Financial analysis and corporate governance

Gulf Cement Company is a leading cement producer in many emerging markets. It is the largest cement producer in the United Arab Emirates with annual production totaling 2.5 million tons. It also exports cement products to 11 countries around the world

Vertical Analysis- Both gross profit and sales have declined by approximately 30% according to the vertical analysis conducted. Most of this decline has occurred due to cyclical changes in the demand for the company's products. In addition, the companies selling expenses have been mixed. Depreciation, according to the vertical analysis has decreased primarily due to a changed from the straight line method to that of an accelerated method. The reasoning on the part of management could be, as mentioned earlier, to make the company seem more or less profitable than it really is. Utilities have been relatively static over the three-year period from 2007-2010, but dramatically increased by from 2009-2010 (approximately 30%). Salaries over the period have also decreased which may also reflect, cutting salaried and hourly workers in anticipation of weak economic demand. Raw materials increased over the period, which were due primarily to high commodity costs associated with the overall business operations. What is alarming is that the company paid higher dividends over this period even though sales and assets dramatically declined. The increase was nearly 4% over the previous year while sales decreased nearly 30%. Again, this may be a corporate governance issue as many of the majority shareholders are all friends with one another. Therefore, they have incentive to heighten the dividend in the midst of turmoil in order to accumulate wealth.

Horizontal Analysis- Much of the same aspects above are apparent in the horizontal analysis. Over the period 2008-2010 profits, assets, and sales all declined. However, if you view the analysis on a yearly basis, a trend of recovery emerges. Sales were down on yearly basis, but at a diminishing rate. This may indicate that a rebound in demand has occurred for the companies products. Likewise, metrics tied almost exclusively to production have either decreased at a diminishing rate, or increased altogether. For example, spare parts, and total deliveries have increased. This may indicate from 2009 to 2010 that companies are ordering products, but they are ordering only small amounts as they are cautious due to the economic environment. This is why we see a trend of diminishing loses year to year.

Using 2008 as the base year, Sales decreased by approximately 25% and 11% in the years 2009 and 2010 respectively. Total assets also decreased by approximately 15% and 12% each year during the same time period. This is again using 2008 as the base year. (Refer to the chart on page 6, section "D" below for more detail). Using 2008 as the base year total liabilities also decreased substantially over the same period with 20% and 12% declines respectively. Much of this decline is due to the cyclical nature of the business operations. Sales generally decrease with a corresponding decrease in demand. As a result of these decrease sales, the company did not use much of its property, plant and equipment and thus sold some of its noncore assets. Likewise, much of the decline in sales was in the cement business segment which declined 12% in 2009 alone due to weak demand. On the asset side of the balance sheet, the company owns significant stakes in various marketable securities. These securities include stocks and to a large extent land. The decline in assets can be attributed to the decline in cyclical stocks overall. For example, housing related stocks in the United States in 2011 alone declined 32% while the KBW financial shares index declined 24%. As such a significant portion of the asset decline can be attributed to stocks and property devaluation. Finally, liabilities decreased, as the company has engaged in some accounting changes. The firm is consistent in regards to how it depreciates its fixed assets. Gulf Cement company is a capital intensive business. As such it has constant expenditures on Property Plant and Equipment. This comes in various forms such as leases, machining, buildings, and so forth. The company depreciates these expenditures on a straight line basis which provides consistency. In addition, much of the equipment is carried at cost further aiding in the consistency. Revenue recognition was altered in the years of 2009 and 2010. In 2009 and 2010 revenue was recognized at the fair value of the receivable. In 2008, there was no mention of fair value at all. Instead in 2008, revenue was recognized when the buyer transferred significant risks and rewards in regards to the ownership of goods. This method is somewhat subjective as the economic reality of the business is not accurately reflected in its financial statement. For example, what constitutes transfer of rewards? Is it when the items exchange hands, or is it when the product is put on the delivery truck? This distinction is critical as the company will not be responsible in the latter scenario but would be in the former scenario. Dividend and interest revenues were consistent over all three years with very little alterations to their recognition. In all three years, dividends were recognized when the shareholders rights to receive payment were established. Likewise interest revenue recognition remained constant as it was recognized on a time accrual basis. Similarly foreign currencies were also consistent. In preparing the financial statements transactions in currencies other than the company's functional currency are recorded at the rates of exchange prevailing at the dates of the transactions. At each balance sheet date, monetary items denominated in foreign currencies are retranslated at the rates prevailing at the balance sheet date. Additionally, non-monetary items carried at fair value that are denominated in foreign currencies are retranslated at the rates prevailing at the date when the fair value was determined.

