Overview and Analysis of Ahc Limited Finance Essay

Financing Proposed : The purpose of this written lending submission is to explore the possibility of lending $5 million to AHC Limited Purpose : Funding in the construction of new office buildings in the area of Northern New South Wales

Business Description and History

AHC Limited (AHC) is a property development company based in Queensland. The company's business operations include incorporating contract residential and commercial building, property development for long-term asset portfolio creation and subdivision of land for residential and industrial development. AHC was listed on the Australian Stock Exchange on 24th of March 1988. The business operation is split in two divisions: commercial and housing divisions. Both businesses were operational in the geographic area between Hervey Bay, Queensland to Ballina in Northern New South Wales. Within the commercial segment, the offerings of the company's consist of Worongary Town Center and Saltwater Estate. In addition, a medical center was completed with doctor, dentist and physiotherapy open at the end of the fiscal year June 30, 2007. Besides that, AHC commercial division specializes in the construction of service stations, shopping centers, factories, show rooms as well as low-rise office buildings. On the other hand, within the housing segment of AHC, AHC Homes have been engaged in the development of new homes for Queensland and Northern NSW families. AHC Homes have earned enviable reputation for stylish design and value for money and have been known as one of the innovators in the quality new home market. AHC display homes are located at Sea Breeze Estate, Pottsville and Regatta Waters Oxenford and Halpine Lake Mango Hill.

Current Borrowings

The company currently holds bank overdraft amounting to $25,748. This overdraft is secured by a floating charge over the Company assets. Besides that, the bank bills are secured by first mortgages over certain freehold land, buildings and work in progress. National Australia Bank has a registered fixed and floating charge over the assets of the Company including: Registered mortgage over property situate 7 South Quay Drive, Biggera Waters Qld 4216 Registered Mortgage Debenture over the whole of AHC Ltd assets including goodwill and uncalled capital and called but unpaid capital together with relative insurance policy assigned to the National Australia Bank Limited Registered Mortgage over property situate Worongary Village Shopping Centre 1 Mudgeeraba Road Worongary Qld more particularly described in Certificate of Title Reference 50310789. Registered Mortgage over property situate Caltex Service Station 2 Helensvale Drive Helensvale more particularly described in Certificate of Title Reference 50366042. Registered mortgage over property situate 9 South Quay Drive, Biggera Waters Qld 4216 Registered mortgage over property situate Cnr Ramsay & Woolgar Roads, Gympie, Qld. The bank bills amounting to $18,432,718 are rolled over monthly and a variable rate of interest is payable on roll over. Specific to the development of the company's non-current asset Worongary Village Shopping Centre, The bill arrangement was originally established in 2003. As such, these bills are classified as non-current debt even though the company does not have an unconditional right to defer settlement for at least twelve months after reporting date. The amount of Current Secured Loan totaling $4,278,352 with Suncorp Metway Ltd is secured by a registered mortgage over property situated at Lots 400, 502 & 2 on SP 213534 Siganto Drive, Helensvale. It is noted that the company also has a bank guarantee facility in place with National Australia Bank amounting to $250,000.

Industry Analysis

Property Industry Outlook: AHC Limited is categorized as part of the property development industry with the company operations divided into 2 divisions: Housing property and commercial property. With the recent global economy downturn due to the US sub prime mortgage crisis, Australia was the only G20 member that did not fall into a recession in 2009 (Westpac 2010). However, the effects of the downturn negatively affected the property market. According to Westpac's outlook on the property market for the next three years, as the price increased in the residential sector in the beginning of 2009 and there are signs that commercial property have begun to recover, the outlook for the next three years would be continued growth (Westpac 2010). The challenge remains however for the property market to grow in a period when the stimulus package is removed (Westpac 2010).

Residential Property

According to Westpac's outlook, expectations for 2010 are for demand to remain healthy in the residential property market as job growth surges over the next few years in respond to the recovery of the economy (Westpac 2010). Interest rates are also expected to increase to ensure the property market will not be overheated. Even though the stimulus is being removed through the forecast period of 2010-2012, the recovery of the economy should stimulate demand in the property market as price stabilizes in 2010 due to expected rise in interest rates (Westpac 2010). These indications of probable signs of growth will bring positive impact on AHC Limited Housing Division's financial position as there will be more opportunities in the future. This might assist to improve AHC Limited's cash flow to service and repay the $5 million loan proposed.

