Background of Caltex Australia

The current report is prepared with the intent to provide investment-related recommendations to a big overseas institutional investor from the perspective of a group of investment analysts involved in a big investment Australian consulting firm. For meeting the purpose of this report, the two organisations selected include Caltex Australia Limited and Washington H. Soul Pattinson and Company Limited that have business operations in diversified areas and they are listed in ASX (Asx.com.au 2018). The financial conditions of these organisations would be analysed based on their published annual reports by using the technique of ratio analysis. Moreover, their historical share prices would be considered and comparison would be made with All Ordinaries Index for the past three years. Besides, the factors having impact on their share prices would be highlighted in this paper as well by assessing the significant announcements associated with these two organisations. Furthermore, the dividend policies of both the organisations would be considered. Based on all these aspects, recommendation would be provided to the overseas investor regarding investment in one particular stock.

The organisation is involved in buying, distributing, refining and selling petroleum products in Australia, Singapore and New Zealand. The operations of Caltex are carried out through Lytton and Supply and Marketing segments. The Lytton segment is engaged in refining crude oil into diesel, petrol, jet fuel, greases and speciality products like liquid petroleum. It has been established in 1900 having its headquarters in Sydney, Australia with an employee base of nearly 5,600 (Caltex 2018). The organisation owns approximately 35% of the oil refining capacity of Australia.

The history of Caltex started years ago when Ampol, the Australian oil importer was listed in ASX in 1940. Ampol and Caltex initiated their refineries in 1950 and 1960 and due to this, intense competition was observed between them in the oil product marketing sector and service station arena. However, with the passage of time, Caltex acquired Golden Fleece and Ampol acquired Total. Moreover, in 1995, these two companies merged with each other that have assisted Caltex in becoming the biggest Australian refiner-marketer. This factor could be identified as the significant comparative advantage of the organisation in the Australian market. Despite all such developments, both Ampol and Caltex have been relatively small.

WHSP is an investment group having diversified asset portfolio within a range of industries. It has been listed on ASX since 1903 and one of its primary contributions to the shareholders is timely and regular payment of dividends. The origin of the organisation is deemed to be observed in the Australian pharmacies. However, at present, it has diversified beyond the pharmaceutical industry and the investment portfolio has widened due to investments in building materials, natural resources, agriculture, telecommunications, retail, investments, property equity and corporate advisory services (Whsp.com.au 2018). For instance, it holds significant shareholdings of 25.3% in TPG Telecom, 50% in New Hope Group, 43.9% in Brickworks Limited, 19.3% in Australian Pharmaceutical Industries, 8.6% in BKI Investment Company Limited, 100% in Pitt Capital Partners and others. All these factors have assisted WHSP in gaining comparative advantage in the Australian market.

Background of WHSP

In the words of Barth (2015), ratio analysis could be defined as the financial statement evaluation, which is used for gaining a quick indication of the financial position of an organisation in several key performance areas. The ratios could be categorised into debt management, short-term solvency, profitability, liquidity, asset management, efficiency and market value ratios. However, as the overseas client is interested particularly in liquidity ratios, profitability ratios and capital structure or leverage ratios, these three types of ratios would be evaluated in the context of Caltex Australia and WHSP.

For evaluating the liquidity position of Caltex Australia Limited and WHSP, the liquidity ratios that are taken into consideration include current ratio and quick ratio. The calculations and analyses of these ratios are represented as follows:

Particulars	Caltex Australia Limited	WHSP
2015	2016	2017	2015	2016	2017
Current ratio	1.65	1.43	1.16	8.96	2.25	3.28
Quick ratio	0.85	0.71	0.44	8.51	1.82	2.81

*(Refer to Appendix 1 for detailed calculations)

From the above figure, it could be identified that Caltex has experienced a decline in current ratio from 1.65 in 2015 to 1.16 in 2017. On the other hand, the current ratio of WHDP has declined significantly from 8.96 in 2015 to 2.25 in 2016; however, it has increased to 3.28 in 2017. In this regard, it is to be noted that current ratio helps in measuring the ability of a firm to settle its short-term obligations with the help of those assets that could be converted into cash easily (Beatty and Liao 2014). In case of Caltex, the main reasons that the ratio has declined over the years are due to the fall in cash balance and significant increase in accounts payable, as it has extended its credit terms with the suppliers. However, for WHSP, the current ratio is observed to be significantly high than the ideal ratio of 2 (Barr and McClellan 2018). In 2015, the ratio is abnormally high due to huge amount of term-deposits received by the organisation. However, the amount of term deposits has declined over the years due to which reduction in current ratio could be observed in the next two years; however, it has adequate cash base kept as idle, which could be invested for improving the existing business operations (Bekaert and Hodrick 2017).

