Profitability & Growth

56

7.3 Financial Ratio Analysis

57 Calculations of ROIC (after tax) based on both the ending value and average value of invested capital is seen in figure 21. By comparison, the levels of ROIC depending on which measure of invested capital is used one can conclude that there is little difference for the years 2015 and 2016. Thus, ending capital ROIC is considered a good measure for benchmarking Volvo’s ability to generate return. With the exception of 2014, Volvo has delivered the highest ROIC amongst the companies in the sample and delivered a ROIC of 25,2% in 2016, as compared to the peer group average of 7,8%. This indicates that Volvo has been relatively successful in generating returns in the near history.

In addition, Volvo show a substantially positive trend, with a ROIC of 5% in 2014 as compared to 25,2%

in 2016. In exception for Fiat Chrysler and Mazda who show positive trends, the rest of the peer group show no clear trend in either direction and volatility is low.

Figure 21. Company ROIC

Source: Constructed by the authors

As stated in the adjustments section of the financial statement analysis, by not accounting for operating leases and allowing for R&D to be treated differently depending on accounting standards, the companies following IFRS accounting standards make a better basis for benchmarking against Volvo. In general, goodwill accounts for a very small proportion of invested capital for the peer group companies and thus have a marginal effect on ROIC with one exception, Fiat Chrysler (42%), and therefore any inference based on Fiat Chryslers performance will be made with caution.

0,0%

5,0%

10,0%

15,0%

20,0%

25,0%

30,0%

2015 2016

0,0%5,0%

10,0%

15,0%

20,0%

25,0%

30,0% 2014 2015 2016

Figure 22a. Average Invested Capital Figure 22b. Ending Invested Capital

58 Profit Margin

Figure 22 show the profit margins for Volvo and its peers. It reveals that, as expected from the five forces analysis, profit margins are relatively low. Average margins for the peer group companies are 5,7%, 6,4% and 5,9% during the period of analysis. As seen in the figure, Volvo has consistently delivered profit margins lower than those of the peer group, even though the company has improved the most during the period.

Despite the time period being too short to draw any substantial conclusion based on time series data, the main components of the profit margin will be indexed to reveal more information on how Volvo has improved its profitability as compared to the comparable companies (Petersen & Plenborg, 2012). The indexed line items are to be interpreted with caution as the comparable companies’ record D&A by function and does not disclose the distribution. Thus, the cost figures presented are likely inflated relative to Volvo’s, decreasing the reliability of the analysis.

Table 9. Revenue per unit

2014 2015 2016

Revenue (€ Million) 14.288 17.035 18.761

Unit Sales (000's) 466 503 534

Revenue per unit (€) 30.670 33.858 35.111 Source: Own compilation, Volvo Annual Reports

Volvo’s revenues have grown at a CAGR of 14,6% which is to be compared with the peer group average of 11,3% (see appendix 11). This relatively high growth is due to both an increase in units sold and in revenue per unit as displayed by table 9, which is in line with the strategy to become established in the premium segment. During the same period, cost of sales has grown at a lower rate than revenues, which has created a CAGR in gross profit of 25,2% as compared to the peer group of 15,4%. R&D expenses and SG&A have also increased at a lower rate than revenues, thus contributing positively to the profit margin.

The only post increasing at a faster pace than revenues is D&A, which is in line with Volvo having made big investments during the period. Compared to its peers, Renault, GM and Fiat Chrysler have been able to increase revenues at a higher rate than cost of sales but GM is the only one that has been able to do so at a comparable level.

0,0%1,0%

2,0%3,0%

4,0%5,0%

6,0%

7,0%8,0%

10,0%9,0%

Volvo BMW Renault GM Ford Fiat

Chrysler 2014 2015 2016

Source: Constructed by the authors Figure 22. After tax profit margin

59 These findings are supported by investigating common size figures and show that Volvo has been able to decrease the cost of sales, SG&A and R&D expense whereas D&A has increased as a percentage of revenue (appendix 11). The decrease in cost of sales is the strongest contributor to the growing profit margin.

However, the analysis also shows that there is room for improvement in cost management as SG&A is relatively high compared to the peer group. Noteworthy is that these figures are excluding D&A, whereas for the peers D&A is likely included in SG&A potentially inflating the relation to revenues.

In conclusion, it is unquestionable that Volvo has been successful in creating value the recent years by both increasing revenue and decreasing marginal cost, thus delivering superior growth in all measures of profitability. However, the margins are still relatively low compared to the peer group, which implies that there is room for improvement with regards to the company’s cost management.

Invested Capital Turnover Ratio

Turnover rate of invested capital is seen in figure 23 and reveals that Volvo has not only improved its turnover rate of invested capital the most, but that it has by far the highest. It also shows that the four companies with the highest ROIC, Volvo, GM, Fiat Chrysler and Mazda also have the highest turnover rates. Thus, the turnover rate of invested capital is a very important source of superior ROIC in the industry. Whilst the average turnover rate of invested capital has been stable at 1,7x, Volvo has increased from 2,9x to 5,3x over the last three years.

This implies that the number of days that Volvo’s invested capital is tied up has decreased from 123 to 68 during the period (Assuming 360 days in a year), as compared to the increase in peer group average from 210 to 214. Thus, Volvo has been able to improve substantially from already low levels.

A common size analysis on the analytical balance sheet items show that most significant current assets are accounts receivable and inventories, whereas the largest non-current assets are PP&E and intangible assets (see appendix 12). With respect to assets, Volvo show a decrease relative to sales but there is no major trend in the data. On the liabilities side, the most significant posts are accounts payable and both other current and non-current liabilities. The decrease is bigger on this side (measuring liabilities as negative values), ultimately leading to operating working capital decreasing from -11,6% to -18,7% of sales. The fact that Volvo’s operating working capital is negative has a big part in explaining Volvo’s relatively high invested capital turnover ratio due to most competitors showing near zero or substantially positive working capital.

0,0x 1,0x 2,0x 3,0x 4,0x 5,0x

6,0x 2014 2015

2016

Source: Constructed by the authors Figure 23. Turnover rate of invested capital

60 The underlying reason to how Volvo has managed to decrease the invested capital turnover ratio becomes clearer when looking at the days on hand (appendix 12). Volvo has managed to utilise its assets more efficiently every year and show decreasing days at hand across the line, but the biggest improvements are made in operating working capital, as implied by the previous reasoning. Further, Volvo is in the lower segment of days on hand regarding all line items, explaining how they have been able to show a substantially higher invested capital turnover ratio relative to peers.

In conclusion, when looking at invested capital turnover, Volvo is outperforming its peers mainly due to tighter management of current liabilities, driving down operating working capital and thus invested capital.