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Financial Position of STV Group

14835 words (59 pages) Business Assignment

1st Dec 2020 Business Assignment Reference this

Tags: Business AssignmentsFinance

ABSTRACT

The main objective of this study is to analyse the financial position of the company STV group. Financial statement analysis is a study of the relationship among various financial facts and figures given in a set of financial statements. The details regarding the historical data have been obtained from Bloomberg terminal, yahoo finance, and the London stock exchange. The secondary data are based on the annual reports published by the company from 2014-2018.

The various tools used for the analysis and interpretations of the group are ratio analysis, valuation of the company and the financial management policy. Graphs and tables have been used for better visual understanding. The various ratios analysed are based on profitability, liquidity and efficiency of the company’s financial statements.

STV group if following negative shareholders equity and also increasing dividends over the past 3 years. On the other hand the company’s turnover is not sufficient to fund the increasing dividend payments. This study recommends reduce accumulated looses and provide security to the shareholders and to increase profits for overall improvement.

INTRODUCTION

UK economy

The UK economy, part of one of the developed countries is highly mark orientated. Raking fifth largest national economy in terms of GDP, the UK contributes 3.5% towards the world economy. According to the report submitted by PWC, the UK economy is anticipated to grow at average rate of 1.4%in 2019 and 1.3% in 2020. This report was however based on the assumption that there will be an agreement on Brexit deal with risks being weighted on downside, in case of disorderly Brexit. (PwC, 2019)

STV Group plc.

Based on Glasgow, STV was incorporated in 2000 and is an essential part of the FTSE small cap index . Originally STV was formed as Scottish television , the ITV licence holder for central Scotland. The company was retitled to Scottish Media Group in 1996 and acquired the licence for Northern Scotland Grampian television, in 1997. The Scottish and Grampian channels were rebranded as STV in 2006. (STV plc, 2019)

STV group along with its subsidiaries produce and broadcast television programmes in the United Kingdom. The company also operates in broadcast, digital, production and external lottery management subdivisions. It provides wide range of options from news, sports, entertainment, weather, competitions, and video on demand and other STV programmes. The STV provides its content through air on TV, website and through video on demand through the STV player. Other than media and TV services sSTV group also provides Internet services, lottery management and sells advertising airtime through space in its media.

STV’s business model is based on delivering unique and high quality content to attract audience, which is sold to advertisers to generate revenues. The content is delivered through multiple media The STV channel is accessible free to air on all the main TV platforms across Scotland. As per the company annual report for the year ended 2018, STV group had the best share of viewing in over a decade with a peak time viewing share of 22.1%. The company also increased its traffic on website by 40% in 2018. (STV plc, 2019)

The median industry in the UK comprises of television, radio, newspapers, magazine and websites. The UK has a wide range of media providers, the most prominent being the BBC, which is publicly owned service broadcaster. The combined revenues of the 100 largest media and entertainment companies in the UK increased to £96.3bn in the last financial year, according to a report from Deloitte. (Deloitte United Kingdom, 2019)

As per the reports from PWC the entertainment and media in the UK is expected to grow towards £80.5 billion by the year 2023. (PwC, 2019)

Audiences, endowed in the digital era, can now consume media content on demand, and attend gigs, sporting events remotely thanks to digital technology. Deloitte forecasts that half of the adults in developed countries will have at least two online subscriptions, doubling to four by 2020. Video on demand is expected to generate the most revenue of about 40% through Internet advertising and Internet access. Virtual reality, over-the-top Video and e-sports are predicted to be the fastest-growing segments in the UK media and entertainment industry over the next five years. (Deloitte United Kingdom, 2019)

Deloitte predicted a decline in the traditional TV viewing activity by the 18-24 year old by 10%-15% in 2018 and 2019 and improbable decline thereafter. The changing climate in how the newer generation watches television has put weight on broadcasters, advertisers and distributors to rethink the traditional approach and react to the changing consumer habits. In the UK, Deloitte estimates there are about 26 million online only subscription .The faster broadband speeds are making media ever more compelling than traditional alternatives, which   gives a clear indication of consumers showing willingness to pay for online content. (Deloitte United Kingdom, 2019)

STV Productions

The STV production is the UK’s leading content business with records of success across range of genres. Highlights include entertainment show catchphrase for ITV, ratings winner Antiques Road Trip for BBC and documentaries Britain’s Polar Bear Cub for Channel 4, Ross Kemp Behind Bars – Inside Barlinnie for ITV and Prison: First & Last 24 Hours for Sky1

The STV’S most viewed show like Britain’s Got Talent, Dancing on ice and dramas including trauma, unforgotten and Vera increased the audience viewership by 16%. The FIFA World Cup led STV to reach viewership to 3.55 million viewers.

Ever-popular STV series, Coronation Street and Emmerdale, continue to grow viewership share since 2017, while the newest series of I'm a Celebrity - Get Me Out Of Here! Were the most popular in Scotland and the most -watched programme across the year, with a 45% share and an average audience of nearly 980,000. The figures are based on consolidated data from BARB, covering 1st January - 6th December 2018, 1900-2230. (Barb.co.uk, 2019)

OFCOM

Ofcom regulates the UK communications industry, which consists of television, radio and video on demand sectors, fixed line telecoms, mobiles and postal services. Ofcom functions under the communications act 2003, the main duty of regulator is to broaden the interest of the citizens and of consumers by promoting appropriate competition where crucial.  Ofcom The regulator ensures people are protected from offensive material, to prevent consumers from unfair treatment and protection of their privacy. (Ofcom, 2019)

Relationship with ITV plc.

The United Kingdom has a diverse range of media providers, the most important being the BBC or the British broadcasting corporation. ITV was launched in 1955 to provide competition to BBC. The legal name for ITV has been changed from channel 3 since the passing of the Broadcasting Act 1990 with the aim to distinguish it from other channels such as BBC 1, BBC 2 and channel 4.  The channel 3 was assigned to regional ITV station to be on the third button with other channels being allotted o the number with the channel’s name.

