CLASS QUESTION
You are an analyst at King Asset Management Company. One of the investment managers
has recently been researching a company listed on the JSE named Sigma Limited (hereafter
“Sigma” or “the Company”). He does not currently own Sigma in the portfolio but it has been
on his radar for a while. He has asked you to help him make the decision as to whether to
purchase shares in Sigma or not. Below is the information you have gathered:
Company business
Sigma is based just outside Johannesburg and their main business is the production and
supply of Electrolytic Manganese Dioxide (hereafter “EMD”). EMD production is used in the
manufacture of alkaline batteries. Alkaline batteries are used in many household items such
as certain MP3 players, CD players, digital cameras, toys, lights and radios. The main input
in the production of EMD is manganese ore. Sigma purchases this from two mines, both
located in the Northern Cape. Sigma has two manufacturing plants, both of which have the
capability to produce various grades of EMD.
Sigma exports around 80% of all EMD they produce. Alkaline battery manufacturing world-
wide is limited to a handful of producers. Consequently, Sigma’s customer base comprises a
small number of very large customers.
Review of 2012
Market demand for EMD remained weak during 2012, with global supply outweighing global
demand. This forced EMD manufacturers to lower prices in the face of increased competition.
The weak demand was mainly as a result of continuing global economic uncertainty. In
particular, the depressed global economic conditions had the effect of limiting consumer
spending, thereby reducing the demand for alkaline batteries. While consumer spending is
expected to recover as the global economy picks up, future growth rates for the alkaline battery
market are expected to remain in decline. Some analysts predict that technological
advancements will eventually lead to a phasing out of alkaline battery use. Management put
considerable effort into operational improvements during the year in order to make Sigma’s
production process more efficient and to try and offset the effect of increasing input costs such
as electricity, labour and transportation.
Financial statements
Statement of Comprehensive Income for the year-ended 31 December 2012:
Notes 2012 2011
R ‘000 R ‘000
Turnover 1 473 623 440 174
Cost of sales 353 749 309 583
Gross profit 119 875 130 591
Other operating costs 72 045 66 021
Operating profit 47 830 64 570
Financing costs 26 013 12 665
Profit before tax 21 817 51 905
Taxation 6 017 14 458
Profit for the year 15 800 37 447
Statement of Financial Position as at 31 December 2012:
Notes 2012 2011
R ‘000 R ‘000
ASSETS
Non-current assets 263 628 273 732
Property, plant and equipment 2 260 337 269 285
Other non-current assets 3 291 4 447
Current assets 373 431 271 304
Inventory 221 142 115 033
Trade and other receivables 146 827 105 037
Cash and near cash 5 462 51 234
TOTAL ASSETS 637 059 545 036
EQUITY
Ordinary share capital and premium 4 856 4 856
Reserves (including accumulated 307 025 296 713
profit)
TOTAL EQUITY 311 881 301 569
LIABILITIES
Non-current liabilities
Long-term liabilities 3 178 410 105 542
Other non-current liabilities 4 54 299 56 952
Current liabilities 92 469 80 973
Trade and other payables 62 669 70 116
Bank overdraft 15 000 -
Tax payable 11 073 8 357
Short-term provisions 3 727 2 500
TOTAL LIABILITIES 325 178 243 467
TOTAL EQUITY AND LIABILITIES 637 059 545 036
Notes:
1. Local sales are all made in Rands. International sales are priced in either Rands or
US$. The mix of Rand versus US$ denominated sales was in line with the previous
year. The Company did not make use of any hedging during 2012 or 2011 as the
directors anticipated that the Rand would weaken against the US$. They were correct
and this worked to the advantage of the Company.
During 2012, the directors considered changing the debtors’ payment policy in order to
encourage more sales. However, they decided to leave it unchanged as their analysis
indicated that this would actually have a negative financial impact on the Company.
2. Capital expenditure consisted of equipment upgrades, replacement and process
improvement. No expansion projects were undertaken in 2012.
3. Included in long-term liabilities is a loan with a principal amount of R100 million.
4. Other non-current liabilities represent deferred tax, as well as a provision for restoring
and rehabilitating the Company’s waste disposal facility.
Analysis
The investment manager started performing an analysis of the Company and performed the
following calculations for 2011, based on the above Financial Statements:
2011
Increase in revenue Need 2010 numbers
Gross profit margin 29.7%
Operating profit margin 14.7%
Net profit margin 8.5%
Fixed asset turnover 1.61
Total asset turnover 0.81
Debt ratio 0.45
Total Debt / equity ratio 0.81
Interest bearing debt / equity ratio 0.35
ROA * 8.5%
ROE 12.4%
* Calculated as EBIAT / Total Assets
REQUIRED
(a) Evaluate the financial statements of Sigma from 2012, with reference to relevant
financial ratios. Your evaluation should focus on:
- Liquidity;
- Asset Management;
- Solvency;
- Profitability
Note:
- Work to two decimal places and 365 days in a year; and
- Assume the calculations that the investment manager has performed so far
are correct.
- Assume a company tax rate of 28%