, 2014). The framework for Porter's Five Forces analysis consists of various competitive forces to the Food And beverages that are described below:

Industry rivalry, competition: This is related to a high degree of Competition among existing firm within the same industry. That means more number of competitors, that deals with same product and services reduces that reduces the power of other company. For example, in food and beverage industry, one company like Domino's Pizza Enterprises Limited deals with variety of food item with faithful price. On the other hand Pizza Hut introduce same product with lower price so the power of other company will reduce.

Potential to new entrants into the industry: It is noticed that power of one company also affected by the force of new entrant into its market. The Industry that require less time and cost for a competition firm to enter into market will affected the position of existing firm.

Bargaining power of buyer: This is related to the ability of customer to buy a product by doing bargaining that will have to drive the prices of product down. It is mainly affected by number of buyer a company has and how much they are significant to company and mainly the actual cost a customer to switch from one company to another. For example, If the Demand of Domino's Pizza Enterprises Ltd keeps on decreasing the prices of product will fall that may reduce its profit.

Bargaining Power of supplier: This is related to the force that will easily drive the price of goods and services provided by a company. It means the more number of supplier to choose from, the easier it will be to switch to a cheaper alternative (Dippelsman, Dziobek and Gutierrez Mangas, 2012).

Threat to substitute: This is basically related to the availability of substitute product that will limit ability to rise price. For example, if customer rely on food product of Domino's Pizza Enterprises Ltd but their product can be substituted with another company goods within same industry at low cost, hold of other company is weekend.

b. Industry fundamental analysis

It is related to the examination of the underlying force which affect the well being of the industry and companies. Most of the evaluation are done to drive a forecast and profit from future price movements. In Industries, the fundamental analysis includes different activities to the company context such as examination of financial data, management operation, business concepts and competition. It also includes the evaluation of total demand and supply forces of the produced offered by different companies operating within the same industry. For doing a proper industry fundamental analysis depends upon its various factors and every industry have a unique term set such as, customer base, market share, industry wide growth etc. For example food and beverage industry has different set for analysis that are described below:

Customer base: Every companies have a different group of customer on which they are depended to increase sale and improve the profitability. Large number of customer base will be more beneficial for company to generate more revenue. For example, Domino's Pizza Enterprises Limited has large number of customer base that help them to generated more profit and Increase productivity (Eichengreen, 2013).

Market share: It is very necessary for company to ascertain their market share within industry in which it operate that aid to figure out actual volume of company business. It is very necessary because it is related to economic of scale, so when the business entity are bigger other than its competition it is easy for them to capture the high fixed cost of capital-intensive industry. For example, the Domino's Pizza Enterprises Limited has possesses 85% of market that makes it the largest player in the food and beverage industry.

Competition: Those industry that have limited number of barriers to entry have a large number of competing companies that create a difficult situation for the existing firm to operate within same industry. The main issue for firm in a highly competitive industry is pricing power, it is related to the power of supplier to increase price and cut cost on to customer. For example, Domino's Pizza Enterprises Limited, has the power to set price for their supplier that wants to do business with this company.

Regulations: In some of the industry the importance of intensity of the good and services, as these regulation are to the public that can forceful impact the attractiveness of the company for the investment purpose. This is noted that when one or more companies represent the whole industry, there are certain rule and regulation made for each company to make profit.

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c. Company fundamentals

Company Analysis: Domino's Pizza Enterprises Limited is the largest pizza chain which is currently running its business in Australia. It has various food stores there and the largest franchisee for domino's pizza brand all over the world. It was introduced in Australia in year 1981 and provided home delivery options in year 1983. Firstly, it was launched in Springwood, Queensland. It has introduced drone delivery system in year 2016 in the partnership of Flirtey Drone Delivery. Now it is running its business with 600 successful stores in Australia.

Fundamental analysis of the company: it is done with the help of ratios that helps to analyse capability of the organisation (Fundamental analysis, 2017). Following ratios are calculated for the company in order to analyse its strength and profitability:

Profitability ratios: These ratios are calculated by the companies in order to evaluate its ability to generate profits in current and upcoming years. Following are the types of profitability ratios that have been calculated for Domino's Pizza Enterprises Limited:

  • EBITDA margin ratio: This ratios is calculated to measure marginal profit and revenues of the organisation for a specific period of time. Higher ratio dictates a good profit margin and low ratio represents lower profitability. It is computed to analyse overall profitability of the organisation and all the direct and indirect costs are considered under this ratio.