ITV is operated by a number of licensees, which provide regional services. Since 2016, the fifteen licences are held by two companies, with the majority held by ITV Broadcasting Limited, part of ITV plc. All companies holding a licence were part of the non-profit body ITV Limited, which authorized and scheduled network programs. This changed after the amalgamation of several companies it has been replaced by affiliation system. With approval from Ofcom, the new system allows ITV plc. To commission and fun network schedule with STV and ITV paying a fee to broadcast it. STV Group was previously in dispute with ITV but this was resolved in 2011 and STV now pays a flat fee to ITV

STVG COMPETITORS

The competitors selected for STV g analysis are ITV, DCD media, catalyst media group, Channel4 and BBC. The earnings of STVg are compared to that of BBC, Channel4 and ITV’s, whereas the ratios are analysed in comparison to ITV, DCD and Catalyst media group. The strategic report of STVG was used to determine BBC, ITV and channel 4 as its competitor. (STV plc, 2019)

However STVg, a FTSE Small Cap company along with ITV plc; are part of the London stock exchange, whereas the BBC and Channel4 are not. To enable comparison with companies within in the London stock exchange, DCD media and catalyst media group were selected. The selection process involved the filtration of all the companies on the London stock exchange on the basis of media and subcategory broadcasting and TV industry. The companies were selected based on the region of headquarters being United Kingdom with a market capital of over 2 million (Londonstockexchange.com, 2019). This enabled us to measure the performance of STV group beside other media and broadcasting firms based on United Kingdom.

The BBC founded in 1922,is one nations oldest broadcaster in the world with a turnover of £4.96 billion (Bbc.com, 2019). ITV plc. On the other hand was founded in 2004 and has total revenue of £3,211 millions as of 2018. Channel4 was formed in 1982 and has around 11 sister channels, with a total turnover of  £975m (Itvplc.com, 2019). Channel 4 with turnover of £975m was established to provide a fourth television service in addition to the license funded BBC one, BBC Two and the single broadcasting network ITV (Annualreport.channel4.com, 2019). All of the above channels have competed with each other to become the United Kingdom’s most watched television. Further financial analyses of STV along with its peers have been explained down the report.

How diverse is STV?

According to the report “UK broadcasting industry report” by OFCOM on diversity and equal opportunities, STV’S viewership reaches 3.5 million people per month. STVs workforce consists of 51% male consistently since 2016, which is 3pp lower than the industry average. The company also reported a mean gender pay gap of 22.8% and a median gender pay gay of 17.3%. STVg also has taken measures to train its employees in partnership with the Scottish Association for Mental Health to help employees. (Ofcom.org.uk, 2019)

FINANCIAL PERFORMANCE & POSITION OF THE COMPANY

Ratio analysis is crucial for investment decisions. It not only helps in knowing how the company has been performing but also makes it easy for investors to compare companies in the same industry and zero in on the best investment option. The data for the purpose of calculation of various ratios have been obtained from the annual reports of the company, London stock exchange (Londonstockexchange.com, 2019) the financial times (Markets.ft.com, 2019) and yahoo finance (Uk.finance.yahoo.com, 2019)

OPERATING PROFIT MARGIN (OPM)

The OPM demonstrates the operational efficiency and pricing power of the company. A higher OPM indicates the company’s efficiency in procuring raw material and converting them into finished products without wastage. STV group has maintained the OPM at the similar levels of 16% however a higher margin is a better sign for investors. The ratio measures the proportion of revenue that is left after meeting variable costs such as raw material and wages. The OPM indicates that the company is failing to increase the OPM over the period.

 

RETURN ON EQUITY

The ROE helps investors to compare the profitability of a company with its peers in the industry. This ratio highlights the management capability of the company. The benefits come when the ROE is higher when earnings are revisited, which produces a higher growth rate.  With that being said a higher ROE could also be higher by increasing the debt of the company

One would expect leveraged companies to exhibit inflated ROEs as a major part of capital on which they generate returns is accounted for by debt. While the company started of with decent return to the equity investors in the year 2014 and 2015 the company has since then been a landslide with a negative equity share capital accounted by the accumulated looses in the past years. The lack of equity share is an indicative of the company’s failure to manage its return efficiently.

LIQUIDITY RATIO

INTEREST COVERAGE RATIO

It indicates how solvent a business is and gives knowledge about the number of interest payments the business can service solely from operations. The ratio can be calculated using EBITDA in place of EBIT to compare companies in sectors whose depreciation and amortisation expenses differ a lot. Or, by the use of earnings before interest but after tax if one wants a more accurate idea about a company's solvency.

While measuring the company’s ability an interest cover ratio of 1.5 or higher is expected. Although the company has had an interest cover higher than the desirable ratio, the company has not been able to maintain it stably over the years. The company also had its lowest interest cover ratio in over 5 years with 2.73 in 2018, leading us to question the company’s ability to pay it debts in the future.

CURRENT RATIO

This shows the liquidity position, that is, how prepared the company is in meeting its short-term obligations with short-term assets. A higher figure signals that working capital issues will not affect the company’s everyday functions. A current ratio of less than one is a matter of concern.

Sometimes companies find it difficult to convert inventory into sales or receivables into cash. This may hit its ability to meet obligations. In such a case, the investor may calculate the acid-test ratio. However, the company has maintained a ratio above 1 in over the years. While ratio of 3.11 in2014 and 3.07 in 2016, indicates the company can cover its current liabilities three times, it may indicate that it's not using its current assets efficiently.

