Introduction
Capital structure is a blend of debt financing and equity and is a crucial factor in the organization’s valuation. The levels of debt and equity financing affect the cash flow and risk hence the amount that investors would be willing to pay for a company. Thus, Capital structure is of concern and matters to investors and value because it affects the cost of an organization’s capital. On the other hand, the organization’s attraction to investors is based on a number of factors including its risk management, competitiveness and performance in terms of return to equity. (Damodaran, 2010) In that view, this analysis evaluates LUKOIL capital structure and investment aspects to determine its capital structure suitability and its suitability as an investment.
Analysis
Company Overview
Lenders attitude towards the company
Lenders attitude about the company has been improving over the past 14 years. That can be demonstrated by improving rating that was achieved and the increasing level of debt in the company’s capital structure.
Capital Basis vs. operating leverage
- Operating leverage
It measures the degree by an organization incurs variable and fixed costs. A business with few sales that provide high gross margin is referred as being highly leveraged. On the other hand, a business that has many sales that each sale contributes low margins are referred as being less leveraged. In increase in volume of sales in an organization is marked by a reduction in fixed costs for each sale unit hence more profitability. Further, an organization with a higher proportion of fixed costs as well as low portion of variable costs is referred as having used high operating leverage. On the other hand, organizations with higher variable costs and low fixed costs proportion have low operating leverage. Thus, given that LUKOIL has high sales that deliver high gross margin, it is less leveraged hence low risk. In that view, the low leverage presents a low risk in forecasting sales (Damodaran, 2010)
- Capital base
It entails the money that was contributed by the first shareholders plus the retained earnings. It is an important aspect as it acts as a benchmark for measuring returns. Thus, it helps investors and shareholders understand how the organization is performing relatively to their investments. (Damodaran, 2010)
Source: (LUKOIL, 2013;2012)
The figures and a chart of liabilities, equity, capital and capital ratios show that although the company’s debt has been increasing, it is low leveraged given the low debt equity and debt capital ratios. However, the ratios increased in 2013 compared to 2011 indicating increased debt in the capital structure. In that view, the low debt is an indication of low-risk structure. (Damodaran, 2010)
Currency Analysis
The business performances in a different currency denominated regions are as summarized on the following table.
Source: (LUKOIL, 2013;2012)
In view of the performance in local and international markets, it is clear that operations in foreign markets were high hence a significant exposure to currency risks. That is because the company’s returns in foreign markets are subject to exchange rate fluctuations presenting a substantial risk. (Damodaran, 2010)
Control
The business is owned and controlled by few shareholders. However, the ownership structure have changed with some shareholders like ING Bank and JP Morgan losing their control in 2013 while National Clearing Depositary gains significant ownership from 11.8% in 2012 to 92.04% in 2013.
Source: (LUKOIL, 2013)
In view of the change, the company has a single major shareholder whose control is likely to influence policies and strategies. In that respect, decision-making process is easier. In addition, given the ownership by the Central Depository, the business has a less risky investors hence reducing risk for other investors.
Distribution
The company’s income distribution is summarized on the following table.
The table and chart shows a significant share of the company’s income is applied in paying dividends to shareholders. In addition, there are trends of increasing dividends while interest expense decreases. Thus, the company’s capital structure is suitable in enhancing investors’ payments while reducing debt cost.
Total sales
Source: (LUKOIL, 2013;2012)
The company has been recording decrease in sales as shown by the continuous decrease from 2011 to 2013. That shows declining performance in the market. (Damodaran, 2010)
Shareholders return
Source: (LUKOIL, 2013;2012)
ROE represents an organization’s net income as a percent of the organization’s equity. It measures the ability to make a profit given the equity investments’. In that view, the LUKOIL’s fluctuating ROE that increases in 2012 and then decreases in 2013 shows the fluctuating ability to apply equity to deliver returns for shareholders. (Damodaran, 2010)
Total dividends
Source: (LUKOIL, 2013; 2012)
Dividend payment is an indication of an organization’s distribution of funds to its shareholders. In that respect, LUKOIL’s fluctuating dividend payment that increases in 2012 and decreases in 2013 shows that investors receipt from the investment fluctuated during the period. (Damodaran, 2010)
Bond and credit rating
The rates given to an organization’s bonds are an indication of its credit quality. The rating is done by private rating agencies such as Fitch, Moody’s and Standard & Poor’s. In that view, the organization has improved in its rating by the various agencies from the low credit rating BB and BB+ in 2006 to a medium credit rating in BBB in 2010. The BBB rate has been maintained and affirmed by agencies including Fitch and Standard & Poor’s. (Cbonds, 2014)
Quick ratio
The ratio is an indication of an organization’s short-term liquidity hence its ability to meet its short-term obligations. Thus, it shows the dollar amount of the liquid assets available to pay for a dollar amount of current debt. (Damodaran, 2010)
The following is a summary of LUKOIL’s quick ratio for three years.