Quick ratio is another liquidity ratio, which gauges the capability of a firm to clear its short-term dues with the most liquid assets. Hence, it denotes that inventories are deducted from current assets at the time of computing this ratio and the ideal standard is considered to be 1 (Brigham et al. 2016). The similar trend is observed like that of current ratio for both the organisations and no significant variations could be observed from current ratio. This implies that none of the firms are focusing on maintaining more inventory base after conducting adequate market analysis. However, since the ratio is declining for Caltex, it could be said that WHSP is placed favourably in terms of competitive position in the Australian market.

Evaluation of Liquidity Position

For evaluating the profitability position of Caltex Australia Limited and WHSP, the liquidity ratios that are taken into consideration include net margin, return on capital employed, return on assets and return on equity. The calculations and analyses of these ratios are represented as follows:

Particulars	Caltex Australia Limited	WHSP
2015	2016	2017	2015	2016	2017
Net margin	2.61%	3.40%	2.90%	12.90%	19.49%	29.47%
Return on capital employed (ROCE)	20.87%	24.60%	23.28%	-0.82%	0.54%	9.34%
Return on assets	10.21%	11.73%	10.65%	1.93%	3.48%	7.34%
Return on equity	19.65%	21.81%	20.98%	2.19%	3.97%	8.57%

*(Refer to Appendix 2 for detailed calculations)

According to the above figure, net margin is observed to increase from 2.61% in 2015 to 3.40% in 2016; however, it has declined again to 2.90% in 2017 for Caltex. In this context, Buehlmaier and Whited (2018) advocated that net margin is the percentage of profit earned by an organisation after deduction of all the relevant costs and expenses. For Caltex, decline could be observed in net margin due to significant rise in net foreign exchange losses and selling and distribution expenses. On the other hand, WHSP has managed to reduce its overall expenses; thus, resulting in greater profit.

ROCE is a financial ratio, which gauges the profitability of an organisation and efficiency with which the employment of capital is made (Callen 2015). In case of Caltex, a steady rate is maintained throughout the years, while the rate has been significantly lower for WHSP despite considerable rise in 2017. The main reason behind such trends is that Caltex has maintained a steady operating profit over the years and for WHSP, operating profit was poor in 2015 and 2016; improvement is observed in 2017 due to which ROCE has increased accordingly.

Return on assets is a financial ratio that denotes the efficiency of an organisation in converting money utilised to buy assets into net profit (Dhaene et al. 2017). Even though the trend is fluctuating for Caltex and the ratio has increased for WHSP over the years, the return of the latter is still lower than the former. This is because net profit of WHSP has increased considerably over the years, while no such remarkable rise could be observed in its asset base. However, the trend is steady for Caltex, due to which it has managed to earn more from its assets.

Return on equity measures the efficacy of an organisation in using money from the shareholders in generating profits and growing the same. In case of Caltex Australia, the ratio has not varied much over the years; however, it has increased considerably for WHSP. Despite such increase for WHSP, it is still lower in contrast to Caltex again due to the unsteady net income earned by the former over the three-year period.

Evaluation of Profitability Position

Therefore, based on the above evaluation, it could be said that the overall profitability position of Caltex is better compared to that of WHSP in the Australian market.

For evaluating the capital structure position of Caltex Australia Limited and WHSP, the leverage ratios that are taken into consideration include debt-to-equity ratio, debt ratio, equity ratio and interest cover ratio. The calculations and analyses of these ratios are represented as follows:

Particulars	Caltex Australia Limited	WHSP
2015	2016	2017	2015	2016	2017
Debt-to-equity ratio	0.83	0.89	1.04	0.13	0.16	0.18
Debt ratio	0.45	0.47	0.51	0.11	0.14	0.15
Equity ratio	0.55	0.53	0.49	0.89	0.86	0.85
Interest cover ratio	9.87	11.74	13.27	-10.94	8.83	119.54

*(Refer to Appendix 3 for detailed calculations)

Debt-to-equity ratio is a capital structure ratio, which contrasts the overall debt of an organisation in contrast to its overall equity. This ratio signifies the percentage of business funding, which comes from the investors as well as the creditors (Finkler et al. 2016). In case of Caltex, it could be seen that the debt-to-equity ratio of the organisation has increased from 0.83 in 2015 to 1.04 in 2016 and the similar trend is noticed in case of WHSP from 0.13 in 2015 to 0.18 in 2017. A lower debt-to-equity ratio is considered to be more favourable, as it implies less risky position, while a higher debt-to-equity ratio implies that the organisation is not performing well (Gassen 2014).

The above situation is supported further by debt ratio and equity ratio computed for both the organisations. It could be observed that most of the funds of Caltex are financed by debt, while WHSP funds majority of its business assets with the help of equity financing. This implies that the shareholders and investors form a significant part in the decision-making process of WHSP (Vogel 2014).

Interest cover ratio is a ratio that the investors and creditors use for gaining an overview of the profitability and risk position of the organisation (Hoskin, Fizzell and Cherry 2014). In case of Caltex, the ratio has increased from 9.87 in 2015 to 13.27 in 2017 and for WHSP; the ratio has experienced a massive increase from -10.94 in 2015 to 119.54 in 2017. The main reason behind such massive rise is due to significant increase in operating profit because of revenue increase as well as that of other income.