QUICK RATIO

The quick ratio is the company’s ability to meets its short-term obligations with its most liquid assets. It indicates the company’s ability to use its near cash assets to meet its immediate obligations.  A result of 1 is considered to be the typical quick ratio, as it signifies that the company is fully prepared with precisely enough assets to be rapidly liquidated to pay off its current liabilities. The company has maintained the quick ratio above the desirable amount of 1 in over the years. For example, a ratio of 1.25 in 2018 indicates that the company has £1.25 of liquid asset to cover each £1 of current liabilities. The higher the ratio, the better the company is performing, however STV g has had a declining ratio since 2014, indicating the company many be stressed to pay its debts. 

EFFECIENCY RATIO

Receivable turnover ratio

The ratio is an accounting measure used to quantify a company’s effectiveness in collecting the money owed by the customers. It indicates how well the company collects the credit extended to the customer and the short-term debt owed to them. Accounts receivable is money owed without interest and hence the ratio can be interpreted as company extending interest free loans to their customer. A high ratio indicates the company is collecting receivables more often throughout the year. For instance the company had a receivable turnover ratio of 6 during the year 2018, meaning the company collected its average receivable 6 times during the year. The ratio although has shown an improvement since the previous year, it is still twice less compared to its consistent performance since 2014.

Total asset turnover

Asset turnover ratio is an efficiency ratio that measures company’s ability to generate sales from its assets by comparing net sales to total assets. The ratio measures the efficiency of company to use its assets to generate sales.it represents how many sales would be generated form each dollar of company assets.  A higher ratio is preferable, for instance the company generated an asset turnover ratio of 1.43 in the year 2018, meaning the company is generating £1.43 of sales for every £1 invested.

GEARING RATIO

DEBT ASSET RATIO

This ratio measures the degree of company’s leverage. It cans also be interpreted as the proportion of company assets that are financed by debt. A ratio greater than 1 shows that majority of the assets is financed by debt. In the case of STVG, except in the years 2014 and 2015 the company has had a ratio greater than 1. The company may be putting itself in danger by financing major portion of its assets through debt, risking the possibility of interest rate to rise.

DEBT EQUITY RATIO

The debt to equity is calculated to evaluate the company’s financial leverage. The D/E is important to measure the extent to which a company is financing its operations through debt vs. wholly equity funds. A higher leverage ratio indicates a company with higher shareholder risk. A debt ratio of .5 means that there are half as many liabilities than there is equity. Since a lower D/E ratio is preferred, the STVg with a ratio of 2.41 is a high risk to the equity holders. With that being said, the company has been recovering from the high D/E of 24.17 in 2014, decreasing it to 6.09 in 2015 to a further 3.42 in 2017.

Debt to Capital Ratio

The debt to equity ratio is the liquidity ratio that calculates a company’s use of financial leverage by comparing the total obligation to total capital. Typically the higher the ratio the greater the risk to lenders and shareholders, a ratio greater than 1 means the company has more debts than capital. The Stage ratio has remained greater than 1 except in the year 2014 and 2015. There is a possibility that if any more liabilities are acquired without an increase in earnings, the company might go bankrupt.

PEER ANALYSIS

Ratios - based on IFRS

STV

ITV

DCD MEDIA

CATALYST MEDIA GROUP

4 imprint group

PE Ratio

84.29

10.67

n/a

16.45

18.6

PEG

-0.98

0.73

n/a

-0.23

0.85

Earnings per Share Growth 

-86.05%

14.71%

n/a

-70.06%

21.77%

Dividend Cover

0.21

1.7

n/a

N/A

1.79

Revenue Per Share 

327.83p

n/a

277.44p

0.12p

2642.75¢

Pre-Tax Profit per Share 

4.95p

n/a

(2.28) p

(0.44) p

158.00¢

Operating Margin 

7.15%

18.69%

-1.06%

-390.43%

6.00%

Return on Capital Employed 

n/a

33.29%

-2.57%

-0.38%

104.13%

Industries have different profitability due to inherent differences in their business models; as a result, price-to-earnings ratio is more of an industry specific measure. According to the P/E either STVG is losing out to other companies or the market has mispriced the company. The PEG growth rate is negative compared to its number one peer the ITV along wit 4 imprint, which has a positive growth rate. The positive side of the company was its ability to pay high dividends despite its low earnings per share, however the dividend cover is below in comparison to ITV and 4Imprint. Over all the company fall 3rd in terms of its performance comparison with ITV and 4Imprint.

FTSE ANALYSIS

STVg is a part of the FTSE small cap, FTSE small cap is an index of small market capitalisation companies comprising of the 351st to the 619th largest-listed companies on the London Stock Exchange main market. The FTSE index has been indicated by the blue graph, the media industry with orange and STVG with black. As the graph shows, while the media industry index and FTSE index have had a somewhat steady growth over the past 3 years, the STVG has had a volatile trend. The graph of STV consists of extreme highs during the year of 2016 when the FTSE small cap and media index performed low and extreme low in mid of 2018 along with the media index, while the FTSE performed well. The STVG is following a volatile of trend comprising of highs and lows and the trend seem to converge in may 2019.

LIMITATIONS OF RATIO ANALYSIS

While the ratio analysis is widely used measure of company’s performance there are various drawbacks attached to it. The essential factor for ratio analysis is the availability of comparative information, the lack of availability of information about the benchmark or industry average limits the reach of ratio analysis. Much of the accounting information available is based on the past performance of the company subjects to the limitation of historical costs. The richness of the picture that the information helps to build is based on the quality of the data available. Even with the availability of quality data, the past information may not be the best estimate for future performance. (Accaglobal.com, 2019)

Buy-and-hold abnormal return approach (BHAR)

The early return based event studies were formulated by fama, fisher Jensen and roll in 1969 capturing the short-term effects of events on stock price. A related methodology was developed to capture the long-term and persistent effect of events on the stock price (Fama et al., 2003). Buy and hold is an investment strategy where investors buy and hold stocks on a long-term basis. The goal is that the investors buy stocks with the approach that the share price will increase in value in the long run. The BHAR is based on the principle that investors hold the stock for long time and calculates return by deducting the normal buy and hold return from the realised buy and hold return.

