Financial Statement Analysis and

Security Valuation

Lecture 3 – October 12, 2022

Arnt Verriest
 Agenda for Today
The Basics: The Core I :
Fundamentals of Financial The Core II:
Varia
Financial Statement Valuation
Statements Analysis

Profitability
3
Analysis

1. Profitability Analysis
➢ LVMH
➢ Bekaert
➢ Mercedes

2. Corporate Cash Holdings

3. Profitability Analysis: Comparison of Diageo and Pernod Ricard
Financial Statement Analysis:
3 Pillars

1. Profitability

2. Solvency

3. Liquidity
 Where are we?
The Basics: The Core I :
Varia and
Fundamentals of Financial The Core II:
Concluding
Financial Statement Valuation
Remarks
Statements Analysis

Profitability
3
Analysis

Credit Risk
4
Analysis

Operating Income 5

Current Assets
6
Liquidity Analysis

Long-Term Assets 7

Tax Accounting 8
 Profitability Analysis
and Interpretation

Focus Companies:
1. LVMH
2. Bekaert
Module 3 3. Mercedes-Benz
4. Cisco
5. Pernod Ricard
6. Diageo
 Disaggregation of ROE
ROE = Return on Equity

Operating return Nonoperating return

RNOA = NOPAT / Av. NOA FLEV x SPREAD

NOPM = NOAT = FLEV = Spread =

NOPAT / Sales Sales / Av. NOA NNO / Equity (RNOA – NNE/NNO)
Gross profit Receivables
margin turnover

SG&A / Sales Inventory Capital Structure Policy

turnover Credit Risk vs.
R&D / Sales
Payables Leverage Effect
turnover
 Return on Equity

𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
ROE =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑬𝒒𝒖𝒊𝒕𝒚

ROE = Operating Return + Nonoperating Return

RNOA =
Return on net
operating assets
 Operating Return: RNOA
• RNOA = Return on Net Operating Assets
Net Operating Profit after Tax (NOPAT)
• RNOA =
Average Net Operating Assets (NOA)
• The income statement reflects operating activities
through revenues, costs of goods sold (COGS), R&D
and selling, general and administrative expenses
(SG&A).

• The balance sheet contains both operating assets

and liabilities, as well as nonoperating items.

• Cash is assumed to be NON-operating!

 Operating Items in the Income Statement

Revenues
- Cost of Goods Sold
Operating
Items Gross Profit
- Selling, General and Administrative Expenses
- R&D
Operating Profit = EBIT
Nonoperating - Interest Expenses
Items + Interest and Dividend Income
Profit Before Tax
Operating - Tax Expense
Items
Net Income
LVMH’s Income Statement

Profit before Tax = 7,972 – 608 = 7,364

 Tax Shield
Tax on operating profit = Tax expense that we would have, in
absence of nonoperating expense and revenue items

Tax on operating profit = Tax expense +

(Pretax nonoperating expenses x Statutory tax rate)

Tax Shield

NOPAT calculation for LVMH:

NOPAT = 7,972 – [2,409 + (608 x 0.30)]
NOPAT = 5,380.6
 Operating Assets and Liabilities
• Operating assets include:
➢ Receivables
➢ Inventories
➢ Intangible assets
➢ Goodwill Net Operating
➢ Property, plant and equipment (PPE)
➢ Lease assets Assets (NOA) =
• Operating assets exclude: Operating Assets
➢ Cash (and cash equivalents)
➢ Short-term and long-term investments
➢ Other financial assets and investments
minus Operating

• Operating liabilities = All liabilities EXCEPT:

Liabilities
➢ Long-term Debt
➢ Short-term Debt
➢ Lease liabilities (!)
Operating Assets (2020) = 87,969

Operating Assets (2019) = 89,919

Operating Liabilities (2020) = 21,320

Operating Liabilities (2019) = 22,151

 NOA for LVMH

• NOA = Operating Assets – Operating Liabilities

• Operating Assets (2020) = 87,969
• Operating Liabilities (2020) = 21,320
• NOA (2020) = 87,969 – 21,320 = 66,649
• We usually consider average NOA
• NOA (2019) = 89,919 – 22,151 = 67,768
• NOA (av.) = 67,208.5
 RNOA of LVMH

• RNOA = NOPAT / Av. NOA

• RNOA = 5,380.6 / 67,208.5 = 8.01%

• Interpretation of the RNOA?

