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Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin

Institute of Business Administration, Karachi

Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin
Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin

Service Industries Limited

Corporate Finance Report

Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin
Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin
Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin
Institute of Business Administration, Karachi Service Industries Limited Corporate Finance Report Prepared by: Saif Ali Momin
Prepared by: Saif Ali Momin Muhammad Rehan Fahad Iqtidar Abdul Moiz Iqbal – 08003 – 06740
Prepared by:
Saif Ali Momin
Muhammad Rehan
Fahad Iqtidar
Abdul Moiz Iqbal
08003
06740
07869
08015

Service Industries Limited

Contents

  • 1 Introduction to Service Industries Limited

2

  • 2 Corporate Governance Analysis ....................................................................................

3

  • 3 Shareholders Analysis

...................................................................................................

4

  • 4 Company Risk Profile and Returns

..............................................................................

7

  • 5 Capital Structure Choices and Optimal Capital Structure

8

  • 6 Dividend Policy

10

Appendix A

12

Appendix B

13

Appendix C

14

Appendix D

17

Appendix E

18

Appendix F

19

Appendix G

21

Appendix

H .....................................................................................................................

23

References

24

1

Service Industries Limited

  • 1 Introduction to Service Industries Limited

‘Servis’ story begins with a group of friends from college-who established Service Industries in 1953, the Company went public in 1959. Ch. Nazar Muhammad (Late), Ch. Muhammad Hussain (Late) - both from Gujrat district and Ch. Muhammad Saeed (Late) from Gujranwala District, started business in 1941 on a small scale in Lahore.

Company started with only manufacturing handbags and some other sports goods. Within years their business flourished remarkably and they were supplying their products to every corner of India at the time of Partition. In 1954, shoe manufacturing plant was installed at industrial area in Gulberg, Lahore. Later management shifted the factory from Lahore to Gujrat.

SIL has annual revenues of about PKR 15 billion and is the largest manufacturer of footwear, tyres & tubes for two-wheelers, and has been the largest footwear exporter of the country for the last 10 years. The company employs more than 8,600 people in its facilities located in Gujrat and Muridke and exports its products in many destinations around the world.

The production side of the company today is restructured into Service Industries Limited (SIL) which has world-class shoes, tyres, tubes and rubber production facilities in Gujrat and Muridke.

Retail side of the company, Service Sales Corporation (Pvt.) Ltd. (SSC) is a leading shoes retailer in Pakistan with more than 450 retail outlets and roughly 2500 independent dealers. However in 2011, SSC became an independent group after the restructuring of the Servis Group.

Footwear

Servis cater to the daily footwear needs of all the members of the family. With its multi-brand approach, constant innovation in design and up-to-date style trends, Servis has products for all age groups and personal tastes. Though Servis is a leader in footwear industry in Pakistan with a market share of 7% but informal shoes Servis is lagging behind Bata. In past, Servis has more focus on sports and casual footwear.

Annual revenues of footwear division exceed USD 83 Million of which 45% come from exports majorly to EU countries Germany, France & Italy. In house manufacturing covers all aspects of shoe manufacturing value chain from model designing, cutting, stitching to lasting (injection) & finishing and downstream activities such as marketing. Present capacity is more than 40,000 pairs of shoes every day.

Major competitors of Servis Shoe business in Pakistan are:

Hush Puppies

2

Service Industries Limited

Bata

Stylo

Borjan

Tyre

Service Industries Ltd entered into tyre & tube business in 1970 with specialized in tyres & tubes for Motorcycle and Bicycle of different kinds. Manufacturing of motorcycle tyres & tubes was started in 1990. SIL is major supplier of tyres & tubes to Japanese motorcycles manufacturers like HONDA, YAMAHA and other local motorcycle assemblers in Pakistan.

Major competitors of SIL in motorcycle tyre business in Pakistan are:

General Tyres and Rubber Company of Pakistan Limited

Panther Tyres

Diamond Tyres Ltd.

  • 2 Corporate Governance Analysis Service Group started with group of friends and it is majorly owned and managed currently by the succeeding family members of the founders of Service Group. Directors hold major shareholding of more than 40% in SIL (see Appendix B). Among board of directors the chairman and executive directors are inheritor of the SIL founders and seems to play active role in running day to day management of the company (see Appendix A). This shows that there is not a huge separation in management and ownership of the company. However, there seems no doubt about the capability of the executive directors as per their education, however their positions in other companies as director may create some problems. But as far as the authority of CEO over board is concerned, this may not be the case here as other board members are also equally part of the ownership in business. So, CEO is generally picked by the Board of Directors. Under Code of Corporate Governance the company seems to fully comply with its requirements, e.g. nomination of at-least one Independent Director which was made necessary in CCG 2012. Financial reporting is as per the standard prescribed. Directors are not part of more than 7 listed company boards. Formation and structure of Audit Committee, HR committee etc. is also as per the code. Service Group ensures that any material / price sensitive information is disseminated among all market participants at once through the stock exchanges. Financial Reports are duly published on the website as well.

