TALLINN UNIVERSITY OF TECHNOLOGY School of Business and Governance Department of Business Administration Linnea Lappi FINANCIAL STATEMENT ANALYSIS ON ARCO VARA AS Bachelor’s thesis Supervisor: Professor Jaan Alver Tallinn 2017 I declare I have written the bachelor’s thesis independently. All works and major viewpoints of the other authors, data from other sources of literature and elsewhere used for writing this paper have been referenced. Linnea Lappi …………………………… Student’s code: 145784 Student’s e-mail address: [email protected] Supervisor Professor Jaan Alver The thesis conforms to the requirements set for the bachelor’s theses …………………………………………… (signature, date) Chairman of defence committee: Permitted to defence …………………………………. (Title, name, signature, date) CONTENTS ABSTRACT ............................................................................................................................. 4 INTRODUCTION .................................................................................................................... 5 1. OVERVIEW OF THE ARCO VARA GROUP ................................................................... 7 1.1 The annual reports of Arco Vara from 2011 to 2016 ..................................................... 7 1.2 The supervisory and management boards of ARCO VARA ........................................ 12 1.3. About methodology of analysis ................................................................................... 15 1.3.1 Traditional analysis ................................................................................................ 15 1.3.2 The categories in financial statement analysis ....................................................... 15 1.3.3. Component analysis .............................................................................................. 17 1.3.4 Cash flow analysis ................................................................................................. 18 2. FINANCIAL STATEMENT ANALYSIS 2012–2016 ...................................................... 20 2.1 Financial statements of Arco Vara ............................................................................... 20 2.1.1 Income statement ................................................................................................... 20 2.1.2 Balance sheet ......................................................................................................... 23 2.1.3 Cash flow statement ............................................................................................... 25 2.2 Traditional analysis ...................................................................................................... 26 2.3 Component analysis ...................................................................................................... 28 2.4 Cash flow analysis ........................................................................................................ 30 2.5 The bankruptcy analysis ............................................................................................... 32 CONCLUSION ...................................................................................................................... 36 REFERENCES ....................................................................................................................... 38 APPENDICES ........................................................................................................................ 40 Appendix 1. Income statements for the years 2011–2016 (thousand EUR) ...................... 40 Appendix 2. Balance sheet for the years 2011–2016 (thousand EUR) .............................. 41 Appendix 3. Cash flow statements, years 2011–2012, indirect (thousand EUR) .............. 42 Appendix 4. Cash flow statements, years 2012–2016, direct (thousand EUR) .................. 43 Appendix 5. Income statement, vertical analysis ............................................................... 44 Appendix 6. Income statement, horizontal analysis ........................................................... 45 Appendix 7. Income statement, trend analysis ................................................................... 46 Appendix 8. Balance sheet, vertical analysis ..................................................................... 47 Appendix 9. Balance sheet, horizontal analysis ................................................................. 48 Appendix 9 continued ......................................................................................................... 49 Appendix 10. Balance sheet, trend analysis ....................................................................... 50 Appendix 11. Financial ratios, used formulas .................................................................... 51 Appendix 11 continued ....................................................................................................... 52 ABSTRACT The purpose of this study was to define the financial status and development of Arco Vara AS during the years from 2011 until 2016. The analysis is based on the information from the annual reports prepared by Arco Vara AS. The following methods are used for the analysis: traditional financial analysis, component analysis on return on equity, cash flow analysis and Altman’s Z-score. There have been various changes in the structure of the company, which have had a positive impact on the company’s performance. The structural changes in the financial position of the company were focused on the changes between current and non-current liabilities. The main factor affecting the profitability of the company and the return on equity was net profit margin, due to fluctuation of the profits during the research period. The Altman’s Z-score of the company was at a catastrophic level in 2012, but the group managed to increase it to the safe-zone. The title is: Financial statement analysis on Arco Vara AS Keywords: Financial statement analysis, Altman’s Z-score, Component analysis, Cash flow analysis INTRODUCTION Financial statement analysis has several roles in an efficient capital market. Financial statements provide useful information for shareholders, so they can know financial status of the company. The lenders are interested in the solvency of the company, whereas the company’s employees might be curious of the future of the company. One of the main users of the financial analysis are managers, as they can use it to detect and react to problematic areas of the company. In this study, the analysed company is an Estonian real estate company Arco Vara. It was chosen, because it is one of the leading real estate firms in the Baltic region (About Arco Vara), and it was discussed previously in a master’s thesis by Jelena Soboleva. Soboleva’s thesis considered the years between 2004 and 2011, and during that time, Soboleva stated that Arco Vara is highly likely to go bankrupt. Soboleva did not recommend to buy the shares of the company nor investing into the company (Soboleva, 2013). Due to this opinion, the author decided to investigate, how the Arco Vara group has managed to avoid bankruptcy, and how the financial situation of Arco Vara has developed after the previous research. In 2017, while doing this research, in the Nasdaq Baltic rating the Arco Vara group has made it to the second place in the field of Most visible