Comparability of Accor and NH Hotels Financial Statements:

As of 2005, both Accor and NH Hotels adopted the International Financial Reporting Standards (IFRS) in to prepare their annual financial statements. The IFRS was developed by the International Accounting Standards Board (IASB) with the intention of aiding comparability of financial statements to meet the demands of increased globalization and cross border investments among other things[1]. The standards have been successfully implied by “more than 8000 listed companies in the EU in a timely fashion and it is in the process of replacing US GAAP in the United States.

However, even with the perceived success of IFRS implementation, there is still concern that companies will struggle to achieve 100% compliance for various reasons. In the case of Accor and NH Hotels, which mirrors the case of many other companies, the issue has mainly been around disclosure and measurement as opposed to how information is presented. Consequently, these concerns extend to the belief that the very purpose of IFRS was not being served, i.e. consistency and comparability.

Looking at the Income statements of both companies for instance, it is difficult to compare the revenues. While Accor clearly stated its revenues and cost of sales figures separately, NH Hotels just had a Net Revenue figure and does not clearly state cost of sales figures. It is then left to interpretation what the net revenue consisted of. The Raw Materials and Consumables may represent the cost of sales figure but with no notes to explain what Net Revenue entailed, it is difficult for someone who is not confident in accounting or financial statement interpretation to determine what the gross profit for NH Hotels is for example. It follows that to the untrained eye, it is difficult to determine what the administrative costs are. Although gross profit is not clearly shown in Accor's Income Statement, it is easier to calculate it by subtracting cost of goods sold from revenue. It would aid comparison if the Revenue Cost of Goods sold and gross margins were clearly showed as well as the administrative expenses.

Accor in preparing their accounts “decided not to:

· restate business combinations that occurred before January 1

· transfer cumulative translation differences at 1 January to retained earnings

· designate at the date of transition to IFRS a financial instrument as a financial asset or financial liability at fair value through profit or loss or as available for sale

· Measure property plant and equipment and intangible assets at fair value at the transition data and use of that fair value as deemed cost

· Apply IFRS2 Share based Payment to equity instruments granted on or before November 7 2002”.

On the other hand NH Hotels declared that they had complied fully with IFRS while noting a few exemptions:

· “Business combinations - IFRS shall not apply retrospectively to any business combinations that took place prior to the change over date

· The Group has decided on the date of changeover to IFRS to state part of its tangible fixed assets at fair value deemed this value to be the market cost attributed on said date in accordance with IFRS1 based on the assessment made by independent experts

· The balance of translation differences at 1 January 2004 has been cancelled. This cancellation has been recorded as a reduction in the value of the reserves of the consolidated companies where said differences originated”.

It is clear that these differences in accounting treatment has been encouraged by IFRS exemptions, which both companies seem to have exploited for their benefit. It would aid comparison, if for example, NH Hotels had treated translation differences the same as Accor or vice versa.

Comparing Price Earnings and Market-to-Book Ratios of Accor and NH Hotels:

Price earnings ratio “can be seen as the number of years that it would take, at the current share price and rate of earnings, for the earnings from the share to cover the price of the share”. The Price Earnings (P/E) ratio is considered a very important way of assessing share performance of companies. Effectively, a high P/E ratio indicates that investors are confident of “higher earnings growth in the future compared to companies with a lower P/E”. By comparing the P/E ratios of Accor and NH Hotels, one can see how much investors are willing to pay for €1 of current earnings. The ratio calculation is current market price per share divided by earnings per share.

On the other hand, the market-to-book ratio is a “ratio used to find the value of a company by comparing the book value of a firm to its market value. Book value is calculated by looking at the firm's historical cost or accounting value” or the per share values. In this instance, the market-to-book ratio has been calculated as share price/net book value per share.

