Table of Contents
I. Company Summary
ITV was born in 1955 with its first broadcast on Channel 3 in the London area. In 18 years the structure of the broadcasting in the UK consisted of 15 separate Channel 3 regional licences, each owned by different enterprise.
Long history of gradual expansion included unifications of Granada,LWT, Carlton, Scottish Media Group (SMG, now STV) and Ulster, making it the owner of all fifteen regional licenses (About ITV, what we do 2012).
The official name of this television company based in the UK is ITV plc which incorporated two bodies – Broadcasting & Online' and ITV Studios, functioning on the commercial basis (Investors chronicle 2012). The first segment operates the ITV family of channels and provides the delivery of media content online, schedules and commissions programmes. The revenue derived mainly comes from selling advertising , complemented by the participation revenue and sponsorships, interactive viewer revenues and the digital terrestrial multiplex, SDN. (About ITV, what we do 2012).
Revenue generated by ITV Studios bases mainly on the ITV Studios UK business, a commercial programme producer. The other part comes from the internationally based production centers (Investors chronicle 2012).
The company’s top position in its sector is not only officially claimed on their website (“largest commercial television network in the UK”), but also noted by the third parties, particularly investors such as Ian Whittaker - Liberum Capital analyst (Fletcher 2012).
In 1985 Martin Sorrell took stake in Wire and Plastic Products Plc, a wire baskets producer, and began the process of business development. In the pursuit of creation of a global marketing service company, after the rebranding into the WPP Plc Sorrell begins the process of acquisition of smaller marketing services companies based in US and UK, proceeding with new services – media, healthcare, advertising – in 90s. (WPP, About us, What we do)
Now WPP functions globally in the 4 main segments: Consumer Insight; Advertising and Media Investment Management; Healthcare and Specialist Communications, Public Relations & Public Affairs, and Branding & Identity.
In 2012 numerous acquisitions by the company took place, many of them in the digital sector. This indicates the further expansion of this huge Holding Company, ranked the Most Effective in its field in the 2012 North American Effie’s Effectiveness Index Rankings.
To sum up, both companies are leading in their sectors, have long history of their expansion to the market and provide diversified range of services. ITV specializes in programme production, broadcasting and gains most revenue from advertising, while WPP provides marketing solutions, entertainment and healthcare solutions. The market price of WPP is almost some 4 times bigger than the one of ITV ( 10,9 bn GBP vs 2,9 bn GBP, Bloomberg data).
II Financial performance
|Dividend payout ratio||25,19%||37,08%|
|Risk indicator, beta||1,143||1,059|
|Annual div yield||2,55%||3,0%|
1. Key Ratios
Some major financial indicators for both companies under analysis can be found in the table. It is, however, not always representative to compare some of the figures between the companies as they come from different sectors. Therefore, the following analysis will include both cross-firms comparisons as well as benchmark considerations were possible.
a. Current ratio is a liquidity indicator and is calculated as current assets ratio to the current liabilities and presents the ability of the company to satisfy its sort-term obligations. Current assets stand for cash and assets expected to be sold, consumed or turned into cash during one year of the balance sheet date approximately. Respectively, current liabilities are company´s obligation due in a one-year term. The preferred current ratio exceeds 1.0. (Stickney, Weil, Shipper & Francis 2007).
ITV thereby shows better figure in this case, exceeding the norm by 0.93, while WPP lacks (although insignificantly) the ability to meet its short-term obligations. However, this indicator might be misleading in some ways. Increased share of short-term borrowings, which often is a good indicator, would lead to a lower current ratio even if the company´s assets are liquid and increased equally.
b. Gearing ratio is obtained from dividing debt by equity. It is also referred as “leverage” sometimes (Watson & Head 2010). ITV´s indicator of 2,61 shows that the company´s liabilities are 2,61 times bigger than the owned capital. Industry benchmark of 1,31(Bloomberg 2011) reveals a quite risky strategy of the company. WPP on the other hand shows similar leverage level of 2,58 indicating high share of borrowed capital.
c. Return on assets is a tool to evaluate the company’s efficiency of using assets in generating revenue, not taking into account the financing of those assets. It relates company’s operating and investment activities, finding the profitability of investment (calculated as net income divided by total assets). ROA shows how much the company earned per each currency unit of assets used (Stickney, Weil, Shipper & Francis 2007). ITV hence earned 0,0819 GBP per 1 GBP of assets while WPP’s indicator showed only 0,0343 GBP. WPP hence performed almost 2.5 times worse in terms of its assets’ usage.