3

Service Industries Limited

Service Industries Limited strives to be a good corporate. Corporate Social Responsibility (CSR) of SIL is classified into the following categories;

Corporate Philanthropy Health Care facilities to communities where they operate Housing facility aims to provide shelter to the homeless senior citizens Schools

o

o

o

Community Investment SIL also donates to other organizations, entities and NGOs

o

Other areas environmental protection, industrial relation etc.

  • 3 Shareholders Analysis Major shareholders of SIL comprise of family of the founding members who also belong to Board of Directors with 44.72% shareholding as discussed earlier. We may expect very little buying or selling of shares in this part of directors. Other portion of institutional shareholders comprise of NIT, Insurance Companies, Banks, Mutual Funds which comprise of 25.95% shareholding and around 22.81% belongs to public.

44.72% 18.43% 4.82% 0.07% 7.44% 22.81% 1.69% 0.01%
44.72%
18.43%
4.82%
0.07%
7.44%
22.81%
1.69%
0.01%
  • NIT and ICP

  • Insurance Companies

  • Associated Companies, Undertakings and Related Parties

  • Others

  • Banks, Development Financial Institutions, Non Banking Financial Institutions

  • Modarbas and Mutual Funds

  • General Public

  • Directors, Chief Executive Officer, and their spouses and minor children

Figure 1: Shareholders breakup by categories

4

Service Industries Limited

14 12 10 8 6 4 2 0 Millions 2014 2013 2012 2011
14
12
10
8
6
4
2
0
Millions
2014
2013
2012
2011
  • Directors, Chief Executive Officer, and their spouses and minor children

  • General Public

  • Modarbas and Mutual Funds

  • Banks, Development Financial Institutions, Non Banking Financial Institutions

  • Others

  • Associated Companies, Undertakings and Related Parties

  • Insurance Companies

  • NIT and ICP

Figure 2: Shareholding pattern by category

5

Service Industries Limited

14 12 10 8 6 4 2 0 Millions 2014 2013 2012
14
12
10
8
6
4
2
0
Millions
2014
2013
2012
  • Remaining with less than 5%

  • National Bank Of Pakistan

  • CDC- Trustee National Investment (Unit) Trust

  • Mrs. Shahida Naeem

  • Mr. Omar Saeed

  • Mr. Hassan Javed

  • Mr. Arif Saeed

  • Chaudhary Ahmed Javed

  • Ch. Ahmed Saeed

Figure 3: Shareholders with more than 5% voting rights

Moreover, if we see the trend of number of shareholders for past three years in Appendix B, we do not see any drastic changes in the number of shareholders in each category except in:

Associated Companies, Undertakings and Related Parties

Modarbas and Mutual Funds

This is also evident from the volume traded in Karachi Stock Exchange is very low for SIL. So major trading that occur is in general public, insurance companies and some financial institutions category. We also observe some trading of shares by directors in the financial reports but that is very limited. An interesting observation from the trading in shares by Executive Directors follow same pattern. The three executive directors and the chairman sell or buy shares in equal quantity as observed through financial reports.

6

Service Industries Limited

The marginal investors in the SIL is little complicated to identify as the firm has significant institutional holdings and large insider holdings. In such scenarios most of the time the large insider is the founder or original owner for the firm, and often, this investor continues to be involved in the top management of firm as the case of SIL. However, from the pattern discussed earlier, here may be Modarbas and Mutual Funds and some financial institutions trade on stock on regular basis and can be marginal investors. Trading in other categories of shareholders seems very limited. It must be noted here that insiders also trade occasionally in the stocks of SIL, so the the leading stockholder will influence the final decision.

  • 4 Company Risk Profile and Returns SIL activities expose to a variety of financial risks: credit risk, liquidity risk and market risk (including currency risk, other price risk and interest rate risk). Overall risk based on regression of KSE100 index and SIL stock monthly returns turns out to be 0.5918 with standard error of 33.57%. With 95% confidence we can say that the risk ranges between -0.0801 to 1.2638; and with 68% confidence level risk ranges within 0.2551 to 0.9286 (refer Appendix C). In general global shoe companies beta averages about 0.96 (Damodaran, 2016). Low SIL beta might be due to diversification of SIL business into tyre manufacturing. Risk profile changes at various level of Capital Structure remain under 1 up to 60% debt level (see Appendix G). However, company still has too much debt above its optimum level which we would discuss later.

The R squared of the regression provides an estimate of the proportion of the risk (variance)
The R squared of the regression provides an estimate of the proportion of the risk (variance) of a firm
that can be attributed to market risk. In case of SIL market specific risk is about 5.09%, while the
94.91% is attributed to firm specific risk which is a very high number and must be diversified.
4
Levered Beta
3.5
3
2.5
2
1.5
1
0.5
0
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Debt Ratio
Debt Ratio

Figure 4: Risk Profile at different debt ratios

7

Service Industries Limited

During the analysis period of 2010 2014, the expected return would be 19.08% per annum for investing in SIL stocks (see Appendix C). The company outperformed the market by 17.54% annually.