Therefore, in terms of leverage position, WHSP is placed in a favourable position in the Australian market in contrast to Caltex Australia Limited.

The above figure mainly helps in representing the monthly stock price movement of the two organisations against All Ordinaries Index for the three-year period. It could be observed that the monthly share price movement of WHSP and Caltex has been fluctuating over the years along with All Ordinaries Index. From the month of January 2016, the stock price of Caltex is observed to decrease until January 2017, after which it has fluctuated in the entire year. However, the trend for WHSP is observed to be fluctuating over the years, which denotes that the trend is not similar to that of Caltex. The relationship of these two stocks with the All Ordinaries Index could be explained with the help of correlation table, which is presented as follows:

Correlation Table:-
	Caltex Australia Limited	WHSP	All Ordinaries Index
Caltex Australia Limited	1
WHSP	-0.062506037	1
All Ordinaries Index	-0.117238811	0.250190378	1

Evaluation of Capital Structure Position

Table 4: Correlation among Caltex Australia Limited, WHSP and All Ordinaries Index

(Source: Au.finance.yahoo.com 2018: Au.finance.yahoo.com 2018)

The above table clearly makes it evident that as the monthly return of the index increases, increase could be observed in monthly stock return of WHSP, while the situation is just the opposite for Caltex. Hence, a positive correlation exists between WHSP and All Ordinaries Index, while there is negative correlation between Caltex and All Ordinaries Index. This implies that the stock price of WHSP is less volatile and that of Caltex is more volatile in contrast to the chosen index.

The two significant announcements that might impact the share price of Caltex include the following:

Acquisition of Milemaker:

Caltex Australia had announced that it planned to enter into an agreement for buying the retail fuel business of Milemaker in lieu of $95 million on 7^th November 2016. This acquisition was completed by the organisation on 4^th May 2017 for avoiding opposition of the particular transaction (Caltex 2018). In this case, since Caltex had incurred a premium for acquiring Milemaker, a large amount of cash has been exhausted and it had to obtain funds by debt financing to acquire the same. Due to this, significant decline could be observed in the stock price of the organisation in this period.

Resignation of Company Secretary:

  On 12^th February 2016, Ms Nawal Silfani has resigned from the position of Company Secretary and the individual was replaced by Mr Peter Lim (Caltex 2018). This implies a change in management position of Caltex. A change in this position carries more downside risk and the risk is greater, as the departure was unplanned. In this case, effect could be observed from that date until January 2017, in which the stock price of the organisation has declined significantly.

The two significant announcements that might impact the share price of WHSP include the following:

Sale of asset portfolio to Accorn Capital Investment Fund:

On 14^th December 2017, WHSP has announced that Accorn Portfolio Investment would purchase a part of its assets for approximately $7.6 million. As the assets of WHSP would be acquired, it would increase an experience an increase in share price in 2028, since it would receive a premium on acquisition (Intelligent Investor 2018).

Winning court case against Perpetual:

Despite having less than 12% shareholding in WHSP, Perpetual earned a considerable profit by disposing off its position, which proved to be costly for the management of WHSP. For dealing with this issue, WHSP has lodged a court complaint against Perpetual and the verdict came in favour of the former. This announcement was made on 10^th July 2017 (Intelligent Investor 2018). This could be identified as an industry wide factor, due to which there has been instability in the stock price of the organisation.

Particulars	Details	Caltex	WHSP
Calculated Beta	A	0.87	0.47
Risk-free Rate	B	5%	5%
Market Risk Premium	C	6%	6%
Required Rate of Return	B + (A x C)	10.22%	7.82%

Conclusion

Table 5: Calculated and required rate of return on Caltex Australia Limited and WHSP

(Source: Reuters.com 2018)

In case of Caltex Australia, the dividend per share of the organisation has increased from 50 cents per share in 2015 to 52 cents per share in 2016 and the increase is further to 54 cents per share in 2017. This implies stable dividend policy is followed by the organisation and additional dividend in the period when the organisation makes greater profit (Petty et al. 2015). On the other hand, WHSP has not missed paying dividends to its shareholders since 1903, which implies that it has followed regular dividend policy. This is maintained when the organisation makes regular earnings (Titman and Martin 2014).

After considering all the above aspects, it could be found that WHSP is placed in a favourable position in the Australian market in terms of liquidity, profitability and solvency, which denotes that investing in this organisation would maximise the return on investment. Moreover, the share price of WHSP even though has fluctuated over the years, it has moved in tandem with the All Ordinaries Index. Finally, it has not failed in making dividend payments to its shareholders since its inception. Therefore, it is recommended to invest in this stock for obtaining better and favourable returns in future.

Conclusion:

The above discussion clearly makes it evident that WHSP has been superior in all the financial aspects over Caltex. Moreover, the stock market returns and regular dividend payments have added further to the financial health of the organisation. Therefore, in terms of investment decision, it could be inferred that WHSP is a better investment option for the investors.

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