                                 

The ABHR has been calculated over a period of 3 years (2016-2018), the data has been derived from the London stock exchange (Londonstockexchange.com, 2019). The analysis takes into account the daily stock price of STVg against the FTSE Small Cap. STVg forms part of the FTSE small cap index of small market capitalisation companies consisting of 351to 619 largest companies in the London stock exchange. STVg with revenue of 117million is in better comparison with the companies in the FTSE small cap hence it has been used the benchmark to evaluate the BHAR.

The 3-year period analysis consists of   a total 759 daily observation of stock price. The data has been downloaded for the period 01.01.2016 to 01.01.2019 from Yahoo finance for STVG and from the London stock exchange historical data of FTSE small cap. The daily return for company and market is calculated by using, Return = stock price on day 2/ da1 -1 for 759 observation of market and company.  The analysis further proceeds by calculating the (1+ daily company return / market return) for all the observations. The analyses concluded by calculating the ABHR, which is the product of sum of all the company return minus the product of sum of all the market return. The final results is -0.304664 signifies a potential deviation of market return from the benchmark. The return on individual stock depends on the volatility relative to the market. The deviation could also be a result of the amount of risk the investor is willing to take; the higher the risk the greater is the reward.

The deviation is the result of volatility, for example the volatility of Nasdaq is greater than the volatility of S&P 500. Volatility is defined as the annualised standards deviation of return, in the theoretical framework volatility not only measures risk but also affects the long-term return of the investor. High volatility corrodes the long-term return while also providing the opportunity to make huge gains.

The idea of investing in FTSE stock through buys and hold strategy, rather than short term is a wise decision, given the returns is more rewarding. Placing your money into the market index like S&P500, FTSE 100 are safe bet, according to S&P Dow jones indices, the chances of a market index outperforming is 86%. However buy and hold has certain downside to, while certain well-selected stocks perform well and bounce back after markets crash not the same can be said about all stocks and can be apocalyptic to the portfolio.

FINANCIAL MANAGEMENT POLICIES

DIVIDEND POLICY

‘‘The nearly universal policy of paying substantial dividends is the primary puzzle in the economics of corporate finance.’’- Feldstein and Green (1983), following Black (1976)

The organized time series conduct of corporate dividend policy suggests that firm specific, theoretical explanations of dividend policy, signalling and agency theories cannot explain the practice of paying decreased dividend (Marsh and Merton, 1987)

In the case of STVG looks impressive to dividend investors with its 5.65% dividend yield and a five-year repayment period.  STV is a dividend company with abundant net income to cover its dividend payout ratio however if a company is paying more than it earns, the dividend may need to be cut back. Majority of empirical works support the hypothesis that investors expect a higher return on shares of dividend paying stocks. The implication of tax liability increases the shareholder’s pre-tax return. However In the year 2018 the company paid out a dividend of staggering 478% of its profits to investors. A dividend payout of such a ratio raises red flags to investors, unless there are extenuating circumstances. STV group paid out nearly 71% of its cash flow in the previous year which although high is still within the range for a corporate.

Under capital asset pricing theory, investors will offer less for shares due to future tax liability of the dividend payment. On the other hand the preference of shareholders expecting a dividend can be explained by factors like risk aversion level, the cost of liquidation of holdings, agency costs and the information availability (Evans et al., 1971). An argument proposed in the works of (Miller and Modigliani, 1961) explained the consequence of tax-adjusted model as the division of investors into dividend tax clientless. In later works, Modigliani 1982 explains that clientele effect will result in only minimal alteration in the portfolio while compares to miller 1977 who predicted a major difference

It is disappointing that the company did not generate enough profits to cover its dividend payment. Although few companies can persistently pay dividends greater than their profits, in the case of STV it is a warning sign.

CAPITAL STRUCTURE

A number of theories have been proposed to explain the choice of debt ratios. While some theories suggest that firms structure their capital based on the various cost and benefits associated with debt and equity financing. The other suggests that the type of assets owned by firms in a way affect the choice of capital structure. By selling secured debt, firms increase the value of their equity by expropriating wealth from their existing unsecured creditor. Stockholders of leveraged firms have an incentive to invest sub optimally to expropriate wealth from the firm's bondholder, (Galai and Masulis, 1976) and (Jensen and Meckling, 1976)

The capital structure of stvg consists of debt, which includes bank loans, cash and cash equivalent and equity attributable to equity holders of the parent, comprising issued share capital, reserves and accumulated loss

The group monitors its capital on the basis of gearing ratio. This ratio is calculated by the total capital. . Gearing ratio is statistically significant to corporate governance. Financial theory suggest that the presence of optimality of debt ratio in firms’ capital structure beyond which this the presence of optimality of debt ratio in firms’ capital structure beyond which this ratio shows negative impact on firms’ financial performance. CONCERN shows negative impact on firms’ financial performance with a negative relationship with firms’ financial performance. As debt holders, control financial performance. The gearing ratios were as follows

 

2018

2017

2016

Total borrowings

42.6

41.6

39.7

Cash and cash equivalents

-6.3

-6.1

-13.3

Net debt

36.3

35.5

26.4

Total equity

-59.1

-53

-53

Total capital

-22.8

-17.5

-26.6

 