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d. Return on equity, in turn, estimates the company’s performance of using capital assets in generating revenue. It measures the profitability of financial decisions Stickney, Weil, Shipper & Francis 2007). Calculated as net income divided by equity it shows that ITV earned 0,3367 GBP per each pound invested by shareholders while WPP came up with almost 3 times less – 0,1282 GBP. However, the benchmark for media industry was 40,34% and for the marketing – 14.44% (Bloomberg 2011). That indicates that ITV performed significantly below its industry average while WPP showed a relatively consistent figure.
e.Dividend payout ratio is calculated as common dividends divided by the net income and gives the insight into the share of a company’s profits returned to the shareholders right away as dividends (Rich, Jones, Heitger, & Mowen 2012). It in fact depends on the company’s dividend policy more than on its actual market position. In ITV 25,19% of profits are distributed to the shareholders, while at WPP this proportion is higher – 37,08%. The conclusion might be that ITV retains bigger proportion of its earnings.
f. Dividend yield id calculated as a ratio of a dividend per share to a market share price. It is in fact the measurement of the rate of return provided by dividends to the stockholders (Rich, Jones, Heitger, & Mowen 2012). The yield of the companies are at the same level – 2,55% at ITV and 3% for WPP’s stocks, while the latter figure is almost 1,5 times higher than the average industry value of 1,9%.
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It could be concluded from the last 2 points analyzed that WPP has a more favourable dividend policy for the investor, having higher yield, exceeding theindustry average, and dedicating higher proportion of its profits to dividends.
g. Price-earnings ratio is calculated as price per share divided by earnings per share. The usual conclusion drawn would look like “the ITV share sells10,71 times earnings and the WPP share – 12.1 times earnings” (Stickney, Weil, Shipper & Francis 2007). The industry average P/E ratios are 15,07 and 20,03 respectively which shows the undervaluation of both companies.
Poor performance is often indicated as one of the causes for such evaluation. But looking into the dynamics of ITV indicators (i.e. from the balance sheet, Appendix A) disproves this assumption: after the recession of 2008-2009 ITV has been steadily regaining its positions. It has decreased its liabilities from 2,448 to 2,112 mln GBP from 2010 to 2011, increased revenue, net income, earnings and dividends per share.
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Moreover, the latest investors chronicle (by Financial Times) recommendation was “BUY” in July 2012 (Hughman 2012).
As for WPP, the slight slowdown in the company’s developed market businesses despite its strong growth in the emerging markets was noted by the investors. The slowest 6 months in terms of growth were followed by a slight drop in its full-year adjusted EPS in 2012 compared with 2011 (Hall 2012).
2. Security Market Line (SML)
SML is a graphic representation and the basic concept of the Capital asset pricing model (CAPM) used to define equilibrium in financial markets. It presents the linear relationship between risk and rate of return for a single correctly priced security, not for the portfolio. The systematic risk of the security in this model is compared with the risk-free return rate and the market return and risk. The equation of the SML looks as the following:
Ri = Rf + β(Rm-Rf)
Where Ri – the rate of return of security,
Rf – risk-free rate of return,
Rm – market rate of return,
β – contribution of the security to the market portfolio deviation (risk) (Watson & Head 2010; Bradfield 2007).
The risk-free assets as well as risk premium are nowadays very controversial concepts. The first are generally considered to be presented by the rate of return on US (sometimes UK) treasury bonds while the calculation of the latter has a lot of approaches. There are historical, required (by the investor) and expected risk premiums (Fernandez 2004).Numerous authors during a long time have claimed in favor of one or another approach, combining it with empirical survey evaluation method. Based on Fernandez (2004, pp. 4-6), empirical findings of Fernandez, Aguirreamalloa & Corres (2012, p.3), S&P 500 and Shotter (2012) it is suggested to take 7,8 % US bond yield as a risk-free rate and 6% (as average of suggestions) for the risk premium.
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Therefore the SML equation will appear as follows:
Ri = 0,078 + 0,06β
The graphic 1 represents the visualized Security Market Line for both companies. β in fact stands for the quantity of risk for the security and is plotted on the horizontal axis of the SML (Bradfield 2007). The rate of return is plotted on the vertical axis respectively. The slope of the line Is equal to (Rm-Rf) or market risk premium. The intersection with Y presents the rate of return for a risk-free share.
The risk-return ratio is actually quite similar for both companies. WPP with a slightly lower risk level of 1,059 compared with that of 1,143 of the ITV therefore represents a lower expected rate of return. Both betas are higher than 1 which means that companies’ rates of return are influenced by the market systemic risk progressively. However, the both yield rates of 3,0% and 2,5% respectively appear under the SML if put on graphic with given betas. That means that given these risk rates the return should have been higher for both companies and they are therefore overvalued. However, as market risk premiums are usually subjective, the line with different parameters would present another picture. So, in terms of comparison from SML analysis it can be concluded that companies are in similar position, WPP slightly leading as it has lower risk and higher dividend yield.