The cost of equity for the firm based on market value is about 19.08%, whereas the cost of debt after tax is 9.02%. With debt to equity ratio of 0.2882 (28.82%) based on market value of debt and equity the cost of capital for SIL is 16.83%. This may be taken as a hurdle rate when company invest in various projects with new or innovative product range selection to maximize the firm value.

  • 5 Capital Structure Choices and Optimal Capital Structure In book value terms the capital structure of SIL is at Debt Ratio of 50%, however for more realistic measure of SIL capital structure we calculated market value of existing SIL debt and current equity market value which arrived at the debt ratio of 22.38% (see Appendix G). Company uses long term and short term debt and retain earnings for its financing while maintaining healthier capital ratios in order to support its business and maximize shareholders’ value. To maintain or adjust the capital structure, the Company also adjust dividend payments to the shareholders, return on capital to shareholders or issue new shares. The Company’s strategy is to maintain optimal capital structure in order to minimize cost of capital. SIL has optimum debt ratio of 20% which much near to its current debt ratio as per our calculation (see Appendix G). Company tries to get the maximum advantage of tax benefit from keeping debt at optimum level. However, company may lose its flexibility in business with increase of debt. In general global average of shoe companies have debt ratio of about 9% (Damodaran). Such companies retain their profits to allow flexibility during any unforeseen situations or financial crisis.

Debt to

Debt to

Cost of

After Tax

Cost of

Firm Value

Capital

Equity

Equity

Cost of Debt

Capital

0%

0.00%

17.43%

6.64%

17.43%

71,395,086.14

10%

11.11%

18.06%

6.98%

16.95%

73,813,395.42

20%

25.00%

18.86%

8.34%

16.75%

74,890,298.41

30%

42.86%

19.88%

10.55%

17.08%

73,154,479.83

40%

66.67%

21.24%

11.23%

17.24%

72,351,085.43

50%

100.00%

23.15%

12.25%

17.70%

70,075,267.98

60%

150.00%

26.01%

14.29%

18.98%

64,468,379.83

70%

233.33%

30.78%

14.29%

19.24%

63,442,520.92

80%

400.00%

40.32%

15.08%

20.12%

60,146,378.06

90%

900.00%

68.94%

18.73%

23.75%

49,634,352.13

8

Service Industries Limited

Service Industries Limited Figure 5: Optimum Cost of Capital Furthermore, SIL stocks are not held by

Figure 5: Optimum Cost of Capital

Furthermore, SIL stocks are not held by huge number of individual investors and most of it is held by family members who actively participate in running day to day operations, so more debt will not add discipline to management.

Looking towards cost of capital schedule in figures below and detail values and calculation in Appendix G, SIL may keep its debt ratio in between 10% to 30% without increasing cost of capital not more than 1%. However current debt level of SIL at market value is PKR 3.05 billion which is PKR 0.324 billion above optimum cost of capital level at debt ratio of 20%. Moreover, less debt will allow flexibility to firm and minimal level of risk in bankruptcy cost due to its nature of business and products.

Service Industries Limited Figure 5: Optimum Cost of Capital Furthermore, SIL stocks are not held by

9

Service Industries Limited

Service Industries Limited Figure 6: Cost of Funding Profile 6 Dividend Policy Service Industries as a

Figure 6: Cost of Funding Profile

  • 6 Dividend Policy

Service Industries as a public listed company return its excess income to shareholders in the form of cash dividends half yearly and sometimes only annually. Dividends during past 10 years of SIL in figure below clearly shows that company tends to maintain or increase its dividends from previous years and tends to follow earnings pattern. However, the rate at which earnings are growing (trend of EPS), dividends are not growing (trend of dividends) with the same rate which illustrates that company retain a good portion of its earnings for new projects and for bad times. Moreover, we did not observe any stock buy back by the company from its retained earnings. While comparing dividend payouts with global shoe companies, average dividend payout for SIL from the graph mentioned below is around 38.69% and average of 88 global shoe companies dividend payout is around 43.36% (refer Damodaran 2016 data).