-159%

-203%

-99%

The movement in equity is due to the increase in pension measurement increase of 11.9m. As the data show above, the company has negative shareholders equity, which raises concern as a potential investor.  Shareholder equity is the result of total assets – total liabilities, revealing how much of it is leftover to the stockholders. Theoretically, negative shareholders equity implies shareholders owe money to the company, however common stock holders are prevented from such a liability by the corporate structure. When shareholders equity is negative it is often indicative of the accumulated losses being treated by the company. It reflects the accounting policies adopted by the company to compensate the loss incurred in the previous years. These exist often only on papers enabling company to stay open even with on going losses. Depreciations, leverage buyout, substantial adjustments to tangible property such as patents can also contribute to negative shareholder’s equity

VIDEO ON DEMAND

Traditional media concepts are a thing of the past, the entire industry is undertaking fundamental change: streaming services are no longer just platforms for the consumption of films and TV programs, now they are investing in the production and licensing of globally successful own content – and are thus in direct competition with the traditional TV and video industry- Deloitte

Broadcaster and media companies are launching their own online video streaming service to be in line with the change in the industry. STV Player is an online video on demand service accessible through the main STV website as well as available on a variety of smartphones, tablets, consoles, set top boxes and Smart TVs. The company launched its ad free subscription video on demand service early this year allowing it to enter the fast growing pay TV market. On 25 February STV announced the launch of STV Player+, available on IOS (Apple devices) for £3.99 per month after a seven-day free trial. The company is also working on making it available for other devices. In 2018 annual report STV reported an increase in online streams by 24% thereby increasing online revenue by 39%. In 2018 the company reported an increase in digital revenue by 17% and increase in digital profit margin to 49%. The STV has almost 3 million registered users in Scotland.

The company also seized the opportunity in on online demands by investing in a four-year strategic partnership with virgin under which virgin will broadcast STV in HD across all cabled STV regions as well as launch STV player on virgin media set top boxes. Virgin media has a 17% market share in Scotland, which is expected to boost player’s distribution. STV also announced a five-year strategic partnership with Sky in January 2019, which will give Sky customers in Scotland access to STV’s regional variants in full HD, as well as to the STV Player on their set top boxes.

While the company is taking the steps in the right direction, STV has a long way to go be in competition with some of the big hits in video on demand like Netflix, amazon prime and BBC iPlayer. The company has some catching up to do in terms of product features like recommendations, auto play, watch offline, favourites and personalisation features which are part of the pack in BBC iPlayer, Netflix, Amazon prime and channel4- strategic report 2018

Corporate responsibility

Environment

STVg recognises the impact of its day-to-day activities on the environment. Throughout 2018, the company had managed to recycle 100% of its waste, resulting in no landfills. FTSE Russell confirms that STVG group had been assessed and satisfied the requirements to become a constitute of the FTSE 4 Good Index Series.

Community

Across the year, STV produced a series of TV programmes to support the children’s appeal. In just over 8 years, the appeal had raised over £19 million and enabled the charity to make 1,102 large and small awards to charitable projects across all 32 local authorities in Scotland. Since the launch of the appeal, STV has formed strong partnerships with high profile corporates like Royal bank of Scotland, Lidl, Optical Express, Quality meat Scotland and Tunnock’s. The project also continued too support communities across Scotland to encourage individuals, schools and business to get involved in charity at local levels. 

Financial risk of lottery operation

The Scottish children’s lottery was launched in October 2016 was awarded licences by the UK Gambling Commission. While operated independently of STV, in agreement with the requirements of these licences, it is provided with financial support by STV, which amounted to a debtor of £11.6m gross, £6.6m net, at 31 December 2018. The responsibility of the lottery lies with STV ELM limited however there is reputational risk to STV, as the holding company. Trade and other receivables of £8.2m (31 December 2017: £8.2m), included within non-current assets, relates mainly to debt due to ELM (the lottery management company)

Since the rise in debtors, the company has placed internal controls to ensure that the terms of the operation of the license are adhered to as the gambling commission has power to impose sanctions in the vent of repeated breach. The overall financial position f the company was heavily affected due to this debt arrangement.

EXCEPTIONAL ITEMS

The company made a provision of £8.7 million during the year to restructure the business from within. The restructure was mainly the result of closure of STV2. The 8 million pounds also included a non-cash write down of stock and assets worth around 6 million pounds. This closure of the company had lead to a loss on sake of £0.8 m and a non-cash write-down of stock and assets of £0.4m. An additional £4.2m provision also had been recorded during the year in relation to the ELM debtor. The outcome resulted in the increase in provision by £4.2 m to £5m. (Proactiveinvestors UK, 2019)

As per the company annual reports in conjunction with the Group's annual financial statements as at 31 December 2017, there have been no changes in any risk management policies since the year 2017.

VALUATION OF THE COMPANY

The goal of company valuation is to give its owners, and other s interested an approximate value of what the company is worth. The mechanism of company valuation is an imperative requisite; the valuation process helps to identify the source of economic value creation and destruction of the company. Value of a company is not be confused with the share price, which is an agreed price between the buyer and seller in the sale of a company.

PV of Perpetuity.

 Perpetuity is a type of annuity that receives an infinite amount of periodic payments. An annuity is a financial instrument that pays consistent periodic payments. As with any annuity, the perpetuity value formula sums the present value of future cash flows.

YEAR

2018

2017

2016

2015

2014

Dividend paid yearly

20

17

15

10

8

Required rate of return

5%

5%

5%

5%

5%

PRESENT VALUE

499

340

300

200

160

Perpetuity Growth Method

The perpetuity growth rate is typically between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%.

Projected profit

225,000

(Forecasted profit for next 10 years)

Growth rate

8%

 

Cost of capital

5%

Perpetual growth

7,875,00

(pv of the company )

LIMITATIONS

The perpetuity growth model is based on constant stream of identical cash flow for an infinite amount of time with no end date. This however, in real life, companies may not maintain the same level cashflow every year. It is also impossible for companies to have the stock dividends increase at a constant rate.