• Clean measure of operating profitability

• What would ROE be if LVMH would be fully

financed with equity?
Bekaert Income Statement (2021)
Bekaert Assets
Bekaert Liabilities and Equity
 RNOA and ROE of Bekaert (2021)
RNOA = NOPAT/av. NOA = 370,703 / 2,340,135 = 15.84%
Operating Profit (EBIT) = 513,086
Tax expense = 133,296
Nonoperating expense = 36,790 = (44,480 - 3,260 - 4,430)
Statutory Tax Rate = 24.7%
Operating Tax = 142,383 = [133,296 + (0.247 x 36,790)]
NOPAT = 370,703

Operating Assets (2021) = 4,084,625 (4,843,756 - 1,803 - 677,270 - 80,058)

Operating Liabilities (2021) = 1,551,909 (77,659 + 23,311 + 844 + 51,979 + 1,062,185 +
177,159 + 4,392 + 86,131 + 68,249)

NOA (2021) = 2,532,716

Av. NOA = 2,340,135
NOA (2020) = 2,147,553

ROE = Net profit / Av. Equity = 343,000 / 1,817,789 = 18.87%

 Disaggregation of RNOA

RNOA = NOPAT / NOA = NOPAT/Sales x Sales/NOA

NOPM = NOAT =
Net operating Net operating
profit margin asset turnover
 Net Operating Profit Margin (NOPM)
• Net operating profit margin (NOPM) reveals how much operating profit the
company earns from each sales dollar/euro.
• NOPM is affected by (among others):
– Industry type
– Degree of competition
– Extent to which customers want to pay a premium
– Cost efficiency – economies of scale

• For LVMH (2020):

NOPM = NOPAT / Revenues
NOPM = 5,380.6 / 44,651 = 12.05%
• This result means that for each 100 euro of sales at LVMH, the company earns
12.1 euro of profit after all operating expenses and tax.

• For Bekaert (2021): NOPM = 370,703 / 4,839,659 = 7.66%

 Net Operating Asset Turnover (NOAT)
• Net operating asset turnover (NOAT) measures the productivity of the
company’s net operating assets.
• NOAT measures efficiency of operating asset use.
• This metric reveals the level of sales the company realizes from each
euro/dollar invested in the firm’s operating assets.
• All things equal, a higher NOAT is preferable.

• For LVMH (2020):

NOAT = Revenues / NOA
NOAT = 44,651 / 67,208.5 = 0.66
• This result means that for each euro invested in net operating assets,
LVMH realizes 66 euro cents in sales.

• For Bekaert (2021): NOAT = 4,839,659/2,340,135 = 2.07

Industry Comparison of NOPM and NOAT
• Profitability position of LVMH looks like:
➢ RNOA = 8%
➢ NOPM = 12%
➢ NOAT = 0.66

• What is your advice to the firm under these scenarios?

• Scenario 1 → Luxury industry looks like:

➢ Industry RNOA = 8%
➢ Industry NOPM = 10%
➢ Industry NOAT = 0.80
• Scenario 2 → Luxury industry looks like:
➢ Industry RNOA = 8%
➢ Industry NOPM = 25%
➢ Industry NOAT = 0.32
 Return on Equity

𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
ROE =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑬𝒒𝒖𝒊𝒕𝒚

ROE = Operating Return + Nonoperating Return

Nonoperating return =
FLEV x SPREAD
Simple Example:

1. Base situation: no debt

Equity = 1000
RNOA = 20%
Profit = 200 (no taxes)

ROE = 200/1000= 20%

ROE = RNOA + [FLEV x SPREAD] = 20% + 0 = 20%

2. We take on 500 of debt against cost of 7%

Equity = 1000
RNOA = 20%
Profit = 300 (20% of 1500) – 35 (7% of 500) = 265
ROE = 265/1000 = 26.5%

ROE = RNOA + [FLEV x SPREAD]

ROE = 20% + [500/1000] x [20%-7%] = 20% + (0.5 x 13%) = 26.5%

FLEV = Debt/Equity
SPREAD = RNOA – Cost of Debt
 Nonoperating Return
ROE = Return on Equity = Net income / Av. Equity

RNOA = FLEV = Spread =

NOPAT / NOA Av. NNO / Av. Equity RNOA – (NNE / Av. NNO)

Nonoperating return definitions:

➢ FLEV = Financial Leverage……………………..Average NNO / Average equity

➢ NNO = Net nonoperating obligations…….Nonoperating liabilities (debt or
financial liabilities) minus
nonoperating assets (cash + investments)

