The Gross Profit Margin

Published Date: 02 Nov 2017

During 2012, there was a plunge in sales of 7.5% attributable to a fall in both local and export sales with a greater decline in local sales by 16.32%. Europe and US both constitute a major proportion of Nishat’s revenue as shown in the graph below. During 2012, the US and Euro zone economic slowdown led to a decline in export sales to these destinations. (Buffery, 2011)The situation was worsened because of the non implementation by EU of the WTO decision of abolition of import duties (Annual Report, 2012)

The company local sales declined due to a sluggish demand from the downstream textile sector as stated by BMA capital analysts, Bilal Qamar. Although, in the last quarter, there was a rebound to higher realized prices in the value added chain along with the benefits of rupee depreciation, Nishat still faced falling sales due to a high number of power outages. (Mujtaba, 2012)

RATIO ANALYSIS

Profitability Ratios:

GROSS PROFIT MARGIN:

The graph above clearly depicts the worsening profitability trend of Nishat. The profitability was better than the competitor Gul Ahmed except for in the year of 2011 where Gul Ahmed had better margins.

In 2011, Although sales were increased by a massive 54%, GP margin was not in line with the sales and fell by 3%. This was due to the halt in production because of unprecedented gas supply suspension for 160 days in FY 2011 and the use of alternative fuels that put a pressure on cost.(Daily Times, 2011)However, the company stilly managed to earn better margins mainly due to timely buying of cotton by its spinning division when prices were low.This helped to set off the increasing power cost impact to some extent. (Annual Report, 2011)However, for other value added products the cost of raw material was still higher and company was not able to pass it well onto the customers. (Annual Report, 2011)

In 2012, the margin was further reduced due to a negative growth in sales revenue as already mentioned above. Additionally, as a result of gas load shedding, the cost was increased with a 30% increase in company’s fuel and power cost mainly due to the usage of alternative fuels such as furnace oil/ diesel which are two to three times expensive than gas.(Jawwad, 2011)

Overall, the textile industry is facing energy crises which is the main cause of increasing cost structure and losing competitiveness. Along with Nishat, Gul Ahmed and other companies are also facing the same problem.

NET PROFIT MARGIN:

Despite of similar GP margins, the two companies could be seen to have a wide gap in their profit margins in all three years. This clearly highlights the efficiency of Nishat in controlling its operating cost as compared to Gul Ahmed.

In 2011, despite of cost pressures, the main drivers behind the increase in margins were a 54% increase in sales along with a 149% increase in operating income. The operating income consisted of the sale of investments, dividend income and smart gains on forward dollar bookings. (BR-Research, 2011) Other operating expense include increased donations paid by the company during the year.

In 2012, the company experienced a decline in margin led by the reduction in sales due to depressed yarn prices and fall in both local and export sales and increasing costs during the year as mentioned above.Furthermore, there is an increase in marketing cost of the company in the successful launch of "Nisha" by Nishat Linen.(Business Recorder, 2012)

However, still the company has performed much better as compared to other companies in the industry who are shutting down or sacrificing margins such as Gul Ahmed experienced a loss in 2012 as depicted by the graph above. (Thomasson, 2012)

RETURN ON EQUITY (ROE):

"Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. "(Investopedia, 2013)

The gauge of profit measuring efficiency of the company clearly shows that the company was performing much better in 2011 as compared to the other two years. However, surprisingly it can be seen that the company was having lower efficiency as compared to its competitor Gul Ahmed in 2010 and 2011. However, the gap widened in 2012 to a greater extent with Gul Ahmed experiencing a loss while Nishat maintained its profitability.

In 2011, the ROE rose to 13.7% which was reported as the highest since FY08.This whopping profitability was a result of a 54% jump in company’s top line during the year.(BR-Research, 2011)This was mainly due to better performance of spinning segment.

In 2012, the ratio declined to its original position of 9.3%. This was the result of reduction in profitability by 27% from Rs. 4.8 billion to Rs. 3.5 billion during the year as a result of the dip in sales revenue. The share capital stood constant in all three years and any changes were purely attributable to changes in the profitability of the company.(Annual Report, 2012)

Liquidity Ratios:

CURRENT RATIO:

The current ratio of Nishat is showing a positive increasing trend while for Gul Ahmed it is fairly similar. This signifies a better liquidity position of Nishat as it has enough current assets to pay off its current liabilities in all three years and is in a safer position than its competitor.