Formula: EBITDA/ sales*100

Particular

2018

2019(Estimated)

EBITDA

237

274

Sales

794

812

EBITDA margin ratio

29.85

33.74

  • Return on capital: It is calculated to measure total amount of return on capital of the company. High ratios represents that company is in good situation.

Formula: (Net income- dividend)/ (Debts+ equity)*100

Particular

2018

2019(Estimated)

(Net income- Dividend)

121

146

(Debt+ Equity)

1302

1411

Return on capital

9.29

10.35

Coverage ratios: these are the financial ratios that helps to analyse that company is able to pay off the outsider's obligations or not. For Domino's Pizza Enterprises Limited following coverage ratios are calculated:

  • Interest coverage ratio(EBIT): It is calculated to analyse that company is able to pay interests on its outstanding debts easily or not (Vodov, 2013).

Formula: Earning before interest and tax/ interest expenses

Particular

2018

2019(Estimated)

EBIT

-115

-134

Interest

9

12

Interest coverage ratio

-12.78

-11.17

  • Interest coverage ratio (EBITDA): It is calculated to analyse that what amount of EBITDA has been paid in the form of interest.

Formula: EBITDA/ interest expenses

Particular

2018

2019(Estimated)

EBITDA

237

274

Interest

9

12

Interest coverage ratio (EBITDA)

26.33

22.83

Leverage ratios: These ratios are considered by investors, lenders and market analysts to make investment and other decisions. Following types of leverage ratios are calculated for Domino's Pizza Enterprises Limited:

  • Funds from operations to debt ratio: This ratio is calculated to analyse that what amount of assets are acquired with the help of shareholder's funds.

Formula: Funds from operations/ total debts*100

Particular

2018

2019(Estimated)

Funds from operations

101

148

Total debts

995

1069

FFO to debt ratio

10.15

13.84

  • Cash flow ratio: This ratio can be explained as the measure of the organisation to fund its own current revenues and expenses. It provides the information that company has enough cash to pay off all the expenses.

Formula: Operating cash flows/ total debts*100

Particular

2018

2019(Estimated)

Operating cash flows

427

506

Total debts

995

1069

Cash flow ratio

42.91

47.33

  • Debt to EBITDA ratio: This ratio is calculated to identify relation between all the debts and EBITDA of the company.

Formula: Total debts/ EBITDA

Particular

2018

2019(Estimated)

Total debts

995

1069

EBITDA

237

274

Debt to EBITDA ratio

4.2

3.90

  • Debt to total assets/ liability: This ratio is computed to identify the relation between debts and assets it shows that what amount of debts can be paid with the help of total assets or liabilities (Salines, Glöckler and Truchlewsk, 2012).

Formula: Debts/ total assets*100

Particular

2018

2019(Estimated)

Total debts

995

1069

Total assets

1302

1411

Debt to total asset/ liability ratio

76.42

75.76

All the ratios needs to be compared with the ratios that are shown in the appendix. All of them are going to be compared with US ratios because EMEA are mainly made for Europe, Middle East and Africa. For Domino's Pizza Enterprises Limited the EBITDA margin ratio is 29.85 for year 2018 and forecasted ratio of year 2019 is 33.74 both of them are more than 24.6 that gets AA credit rating (Fernndez and et. al., 2016). Return on capital ratios for year 2018 and 2019 are 9.29, 10.35 respectively. Both the ratios are less than 11.8 and going to be ranked B according to the table. EBIT interest coverage ratio for year 2018 and 2019 are -12.78, -11.17 respectively and both of them are less than 1.6 which has been shown in the table and going to be ranked B. EBITDA interest coverage ratios for year 2018 and 2019 are 26.33, 22.83 both the ratios are more than 20.5 but less than 29 so the rank will be provided AA.

FFO to debt ratios for year 2018 and 2019 are 10.15, 13.84 respectively and both of them are less than 17.5 Hence the rating for them is B. Free operations cash flow ratios are 42.91, 47.33 for year 2018 and 2019 both the ratios are more than 32.8 but less than 52.3 hence they are rated BBB according to the table. Debt to EBITDA ratio for year 2018 and 2019 are 4.20, 3.90 respectively and both are less than 6.6 but more than 3.3 hence these are rated B according to the credit rating table. Debt to total assets or liability ratios are 76.42, 75.76 for year 2018 and 2019 these ratios are less than 54.9 hence the ranking for them is B.