10

Service Industries Limited

2009 70 60 50 40 30 20 10 2006 2007 2008 80 2010 2011 2012 2013
2009
70
60
50
40
30
20
10
2006
2007
2008
80
2010
2011
2012
2013
2014
2015
EPS (Rs.)
Dividend
Linear (EPS (Rs.))
Linear (Dividend)
12.50
7.50
7.50
7.50
4.50
3.00
13.42
10.59
8.13
36.03
27.28
0
54.94
28.32
20.00
78.63
37.50
64.28
51.49
25.00
17.50
90

Figure 7: Payout ratio

During analysis period of 5 years SIL increased its reserves by PKR 1.264 billion which is 80% increased in comparision to reserves level of 2010. Keeping in view the SIL business where continious innovation and marketing is required it is necessary to retain earnings to cover for bad times and for new projects. However, surplus cash that exceeds the optimum capital ratio should be return to shareholders in the form of cash dividends. Reason for cash dividends against capital gain is due to the fact that the number of shareholders are limited and might not change very frequently, so they may be more interested in cash dividends rather than capital gain on the shares held to invest elsewhere.

2,000 Reserves 2011 2012 2010 2013 2014 Millions 1,000 1,500 2,327 2,500 3,000 2,844 500 -
2,000
Reserves
2011
2012
2010
2013
2014
Millions
1,000
1,500
2,327
2,500
3,000
2,844
500
-
1,580
1,900
1,893

Figure 7: Accumulated reserves

11

Service Industries Limited

Appendix A

 

Director Category

Shareholding in Servis

Board of Directors

Chaudhry Ahmed Javed (Chairman)

Non-Executive Director

2,009,936

16.7094%

Mr. Omar Saeed (Chief Executive)

Executive Director

995,896

8.2793%

Mr. M Ijaz Butt

Non-Executive Director

40,069

0.3331%

Shares held by family member ->

477,218

3.9673%

Mr. Arif Saeed

Executive Director

999,545

8.3096%

Shares held by family member ->

94,937

0.7892%

Mr. Hassan Javed

Executive Director

758,015

6.3017%

Mr. Riaz Ahmed

Independent Director

4,000

0.0333%

Mr. Shaukat Ellahi Shaikh

Non-Executive Director

Mr. Muhammad Amin

Non-Executive Director

Mr. Manzoor Ahmed (NIT Nominee)

Non-Executive Director

Advisor

Ch. Ahmad Saeed

610,460

5.0750%

Chief Financial Officer

Mr. Jawwad Faisal

Company Secretary

Mr. Waheed Ashraf

Audit Committee

Mr. Manzoor Ahmed (Chairman) (NIT Nominee)

Non-Executive Director

Mr. Riaz Ahmed (Member)

Independent Director

4,000

0.0333%

Mr. Muhammad Amin (Member)

Non-Executive Directors

Human Resource Committee

Mr. Riaz Ahmed (Chairman)

Independent Director

Mr. Arif Saeed

Executive Director

999,545

8.3096%

(Member)

94,937

0.7892%

Mr. Muhammad Amin (Member)

Non-Executive Director

Auditors

 

Legal Advisor

M/s. Bokhari Aziz & Karim 2-A, block-G, Gulberg-II, Lahore.

12

Service Industries Limited

Appendix B

   

2014

 

2013

 

2012

Categories of Shareholders

No. of

Shares

% of

No. of

 

Shares

% of

 

No. of

Shares

% of

ShHdr

Held

Total

ShHdr

Held

Total

ShHdr

Held

Total

NIT and ICP

 
  • 1 0.01%

900

 

1

 

900

0.01%

 

2

5,354

0.04%

Insurance Companies

 

8,554

  • 2 0.07%

 

1

 

4,354

0.04%

 

1

10,144

0.08%

Associated Companies, Undertakings and Related Parties

 
  • 3 4.82%

580,138

 

1

 

10,144

0.08%

 

2

44,214

0.37%

Others

 

203,483

  • 22 1.69%

 

8

 

659,117

5.48%

 

4

383,848

3.19%

Banks, Development Financial Institutions, Non Banking Financial Institutions

 

895,332

  • 22 7.44%

 

27

 

1,087,604

9.04%

 

27

1,781,033

14.81%

Modarbas and Mutual Funds

 
  • 11 18.43%

2,217,365

 

4

 

1,823,439

15.16%

 

5

1,836,539

15.27%

General Public

1,254

2,743,401

22.81%

1,288

 

2,971,615

24.70%

1,361

2,812,241

23.38%

Directors, Chief Executive Officer, and their spouses and minor children

8

5,379,616

44.72%

8

 

5,471,616

45.49%

 

8

5,155,416

42.86%

 
   

2014

 

2013

   

2012

 

Shareholders holding more than 5% voting rights

 

Shares

% of

Shares

 

% of

Shares

 

% of

Held

Total

Held

Total

 

Held

Total

Ch. Ahmed Saeed

 

610,460

5.07%

610,460

 

5.07%

 

610,460

 

5.07%

Chaudhary Ahmed Javed

 

2,009,936

16.71%

2,032,936

 

16.90%

1,954,286

 

16.25%

Mr. Arif Saeed

 

999,545

8.31%

1,022,545

 

8.50%

 

942,295

 

7.83%

Mr. Hassan Javed

 

758,015

6.30%

781,015

 

6.49%

 

702,365

 

5.84%

Mr. Omar Saeed

 