In 2011, current liabilities were increased by 57% mainly due to increase in short term borrowings to fund the increasing need of working capital requirement as a result of higher cotton prices.(Jamal, 2010)On the other hand, current assets were also increased by 57%, setting off each other and keeping ratio merely similar to the preceding year.

In 2012, there was not a greater change in company’s liquidity position and so the ratio was only slightly increased. Ideally, a current ratio must be 2:1. But it varies from industry to industry. (Business Liquidity, 2012)

ACID TEST RATIO:

Acid test ratio provides a more rigorous assessment of the liquidity position by removing the stock (considered least liquid) from the calculation. (Business Liquidity, 2012)

The graph shows an increasing trend of the liquidity situation in Nishat. While, on the other hand, its competitor Gul Ahmed is facing severe liquidity problems.As a matter of fact, both companies are not showing healthy ratios. As an ideal acid test ratio is considered to be 1:1

In 2010, the situation was not favorable as the company had only 0.5Rs of liquid funds to pay off its 1Rs. Short term obligations.The ratio was slightly improved in 2011 and further in 2012.

RECEIVABLES TURNOVER:

The receivables were converted into cash more speedily in 2011 as compared to the other two years. In comparison to the competitor, Nishat has performed much better as Gul Ahmed has a low turnover ratio in all three years. This signifies the company’s better cash position as compared to Gul Ahmed.

In 2011, Nishat has improved its operational performance with better credit policies because of which its customers were paying more quickly as compared to the prior period. However, in 2012, the ratio dropped from 19.6 to 12.9 times. This was even lower than the ratio in 2010 at 15.4. Such a big plunge is due to the financial crises in the country and economic slowdown in major foreign markets because of which receivables is taking more time to pay.

PAYABLES TURNOVER:

It can be clearly seen from the above graph, that Nishat pays its creditor more readily than Gul Ahmed. As can be seen in the earlier ratio, Nishat’s receivables pay more quickly and so cash is available to pay off creditors at a faster pace. However, paying creditors so quickly would mean Nishat is losing the benefit of free sources of financing as obtained by Gul Ahmed.

In 2011, the large improvement was led by a massive increase in cost of sales during the year due to a sharp rise in sales level. On the other hand, payables were only increased slightly during the year and not in line with cost of sales. This indicates that they were paid more quickly.

In 2012, the ratio declined indicating that the company is taking more time to pay its creditors, although the liquidity ratios show an improving trend. This is due to longer credit period offered by suppliers.

INVENTORY TURNOVER:

The inventory was turned over more times in Nishat as compared to Gul Ahmed. The graph further highlights the falling ratio trend of Nishat over a three year period. However, the reduction was only minor.

In 2011, the company performance with respect to selling and managing the inventory was merely similar to the preceding year. There was an increase in both inventory and cost of sales. The stock in trade was increased by almost 62 % which was mainly due to a rise in work in process stocks.

In 2012, the ratio was further declined slightly compared to the previous year reflecting a reduction in company’s management efficiency in converting inventory into sales. The cost of sales was reduced with a greater proportion as compared to the inventory during the year. This was mainly due to lower demand of textile products during 2012. (reporter, 2011)

Gearing Ratios:

GEARING:

Nishat has maintained its borrowing level to a much lower and safer position than its competitor Gul Ahmed. The ratio was increased by 4% in 2011 and declined slightly from 27.4% to 25.7% in 2012.

In 2011, with a hike in raw material prices and increased working capital requirement, the company was in need to borrow more funds. (Jamal, 2010)This resulted in an increase in short term borrowings by almost 57%.

In 2012, the ratio was reduced despite of an increase in long term liability to finance new alternative fuel power plant, some machinery and new equity investment in subsidiary companies during the year. (Business Recorder, 2012)The reduction was a result of repayment of some short term borrowings and finance lease obligations. (Annual Report, 2012)

Hence, Nishat possess a lower financial risk as less than half of its assets are financed by debt and it has maintained more reliance on equity funds while other companies such as Gul Ahmed is under increased financial risk due to heavy gearing. (The News, 2013)

INTEREST COVER:

The graph depicts that clearly Nishat was having a better interest cover than Gul Ahmed in all three years. However, the ratio was increased in 2011 and then fell by 1 times in 2012.

In 2011, the company’s finance cost was increased by almost 42% due to the increase in borrowing and its rate. The changes in borrowing rate was the result of an increase in the export refinancing rate by State Bank of Pakistan. (Zaheer, 2011) .However, despite of this increase, the company still managed to increase its interest cover which was mainly due to higher earnings and a rise in sales revenue this year. (Annual Report, 2011)

In 2012, the company experienced a rise in finance cost mainly because of increased longer term borrowings this year to fund the capital expenditure. This, together with a fall in earnings by 17% resulted in the decline of the ratio.