improvement over 3 years (Nasdaq Baltic). The methods used to analyse the financial status of the company are traditional financial statement analysis, component analysis by DuPont formula, cash accounting system and Altman’s Z-score model. While discussing the financial statements of Arco Vara, the used methods are vertical, horizontal and trend analysis, because it allows thorough comparison between the years studied. In the trend analysis, the base year is set to 2012, as it is the first year that had its financial statement numbers adjusted to the changes in the structure of the company. The methods were chosen to provide as wide view of the financial position of the company as possible. In bankruptcy analysis, Altman’s Z-score is one of the most popular and used methods, and it was applicable in this study. Thesis begins by introducing the Arco Vara group by an overview of the information provided in the annual reports. Discussion also presents the changes on the supervisory and 5 management board, because during a relatively unstable period in a company’s history, the people behind it and their connections can be considered relevant. The first chapter also explains the methods used in the research, which include traditional financial statement analysis, component analysis and cash flow analysis. The results are discussed after the methodology overview, starting with the financial statement analysis and traditional analysis, continuing to component analysis and cash flow analysis. The discussion ends with an Altman’s Z-score analysis. 6 1. OVERVIEW OF THE ARCO VARA GROUP Arco Vara is an Estonian company in real estate industry. The company was established by the name of AS Arco Vara Kinnisvarabüroo in 1992 by Arti Arakas, but since 1994, the company has been known as Arco Vara AS (Nasdaq Baltic). Arakas was soon accompanied by Hillar-Peeter Luitsalu and Richard Tomingas (Arco Vara History). During the 1990’s the company spread throughout Estonia, and in 1997 the group started to expand to other Baltic states, starting from Latvia. In 2006 the group opened offices in Bulgaria and Romania, and a year later the group had its initial public offering (Ibid.). Arco Vara’s business areas include property management, real estate development and intermediation and valuation of real estate (Nasdaq Baltic). Even though the group operates throughout the Baltic region and in Romania, the main markets are in Estonia, Bulgaria and Latvia (Ibid.). Nowadays the CEO of Arco Vara is Tarmo Sild, and Hillar-Peeter Luitsalu is the chairman of the supervisory board. Overview of the Arco Vara group in this study is based on the information gathered from the annual reports from the research period. 1.1 The annual reports of Arco Vara from 2011 to 2016 During the research period, Arco Vara AS has been through some major structural changes. At the beginning of the period, in 2011, the core activities of the group included construction of buildings, civil engineering, specialised construction activities and real estate activities. These activities can be divided in to three divisions: Development, construction and services (Annual report 2011). The service division includes valuation, brokerage and consultation services, whereas the development division’s activities contains developing complete commercial real estates and living environments. The division of construction used to operate as a general contractor and builder, and provided environmental engineering and construction services. The construction division was reorganized during 2011 to avoid risks and potential losses (Annual report 2011), but it was not enough, as in 2014 the group decided to give up the construction division and the group sold Arco Ehitus OÜ in February 2014 (Annual report 2013). In 2016 the group focused on the services and development division. In year 2016, the core activities were real estate development, real estate agencies, rental and operating of 7 leased or own real estate, and the management of real estate on a contract or fee basis (Annual report 2016). The change in the number of employees is presented in Figure 1. In 2012 the number of employees dropped, increased again during 2013, and then remained stable for three years, but during 2016 the number of staff declined again. The reason for the drop in 2012 was explained in the annual report, and the layoffs were caused by the changes in the general management and in the construction division (Annual report 2012). Also, the shrinkage of development projects caused termination of employment in the construction division (Ibid.). The increase in workforce in 2013 can be explained by the increase in employed brokers and appraisers in the service division. In 2016 the decrease of the workforce was caused by the sale of the Latvian brokerage agency Arco Real Estate SIA (Annual report 2016, 10). Number of employees 200 150 100 50 0 2011 2012 2013 2014 2015 2016 Number of employees Figure 1. Number of employees Source: (Annual reports 2011–2016) The risks in 2011 introduced in the annual report included credit risk, liquidity risk, interest rate risk and currency risk. In 2012, the credit risk was stated to be caused mainly by construction division, but in 2013, also the development division was characterized to have credit risks. However, in 2014, along with the cut out of the construction division, the credit risk was removed from the possible risks attached to the company (Annual report 2014). In 2015, the group added the strategic risk to the company’s main risks, as the equity was tied on the development division, and the demand for the product was based on the forecasts. Tying equity in to division, in which the demand is estimated by forecasts, generates a high strategic risk for the company (Annual report 2015). 8 Arco Vara had its initial public offering in 2007. Changes in the trading history of Arco Vara from 2011 until 2016 are presented in the Figure 2. The main trend of the stock prices has been declining, but there is a clear spike in the stock price in August 2012. During the years 2013 and 2016 the price of the stock was quite stable, and the stock price has been changing around one euro. There is a slight increase in stock price at the end of 2016. The number of shares increased during 2014 from 4,741,707 shares to 6,117,012 shares. However, the number of shareholders has declined during the years 2012 and 2016 (in 2012 the number of shareholders was 1,883, but in 2016 there were 1,502 shareholders). Shares owned by the members of the supervisory and management board are discussed further in chapter 1.2. Figure 2. The change in the stock price during the years 2011– 2016. Horizontal axis presents the years, and vertical axis presents the stock prices Source: (Nasdaq Baltic) During the years 2011–2016, dividends were paid in 2015 and 2016, but not before that. In the author’s opinion, the reason for not paying dividends could be the losses and structural changes during the financial years of 2012–2014. One reason could also be the Estonian taxation system, where income taxes are paid based on the dividends paid, not on net profit. Dividends paid were stated in the financing activities in the consolidated cash flow statement, while dividends received were stated in the unconsolidated cash flow statement, in the section of investment activities. 9