995,896

8.28%

1,018,896

 

8.47%

 

940,246

 

7.82%

Mrs. Shahida Naeem

 

800,226

6.65%

800,000

 

6.65%

 

799,774

 

6.65%

 

Total

6,174,078

51.32%

6,265,852

52.08%

5,949,426

 

49.46%

CDC- Trustee National Investment (Unit) Trust

 

1,660,475

13.80%

1,660,475

 

13.80%

1,681,975

 

13.98%

National Bank Of Pakistan

 

842,126

7.00%

842,126

 

7.00%

1,002,239

 

8.33%

 

Total

2,502,601

20.80%

2,502,601

20.80%

2,684,214

 

22.31%

13

Service Industries Limited

Appendix C

Calculation of Expected Return using CAPM Model for Service Industries Limited.

Expected Return = Riskfree rate + Beta * Risk Premium

or

Expected Return = Riskfree Rate+ Beta * (Expected Return on the Market Portfolio Riskfree Rate)

Three inputs required in this model are calculated below:

  • a. Risk Free Rate

Pakistan Government Bond 10 year was quoted at 9.01% p.a. on February 25 th , 2016. This can be considered as Risk Free return in Pakistan.

  • b. Risk Premium Using thumb rule on country’s bond rating and default spreads Pakistan sovereign bonds rating from Moody’s and historical risk premium for AAA rated country is detailed below:

Country

Moody’s

Country Default

Equity Risk

Spread (Rating)

Premium

US

AAA

0.00%

6.25%

Pakistan

B3

7.21%

13.46% (7.21+6.25)

Scale up the default spread by 50% to gauge the additional risk in stock market, so

Total Risk Premium of Pakistan = 6.25 + 7.21*1.5 = 17.07%

  • c. Beta Performing regression of stock returns (Rj) against market returns KSE-100 index (Rm) for period of 5Y from Jan 2010 to Dec 2014 with monthly return data (refer Appendix H for data). Rj = a + b * Rm where a is the intercept and b is the slope of the regression. From the regression output is detailed below,

14

Service Industries Limited

Service Industries Limited a = 1.6626% b = 0.5918 point estimate Standard Error of Beta =
Service Industries Limited a = 1.6626% b = 0.5918 point estimate Standard Error of Beta =

a = 1.6626%

b = 0.5918 point estimate

Standard Error of Beta = 0.3357

so, b ranges between -0.0801 to 1.2638 with 95% confidence;0.2551 to 0.9286 with 68% confidence

since,

R f = 9.01% p.a.

so, Monthly R f = 9.01/12 = 0.7508% monthly

a

R f * (1-b)

1.6626%

>

0.7508 * (1-0.5918) = 0.3065%

Jensen’s Alpha = 1.6626 0.3065 = 1.3561%

15

Service Industries Limited

Service did 1.3561% better than market, per month, between 2010 and 2014.

Annualized = (1+0.013561) 12 1 = 0.1186 = 17.54%

The R squared of the regression 5.09% attributed to market risk

(1 R 2 ) = 94.91% attributed to firm specific risk

Expected Return = Riskfree rate + Beta * Risk Premium

Expected Return = 9.01 + 0.5918 * 17.01 = 19.08%

16

Service Industries Limited

Appendix D

Measure of Operating Leverage

Fixed Costs Measure = Fixed Costs / Variable Costs

EBIT Variability Measure = % Change in EBIT / % Change in Revenues

Year

Sales

% Change in Sales

EBIT

% Change in EBIT

2010

9,421,408,000.00

-

665,659,000.00

-

2011

11,549,029,000.00

22.58%

772,314,000.00

16.02%

2012

12,167,267,000.00

5.35%

514,572,000.00

-33.37%

2013

14,685,638,000.00

20.70%

1,053,734,000.00

104.78%

2014

16,495,123,000.00

12.32%

1,276,029,000.00

21.10%

 

Average

15.24%

 

27.13%

EBIT Variability Measure = 27.13 / 15.24 = 1.78

The higher this number, the greater the operating leverage.

Unlevered / Asset beta

Year

2014

2013

2012

2011

2010

Interest Bearing Long Term Liability

958,315

514,365

400,215

233,123

240,525

Interest Bearing Short Term Liability

2,279,717

1,628,302

2,160,224

1,692,977

1,207,975

Shareholder Equity

2,963,949

2,447,086

2,019,951

2,012,906

1,699,826

Debt to Equity Ratio

1.09

0.88

1.27

0.96

0.85

*Average D/E from 2010 2014 = 1.01

0.5918 = ß u (1+ ((1-0.32)*1.01))

ß u = 0.3508

17

Service Industries Limited

Appendix E

An interest coverage ratio for Service Industries Limited.

Interest Coverage Ratio = EBIT / Interest Expenses

‘000 Rs.

