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Module 6

This document discusses financial metrics like RNOA and ROCE used to evaluate the performance of Fauji Foods over several years. It analyzes factors driving high RNOA and ROCE ratios for the company, including increasing sales, higher operating revenues, lower operating expenses, and efficient use of assets. Financial leverage is also examined in the context of ROCE.

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Halimah Sheikh
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31 views3 pages

Module 6

This document discusses financial metrics like RNOA and ROCE used to evaluate the performance of Fauji Foods over several years. It analyzes factors driving high RNOA and ROCE ratios for the company, including increasing sales, higher operating revenues, lower operating expenses, and efficient use of assets. Financial leverage is also examined in the context of ROCE.

Uploaded by

Halimah Sheikh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Module 6

RNOA: – Return on Net Operating Assets a financial metric is used to evaluate how much
operating income a company derives relative to the operating assets it holds. Fauji food
maintained a very healthy RNOA for past four years lowest in 2019 at 15% and highest in 2016-
2017 at 23%.

In order to explain the high returns on operating assets we look at the drivers for RNOA, we can
define RNOA as followings

i. RNOA = NOPAT ÷ Average Net Operating Assets


ii. RNOA = NOPAT margins × Average NOA Turnover
iii. RNOA = NOPAT margins × Average OA Turnover × (1 + OL Leverage)

NOPAT or Net Operating Profit After Tax (EBIT [1 − Tax rate]) is the after-tax profit earned
from the net operating assets. The higher values of NOPAT and the increasing rate in the values
of NOPAT for past five years suggest that firm is increasing its operating income. This can be
attributed to the continuous increase in sales over the past five years with the firm cutting down
distribution expenses leading to lower operating expenses and higher operating revenues. The
value of NOPAT for year 2019 is 1550338921

NOPAT Margin (NOPAT ÷ SALES) which determines the amount of NOPAT that is generated
from a firms total operating revenue and provides insights regarding the efficiency of the firm.
We can observe that the NOPAT margin has an increasing trend and has hit the highest in 2017
at 28%. This shows that Fauji foods is increasing its efficiency which is visible by decrease in
distribution expenses thus reducing the operating expenses and becoming more efficient.

Average NOA Turnover (SALES ÷ Average NOA) shows the revenue generation capabilities
of the firms operating assets. Fauji maintains a stable turnover ratio; these results are supported
by the fact that while the sales are increasing so are the net operating assets which in turn help
maintain the turnover ratio and hence allows for a high RNOA ratio. The average NOA turnover
is the highest in year 2017 which is 0.87 this year Fauji Foods Limited is utilizing its assets
efficiently while on the other hand in year 2019 Fauji Foods Limited had the lowest Average
NOA Turnover because the firm was not utilizing its assets well.

Operating Leverage (1 + OL Leverage) show that to an extent the operating liabilities will
prove to beneficial for the firm as they generally do not entail any cost if used correctly. For the
five-year analysis period we see that the Operating Leverage is highest in 2017 at 0.43 which
results in the highest RNOA in the five-year period at 43%.

1. ROCE
ROCE – Return on Common Equity can be used in assessing a company’s profitability and
capital efficiency. It shows how well a company is generating profits from its capital. For Fauji
Foods, high ROCE has been generated having over 100% returns and this just shows how
profitable the firm is. To understand more we look at first what are the drivers for ROCE:

i. ROCE = (NI − Preferred Dividend) ÷ Average Shareholders’ Equity


ii. ROCE = Adj Profit Margins × Avg Asset Turnover × Equity Multiplier
iii. ROCE = RONA + Lev × Spread

One of the main reasons for Fauji Foods high returns on capital is the fact that the Net Income
exceeds the shareholder’s equity and hence we see returns above 100%.

Adjusted Profit Margins ((Net Income − Preferred Dividend) ÷ Sales) shows that the
increasing sales for the firm in the five year analysis period, increased the net income which
leads to an increased ROCE. Adjusted Net Profit margins have faced a decrease during the last 3
years from 0.15 in 2015 to 0.33 in year 2017 but then from 2017 to 2019 the adjusted net profit
margins increased at an increasing rate.

Average Asset Turnover (Sales ÷ Average Asset) remains stable and good between 0.45 and
0.75 showing that the firm is generating regular and smooth revenue streams using its assets.
This is backed by increase in sale amounts in the analysis period from 2015-2019.

Equity Multiplier (Average Asset ÷ Average Common Equity) shows how much of a firms
assets are financed through the equity. For Fauji Foods Limited the equity multiplier is low
which suggests that less of the assets were funded by debt financing than by equity. Lower
equity multiplier for Fauji Pakistan Foods limited is more favorable and good because this shows
that Fauji Foods Limited is using more of its equity and less debt to finance the purchase of the
assets. The equity multiplier was highest in year 2017 at around 1.94 as compared to the
performance of 4 years.

Financial Leverage has two components which drive the ROCE value, the first one being Degree
of Financial Leverage (LEV) (Average NFO ÷ Average Common Equity) and the second is the
Spread (ROCE – RNOA) / LEVERAGE. So as long as the spread is positive the financial
leverage will increase the ROE meaning that the firm earns higher returns in NOA than the cost
of debt financing those assets. The positives spread values for Fauji Foods shows that the firm is
earning more returns from operating assets than the financial. In the case of financial leverage all
the leverages over the past 4 years is greater than 1 which indicates that Fauji Foods Limited is
not in a secure position and is able to meet its current obligations.

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