➢ Spread………………………………………………….RNOA – (NNE / Av. NNO)

➢ NNE = Net nonoperating expenses………..Nonoperating expenses (interest
expenses), net of tax.
Equals (NOPAT – Net Income)
LVMH’s Income Statement
Nonoperating Liabilities (2020) = 48,522
Nonoperating Assets (2020) = 20,702
 Nonoperating Return of LVMH (2020)
• ROE = 4,955 / 38,597 = 0.12837 = 12.84%
• RNOA = 8.01%

• NNO (2020) = 48,522-20,702 = 27,820

• NNO (2019) = 35,991-6,588 = 29,403
• Av. NNO = 28,611.5
• Av. Equity = 38,597
• NNE = 425.6 = (1 - tax rate) x Nonoperating Expense
= (1 - 0.30) x (608)
= (NOPAT - Net Income) = (5,380.6 – 4,955)
• ROE = 0.08006 + 28,611.5 x (0.08006 – 425.6 )
38,597 28,611.5
• ROE = 0.08006 + (0.7413 x 0.06518) = 0.1284 = 12.84%

• CHECK!! → ROE = 4,955 / 38,597 = 12.84%

Nonoperating Return of Bekaert (2021)
• ROE = 343,000 / 1,817,789 = 18.87%
• RNOA = 15.84% (see before for details)
• NNO (2021) = 432,142
• NNO (2020) = 612,498
• Av. NNO = 522,320
• Av. Equity = 1,817,789
• NNE = 27,703 = (1 - tax rate) x (Nonoperating Expense)
= (1 - 0.247) x (36,790)
= (NOPAT - Net Income) = (370,703 – 343,000)
• ROE = 0.1584 + 522,320 x (0.1584 – 27,703 )
1,817,789 522,320
• ROE = 0.1584 + 0.03027 = 0.1887
•
• CHECK!! → ROE = 343,000 / 1,817,789 = 18.87%
• Conclusion: Leverage effect fails to kick in because of low FLEV. Roe is still
high, because of a high RNOA. Bekaert seems to offset operational risk with
lower financial risk.
 BMW’s RNOA and ROE (2016)
RNOA = NOPAT/av. NOA = 7,022.27 / 122,969 = 5.71%
Operating Profit = 9,827 (9,386 + 441)
Tax expense = 2,755
Nonoperating expense = 162
Statutory Tax Rate = 30.7%
Operating Tax = 2,755 + (0.307 x 162)
NOPAT = 7,022.27

Operating Assets (2016) = 170,325 (188,535 – 7,880 – 7,065 – 2,705 – 560)

Operating Liabilities (2016) = 43,441 (4,587 + 5,039 + 2,795 + 5,357 + 5,879 +
1,074 + 8,512 + 10,198)
NOA (2016) = 126,884 Av. NOA = 122,969
NOA (2015) = 119,054

ROE = Net profit / Av. Equity = 6,910 / 45,063.5 = 15.33%

BMW’s Nonoperating Return (2016)
• RNOA = 0.057106
• NNO (2015) = 42,326 + 55,405 – 7,880 – 7,065 – 2,705 – 560 = 79,521
• NNO (2015) = 76,290
• Av. NNO = 77,905.5
• Av. Equity = 45,063.5
• NNE = 112,27 = (NOPAT - Net Income)
= (1 - tax rate) x Nonoperating Expense
= (1 - 0.307) x (489 - 131 - 196)
• ROE = 0.057106 + 77,905.5 x (0.057106 – 112.27 )
45,063.5 77,905.5
• ROE = 0.057106 + 0.09623 = 0.1533 = 15.33%
• ROE = 6,910 / 45,063.5 = 0.1533 = 15.33%
• Conclusion? Very big leverage effect for BMW because of high
debt level (FLEV) as well as high SPREAD.
 ROE Disaggregation – Cisco (2017)
• NOPAT = 11,973 – (2,678 + (-314) x 0.35) = 9,404.9
• NOA (2017) = 59,326 – 29,964 = 29,362
• NOA (2016) = 55,896 – 29,424 = 26,472
• Av. NOA = 27,917
• RNOA = 0.3369 = 33.7%
• NNO (2017) = 33,717 – 70,492 = -36,775
• NNO (2016) = 28,643 – 65,756 = -37,113
• Av. NNO = -36,944
• Av. Equity = 64,861
• NNE = (-314)x(1-0.35) = -204.1
• ROE = 0.3369 + (-36,944) x (0.3369 – (-204.1) )
64,861 (-36,944)
• ROE = 0.3369 + (-0.18875) = 0.14815 = 14.8%
• CHECK ➔ ROE = 9,609 / 64,861 = 0.14815 = 14.8%
 Hoarding cash – WHY?
1. Precautionary motives (buffer)
2. Financial flexibility
3. Offset operational leverage / risk
4. No (attractive) investment opportunities
5. Easier to consume private control benefits
6. Tax purposes