Dividend discount Model (DDM)

Stock price fluctuations can be explained by the changes in the expected present values of future dividends. The volatility tests conducted by (LeRoy and Porter, 1981)and (shiller, 2019) found that tests based on DDM with in a constant discount rate, the stock market volatility was far greater than the subsequent changes in dividends can be found in various sources, e.g. in “Financial Management – Theory and Practice” (Brigham & Gapenski, 1997, p. 254)

Year

2015

2016

2017

2018

Dividend growth rate

25

49.49

13.64

17.65

Average dividend growth rate

26.47

 

2018

2019

2020

2021

EXPECTED FUTURE DIVIDEND @ 26.47% GROWTH RATE

20

25.924

31.989

40.4564

       

DISCOUNTED DIVIDENDS @8.25%

23.36628176

27.29888153

31.89359827

PRESENT VALUE OF FUTURE DIVIDENDS

82.55876156

The free cash flow is the amount of “cash not required for operations or reinvestment” (Brealey, Myers, & Allen, 2006, p. 998). The DDM is an income-based method towards valuing a company that is based upon the theory that the value of a business is equal to present value of its projected future cash flows. The terminal value represents the point in time when the cash flows level off.

The terminal value and amounts of the projected cash flow is calculated using the appropriate discount rate, which emphasises the risk involved in investing in the company being valued. In arguing that there is ‘room for fads’ in aggregate stock prices, Shiller (1990) emphasizes that most of the variation in annual stock returns is not explained by contemporaneous dividend changes

expected dividend per share

7(2018 dividend per share

cost of equity

7

dividend growth rate

5

value of stock

367.5

  • D = the estimated value of next year's dividend - £7
  • r = the company's cost of capital equity – 7%
  • g = the constant growth rate for dividends, in perpetuity – 5 %

Valuation Earning Model

TWO-STAGE DCF MODEL

The intrinsic value can be obtained by discounting the future expected cahflow to today’s value. The Discounted Cash Flows (DCF) model does this.

The two-stage DCF model, as the name states, takes into account two stages of growth. The first stage is generally a greater growth period, which levels off towards the terminal value, detained in the second steady growth period. The process uses analyst estimate in the absence of the previous year free cash flow. The growth has been estimated using the average annual growth rate over the past five years, but capped at reasonable level. The obtained values are then discounted to its present value and added to give the present value of the cash flows. If used wisely, the discounted cash flow valuation is a powerful tool to evaluate the values of a variety of assets and also to analyze the effects that different economic scenarios have on a company’s value

5-year cash flow forecast

 

2018

2019

2020

2021

2022

LeveredFCF (£, Millions)

£12.00

£12.77

£14.05

£14.33

£14.61

Source

Analyst x3

Analyst x3

Analyst x2

Extrapolated @ (1.99%)

Extrapolated @ (1.99%)

Present Value Discounted @ 8.28%

£11.08

£10.89

£11.07

£10.42

£9.82

Present Value of 5-year Cash Flow (PVCF)= UK£53.28m

Once the present vale of future of cash flows in the 5-year period is calculated, we need to calculate the terminal value, which accounts for all the future cash flows. The growth rate is kept at a minimum compared to make sure it does not exceed the GDP. In the case of STVG the growth rate used is the 10-year government bond rate at 1.4%. As for the 5-year growth period, the cash flow is discounted at today’s vale of equity at 8.3%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£14.61m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£215.31m

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£215.31m ÷ ( 1 + 8.3%)5 = UK£144.66m

The total value is the sum of cash flows for the next five-year and the discounted terminal value, which in the case of STVg is UK £197.94m. The intrinsic value is obtained by dividing the total by the number of shares outstanding, which is £5.05. The terminal value when compared to the share price in 2018 was £4.4; the stock is slightly over priced by 12.90%.

Assumptions

The most important inputs to a discounted cash flow are the discount rate and the actual cash flows. From investor point of view the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC), which accounts for debt. In this computation I’ve used 8.3%, which is grounded on a levered beta of 0.800. This is obtained from the Bottom-Up Beta method based on similar companies, with an implied limit between 0.8 and 2.0.

LIMITATIONS

The DCF method is based on the projection of earnings and there is an vagueness attached with projection of cash flow.  If the company’s operations lack visibility, it becomes challenging to forecast sales, operating expenses and capital investment with conviction. DCF Model is not suited for short-term investing. Instead, it focuses on long-term value creation

Free Cash Flow Model

Free cash flows refer to the cash a company generates after cash outflows. It helps support the company's operations and maintain its assets. Free cash flow measures profitability. It includes spending on assets but does not include non-cash expenses on the income statement.

According to the report by CFA report, free cash flow is used whenever one or more of the following conditions is present (CFA Institute, 2019):

  • The company does not pay dividends.
  • The company pays dividends but the dividends paid differ significantly from the company’s capacity to pay dividends.
  • Free cash flows align with profitability within a reasonable forecast period with which the analyst is comfortable

Free cash flow to the firm at the time of t can be estimated as follows. The formula for calculating the FCFF is shown below. (Damodaran, 1996, p. 237).

 

FCFF = EBIT – tax + Depreciation – Capital expenditure – Increase NWC

 

Free cash flow

2018

2017

2016

2015

2014

EBIT

20,100

19,000

19,700

20,300

19,500

Taxation

-300

-2,200

-3,100

-1,600

-2,600

Depreciation

1700

1600

2000

2200

1900

less cap ex

-3400

-3400

-3200

-2300

-5000

in crease in NWC

3300

-10300

-6500

-244

-900

FCFF

21400

4700

8900

19400

12900

 

Free cash flow is increasing as compared to previous year – this will help to support company for its operation and maintain its assets-  (Note: During the year 2018 there is provision of unusual expenses £ 14500)  - based on the above, the expected cash for the year 2019 £13460 (Average of last 5 years)

Free cash flow to equity 

FCFEis one of the discounted cash flow valuation approaches to calculate the fair price of the stock. FCFEmeasures how much cash a firm can return to its shareholders and is calculated after taking into account the taxes, capital expenditure and debt cash flows.It is the amount of cash a business generates that is available to be potentially distributed to shareholders. 