The ratios are as follows:

Ratio

Accor

NH Hotels

NBV per share

20.02

6.46

Earnings per share

1.55

0.46

Share Price

46.46

9.76

P/E Ratio

29.97

21.22

Market-to-Book-Ratio

2.32

1.51

Table 1: P/E and Market-to-book ratios

From the table and analyzing the P/E Ratios, it is clear that investors will be willing to pay more for Accor for €1 of current earnings, (i.e. €29.97 compared to €21.22 for NH Hotels). As aforementioned, this indicates that investors are more confident of future higher growth in earnings for Accor than NH Hotels. Investors must be cautioned that relying solely on P/E Ratios to make investment decisions is not a wise idea. The problem is that the way earnings per share the companies may be different. Earnings per share are open to manipulation to ensure preparers of financial information present the company's financial position and performance in as favorable a light as possible. “Although IAS seeks to promote the extent to which financial statements are prepared on a consistent basis from one business to another, there are still areas where one business may legitimately deal with the same transaction or event differently from another”.

The main problem in earnings per share distortions is how costs are matched against revenues. “The costs are normally not expressed in the same terms as the revenues where there are changing prices (historic cost and stable monetary unit conventions). Since the costs tend to be incurred before the revenues are recognized, during a period of price inflation there is a tendency for costs to be understated, causing profit to be understated”.

In the case of market-to-book ratios, these are calculated in order to determine which stocks are overvalued and which are undervalued. Where the market-to-book ratio is greater than 1, a stock is said to be overvalued. It is undervalued when the market-to-book ratio is less than 1. From Table 1 above, it appears that both Accor (2.32:1) and NH Hotels (1.51:1). One of the problems with the market-to-book ratio is that does not factor in intangible assets like brand value and intellectual property, which may contribute significantly to the assets of companies of certain industries. The hotel industry appear to be one of them, consequently, this measure may be inappropriate. Furthermore, other balance problems may make using this ratio to compare stock unwise. In reality, it may be that both stocks are undervalued if it transpires that the book values are higher than they should be. For example, “adherence to the historic cost, prudence, going concern and stable monetary unit conventions, coupled with the use of a fairly restricted accounting definition of an asset tends to cause financial statements to understate the amount of wealth that is invested in the business”.

Consequently, comparisons are difficult. Ratios are not there to provide the solutions but to ask questions. For instance, where an investor finds that both stocks appear overvalued based on ratio calculations, instead of deciding against investing in either, he could instead carry out further investigation to either prove or disprove the findings.

Determine credit rating for NH Hotels and compare with Accor's rating:

Bond ratings “rate the company's ability and willingness to repay their debt and they're used by financial institutions and private investors to determine which bonds to buy and which ones to sell. Higher ratings are important since they translate into more security for investors and lower interest costs for bond issuers”.

Two of the world's top credit rating agencies, Fitch and Standard and Poor's rated Accor BBB, according to The Free Dictionary are “a medium grade assigned to a debt obligation by a rating agency to indicate an adequate ability to pay interest and repay principal. However, adverse developments are more likely to impair this ability than would be the case for bonds rated A and above. A BBB rating is the lowest rating a bond can have and still be considered investment grade”. Unfortunately, due to the small size of NH Hotels public debt they were not issued a rating by one of the credit rating agencies.

Therefore, to provide an analysis and subsequently determine a rating for NH Hotels, a quantitative analysis for Accor's competitor will be carried out to establish whether “they will have sufficient cash flow in the future to pay the interest and repay the principal on its bonds, and to determine how much financial cushion the company will have in order to accomplish that”. The rationale to be used to determine the rating from a quantitative perspective will be:

  1. How much gearing (borrowing as a proportion of equity) is in NH Hotels' business
  2. How effectively they can meet their interest payments as they fall due (times interest covered)
  3. Ability to meet short term obligations as they fall due (liquidity)

A comparative analysis with Acorn will be performed and depending on the results when compared with Acorn, a rating will be established. When the results are similar, the same rating will be applied. If the results are in favor of NH Hotels potentially the rating could be higher although this is by no means certain. Similarly, where the results are worse than Accor's, the rating might be lower. Again, this is by no means certain.