Year

2014

2013

2012

2011

2010

Financial Charges

331,581

306,329

322,151

237,695

177,727

EBIT

1,276,029

1,053,734

514,572

772,314

665,659

Interest Coverage Ratio

3.85

3.44

1.60

3.25

3.74

*Average Interest Coverage Ratio from 2010 2014 = 3.176

A synthetic rating (from table below) for Service Industries Limited based on Interest Coverage Ratio of 3.176 found to be Ba2/BB, for which default spread is 4.25%.

For smaller and riskier firms

If interest coverage ratio is

     

greater than

≤ to

Rating is

Spread is

-100000

  • 0.499999 D2/D

 

20.00%

  • 0.5 C2/C

 
  • 0.799999 16.00%

 
  • 0.8 Ca2/CC

 
  • 1.249999 12.00%

 

1.25

  • 1.499999 Caa/CCC

 

9.00%

1.5

 

B3/B-

  • 1.999999 7.50%

 

2

  • 2.499999 B2/B

 

6.50%

2.5

  • 2.999999 B1/B+

 

5.50%

3

  • 3.499999 Ba2/BB

 

4.25%

3.5

3.9999999

Ba1/BB+

3.25%

4

  • 4.499999 Baa2/BBB

 

2.25%

4.5

 

A3/A-

  • 5.999999 1.75%

 

6

  • 7.499999 A2/A

 

1.25%

  • 7.5 A1/A+

 
  • 9.499999 1.10%

 
  • 9.5 Aa2/AA

12.499999

 

1.00%

12.5

100000

Aaa/AAA

0.75%

A pre-tax cost of debt for your firm = Risk free Rate + Default Spread = 9.01 + 4.25 = 13.26%

Taking latest corporate tax rate of 32%, an after-tax cost of debt for Service Industries Limited would be:

After-tax cost of debt = Pre-tax cost of debt (1 tax rate) = 13.26 * (1 0.32) = 9.017%

18

Service Industries Limited

Appendix F

Debt to Equity Ratio based on book value found to be 1.09 as per table below from Financial Statements.

Year

2014

2013

2012

2011

2010

Interest Bearing Long Term Liability

958,315

514,365

400,215

233,123

240,525

Interest Bearing Short Term Liability

2,279,717

1,628,302

2,160,224

1,692,977

1,207,975

Shareholder Equity

2,963,949

2,447,086

2,019,951

2,012,906

1,699,826

Debt to Equity Ratio

1.09

0.88

1.27

0.96

0.85

Equity / (Debt + Equity)

47.79%

53.32%

44.10%

51.10%

53.99%

Debt / (Debt + Equity)

52.21%

46.68%

55.90%

48.90%

46.01%

Debt to Equity Ratio based on Market Value

Breakup of Interest Bearing Long Term Liabilities including Current Portion with maturity is detailed below:

 

Time Due

Amount Due

FS Reporting

Last Payment Due on

(yrs)

‘000

% Due

31-Dec-14

31-Dec-15

1.0

2,105,352

65.02%

31-Dec-14

30-Dec-15

1.0

10,415

0.32%

31-Dec-14

30-Dec-15

1.0

11,196

0.35%

31-Dec-14

28-Jun-16

1.5

21,455

0.66%

31-Dec-14

14-Sep-16

1.7

4,551

0.14%

31-Dec-14

25-Oct-16

1.8

2,686

0.08%

31-Dec-14

25-Oct-16

1.8

2,143

0.07%

31-Dec-14

02-Nov-17

2.8

50,709

1.57%

31-Dec-14

18-Mar-20

5.2

215,595

6.66%

31-Dec-14

22-Aug-20

5.6

250,000

7.72%

31-Dec-14

02-Jan-20

5.0

563,930

17.42%

Weighted Average

2.372

3,238,032

Total debt due as at Dec 31, 2014 = 3,238,032,000.00

Total interest expense for the year 2014 = 331,581,000.00

Pre-tax Cost of Debt = 13.26%

19

Service Industries Limited

1

(1 + )

1−

= × +

(1 + )

 

1−

 

1

= 331,581,000 ×

(1 + 0.1326) 2.372

 
 

0.1326

+

3,238,032,000.00

=

3,049,461,367.45

(1 + 0.1326) 2.372

Cost of Equity = Risk free rate + Beta * Risk Premium = 9.01 + 0.5918 * 17.01 = 19.08%

Market Value of equity = Price of stock * No. of shares = 879.5 * 12,028,789 = 10,579,319,925.50

* Price of Service Industries Limited stock on February 25 th , 2016 = Rs. 879.5

Equity / (Debt + Equity) = 10,579,319,925.50 / (10,579,319,925.50 + 3,049,461,367.45) = 77.62%

Debt / (Debt + Equity) = 3,049,461,367.45 / (10,579,319,925.50 + 3,049,461,367.45) = 22.38%