FCFE = Net income + Depreciation and amortization + changes in working capital – capital expenditure + net borrowing

The free cash flow is negative as compared to previous year due to unusual expenses of £14500/-

LIMITATIONS

Unlike the DCF method, the FCFE model has various limitations. The model is useful only when the company’s leverage is not volatile and it cannot be applied to companies with changing debt leverage. It overlooks the fact that corporation is a separate legal entity and that these profits are not freely withdrawn by the shareholders (Miller and Modigliani, 1961).

The FCFE is not readily available unlike the dividends and hence an analysis has been conducted by calculating these data from the information provided by the company financial reports.

Price earning multiplier

The P/E valuation method is one of the most popular methods used to value a company as it captures risk and growth of a stock. Hence, a firm’s value can be assessed reasonably by the use of P/E ratio with comparison to firms with similar risk. This ratio is useful when a firm's value is not observable (Boatsman and Baskin, 1981).

The earnings multiplier, also called the price-to-earnings ratio (P/E), is a valuation method used to compare a company's current share price to its per-share earnings. 

 Earning multiplier = Market value per share / Earning per Share (EPS)

This ration helps investors determine the market value of a stock as compared to company's earnings. A higher P/E ratio shows that investors are willing to pay a higher share price today because of growth expectations in the future. The PE ratio is much higher during last year.

key fundamentals

2014

2015

2016

2017

2018

Revenue in M

120.4

116.5

120.4

117

125.9

pre tax in M

17.3

9.8

15.7

13.9

1.9

EPS in p

38.7

29.8

32.5

30.1

4.2

PE

9.43

17.28

11.03

11.24

84.29

PEG

0.47

-0.75

1.26

-1.58

-0.98

EPS growth

20%

-23%

9%

7%

-86%

Dividend Cover

4.84

2.98

2.17

1.77

0.21

Dividend Yield

2.19%

1.94%

4.18%

5.03%

5.65%

Model Comparison discussion:

Do all the model provides the same value?

No, all 4 model shows difference value and different method of valuation and as well as different assumption:

Dividend Discount Model – seems to be matching as compared to other models

Forecasting free cash flow based on the last 5 years data is highly difficult – further the company made provision of unusual expenses provision for the last 4 years work out £ 27.70 million due to the above forecasting become difficult

Free Cash Flow equity (FCFE) - shows negative number during the year 2018 due to unusual expenses

Valuation based on literature

According to the dividend policy formulated by midgillani and miller 1961, companies face the dilemma as to whether to reduce dividend and rely on retained earnings or to raise dividends but float new shares. The higher dividend payout in any period, the greater the need for capital to be raised . The STVg has done neither in the past two years, the dividends paid out in the past two years amount to 13.1 million with further 1.2 million spent to buy back and cancel shares.. A firm which pays dividend will have to raise funds externally or through earnings to invest in future policies, the company has had accumulated looses in the past years which have been carried forward.

However, the miller method showed that as long s firm was realising the return, as expected by the market it did not matter whether it came back to shareholders now or in the form capital appreciation later. Thus, values are determined by the ability of firm’s assets to produce earnings and the investment policy chosen by the company. The shareholders are indifferent between the payment of dividends and retention of earnings. The DCF analysis is a great instrument to analyse what assumptions and conditions have to be fulfilled in order to reach a certain company value. This is particularly supportive in the case of capital budgeting and in the conception of achievability of plans

As with all other financial models, the soundness of the DCF method almost wholly depends on the quality and validity of the data that is used as input. If used wisely, the discounted cash flow valuation is a influential tool to calculate the values of a diversity of assets and also to analyse the results that different economic circumstances have on a company’s value.

However, with the use of several valuation techniques, their distinct shortfalls are reduced and the ultimate goal in the field of company valuation can be reached. I conclude that using the DCF method in combination with other methods, like the trading comparable or precedent transaction analysis is an effective approach to obtain a realistic range of appropriate company values. STV group should focus on resolving the accumulated losses and retain earnings with intention to increase the share value by making profits in the future.

Conclusion

An investor can earn an average market return by buying an index fund however if an investor is in individual stock, one can do better or worse than the index fund. However investors in STV group plc have savoured the harsh downside in the 2018, as the share price dropped by 20%. This is well below the market return of 2.2%. Though the stock is actually up 10% over the past three years, markets are some times efficient but prices are not always of the reflective of the underlying business.

The company reported a drop in EPS of 86% for the year 2018; this resulted in the drop in share price. Although he drop in share price of 20% isn’t a massive reduction, it is the P/E ratio of 85.2, which signals some real optimism that earnings will eventually bounce back.

From dividend perspective, it is vital to evaluate the modification between total shareholders and share price return. The TSR integrates the value of any supplements along with dividends, based on the assumption of dividends being reinvested. The company’s TSR over the last year was 15%, which is better than the return on share price. With a five-year dividend history and a dividend yield of 5.65%, the company shares look enticing. The company also bought back shares in the last two years spending £1.2 million and approximately 2.8% of the market’s share.

With that being said, if a company is paying more than it earns, dividends may eventually be cut. This cuts out the only sources of income as well as the declines the value of investment. STVG paid out nearly 480% of its earnings in the form of dividends; from a potential investor point of view that hopes to own the company in the future a pay-out ratio of above 100% is definitely a concern. The company seems to be over compensating for the loss incurred due to ELM, the lottery company. The company also recorded a Net Debt 2.42 times the EBITDA, which can fast track the growth but it is highly risky.