Articles (see Blackboard)

• The Economist (June 3, 2017)
• Financial Times (Sep 15, 2017)
• Financial Times (Mar 25, 2020)
 Profitability Analysis:
Pernod Ricard versus Diageo for 2019
• ROE = 9.5 %
• RNOA = 8.0 %
→ NOPM = 18.5 %
→ NOAT = 0.43
• Nonoperating return = 1.5 %
→ FLEV = 0.36
→ Spread = 4.2%

• ROE = 30.5 % (3,337/10,934.5)

• RNOA = 16.0 % (3,432.2/21,259.5) (ζ=20%)
→ NOPM = 26.7 %
→ NOAT = 0.61
• Nonoperating return = 14.4 %
→ FLEV = 0.94
→ Spread = 15.2%
Conclusions?
 Un-doing the COVID-19 impact for
Pernod Ricard versus Diageo for 2020
• ROE = 1,251.1/15,196.5 = 8.2%
• NOPAT = 2,260 – [(1,283+366)*0.3+258] = 1,507.3
• RNOA = 1,507.3/21,722 = 6.94%
→ NOPM = 1,507.3/8,448 = 17.8%
→ NOAT = 8,448/21,722 = 0.39
• Nonoperating return:
→ FLEV = 0.4294 (NNO 2020=7,845; NNO 2019=5,205)
→ Spread = 3.014%

• ROE = 2,765.4/9,298 = 29.7%

• RNOA = 2,840.4/21,736.5 = 13.07%
→ NOPM = 2,840.4/11,752 = 24.2%
→ NOAT = 11,752/21,736.5 =0.54
• Nonoperating return:
→ FLEV = 1.339 Conclusions?
→ Spread = 12.466%
 Profitability Analysis
Pernod Ricard versus Diageo for 2021
• ROE = 1,318/14,643 = 9.0%
• NOPAT = 2,423 – [(62+371)*0.3+667] = 1,626.1
• RNOA = 1,626.1/21,943 = 7.4%
→ NOPM = 1,626.1/8,824 = 18.4%
→ NOAT = 8,824/21,943 = 0.40
• Leverage effect = small (2.59%)
→ Firm does not use a lot of debt

• ROE = 2,799/8,435.5 = 33.2%

• RNOA = 3,086.2/21,355 = 14.5% (EBIT=4,065)
→ NOPM = 3,086.2 /12,733 = 24.2%
→ NOAT = 12,733/21,355 = 0.60
• Leverage effect = big (18.7%)
→ Firm uses a lot of debt at a low interest rate

Conclusions?
Operating assets for Pernod Ricard vs Diageo
Operating assets for Pernod Ricard vs Diageo

What is your conclusion from this comparison?

 Additional remarks on Profitability Analysis
1. “Other” items are usually operating items.
2. Joint-ventures is an operating item.
3. Leased assets are operating while lease liabilities are
nonoperating!
4. For Noncontrolling interests (or minority interest) it is
advisable to ignore them, i.e.:
➢ Include NCIs in Net income (do not use the parent’s
share)
➢ Include NCIs in Equity (use total equity)
➢ See the example of Walmart in the extra exercises.
5. Ignore discontinued operations, i.e., do not treat them as
operating or nonoperating; or treat them as nonoperating if
they are immaterial.
Further practice on profitability analysis:
1. BMW (2016)
2. Pernod Ricard and Diageo (2019; 2020)
3. Air Liquide (2013)
4. Henkel (2013)
5. Roper Industries (2013)
6. AstraZeneca (2013)
7. Walmart (2014)
8. Johnson and Johnson (2015)
9. BASF (2016)
10. GlaxoSmithKline (2017)
11. Caterpillar (2018)
12. Adidas (2019) (from the final exam of January 2021)
13. Daimler (2020)

Solutions are on Blackboard!