All the ranks are shown in the following table:

Ratios

2018

Credit rating

2019

Credit rating

EBITDA margin ratio

29.85

AA

33.74

AA

Return on capital

9.29

B

10.35

B

EBIT interest coverage

-12.78

B

-11.17

B

EBITDA interest coverage

26.33

AA

22.83

AA

FFO to debts ratio

10.15

B

13.84

B

Cash flow ratio

42.91

BBB

47.33

BBB

Debt to EBITDA ratio

4.2

B

3.9

B

Debt to total asset or liability ratio

76.42

B

75.76

B

For 2019 all the ratios are estimated on the basis of last years. All the credit ratings are provided according to the table which has been provided in appendix.

Altman Z score analysis

Altman Z score analysis is a technique of ascertaining credit strength of a company. This score analysis is based on five financial ratios which are calculated from the data of a company. It uses various ratios such as profitability, leverage, liquidity, solvency and activity. Altman Z score for a company like Domino's Pizza enterprises limited should be at least 1.8. Main aim of this score analysis is to keep an eye on the investments of the company. This score can serve assurance to investors whether to invest in an security or not. This score is calculated to check the financial health of company (McAndrews, 2015).

Altman Z score is calculated using five ratios. Formula of this Altman Z score is presented below:

0.717A + 0.847B + 3.107C + 00.420D + 0.998E

where,

A = Working Capital / Total assests

B = Retained Earnings / Total Assets

C = Earnings Before Interest and Tax / Total Assets

D = Market Value of Equity / Total Liabilities

E = Sales / Total Assets

It is considered that if a Z score of the manufacturing company is less than 1.8, then the company is heading towards the situation of bankruptcy (Lee, 2014). Efficiency of Altman Z score is classified in three categories which are mentioned below:

Safety Zone

Z score > 2.9

Grey Zone

Z score is between 1.23 and 2.9

Bankruptcy zone

Z score < 1.23

Investors can also use this score to identify whether the company can help them earn returns and profit or not. They can also ascertain whether they should sell their pre acquired stocks or not. Altman Z score indicates companies risks which are significantly increasing and which can result in bankruptcy. This score for Domino's is ascertained below by using financial data for the year of 2018 (Karacimen, 2014).

Altman Z score for Domino's Pizza Enterprises Limited

A

(230 - 201 / 1302) = 0.0222

B

191 / 1302 = 0.146

C

237 / 1302 = 0.182

D

193 / 1302 = 0.148

E

794 / 1302 = 0.609

Z Score = 0.717A + 0.847B + 3.107C + 00.420D + 0.998E

= 0.717 * 0.0222 + 0.847 * 0.146 + 3.107 * 0.182 + 0.420* 0.148 + 0.998* 0.609

= 0.015 + 0.123 + 0.565 + 0.062 + 0.607

= 1.37

Current Altman Z Score From the above calculations it has been ascertained that Altman Z Score for Domino's Pizza Enterprises Limited is 1.37 which is less than 2.9 which shows that this company is in grey area. There can be various reasons for this score like negative operating income and low earnings. Another reason for this low score is that this company has not distributed dividend in many years to their shareholders due to which investments against this company are low. Another reason for this low score can be increasing liabilities for this company. Due to which this company is unable to pay their long and short term debts (Haw, Lee and Lee, 2014).

Forecasted Altman Z Score Forecasted Z Score is used to predict future condition of a company. From the financial statements of this company it has been ascertained that in next year this company can enhance their financial performance a bit due to high sales and profit. Forecasted Z score of this company is 1.72. This score is predicted from above forecasted ratios. By continuous increasing this score it has been ascertained that in next 5 years this company can enter in grey area and risk of bankruptcy can be evaded (Filardo, Mohanty and Moreno, 2012).

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CONCLUSION

From the above project report, it has been ascertained that debt securities of an organisation can impact their performance and profitability. By conducting industry analysis of this company using Porter five forces model it has been observed that this company is having more effective managerial position than financial position. In this project report two main analysis are performed which are capacity and Altman analysis. From the capacity analysis it has been seen that food and beverages company is earning high revenue and sales due to current trend of packaged food. From the similar analysis it has been observed that the selected company that is Domino's Pizza Enterprises Limited is facing various problems which are ascertained from ratio analysis. Altman analysis has provided information that this company is heading towards bankruptcy due to which they has to take various decisions for their performance improvements like attaining competitive advantage.

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