Source: (LUKOIL, 2013; 2012)
The figures and the chart show a decreasing ratio hence an indication of the declining ability of the company to pay for its short-term debts. In that respect, there is increasing the risk of short-term liquidity. However, the ratios above 1 are an indication of adequate funds to pay for the debts. (Damodaran, 2010)
Interest cover
Interest cover shows how easier it is for an organization to pay for its interest debt and is calculated by dividing income before tax by interest expense.
Source: (LUKOIL, 2013; 2012)
In view of LUKOIL’s fluctuating but relatively rising interest cover, it is an indication of improving ability to pay interest expense. In addition, the higher cover ratio is an indication that the organization does not have a huge debt burden hence a low-risk capital structure given its performance. (Damodaran, 2010)
Competitiveness
LUKOIL has been the leading integrated oil and gas company accounting for about 16% of the country’s crude oil production and reported 17.3 billion barrels of oil reserves majority of which is located in Russia. The countries exploration extends to countries in Middle East, Eastern Europe, South America and Asia. In addition, the company owns refineries in five countries while distribution and marketing are done in over 30 countries. In addition, the company has over 6000 gas stations and power generating assets in Romania, Bulgaria, Russia and Ukraine. The company’s competitors include NK Rosneft OAO, Gazprom Nef JSC, Joint-stock Company and BP Plc. (Hoovers, 2014)
Comparing LUKOIL with competitors, the following table summarizes their performance on various aspects.
In view of the above performance figures, it is clear that LUKOIL is relatively competitive compared to BP and Joint stock company. That is given the company’s significant revenue, net income and earnings per share given its size that falls between the two as shown by market capitalization. Thus, LUKOIL has better performance that places it better to investors owing to significant earnings per share. (Damodaran, 2010)
Summary and conclusion
In view of the analysis, it is clear that the company has low leveraged operations and capital base. Thus, LUKOIL has a low-risk capital structure will relatively low debt compared to equity. That means that the business has low-interest debt. In addition, the business has adequate assets to meet its short-term obligations in addition to having suitable credit and bonds rating. However, its international operations that account for a significant portion of its income present an exchange rate fluctuation risk. On the other hand, the business performance in terms of sales and income is relatively better compared to competitors given its market capitalization. In summary, the business has a suitable capital structure and is a low-risk investment that provides relatively higher returns for investors.
Reference list
Cbonds. (2014). LUKOIL. Retrieved from, http://cbonds.com/organisations/emitent/128
Damodaran, A. (2010). Applied Corporate Finance. 3rd Ed. Colorado: Wiley.
Hoovers. (2014). Top Competitors for OAO LUKOIL. Retrieved from,
http://www.hoovers.com/company-information/cs/competition.OAO_LUKOIL.dd3f0d049250fee8.html
LUKOIL. (2012). 2012 Annual Report. Retrieved from,
http://www.lukoil.com/materials/doc/Annual_Report_2012/Lukoil_GO_2012_eng.pdf
LUKOIL. (2013). 2013 Annual Report. Retrieved from,
http://admin.writerbay.com/my_orders?subcom=detailed&id=210031878
LUKOIL. (2014). General Information. Retrieved from,
http://www.lukoil.com/static_6_5id_29_.html
Yahoo Finance. (2014). LUKOIL Competitors. Retrieved from,
http://finance.yahoo.com/q/co?s=LUKOY+Competitors