Office Property

As supply remained low and demands are expected to improve, the office market is near its peak in most markets over Australia, this is especially true in New South Wales (Westpac 2010). It is also stated in Westpac's outlook that while most markets have peaked, recovery of rents or values is not anticipated until later in the year of 2011 (Westpac 2010). As the proposal of lending $5 million to construct new office buildings in a fast growing area of Northern New South Wales is currently being considered, the future outlook looks well for AHC Limited. As supply of office buildings is currently low where market has peaked, it would be a good opportunity for AHC Limited to use the funds to construct these office buildings to take advantage of the expected outlook. As such, it would be reasonable to say that the funds lent to AHC Limited suits the purpose of the loan, as supply remains low and economy rising, the New South Wales market is expected to improve in future. The commercial property markets are also said to be entering the recovery phase of the investment cycle (Property Council 2010). As total returns recorded for Australia's commercial property market has improved at the end of December 2009, the results indicates improvement for the markets and signifies the commercial property market recovering from a trough in the property investment cycle in mid 2009 (Property Council 2010). As such, it is safe to say that AHC Limited's decision to use the funds to invest in office buildings has a positive outlook and it is unlikely that the company would default on the loan. Another similar article by Lynne Blundell (2010) stated that Australia's office market has retained their shine in comparison to other countries around the globe after the global financial crisis. Even though Australia withstood the global economic downturn better than most countries, the country still experienced a decline in office demands and rising vacancies in 2009 (Lynne Blundell 2010). However, recent fall in national unemployment and rising rental incentives offered by landlords would indicate an intense competition for office blocks in 2010 (Lynne Blundell 2010).

Risk factors in Property Development Industry

Pre-construction Risk

A study conducted by Newell and Steglick (2006) shows that overall respondents in the study think that this phase of property development has the highest overall risk due to uncertainty in pre-construction phase and other factors being out of developer's control. The study also shows that Environmental risk which scored the highest among the risk ratings is seen as the highest risk factor in this phase of property development (Newell and Steglick 2006). There are other risk factors which include risk in terms of approval, title, political, feasibility and infrastructure in the pre-construction phase (Newell and Steglick 2006). In mitigating such risks, various strategies can be employed by AHC Limited such as analyzing cost impacts before committing to address environmental risk; purchase conditional on rezoning, confirm pre-DA if extra approvals are needed to address approval risk; evaluate land deficiency into land price to address market risk; and dealing only with experienced builders and developers to avoid experience risk (Newell and Steglick 2006). Such strategies would assist in reducing the risk involved when making decisions in the pre-construction phase.

Contract Negotiation Risk

The contract negotiation phase of property development is seen as the second highest overall risk in the study conducted by Newell and Steglick (2006). In this phase, it is found that land cost and acquisition terms are significant risk factors to manage in the contract negotiation phase (Newell and Steglick 2006). To address the land cost risk involved, proper price negotiation is done to provide adequate contingencies. AHC Limited can also negotiate adjustment mechanisms for price and conditions to minimize acquisition term risks (Newell and Steglick 2006). By carefully mitigating those risks, property developers will gain a fair and flexible contract terms as well as allowing for reasonable profit margin.

Construction Risk

In this phase of property development, there are three specific risk factors seen to be important in the overall development process: time delay risk, cost increase risk and engineering risk (Newell and Steglick 2006). In order to overcome time delay risk, property developers usually take steps in ensuring there is adequate insurance cover (Newell and Steglick 2006). Besides that, developers also usually penalize builders for any delay in the construction to avoid any time delay costs as delay of construction would lead to a breach of terms of construction contract and would cost the company (Newell and Steglick 2006). Cost increase risk on the other hand is usually overcome by negotiating fixed price building contract in order to avoid any sudden cost increase (Newell and Steglick 2006).