Debt / Equity = 3,049,461,367.45 / 10,579,319,925.50 = 0.2882

Cost of Capital (Based on market value) = 19.08 * 0.7762 + 9.017 * 0.2238 = 16.83%

Cost of Capital (Based on book value) = 19.08 * 0.5006 + 9.017 * 0.4994 = 14.05%

20

Service Industries Limited

Appendix G

Capital Structure

  • a. Estimating Cost of Equity

Estimate the unlevered beta for the firm

ß u = ß L / (1+ (1-t)(D/E)) = 0.5918 / (1+ (1-0.32)*0.2882) = 0.4948

Since,

ß L = ß u (1+ (1-0.32)*(D/E))

Cost of Equity = Risk free rate + Beta * Risk Premium = 9.01 + ß L * 17.01

Debt to Capital

Debt to Equity

Levered Beta

Cost of Equity

0%

0.00%

 
  • 0.4948 17.43%

10%

11.11%

 
  • 0.5322 18.06%

20%

25.00%

 
  • 0.5789 18.86%

30%

42.86%

 
  • 0.6390 19.88%

40%

66.67%

 
  • 0.7191 21.24%

50%

100.00%

 
  • 0.8313 23.15%

60%

150.00%

 
  • 0.9995 26.01%

70%

233.33%

 
  • 1.2799 30.78%

80%

400.00%

 
  • 1.8407 40.32%

90%

900.00%

 
  • 3.5231 68.94%

  • b. Estimating Cost of Debt

SIL Current Financials

Year

2014

Revenues

16,495,123,000

EBITDA

1,517,495,000

Depreciation & Amortization

241,466,000

EBIT

1,276,029,000

Financial Charges

331,581,000

Market value of SIL = Debt + Equity = 3,049,461,367.45 + 10,579,319,925.50 = 13,628,781,292.95

Pre-tax cost of Debt = 13.26%

Risk free rate = 9.01%

Tax Rate = 32%

21

Service Industries Limited

           

Interest

 

After

Debt to

Debt in PKR

Interest Expense

Interest

Bond

Spread

Rate on

Tax Rate

Tax

Capital

Coverage

Rating

‘a’

Debt

Cost of

   

a + Rf

 

Debt

0%

-

-

Aaa/AAA

0.75%

9.76%

32.00%

6.64%

10%

1,362,878,129.30

180,717,639.94

 
  • 7.061 A2/A

1.25%

10.26%

32.00%

6.98%

20%

2,725,756,258.59

361,435,279.89

 
  • 3.530 Ba1/BB+

3.25%

12.26%

32.00%

8.34%

30%

4,088,634,387.89

542,152,919.83

 
  • 2.354 B2/B

6.50%

15.51%

32.00%

10.55%

40%

5,451,512,517.18

722,870,559.78

 

B3/B-

  • 1.765 16.51%

7.50%

 

32.00%

11.23%

50%

6,814,390,646.48

903,588,199.72

 
  • 1.412 Caa/CCC

9.00%

18.01%

32.00%

12.25%

60%

8,177,268,775.77

1,084,305,839.67

 
  • 1.177 Ca2/CC

12.00%

21.01%

32.00%

14.29%

70%

9,540,146,905.07

1,265,023,479.61

 
  • 1.009 Ca2/CC

12.00%

21.01%

32.00%

14.29%

80%

10,903,025,034.36

1,445,741,119.56

 
  • 0.883 Ca2/CC

12.00%

21.01%

28.24%

15.08%

90%

12,265,903,163.66

1,626,458,759.50

 
  • 0.785 C2/C

16.00%

25.01%

25.11%

18.73%

100%

13,628,781,292.95

1,807,176,399.45

 
  • 0.706 C2/C

16.00%

25.01%

22.59%

19.36%

As long as interest expenses are less than PKR 1,276,029,000, interest expenses remain fully tax- deductible and earn the 32% tax benefit. At 70% debt ratio, the interest expenses are PKR 1,265,023,479.61 and the tax benefit is therefore 32% of this amount.

At 80% debt ratio, however, the interest expenses increased to PKR 1,445,741,119.56, which is greater than the EBIT of PKR 1,276,029,000. We consider the tax benefit on the interest expenses up to this amount:

Maximum Tax Benefit = EBIT * Marginal Tax Rate = 1,276,029,000 * 32% = 408,329,280

Adjusted Marginal Tax Rate = Maximum Tax Benefit/Interest Expenses

  • c. Firm Value and Cost of Capital

Value = Expected Cash flow to the firm next year / (Cost of capital g)