Table 2 shows the Capital and Liquidity ratios for Accor and NH Hotels.

NH Hotels

Accor

Ratios

2005

2004

2005

2004

Debt to Equity Ratio

0.66:1

0.67:1

0.42:1

1.1:1

Times Interest Covered

3.18 times

3.16 times

5.3 times

5.0 times

Current Ratio

0.74:1

1.04:1

0.79:1

0.98:1

Acid Test Ratio

0.51:1

0.75:1

0.78:1

0.96:1

Figure 2: Capital Gearing and Liquidity Ratios

Debt to Equity Ratio:

The Debt to Equity Ratio is “a measure of a company's financial leverage. It indicates what proportion of equity and debt the company is using to finance its assets”. The higher the debt to equity ratio, the more a company's growth has been financed by debt as opposed to equity. In this scenario, the company is said to be highly geared. High gearing can put a business at risk as interest payments are due irrespective of financial performance. In the case of equity being predominantly used to finance a business, where it transpires that a business underperforms or operates at a loss, the equity holders (or owners of the business) would be happier to defer dividend payments due them. From the table above, the proportion of debt used to finance NH Hotels was higher than the proportion for Accor in 2005. Strikingly, Accor had reduced its level of gearing significantly from a very dangerous 1.1:1 in 2004 to 0.42:1. While NH Hotels remained fairly constant at just over 0.65:1, it is evident that its scope for safe additional borrowing is significantly less than Accor's.

The Times Interest covered ratio “looks at how many times the interest could be met from the profits. It is therefore some measure of how easily the business is able to cover its interest payment obligations out of its profits”_ftn18">.

This ratio is calculated as:

profit before interest and taxinterest

As for the Debt to equity ratio, the Times Interest covered remained relatively constant between 3.16 times in 2004 and 3.18 times in 2005. Accor's figures revealed that they as a business were in a better position to meet interest payments from profits, recording 4.97 times in 2004 and an improved 5.31 times in 2005.

The figures above reveal that although NH Hotels have very little bond commitments, they however, are relatively under more long term debt pressures than Accor. Although normally alarm bells should start ringing when debt to equity ratio approaches and exceeds 0.8:1, for NH Hotels to increase its creditworthiness, it may be advise to release the debt burden, just like Accor. Both companies seem to be in a good position to repay interest on long term debt. However, Accor also outperforms NH Hotels here.

From a liquidity perspective both the current and acid test ratios indicate that NH Hotels are faring worse than Accor in managing their working capital. The current ratio explains the ability of using current assets to meet current liabilities obligations. Normally, companies aim for greater than a ratio of 1:1. NH Hotels achieved this in 2004 however; they have slipped down to 0.74:1. This compared less favorably with Accor's 0.79:1 even though the latter also experienced a worsening position from 2004. Even more seriously, is when the acid test ratio is looked at. The acid test ratio measures the ability of the more liquid assets to pay of credit liabilities, therefore inventory an asset which usually takes a while to convert to cash relevant to other assets like debtors and stocks, is omitted. While Accor's liquidity remained fairly constant looking at both ratios (due to small inventory), NH Hotels' significantly worsened to the point where in 2005, current liabilities where nearly twice as much as current assets, when the reverse is usually suggested.

Consequently, based on this analysis and the apparently inferior debt analysis to Accor's, NH Hotels should be given a rating of BB+ (i.e. below investment grade). A BB+ grade implies that there is high risk involved and that the chances of repayment are moderate. This is because it appears from the analysis above that NH Hotels is more likely to default on its commitments than Accor. While Accor is indicating an improved position, NH Hotels' position seems to be deteriorating.

Source: Essay UK - http://turkiyegoz.com/free-essays/finance/company-valuation-and-performance.php


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