Overall, Nishat was in a much safer position than its competitor, Gul Ahmed , which had a lower cover ratio due to its higher borrowing and finance cost.

Investor’s Ratios:

PRICE EARNING (P/E) RATIO:

The price earning ratio of Nishat was visibly higher than Gul Ahmed in all three years. The gap was massively increased between the two companies in 2012. This was due to a negative EPS of Gul Ahmed which the market does not report. It appears that there was a plunge in the ratio of Nishat in 2011 indicating a lower stock market confidence on the company. But the company recovered the position in 2012 with increased ratio.

The share price of the company could be seen in the chart below which corresponds to the movement in the FTSE 100 index. Although in 2011, EPS was increased by 66% but the ratio declined mainly due to share price not increased by the same proportion and only experienced a growth of 16%. This would mean company earnings were not upto the expectations of the market and so the market responded with a lower increase in share price.

In 2012, there was a drop in share price along with a drop in EPS. This was due to inventory losses in the first quarter due to sharp decline in cotton prices compared to the preceding year.(The Express Tribune, 2011)However, the dip in EPS was higher than that of Share price and so the ratio rose in 2012.

EARNINGS PER SHARE (EPS):

Both companies were exposed to a fluctuating trend in EPS during the three year period. Although in 2012, the ratio declined due to lower profitability, Nishat showed a phenomenal performance by achieving a high EPS while other companies in the industry such as Gul Ahmed was facing negative EPS.

In 2011, although the ratio was improved, it was much lower than that of Gul Ahmed. This was due to better earnings achieved by Gul Ahmed. In all three years, the number of shares remained constant highlighting the fact that any changes in EPS were a reflection of changes in theprofitability of the company.

DIVIDEND COVER:

This highlights that the company’s ability to maintain the dividends even if profit falls. (Dividend cover, 2012)

The ratio indicates a falling trend. It was slightly reduced in 2011 and with a more proportion in 2012. However, it is still safe as the company has enough profits to pay dividends in future. The ratio of retention and payout was more in 2010 showing that too much was retained in the business and less was paid out to the shareholders. Typically, dividend cover of 2 is regarded as ideal(Hobson, 2012)

The dividend cover of the company is quite favorable except in 2011 in comparison. This is because Gul Ahmed has not adopted a policy of paying dividends consistently. It has only paid in one year during the three year period while Nishat on the other hand has maintained its increasing dividend policy.

CONCLUSION

The falling profitability of the company is an alert for the company to adopt new strategies to regain its profitability position. This fall is attributable to a fall in sales with economic slowdown in major export markets of the company. Textile industry faced a major threat of gas load shedding with negligible government support during the period. However, the company posses strong strategic and marketing capabilities to maintain its position in the market while many other companies are exiting the industry due to escalating costs and increased competition in the textile sector. The company posses state of the art equipment and strong customer base and it can easily avail the opportunities of entering into technical textile sectors and taking benefit of an EU free trade agreement in future.

The company has maintained the lower gearing level as compared to its competitor,Gul Ahmed and is seen to experience improvement in its liquidity position during the three year period. Nishat investor’s ratios depict a fluctuating trend of the stock market confidence. With the prevalence of high interest rates and depreciation of the currency, the investment in machinery and new technology has become expensive. Still, the company has managed to invest in 30 air jet looms and new heat and power plant to retain its position as one of the leading textile companies of Pakistan. Nishat has greatly contributed to its CSR during the period with installation of water treatment plant and plant 20,000 tree scheme.

RECOMMENDATIONS

Improve sales and falling profitability by exploiting new markets as world textile demand is increasing at a rate of 2.5% p.a.

Nishat must work to take advantage of such a huge market of technical textiles. That will improve the company’s position of having a diversified product portfolio.

Nishat must be ready to avail the opportunity of free trade in the US and EU after the final results of negotiations which are currently going on.

The company should utilize its strength in marketing capabilities and should use it to increase its international exposure and sales.

With current cost pressures and poor support from government, results of the upcoming elections in 2013 might reveal new opportunities with changes in policies by the new government.

With high cost structure, Nishat should utilize its strength of having its own power plant and advanced technology and should aim to continually improve it to retain its competitive edge in the market.