Suppose cash flows are PKR 10,000,000 with growth of 3%, so

Debt to

Debt to

Cost of

After Tax

Cost of

Firm Value

Capital

Equity

Equity

Cost of Debt

Capital

0%

0.00%

17.43%

6.64%

17.43%

71,395,086.14

10%

11.11%

18.06%

6.98%

16.95%

73,813,395.42

20%

25.00%

18.86%

8.34%

16.75%

74,890,298.41

30%

42.86%

19.88%

10.55%

17.08%

73,154,479.83

40%

66.67%

21.24%

11.23%

17.24%

72,351,085.43

50%

100.00%

23.15%

12.25%

17.70%

70,075,267.98

60%

150.00%

26.01%

14.29%

18.98%

64,468,379.83

70%

233.33%

30.78%

14.29%

19.24%

63,442,520.92

80%

400.00%

40.32%

15.08%

20.12%

60,146,378.06

90%

900.00%

68.94%

18.73%

23.75%

49,634,352.13

22

Service Industries Limited

Appendix H

Monthly Return Data of KSE100 Index and SIL Stock from Jan 2010 to Dec 2014

Date

KSE100

Return

SRVI

Return

Date

KSE100

Return

SRVI

Return

08-01-2010

9776.21

-

271.88

-

24-01-2013

17056.36

0.67%

173.17

3.86%

29-01-2010

9614.19

-1.66%

278

2.25%

22-02-2013

18074.27

5.97%

168.6

-2.64%

26-02-2010

9657.79

0.45%

326.32

17.38%

29-03-2013

18043.31

-0.17%

167.7

-0.53%

26-03-2010

10137.93

4.97%

344.01

5.42%

26-04-2013

18917.71

4.85%

220.66

31.58%

30-04-2010

10428.12

2.86%

293.36

-14.72%

31-05-2013

21823.05

15.36%

247

11.94%

28-05-2010

9521.15

-8.70%

208.03

-29.09%

28-06-2013

21005.69

-3.75%

260.99

5.66%

25-06-2010

9796.85

2.90%

212.67

2.23%

26-07-2013

23497.07

11.86%

253.1

-3.02%

30-07-2010

10519.02

7.37%

220.33

3.60%

30-08-2013

22160.85

-5.69%

311.17

22.94%

27-08-2010

9598.71

-8.75%

205.1

-6.91%

27-09-2013

22387.31

1.02%

296.53

-4.70%

24-09-2010

9909.45

3.24%

183

-10.78%

25-10-2013

22445.59

0.26%

309.14

4.25%

29-10-2010

10598.4

6.95%

207.95

13.63%

29-11-2013

24302.19

8.27%

350.89

13.51%

26-11-2010

11145.02

5.16%

229.59

10.41%

27-12-2013

25258.05

3.93%

545.92

55.58%

31-12-2010

12022.46

7.87%

240.04

4.55%

31-01-2014

26784.34

6.04%

473.46

-13.27%

28-01-2011

12462.7

3.66%

230.09

-4.15%

28-02-2014

25783.28

-3.74%

470.46

-0.63%

25-02-2011

11223.52

-9.94%

187.99

-18.30%

28-03-2014

27116.13

5.17%

487.25

3.57%

25-03-2011

11552.13

2.93%

195.81

4.16%

25-04-2014

28850.08

6.39%

550.5

12.98%

29-04-2011

12057.54

4.38%

172.34

-11.99%

30-05-2014

29737.69

3.08%

632.34

14.87%

27-05-2011

12225.52

1.39%

177.39

2.93%

27-06-2014

29343.76

-1.32%

495

-21.72%

24-06-2011

12464.26

1.95%

179.61

1.25%

28-07-2014

30314.07

3.31%

578.1

16.79%

29-07-2011

12190.37

-2.20%

192.11

6.96%

29-08-2014

28567.74

-5.76%

662.57

14.61%

30-08-2011

11070.58

-9.19%

191.92

-0.10%

26-09-2014

29705.65

3.98%

841.87

27.06%

30-09-2011

11761.97

6.25%

198.83

3.60%

31-10-2014

30376.53

2.26%

1016.8

20.78%

28-10-2011

11561.67

-1.70%

205.1

3.15%

28-11-2014

31197.98

2.70%

989.53

-2.68%

25-11-2011

11648.14

0.75%

201.87

-1.57%

26-12-2014

31993.01

2.55%

960

-2.98%

30-12-2011

11347.66

-2.58%

194.99

-3.41%

27-01-2012

11960.22

5.40%

209.95

7.67%

10-02-2012

12231.6

2.27%

202

-3.79%

30-03-2012

13761.76

12.51%

188.03

-6.92%

27-04-2012

14042.77

2.04%

171.76

-8.65%

25-05-2012

13925.06

-0.84%

166.11

-3.29%

29-06-2012

13801.41

-0.89%

165.92

-0.11%

27-07-2012

14526.41

5.25%

169.88

2.39%

31-08-2012

15391.58

5.96%

175.33

3.21%

28-09-2012

15444.82

0.35%

187.1

6.71%

25-10-2012

15812.72

2.38%

162.95

-12.91%

30-11-2012

16573.86

4.81%

168

3.10%

28-12-2012

16943.19

2.23%

166.73

-0.76%

23