Gulf Cement company is not consistent in its pension contributions. In 2008, during a period of heavy decline, the company increased its assumptions on future market returns thus lowering its contributions. This translated directly to the bottom line as less money is contributed to fund employee retirement. Foreign exchange transactions are recognized in the year in which they occur in 2008 which is a stark contrast to 2009 when it was recognized on the day of the transaction. This allows the company some room in determining how it recognizes foreign exchange transactions. By doing this the company can wait until the end of the year for more favorable terms in regards to earnings occur. Gulf Cement Company also extended the useful lives of much of its equipment to better allocate depreciation expense in the companies favor in 2008 and 2009. Also in 2008, investment property values were stated on the balance sheet date. In 2009 and 2010 they were stated at the end of the reporting period. This can be partially attributed to the declining housing market which affected property values.

When looking at the accounting policy changes, most of them occurred in 2008. I believe this is in direct response to low consumer demand and tepid economic conditions. The businesses that Gulf Cement Company operates in are cyclical in nature. As such, during times of economic turmoil, then tend to suffer more so than the broader economy. This instance is no different and the company attempted to dress up its earnings and policies in 2008 and 2009 to make the company seem more profitable than they really were.

With regards to its financial health, the company has worked hard to reestablish its financial strength and investment grade profile, as the recession stunted financial growth and profitability. Gulf Cement Company boasted continual improvement from year 2008 to 2010; even with its largest capital spending of $4.2 million to support cement equipment upgrades, it ended the year with $73 million in profit. This has allowed them to move forward with its capital plan for 2011 without seeking investors. Gulf Cement Company also issued approximately 822,000, 000 equity shares, this issuance supported the company's growth and its aim to improve financial viability. Proceeds from equity in 2010 also reduced the Gulf Cement Company's debt by $150 million.

The company reports its earnings under two different segments: Manufacturing and property investments. Per the company's 2010 annual report, "revenues from the sales of manufacturing business segments in 2010, 2009 and 2008 accounted for 44.8%, 44.8% and 65.6%, respectively, of our total consolidated revenues." The actual earnings for each segment over the last five years with the Compound Annual Growth Rate can be seen in the chart below:

Earnings Before depreciation, depletion and amortization expense and amortization of excess cost of equity investments

2010

2009

2008

CAGR

Securities

-11.54%

Property Investments

7.79%

Manufacturing

14.6%

Segment Earnings before depreciation, depletion and amortization

8.95%

Segment Net Income

5.74%

The revenues the company receives from their manufacturing, property investments and related storage facilities are received under contract and are therefore relatively stable.

As the Gulf Cement Company distributes most their cash generated from operations to the partners, they have to rely on external financing sources, including commercial borrowings and issuances of debt and equity securities. In the past, to finance acquisitions, the firm has mainly utilized "short-term debt and repaid such debt through the subsequent issuance of equity and long-term debt." The company has $11.5 million in variable rate debt which, if the interest rates increase, could cause an increased amount of cash to service the debt. With the company's current debt to equity ratio (mentioned in the financial analysis segment), and the current economic crisis, it may be difficult to raise the required capital to complete the acquisition.

Some concerns about the company's acquisitions are with stand-alone debt which increased to $14.5 million from $3.2 million, and they are counting with the sales of the some of these acquisitions assets to repay part of this debt. They are counting in their experience and ability to execute assets sales and drop -- downs to get meaningful cost saving as this is not the first time they have acquired a company with their acquisition of Santa Fe pacific partners in 1997 and KN Energy in 1999.

C. The trend within the sector is one of mass consolidation. In the midst of the current market pessimism, many companies are going bankrupt or struggling to remain profitable. This creates purchasing opportunities as stronger competitors now have an opportunity to purchase a rival at very low prices relative to their intrinsic value. This is especially important for Gulf Cement Company as it now has a means to increase earnings per share while also diversifying its distribution network. As such, the industry is taking advantage of low asset values and purchasing competitors then might not have otherwise considered.

D.

Year

2008

2009

2010

Current Assets

$175,222,393.00

$1,032,470,213.00

$1,024,262,609.00

Total Assets

$1,810,626,071.00

$1,592,528,763.00

$1,649,954,411.00

Current Liabilities

$151,535,647.00

$109,969,066.00

$118,726,784.00

Total Liabilities

$246,564,395.00

$123,488,012.00

$172,891,948.00

Net Income

$2,118,827.00

$36,165,310.00

$73,636,501.00

Owners Equity

$1,564,061,676.00

$1,469,040,751.00

$1,477,062,463.00

Total Sales

$1,078,139,939.00

$743,155,447.00

$609,253,683.00

Revenue

$1,078,139,939.00

$743,155,147.00

$609,253,683.00

Sales

Cost of goods sold

$748,698,330.00

$575,827,406.00

$616,895,008.00

Inventory