Financial Analysis

 Ratios Analysis

Table 4.1: Current Ratio Calculation 2007 2008 2009 Current Ratio = 2.27:1 = 1.97:1 = 2.39:1 The current ratio is categorised under liquidity ratio. Liquidity ratio is compute to determine whether the business has the ability to meet its short-term financial obligations (Sathye et al. 2003). The ideal ratio for the current ratio is 2 but there a fluctuation between 1.5 and 2 is still acceptable (Clemens & Dyer 1986 cited in Sathye et al. 2003). From the table above, we can see that the current ratio for AHC Limited have an almost ideal ratio according to the benchmark. These ratios mean that AHC Limited has been utilising their current assets for profitable use. These ratios also show that AHC Limited do not have a high amount of debtors.

Debt-to-Equity Ratio

Table 4.2: Debt-to-Equity Ratio Calculation 2007 2008 2009 Debt-Equity Ratio = 1.06:1 = 1.23:1 = 1.13:1 The debt-to-equity ratio is categorised under the leverage ratios. Leverage ratios are used to judge the proportions and manageability of debt carried by a firm (Sathye et al. 2003). The debt-to-equity ratio specifically shows the proportion of amount borrowed by a firm compared with the proprietor's investment in the firm (Sathye et al. 2003). The generally accepted benchmark for this ratio is that it should not exceed 2. Based on the debt-to-equity ratio for the 3 years, the proprietor's stake in AHC Limited has not fluctuated much. The proprietor's stake in AHC Limited has remained an average of 47%. Thus, creditors enjoy a higher level of protection due to the fact that the proprietor's stake in AHC Limited is large.

Inventory Turnover Ratio

Table 4.3: Inventory Turnover Ratio Calculation 2007 2008 2009 Inventory Turnover Ratio = 0.68:1 = 1.14:1 = 1.05:1 The inventory turnover ratio is categorised under the efficiency ratios. Efficiency ratios are used to measure how efficiently the firm utilise its assets (Sathye et al. 2003). The inventory turnover ratio reflects the efficiency of the firm in management of inventory (Sathye et al. 2003). The inventory turnover ratio for AHC Limited is relatively low. Although a high inventory turnover ratio indicates a fast moving inventory. However, this does not necessarily apply in this case. AHC Limited operates its business in the real estate industry. Their inventory consists of residential, commercial and industrial buildings developments (AHC 2010).

Net Profit-Sales Ratio

Table 4.4: Net Profit-Sales Ratio Calculation 2007 2008 2009 Net Profit-Sales Ratio = 84.04% = 11.44% = 7.25% The net profit-sales ratio is categorised under the profitability ratios. The profitability ratios are used to measures the profitability of sales generated through operations (Sathye et al. 2003). Net profit-sales ratio specifically measures the profitability of the firm when all the costs, including administrative costs are taken into account (Sathye et al. 2003). There is no specific benchmark for this net profit-sales ratio. However, the higher the ratio, the better it is. We can see from the table above that the net profit-sales ratio has been decreasing in the last 3 years. This indicates that the profit for AHC Limited has been decreasing even though sales have been increasing at the same time.

Conclusion

AHC Limited is a company that suffered high losses at the year ended 2008 due to the global financial crisis which heavily affected Australia's property market as a result of job losses and fall in demand for housing and commercial properties. Therefore, currently the company is not in its past health and financial position as it was before. This is due to the financial crisis which caused the statement of financial position of the company to shrink greatly as it absorbed heavy losses. The financial health position of the company appears to be relatively good compared with industry benchmark in terms of current ratio and debt to equity ratio. However, it is noted that the company is not doing well in terms of profitability ratio as the Net profits to sales ratio fell from 84% to 7.25% at the year ended 2009 from 2007. This might indicate AHC poor ability to generate profit as their total profit plunged from $7 million to $1.9 million. This will affect AHC's capacity to service and repay the $5 million credit facility. At the moment, it can be concluded that AHC Limited would not be suitable as a lending proposition. Even though the outlooks on the property seems to be positive and there will be growth in the industry in near future, it is not evident that AHC Limited would be able to generate necessary cash flows to service and repay the $5 million credit facility. It is also probable that other strong competitors within the industry would cause setbacks for AHC Limited within the loan period, which would lead to risks that AHC defaulting on the loan. As such, it is recommended that we do not consider the possibility of lending to AHC $5 million for working capital.

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