Although the dividend payment seems to be growing decently is it enough to Invest in the company? Sadly the answer is no, while dividend is on the rise, the company reported a provision of £8.7 million during the year owing to the closure of STV2, resulting in the loss from discontinued operations.

In conclusion from a dividend stock point of view, decision needs to be made whether the dividend will grow progressively over the years. If the company is able to uphold its dividend pay-out notwithstanding the economic circumstances it is noteworthy the further consideration. With EPS and given the short history of dividend stock it is hard to look past the flaws.  Given loss incurred from the sale of STV2 and provision of 8 million pounds in exceptionally item on would not be incline to think of STV group as a reliable dividend player.

APPENDIX

Profitability

Year

2014

2015

2016

2017

2018

Profitability in %

Operating Margin

0.16

0.16

0.16

0.15

0.16

Profit Margin

12.21

9.79

10.47

10

1.27

ROE

264.87

158.33

0

0

0

ROCE

28.51

19.59

22.27

20.14

4.84

LIQUIDITY

         

Year

2014

2015

2016

2017

2018

Interest Cover

8.86

6.77

14.08

14.9

2.73

Quick Ratio

2.18

1.93

1.99

1.63

1.25

Current Ratio

3.11

2.96

3.07

2.87

2.02

COSOLIDATED INCOME STATEMENT

INCOME STATEMENT

31-Dec-14 

31-Dec-15 

31-Dec-16 

31-Dec-17 

31-Dec-18 

Revenue 

120.4

116.5

120.4

117

125.9

Operating Profit/(Loss) 

19.5

11.5

16.9

17.4

9

Net Interest 

-2.2

-1.2

-1.2

-1

-1.1

Profit Before Tax 

17.3

9.8

15.7

13.9

1.9

Profit After Tax 

14.7

11.4

12.6

11.7

1.6

Discontinued Operations

         

Profit After Tax 

n/a

n/a

n/a

n/a

n/a

PROFIT FOR THE PERIOD 

14.7

11.4

12.6

11.7

1.6

FIVE YEAR SUMMARY

RESULTS

2014

2015

2016

2017

2018

Revenue

120.4

116.5

120.4

117

125.9

 

Profit from operations before exceptional items

19.5

20.3

19.7

19

20.1

Profit on ordinary activities before taxation and exceptional items

17.3

18.6

18.5

15.5

17.2

ASSETS

         

Non current assets

26.9

22.3

38.4

39.2

40.1

Current asset

61.2

55

55.6

94

53.4

Total asset

88.1

77.3

94

92.6

83.5

Equity and liability

         

Current liability

19.7

18.6

18.1

18.6

21.5

Non current liability

64.9

47.8

128.9

112.3

121.1

Equity

3.5

10.9

-53

-38.3

-59.1

Total equity and liabilities

88.1

77.3

94

92.6

83.5

Key statistics

 

 

 

 

 

Earnings per ordinary share –Basic

38.7p

29.8p

32.5p

30.1p

4.2p

                                    -Diluted

37.6p

29.0p

31.9p

29.6p

4.1p

Dividend per ordinary share

8.0p

10.0p

15.0p

17.0p

20.0p

           

CONSOLIDATED BALANCE SHEET

Balance Sheet

31-Dec-14 

31-Dec-15 

31-Dec-16 

31-Dec-17 

31-Dec-18 

( £ m )

( £ m )

( £ m )

( £ m )

( £ m )

Assets

         

Non-Current Assets

         

Property, Plant & Equipment 

8.8

7.5

7.3

8.6

9.8

Intangible Assets 

9.5

4.5

2.7

2.6

1.9

Investment Properties 

n/a

n/a

n/a

n/a

n/a

Investments 

1.2

0.7

0.8

1.4

0.7

Other Financial Assets 

n/a

n/a

n/a

n/a

n/a

Other Non-Current Assets 

0

0

0

0

0

 

26.9

22.3

38.4

39.2

40.1

Current Assets

         

Inventories 

18.3

19.2

19.5

20.6

14.4

Trade & Other Receivables 

23.1

22.1

22.8

26.7

20.7

Cash at Bank & in Hand 

19.8

13.7

13.3

6.1

6.3

Current Asset Investments 

n/a

n/a

n/a

n/a

n/a

Other Current Assets 

0

0

0

0

0

 

61.2

55

55.6

53.4

43.4

Total Assets 

88.1

77.3

94

92.6

83.5

Liabilities

         

Current Liabilities

         

Borrowings 

n/a

n/a

n/a

n/a

n/a

Other Current Liabilities 

4.6

3.6

14.1

14.3

5.6

 

19.7

18.6

18.1

18.6

21.5

Net Current Assets 

41.5

36.4

37.5

34.8

21.9

Non-Current Liabilities

         

Borrowings 

49.2

39.4

39.7

41.6

42.6

Provisions 

n/a

n/a

n/a

n/a

n/a

Other Non-Current Liabilities 

0.8

0.6

0.4

0.1

0

 

64.9

47.8

128.9

112.3

121.1

Other Liabilities 

n/a

n/a

n/a

n/a

n/a

Total Liabilities 

84.6

66.4

147

130.9

142.6

Net Assets 

3.5

10.9

-53

-38.3

-59.1

Capital & Reserves

         

Share Capital 

19.6

19.6

19.8

19.7

19.6

Share Premium Account 

101.8

101.8

101.9

101.9

101.9

Other Reserves 

n/a

n/a

n/a

n/a

n/a

Retained Earnings 

-291.9

-284.8

-348.5

-334.1

-355

Shareholders Funds 

3.5

10.9

-53

-38.3

-59.1

Minority Interests/Other Equity 

n/a

n/a

n/a

n/a

n/a

Total Equity *  

3.5

10.9

-53

-38.3

-59.1

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